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Calculating enterprise value for financials like banks and credit services?


berkshire101
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Enterprise value is calculated as market cap plus debt minus cash.  For financials such as banks and credit services, what do you consider as debt?

 

SYF's liabilities that would be consider - I think - deposits ($43.5 billion), borrowings of consolidated securitization entities ($13.6 billion), bank term loan ($4.2 billion), and senior unsecured notes ($6.6 billion).  In total, SYF has $67.8 billion in borrowing liabilities and $15.5 billion in cash/investments.

 

SYF's current market cap is $21.2 billion.  If you take the numbers above, the enterprise value would be $73.5 billion.  Is this the correct way to calculate enterprise value for financials?  Typically, the  deposits and borrowings of consolidated securitization entities are secured by loan receivables.  Would you include loan receivables in the cash/investments too? 

 

Many thanks.

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I think Nate will perhaps have a more eloquent response, but to me, I would not consider deposits as liabilities - at least for the reasons you normally calculate enterprise value (ie, they aren't getting paid off in an acquisition, you aren't splitting cash flows with depositors, generally).

 

For a financial, I would think more about the economics of the overall business, take out value, the stability of the "capital structure" however you define it (equity + PFD + debt), and the incentives and protections both implied and real of various folks providing funding (including depositors of various kinds) and stress test how the economics of the business can change.

 

Short answer though, I would not, and do not, consider enterprise value in financials, debt + equity matters, and if liabilities need to include deposits, you have a problem. :)

 

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Thanks for the added info.  The reason I ask is there might be a financial that has multiple lines of businesses.  So one way to value them would sum-of-the-parts.  But I need to understand what's consider debt and cash.  In some cases, a credit service company's funding might rely more on credit facilitates rather than deposits. 

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Thanks for the shout-out Ben.

 

First off enterprise value has no place with financials, it's a metric that's irrelevant and shouldn't be considered, especially with a bank like Synchrony.

 

Second a sum of the parts isn't really appropriate either.  It might seem unique at first blush that a bank has a number of different and potentially valuable product lines, that is until you realize that almost all banks have the same variations of those subsidiaries and product lines.  There isn't much unique in banking.  You can't just hive off a financial services arm, or a credit card processing arm.  Maybe there are exceptions here and there, but in general think of a bank as one entire integrated unit.  All parts work together.

 

So with that said you're looking at deposits and funding?  On a balance sheet deposits are clearly a liability, it's someone else's money that a bank is investing.  But it's also the bank's greatest asset.  It's a very cheap source of government backed funding.  There is almost no risk to deposits, as long as a bank stays compliant on their FDIC insurance depositors have 100% protection up to limits, and a bank has this ongoing cheap source of funding as long as they offer a service that a customer might want and pay somewhat competitive rates.

 

It seems like your question is how to value a bank.  There are really three ways, in relation to peers and the market, ultimate take-out value, or a discount cash flow.  Unless a bank is truly unusual all three of these values should be roughly equal.

 

Relation to peers: Look at state and local peers that are the same size and see what they trade for.  In general banks are at about 1.3x TBV right now.  On an earnings basis about 15-17x earnings.  If SYF trades in this range they'd be fairly valued on a relative basis.

 

Secondly take-out value.  This is the ultimate ceiling for intrinsic value, it's the highest and best value for the bank.  Look at TTM earnings and then operating expenses with a estimate of after tax cost savings.  Apply a multiple of 10x to the result.  This is what the bank in theory could be acquired for and if the acquirer were to maximize cost savings.  Things like duplicated staff, reduced IT expenses etc.

 

Lastly is just a simple DDM, you have two phases, the current dividends projected into the future with growth and then a terminal stage.  Make some assumptions about discount rates (10% is fine) and growth rates.

 

I'll say this, about 85-90% of banks trade for the result of these three values.  In a lot of ways it's really incredible, the market is really that efficient.  If you put these values together and do a simple average that's 'fair value'.  So the question is if the bank isn't trading for fair value why not?  That's what you need to find.

 

I haven't looked at Synchrony at all, but I know from industry literature they're LOVED for their commercial lending.  Commercial lending can be great, it's like the financial advisor business.  A lender brings their book with the them when they leave clients, and SYF has done a great job of pulling in lending officers.  The upside is rates on commercial loans are higher on average.  The downside is the bank is exposed to a lot more risk.  If the economy hits the skids commercial loans take a hit.  Most people would rather close their business verses lose their house.  Especially because in many cases a bankruptcy doesn't actually destroy the business, it just wipes away the debt and puts the bank in control.

 

If I remember correctly SYF is a new creation post-crisis.  We don't really know about the quality of their commercial lending.  Are these guys growing fast?  Are they making stretch loans to hit growth targets?  I was part of a very interesting debate at the Philly Microcap conference where a few bank experts believed SYF was complete crap, and there were others saying it was the second coming of banking.

 

I think you really need to buy into the story of these guys.  Do you love what they're doing? Are they changing banking? 

 

The only news I saw from them was they saw increased write-offs of 30-40bps.  They expect to charge-off 4.7% of loans.  I recognize that they are doing some credit cards, but this is a really high level.  Contrast this to Discover's 2.4% charge-off rate, and the fact that in the industry Discover is historically known to have the lowest quality borrowers it's a warning sign for sure.  The economy is doing well and they're notching 5%, what happens in a recession, will they hit 10%, 12%?

 

If you're digging into these guys I'd be looking intently at the loan book, reserves, ALLL, capital and trends related to all of those.  Model out some loss scenarios, model them out for 2-3 years and see what it looks like.  Are they doing to have to raise preferred or something to make it through?

 

Hope this helps.

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