Shawbrook Case Study:

Commercial Bank
Valuation
Got Buy-to-Let Mortgages?
This Lesson: Overview and Strategy
Mostly an overview of what this
valuation module is about, and what
we’re building up to at the end.

CAN skip the video if you want and just

review the slides – not even getting into
Excel quite yet.
Lesson Plan:
 Part 1: Our Goals and the End Product

 Part 2: How This is Different from Module 1

 Part 3: Excess and Deficit Capital Adjustments

 Part 4: What to Focus on and What to Skip

Our Goals and the End Product
 Hedge Fund Stock Pitch: Make a long/short recommendation on
the company, back it up with catalysts and risk factors, and explain
why the company is mispriced

 Equity Research Report: Similar, but “softer” views and not as

strong an opinion / not completely opposed to consensus views

 Investment Banking Pitch Book: How much is Shawbrook worth

if it sells the company? What M&A process should it follow?

 Goal: To learn how to use valuation and financial modeling in

different contexts, and to see how it differs in these fields
Our Goals and the End Product
 Methods: Build on what we have already completed – the 3-
statement model – and link it into the valuation methodologies

 Requirement 1: We’ll need to analyze peer companies, collect

data, and use them for key numbers such as Cost of Equity

 Requirement 2: We’ll also have project Shawbrook further into

the future, beyond the 5-year period – too short because it’s
not yet issuing dividends

 Requirement 3: And we’ll have to understand some subtle

adjustments, such as the ones for excess and deficit capital
How This is Different from Module 1
 Similarities: The same basic methodologies – Dividend Discount
Model, Public Comps, and Precedent Transactions (using
multiples like P / E, P / BV, and P / TBV)

 Difference #1: Real Life vs. Imagined/Simplified Example

(Star Wars Original Trilogy vs. Prequels)

 Result: More adjustments and real data gathering will be

required – have to comb through filings to find the numbers

 Result 2: Will also have to make adjustments for non-recurring

charges, calendarization (LTM period of June 30th), and so on
How This is Different from Module 1
 Difference #2: Some new methodologies! Namely the “Residual
Income” (AKA Excess Returns) Model and Regression Analysis

 Residual Income: Takes a bank’s Book Value, and adds the PV of

the bank’s (ROE – Cost of Equity) each year into the future

 Idea: If a bank’s ROE is exactly the same as its Cost of Equity, it’s
worth about its current Book Value; otherwise, it might be worth
more or less than that

 Good For: Banks that are not currently issuing dividends

(Shawbrook), or banks where most value comes from currently
in-place Balance Sheet
How This is Different from Module 1
 Regression Analysis: Since P / BV and ROE are closely linked for
banks, you can run a regression and get a formula that links them

 Example: A bank’s implied P / BV equals 6.74 * ROE – 0.32, and

R2 = 0.91, so this is a reasonably good correlation

 Result: You can apply this equation to the bank you’re analyzing
and estimate what it “should” be worth based on that

 Good For: Checking other methodologies, getting a rough idea of

value, and comparing your company to a broad set of comps
How This is Different from Module 1
 Difference #3: More complex dividend discount model

 Multiple Stages: Shawbrook’s initial dividends, dividend growth,

and stabilized period  risk/return changes in each stage

 Scenarios and Projections: Need to extend these further into the

future and make them line up with Base/Downside/Upside cases

 Treatment of Shares: Gets more complex because we must factor

in dilution from stock issuances – affects per-share value!

 Stub Periods: Takes place 3/4 through the year with 1H results
How This is Different from Module 1
 Other Methodologies: Some sources also list methodologies like
Sum of the Parts, Warranted Equity, Asset/Liability Valuation…

 Sum of the Parts: Not applicable here since SHAW is a pure-play

commercial bank; more useful for larger, diversified banks

 Warranted Equity: This is redundant because we end up using

ROE, Ke, and Net Income Growth in the DDM anyway

 Asset/Liability Valuation: Not even close to enough information

to mark to market the entire BS here – and it wouldn’t be too
useful since SHAW is almost all Loans and Deposits
Adjustments for Excess and Deficit Capital
 QUESTION: If a bank has “too much” capital, how should that
affect its valuation?

 Example: The bank’s Equity Value is $1100, its Book Value is $1000,
and it’s targeting a 12% CET 1 Ratio ($600 in CET 1)

 But: The bank actually has $700 in CET 1, for a Ratio of 14%

 Should the bank’s P / BV multiple still be 1.1x in this scenario?

 No, probably not – the bank could distribute that excess capital
in the form of dividends
Adjustments for Excess and Deficit Capital
 Adjustments: The bank has $100 in “Excess Capital,” since it has
$700 in CET 1 but is targeting only $600

 Adjustments: Subtract $100 from both the numerator and

denominator of the P / BV formula

 Adjusted P / BV: ($1100 – $100) / ($1000 – $100) = 1.11x

 So: Its implied value goes up slightly… but not much of a

difference here because it has little excess capital

 Deficit Capital: Same idea, but its value would decline

Adjustments for Excess and Deficit Capital
 Public Comps: You should theoretically adjust for this issue by
assuming some “standard” CET 1 Ratio for all of them

 M&A Comps: More difficult since the acquired companies will be

quite a bit different, and since information is so limited

 DDM / ResInc Models: You’ll have to adjust dividends and ROE for
excess or deficit capital… or somehow factor it in

 Regression: Not worth factoring in since you typically look at a

broad set of banks of all sizes – would Barclays and Shawbrook
really be targeting the same CET 1 Ratio?
What to Focus On and What to Skip
 Most Important Parts: How to pick the public comps and M&A
comps and interpret them, and set up a multi-stage DDM
 Lessons #2, 7, 8, and 10 – 13

 Less Important: The Residual Income Model and the Regression

Analysis – interesting, yes, but unlikely to come up in interviews
 Lessons #9, 14, and 15

 Least Important: The detailed walk-through of each public comp

with nitty-gritty adjustments and number pulling
 Lessons #3 – 6 – Maybe look at one of these to get the idea

 Lessons #17 – 19: Look at just the written docs to save time
Recap and Summary
 Part 1: Our Goals and the End Product

 Part 2: How This is Different from Module 1

 Part 3: Excess and Deficit Capital Adjustments

 Part 4: What to Focus on and What to Skip