Simon Benninga. Financial Modelling 3-rd edition

Подождите немного. Документ загружается.

188 Chapter 5

In this spreadsheet we have used the format of the consolidated

statement of cash ﬂ ows. The highlighted items relate to Cullen Frost’s

ﬁ nancing that we consider to be not directly related to its lending or

other banking activities. The sum of the activities is the bank’s free cash

ﬂ ow.

5.4 Large Bank Corporation Buys Small Bank: A Valuation Example

We implement the bank FCF valuation model by examining a possible

purchase of Small Bank, Inc., by Large Bank Corporation. Our prob-

lem will be the valuation of Small Bank. In February 2007, Daniel Rogers,

the CEO of Large Bank Corporation, was approached by an investment

banker representing Small Bank, Inc. Small Bank’s board had become

convinced that there was no future for Small without its incorporation

into a larger corporate structure. Small Bank was a very conservatively

ﬁ nanced bank that had 350 ofﬁ ces throughout North and South Carolina.

Its loan portfolio was about 70 percent consumer loans, 20 percent real

estate lending, and 10 percent commercial loans. Small Bank was largely

deposit driven: Of the $9 billion of total assets at year-end 1997, $7.6

billion were deposits, a signiﬁ cant percentage of which were non-inter-

est-bearing. Large Bank, by contrast, had $31 billion of deposits out of

total assets of $45 billion, but $23 billion of these deposits were interest-

bearing. Small Bank’s management was concerned that the cost of

deposits would rise over the coming years, as their customers started to

become more like the sophisticated customers of Large Bank. Further-

more, Small Bank’s management knew that there were signiﬁ cant econo-

mies of scale in check processing and other “back ofﬁ ce” activities that

would stem from a merger with a large, efﬁ cient organization like Large

Bank. Small Bank’s current share price was $45.

Dan Rogers was interested in the deal: Under his leadership, Large

Bank Corporation had been aggressive in purchasing numerous smaller

banks. Its stock price rise had been very impressive, and Rogers was

determined to keep purchasing banks. Large Bank had also branched

out into securities dealership, having purchased one of the major mutual

fund organizations. In the course of its expansions, Large Bank had

learned some lessons the hard way:

189 Bank Valuation

•

Engage only in share deals: Large Bank’s preferred merger was an

exchange of shares and a pooling of interest.

•

Make purchases only where markets were mutually exclusive.

•

Make purchases only where signiﬁ cant operational gains could be

made.

5.4.1 Analysis

Rogers asked one of his ﬁ nancial analysts to perform a “quick and dirty”

analysis of a possible merger between the two ﬁ nancial institutions. He

wanted to come up with a range of possible values for Small Bank so

that he could then discuss the merger with his chairman. If the chairman

and some other leading members of the board’s ﬁ nance committee

thought that the proposed merger should be brought to the full board

of Large Bank, then an investment banking adviser would be brought in

to work with the bank’s staff to do a full-blown (and expensive) analysis

of the merger.

5.4.2 The Model

Large Bank’s ﬁ nancial analyst built a model, based only on publicly

available information and some educated guesses. The critical assump-

tions of the model were as follows:

•

Increasing cost of deposits over time: The market for “free”

deposits—deposit accounts without interest paid to the depositor—was

thought to be gradually phased out.

•

A dividend payout ratio of 60 percent.

•

Five percent of deposits held as non-interest-bearing cash.

•

No increase in Small Bank’s debt.

•

A signiﬁ cant decrease in Small Bank’s expense ratio (calculated by the

analyst as the percentage of expenses out of net interest income). This

represented savings in stafﬁ ng and computerization—much of Small

Bank’s back ofﬁ ce work could comfortably be accommodated by Large

Bank with a signiﬁ cant decrease in costs.

190 Chapter 5

BACDEFHG

Cash as percent of deposits 5.0%

Interest on cash 0.0%

Interest on other investment securities 6.19%

Interest on mortgages 8.13%

Interest on other earning assets 6.71%

Interest on loans 8.77%

Interest on deposits 3.51% 3.60% 3.80% 3.90% 4.00% 4.20%

Interest on short-term borrowing 4.72%

Interest on long-term debt 6.38%

Loan loss as % of outstanding loans 0.30%

Noninterest income as % of interest income 25.30%

Noninterest expense as % of net interest income 70.00% <-- was 74.35%, but Large Bank analyst thinks this will go down to 70%

Growth rate of net loans 6%

Growth rate of deposits 5%

Depreciation rate 10%

Income tax rate 35%

Dividend payout ratio 60%

Balance sheets

2006

Financial

statements

2007 2008 2009 2010 2011

Cash 386,832 400,042 420,044 441,046 463,098 486,253

<-- =$B$2*G40

Other investment securities, including

money market instruments

[balance sheet plug]

2,190,106 942,851 949,564 952,879 952,403 947,709

<--

=IF(G26+G28+G29+G30+G35+G37>G47,

0,G47-(G26+G28+G29+G30+G35+G37))

Mortgage loans held for sale 18,953 18,953 18,953 18,953 18,953 18,953 <-- =F28

Other earning assets 21,444 21,444 21,444 21,444 21,444 21,444 <-- =F29

Loans, net 5,869,914 6,222,109 6,595,435 6,991,161 7,410,631 7,855,269 <-- =F30*(1+$B$17)

Land 38,099 38,099 38,099 38,099 38,099 38,099

Other fixed assets 282,956 356,728 396,364 440,405 489,339 543,709 <-- =G34+G35

Accumulated depreciation 156,754 192,427 232,063 276,104 325,038 379,408 <-- =F34-G69

Net fixed assets and land 164,301 164,301 164,301 164,301 164,301 164,301 <-- =F35

Other assets 360,087 360,087 360,087 360,087 360,087 360,087 <-- =F37

Total Assets 9,011,637 8,129,786 8,529,828 8,949,872 9,390,918 9,854,016 <-- =G37+G35+SUM(G26:G30)

Deposits 7,619,842 8,000,834 8,400,876 8,820,920 9,261,966 9,725,064 <-- =F40*(1+$B$18)

Short-term borrowings

[balance sheet plug]

251,687 0 0 0 0 0

<-- =IF(G38>G40+SUM(G42:G46),G38-

G40-SUM(G42:G46),0)

Long-term indebtedness 2,826 2,826 2,826 2,826 2,826 2,826 <-- =F42

Other liabilities 126,126 126,126 126,126 126,126 126,126 126,126 <-- =F43

Shareholders' Equity

Stock 489,322 489,322 489,322 489,322 489,322 489,322

Accumulated retained earnings 521,834 585,807 646,865 709,962 775,863 844,684 <-- =F46+G74

Total Liabilities and Shareholders' Equit

9,011,637 8,129,786 8,529,828 8,949,872 9,390,918 9,854,016 <-- =SUM(G40:G44)

Income statements

2007 2008 2009 2010 2011

Interest income

Interest on cash balances 0 0 0 0 0 <-- =$B$3*(G26+F26)/2

Interest on other investment securities 96,965 58,570 58,881 58,968 58,808 <-- =$B$4*(G27+F27)/2

Interest on mortgage loans 1,541 1,541 1,541 1,541 1,541 <-- =$B$5*(G28+F28)/2

Interest on other earning assets 1,439 1,439 1,439 1,439 1,439 <-- =$B$6*(G29+F29)/2

Interest on net loans 530,235 562,049 595,772 631,519 669,410 <-- =$B$7*(G30+F30)/2

Total interest income 630,180 623,599 657,633 693,467 731,198 <-- =SUM(G52:G56)

Interest expense

Interest on deposits -280,829 -302,432 -335,195 -361,217 -389,003 <-- =-F9*G40

Interest on short-term borrowings 0 0 0 0 0 <-- =-$B$10*G41

Interest on long-term borrowing -180 -180 -180 -180 -180 <-- =-$B$11*G42

Total interest expense -281,010 -302,612 -335,375 -361,397 -389,183 <-- =SUM(G60:G62)

Net interest income 349,170 320,987 322,257 332,070 342,015 <-- =G57+G63

Provision for loan loss -18,138 -19,226 -20,380 -21,603 -22,899 <-- =-$B$13*(G30+F30)/2

Noninterest income 159,436 157,771 166,381 175,447 184,993 <-- =$B$14*G57

Noninterest expenses -244,419 -224,691 -225,580 -232,449 -239,411 <-- =-$B$15*G65

Depreciation and amortization -35,673 -39,636 -44,040 -48,934 -54,371 <-- =-$B$20*G33

Income before income tax 246,049 234,841 242,678 253,465 264,699 <-- =SUM(G65:G68)

Provision for income tax 86,117 82,194 84,937 88,713 92,645 <-- =$B$21*G70

Net income 159,932 152,646 157,741 164,753 172,054 <-- =G70-G71

Dividends 95,959 91,588 94,645 98,852 103,233 <-- =$B$22*G72

Retained earnings 63,973 61,059 63,096 65,901 68,822 <-- =G72-G73

SMALL BANK

Pro forma model

191 Bank Valuation

The balance sheet model is similar to the model of section 3.7. There

are effectively two plugs:

•

Cash balances are determined by the assumption that Small Bank

requires balances of 5 percent of deposits in cash.

•

If the bank’s activities can be ﬁ nanced by using balances of other secu-

rities (row 27), then these will be used.

•

If the bank’s activities require further ﬁ nancing, then this will come

from short-term borrowing (row 41).

Given the pro formas, the analyst derived Small Bank’s anticipated

cash ﬂ ows:

BACDEFHG

Free Cash Flow Calculations

2007 2008 2009 2010 2011

Profit after taxes 159,932 152,646 157,741 164,753 172,054 <-- =G72

Add back depreciation 35,673 39,636 44,040 48,934 54,371 <-- =-G69

Add back after-tax interest on permanent debt 117 117 117 117 117 <-- =-(1-$B$21)*G62

Changes in operating Net Working Capital

Subtract increases in Cash -13,210 -20,002 -21,002 -22,052 -23,155 <-- =F26-G26

Subtract increases in Fixed Assets at Cost -73,772 -39,636 -44,040 -48,934 -54,371 <-- =F33-G33

Free cash flow 108,740 132,761 136,856 142,817 149,016 <-- =SUM(G78:G83)

The β of Small Bank is estimated to be 0.9. Since Small Bank has very

little permanent debt, the analyst assumes that it is essentially an all-

equity ﬁ rm. This assumption gives the following valuation:

100

101

102

103

104

105

106

107

108

109

110

111

112

BACDEFHG

Valuation of FCFs and terminal value

Equity beta 0.9

Risk-free rate 5.80%

Market risk premium 8.00%

Cost of equity, r

10.97% <-- =B87*(1-B21)+B86*B88

Cost of debt, r

6.38% <-- =B11

Current market value/share of Small Bank 51.00 <-- This is the current market value of Small Bank shares

Number of shares of Small Bank 32,406,000

Equity value 1,652,706,000 <-- =B92*B93

Debt value 128,952

Percentage of equity in capital structure 99.99% <-- =B94/(B94+B95)

Percentage of debt in capital structure 0.01% <-- =1-B96

Tax rate 35% <-- =B21

Discount rate, WACC 10.97% <-- =B89*B96+B97*(1-B98)*B90

Terminal growth rate of FCF 5.00%

2007 2008 2009 2010 2011

Free Cash Flow 112,401 136,423 140,517 146,479 152,678 <-- =G83

Terminal value 2,685,288 <-- =G104*(1+B101)/(B89-B101)

Total 112,401 136,423 140,517 146,479 2,837,966 <-- =G104+G105

Value of Small Bank 2,210,090,780 <-- =NPV(B100,C106:G106)*(1+B100)^0.5*1000

Long-term debt 128,952,000 <-- =B42*1000

Implied equity value 2,081,138,780 <-- =B108-B109

Number of Small Bank shares 32,406,000

Imputed per-share value of Small Bank 64.22 <-- =B110/B111

192 Chapter 5

Here are several comments about this valuation:

•

For generality, we have computed the WACC of Small Bank by taking

the weighted average of its market equity value (cell B94) and its debt

(B95). We could, of course, have just “eyeballed” the data and seen that

Small Bank is essentially an all-equity operation. Neither deposits nor

short-term debt are counted as debt for the purposes of computing the

WACC.

•

Because we have written Small Bank’s ﬁ nancial statements in thou-

sands of dollars, we multiply the valuations in rows 108 and following by

1,000.

•

Although the current market value of a share of Small Bank is $51 (cell

B92), the value per share imputed by the Large Bank analyst is signiﬁ -

cantly more (cell B112).

5.4.3 Sensitivity Analysis

By doing a Data|Table on the WACC and the long-term growth rate, the

Large Bank analyst can judge the sensitivity of the valuation on its two

main determinants:

126

127

128

129

130

131

132

133

134

135

136

137

BACDEF

Data table header: =B112 --> 64.22

0% 2% 3% 5% 6%

8.0% 43.85 51.36 56.54 72.08 84.54

8.5% 43.02 50.39 55.45 70.68 82.88

9.0%

42.22 49.43 54.39 69.31 81.26

9.5% 41.44 48.50 53.36 67.97 79.68

10.0% 40.67 47.59 52.35 66.66 78.14

10.5% 39.92 46.70 51.37 65.39 76.63

11.0% 39.19 45.83 50.41 64.15 75.16

11.5% 38.47 44.99 49.47 62.93 73.73

12.0% 37.78 44.16 48.55 61.75 72.33

Sensitivity analysis of Small Bank's value as function of its WACC and long-term growth

Noninterest expense as % of net interest income (cell B15): 70.00%

The efﬁ ciency ratio is an important determinant of the valuation. If

Small Bank’s noninterest expense ratio can be reduced by a further 5

percent, then the valuation rises signiﬁ cantly:

193 Bank Valuation

126

127

128

129

130

131

132

133

134

135

136

137

BACDEF

Data table header: =B112 --> 69.18

0% 2% 3% 5% 6%

8.0% 47.36 55.41 60.95 77.60 90.95

8.5% 46.48 54.36 59.79 76.10 89.17

9.0%

45.62 53.34 58.66 74.63 87.43

9.5% 44.78 52.34 57.55 73.20 85.74

10.0% 43.95 51.37 56.47 71.80 84.09

10.5% 43.15 50.41 55.41 70.43 82.47

11.0% 42.37 49.48 54.38 69.10 80.90

11.5% 41.60 48.58 53.38 67.80 79.36

12.0% 40.85 47.69 52.39 66.53 77.86

Sensitivity analysis of Small Bank's value as function of its WACC and long-term growth

Noninterest expense as % of net interest income (cell B15): 65.00%

5.5 Calculating the Exchange Ratio

At the time of the case, Large Bank had 294,330,960 shares worth $58

per share. Large Bank intended to do an exchange offer for Small Bank’s

shares, and the question about the proper exchange ratio was discussed.

Assuming that the pro forma valuation of Large Bank is correct, this

yields an exchange ratio of

x =

Calculated per-share valuation of Small Bank

Current market pric

ee per share of Large Bank

Doing these calculations yields the following:

108

109

110

111

112

113

114

115

116

117

118

119

120

121

122

123

BACDE

Value of Small Bank 2,210,090,780 <-- =NPV(B100,C106:G106)*(1+B100)^0.5*1000

Long-term debt 128,952,000 <-- =B42*1000

Implied equity value 2,081,138,780 <-- =B108-B109

Number of Small Bank shares 32,406,000

Imputed per-share value of Small Bank 64.22 <-- =B110/B111

Number of Large Bank shares 294,330,960

Value of Large Bank share 58.00

Market value of Large Bank equity, before merger 17,071,195,680 <-- =B115*B114

Exchange ratio (number of shares of Large Bank

offered per share of Small Bank

), x

1.11 <-- =B112/B115

Check

Number of shares, new entity 330,212,663 <-- =B114+B117*B111

Value of equity, new entity 19,152,334,460 <-- =B114*B115+B110

Total value of Large Bank ex-shareholders 17,071,195,680 <-- =B115*B114

Total value of Small Bank ex-shareholders 2,081,138,780 <-- =B115*B111*B117

The exchange ratio of 1.11 (cell B117) is the maximum exchange ratio

that Large Bank should offer for Small Bank. It could, of course, offer

less: There is plenty of negotiating room between the current market

value of Small Bank ($51 per share) and the imputed value from the

194 Chapter 5

FCF valuation of $64.22. For example, if Large Bank offers an exchange

ratio of 1, it is essentially valuing Small Bank at the same price as Large

Bank and thus still offering the Small Bank shareholders a premium of

$7 over their current market value.

5.6 Alternatives to Free Cash Flow Valuation of Financial Institutions

In the next two sections we show two variations on the bank valuation

model. The ﬁ rst model assumes that the projected equity payouts of an

institution are determined by the necessity to reserve a percentage of

the retained earnings as reserves.

The second model assumes that the price/earnings (P/E) ratios are

used to value a bank acquisition. This is a common practice in the banking

industry.

5.7 Valuing a Bank by Using Capital Adequacy Ratios

An alternative way to value a bank is to back into the equity cash ﬂ ows

by modeling the bank’s capital adequacy ratios.

3,4

Implementing this

approach determines the maximum payout to equity as a residual deter-

mined by capital adequacy requirements:

3. I am indebted to Hernán Burde for sharing this idea with me. Hernán suggested that

this particular form of bank valuation may be very appropriate to underbanked coun-

tries, where the growth rate of a ﬁ nancial institution is essentially determined by a

bank’s ability to maintain its capital adequacy. I suspect this approach also works well

for many small banks in more sophisticated economies.

4. These valuations could be based either on BIS requirements or on a VaR approach.

Residual Approach to Bank Equity Cash Flow

Assets Liabilities

Cash and marketable securities Operating current liabilities—borrowed funds

Loan portfolio Debt

Net ﬁ xed assets Equity

Total assets Total liabilities and equity

Next year’s equity =

Year-t equity

+% reserve against increase in loan portfolio

+% margin for business expansion, prudence, etc.

⇒ Determines maximum payout to equity

195 Bank Valuation

Here is a simple example:

BACDEF HG

Cash as percent of deposits 20%

Deposit growth 10%

Loan growth 12%

Interest paid on deposits 1%

Interest earned on loans 11%

Interest paid on borrowing 6%

General, selling, administrative expenses, growth 3%

Fixed assets at cost, growth 10%

Depreciation rate 8%

Equity as percentage of loans 15% <-- Capital adequacy ratio

Balance sheet

Assets

2006 2007 2008 2009 2010 2011

Cash 740,000 814,000 895,400 984,940 1,083,434 1,191,777

<-- =G24*$B$2

Loans

4,000,000 4,480,000 5,017,600 5,619,712 6,294,077 7,049,367

<-- =F16*(1+$B$4)

Fixed assets at cost 400,000 440,000 484,000 532,400 585,640 644,204 <-- =F18*(1+$B$9)

Depreciation 100,000 133,600 170,560 211,216 255,938 305,131 <-- =F19+$B$10*AVERAGE(F18:G18)

Net fixed assets 300,000 306,400 313,440 321,184 329,702 339,073 <-- =G18-G19

Total Assets 5,040,000 5,600,400 6,226,440 6,925,836 7,707,214 8,580,217 <-- =G20+G16+G15

Liabilities and equity

2006 2007 2008 2009 2010 2011

Deposits 3,700,000 4,070,000 4,477,000 4,924,700 5,417,170 5,958,887 <-- =F24*(1+$B$3)

Borrowing 700,000 858,400 996,800 1,158,179 1,345,932 1,563,925

<-- =IF(G21>G24+SUM(G26:G28),G21-G24-SUM(G26:G28),0)

Shareholders' equity

Stock 200,000 200,000 200,000 200,000 200,000 200,000

Accumulated retained earnings 440,000 472,000 552,640 642,957 744,112 857,405 <-- =$B$11*G16-G27

Total Liabilities and Shareholders' Equity 5,040,000 5,600,400 6,226,440 6,925,836 7,707,214 8,580,217 <-- =SUM(G24:G28)

VALUING ROSARIO BANK

A model using residual equity cash flows

Rosario Bank is an all-equity bank that uses deposits and relatively

modest borrowing to ﬁ nance substantial cash reserves and a growing

loan portfolio. The bank’s accumulated retained earnings are determined

by the necessity of maintaining a 15 percent ratio of equity to its loan

portfolio (highlighted row 28). Therefore, the bank’s borrowing is the

plug in the balance sheet model.

Rosario Bank pays little on its deposits and earns well on its loans. Its

income statement is as follows:

BACDEF HG

Income statement

2006

2007 2008 2009 2010 2011

Interest income 440,000 466,400 522,368 585,052 655,258 733,889 <-- =$B$6*AVERAGE(F16:G16)

Interest expense <--

Paid on deposits -37,000 -38,850 -42,735 -47,009 -51,709 -56,880 <-- =-$B$5*AVERAGE(F24:G24)

Paid on loans -42,000 -46,752 -55,656 -64,649 -75,123 -87,296 <-- =-$B$7*AVERAGE(F25:G25)

GSA expense -200,000 -200,000 -200,000 -200,000 -200,000 -200,000

Depreciation -30,000 -33,600 -36,960 -40,656 -44,722 -49,194

Net income 131,000 147,198 187,017 232,738 283,704 340,520 <-- =SUM(G32:G37)

Rosario Bank’s payouts to equity holders are determined by the

capital adequacy ratio:

BACDEF HG

Cash flow to equity

2007 2008 2009 2010 2011

Net income 147,198 187,017 232,738 283,704 340,520 <-- =G38

Add back depreciation 33,600 36,960 40,656 44,722 49,194 <-- =-G37

Free cash flow 180,798 223,977 273,394 328,426 389,713 <-- =SUM(G41:G42)

Subtract increase in accumulated retained earnings -32,000 -80,640 -90,317 -101,155 -113,293 <-- =F28-G28

Equity cash flow 329,596 367,314 456,472 555,697 666,133 <-- =SUM(G41:G44)

196 Chapter 5

We now use the model of Chapter 3: We value Rosario Bank by dis-

counting its equity cash ﬂ ows at the cost of equity, modeling the terminal

value by using an estimated long-term equity cash ﬂ ow growth rate:

BACDEF HG

Valuing Rosario Bank

Cost of equity, r

16.00%

Long-term equity cash flow growth 8.00%

2007 2008 2009 2010 2011

Equity cash flow 329,596 367,314 456,472 555,697 666,133 <-- =G45

Bank terminal value 8,992,802 <-- =G52*(1+B49)/(B48-B49)

Total equity cash flow + terminal value 329,596 367,314 456,472 555,697 9,658,935 <-- =SUM(G52:G53)

Valuation, using midyear discounting 6,198,542 <-- =NPV(B48,C54:G54)*(1+B48)^0.5

5.8 Using P/Es to Value a Bank Acquisition: First Federal Savings Bank

We ﬁ nish this chapter with a minicase that illustrates yet another approach

to bank valuation. This time we use P/E ratios to value a bank.

Here’s the story: Your client, Fairmont National Bank, a $750 million

community bank in Fairmont, West Virginia, has received an invitation

to bid competitively to acquire First Federal Savings Bank, 20 miles away

in Clarksburg, West Virginia. The invitation was sent out by First Feder-

al’s investment banker. Fairmont National has asked your ﬁ rm to assist

them in bidding for First Federal. Your assistance would include

•

Evaluating First Federal as an acquisition considering Fairmont Nation-

al’s objectives.

•

Predicting the actions of other potential bidders including Clarksburg

National Bank, about the same size as Fairmont National, but headquar-

tered 20 miles away, and a likely bidder.

•

Preparing the client’s bid including the price (i.e., the ﬁ nancial consid-

eration) and a list of social undertakings (the nonﬁ nancial consideration)

including the probable number of First Federal’s employees who would

be terminated after the acquisition and the amount of termination com-

pensation they would receive.

5. I want to thank David Martin and Jon Holtaway of Danielson Associates for helping

me with this case.

197 Bank Valuation

5.8.1 Fairmont National Bank

Your client is a better-than-average performer, but it wasn’t always. Ten

years ago it was a poor performer: expenses were too high, fee income

was too low, and it was relatively underlent—all measured in terms of

its peers. After a change in management, Fairmont National began to

improve steadily by controlling expenses more effectively, adjusting its

fee schedules, and focusing more management attention on lending. But

for the past two years, earnings have been ﬂ at, and loan growth has

slowed. Meanwhile, equity has been growing in relation to assets, causing

Fairmont’s return on equity to fall slightly.

Fairmont’s management concluded that it could no longer grow the

bank’s earnings by ﬁ xing its problems—it had to expand either by

opening branches or by acquiring another bank. De novo branch open-

ings offer a very slow payback, and in an industry that is already over-

banked and overbranched, it usually makes more sense to acquire a bank

and eliminate a competitor than to open a branch and add a competitor.

Consequently, when Fairmont management heard about the opportunity

to acquire First Federal, they were enthusiastic and determined to bid

aggressively but sensibly. “Aggressively but sensibly” means they wanted

to win and would be willing to suffer a short-term ﬁ nancial setback if it

promised to pay off in the longer term. They hired you, their investment

banker, to advise them on bidding for First Federal.

5.8.2 First Federal Savings Bank

First Federal is a traditional thrift. That is, it was organized under laws

that effectively limited it to residential mortgage lending. Traditionally,

thrifts funded their residential lending with passbook savings and certiﬁ -

cates of deposit, and as passbook savings became a smaller and smaller

part of thrifts’ funding, their net interest margins grew very thin. In

recent years, thrifts have been permitted to engage in virtually every

business permitted to commercial banks, but most have found it difﬁ cult

to develop the more proﬁ table business enjoyed by commercial banks.

The ﬁ nancial comparison of First Federal, Fairmont, and Clarksburg

National Bank shows the typical differences between banks and thrifts.

First Federal’s board and executives had felt they could “commercial-

ize” the thrift, but they found the process was slow and began to doubt

that they had the management to succeed. They felt, after talking with