Bank and Holding Company Stock Buybacks: Being Vigilant About Value
Please be aware: More recent data has been published since the time of this post. To see current market trends, check out the most recent issues of Market Updates.
We recently were the bearers of bad news to a bank client’s board of directors. We had to tell them that their stock, determined on a minority, nonmarketable basis, was not worth 160% of book value— the price at which they had been redeeming stock. “How,” they asked, “could our value decrease when we are still profitable and our book value has gone up?”
This is just one example of a bank or holding company using pre- recession multiples to buy back stock. Surely the selling stockholders were happy, but the remaining stockholders should not have been.
The potential impact of buybacks on stockholders is a topic of persistent misunderstanding. Too often, we hear, “But this is what we have always paid!” This head-in-the-sand approach unfairly enriches the selling stockholder and leaves the remaining stockholders holding the mostly empty bag; and quite frankly, no one should want to be the last remaining stockholder.
Buybacks can sometimes be a prudent use of capital during tough economic times. Throughout the recent recession and even now, an upsurge in buyback activity is taking place, with many companies reasoning that the best investment they can make is in themselves.
The goal of repurchasing shares is to maximize return for shareholders, and as long as the bank or holding company gets at least one dollar of value for every dollar it spends on a buyback, it will create that shareholder value. However, such value can’t be realized unless stocks are properly valued in the first place. That means management has to determine the intrinsic value of the company and thereby determine the per-share amount.
Enter the Process of Valuation
A valuation is the best first step toward intelligent buybacks. It removes the risk that comes when banks and holding companies set prices themselves. Establishing a more accurate stock value is fair to all shareholders and provides sound support for the buy/sell agreement. A formula is only as good as the math in this situation, and in an effort to “simplify the approach,” a formula may very well overvalue or undervalue at any given point in time.
Stock determined on a minority, nonmarketable basis with a value of 160% of book implies a controlling, marketable value of 2.67 times book calculated as 1.60 ÷ 0.75 ÷ 0.80, whereas we are assuming a lack of marketability discount of 25% and a minority interest discount of 20%.
While some banks were selling at 2.67 times book in 2007 and earlier, banks generally are not trading anywhere close to 2.67 times book today. While exceptions do exist, the rule is that a multiple this strong is not occurring with any frequency. In fact, almost everyone in the industry is well aware of the numbers at which other banks have recently sold.
If you are using the sales of other banks as your comparables, keep in mind that this represents a majority, marketable conclusion. If you are looking to use metrics from these transactions, a minority interest discount and a lack of marketability discount are necessary to convert to a minority, nonmarketable conclusion...in other words, the price a board would pay to redeem minority blocks of stock.
In addition, consider how the public market values banks today. Many institutions are trading below book value, and the publicly traded banks are marketable.
The bottom line is that board members must act in a fiduciary role. As such, your organization should not pay pre-recession multiples in today’s environment. Otherwise, you enrich the sellers by overpaying, leaving existing stockholders with values less than what they were prior to the stock buyback.
The reality is most banks today will have a minority, nonmarketable fair market value between 50% and 100%. Although there are exceptions, this range, while wide, includes most banks.
Buy Back But With Confidence
Well-executed buybacks can benefit your organization and provide value to your stockholders when a valuation serves as an important foundation for your financial decision. If you have a buy/sell agreement or policy and are paying pre-recession multiples, consider having an external source prepare a valuation as a reasonableness check. While you may receive some results that vary from your expectations, those same results will help prevent overpaying for your stock.