BANK MERGERS

AND ACQUISITIONS
Bank Management, 5th edition.
Timothy W. Koch and S. Scott MacDonald
Copyright 2003 by South-Western, a division of Thomson Learning
Mergers and acquisitions continue to be a
significant force in the restructuring of the
financial services industry.
The number of banks has declined from 14,451
banks in 1982 to only 8,080 in 2001.
Total number of branch offices, however, grew
from 34,791 to 64,087.
0
10,000
20,000
30,000
40,000
50,000
60,000
70,000
80,000
Number of U.S.
Banking Offices
Branches 10,556 15,872 21,839 30,205 38,738 43,293 50,406 56,512 64,079 63,989
Banks 13,126 13,544 13,511 14,384 14,434 14,417 12,347 9,942 8,315 8,178
1960 1965 1970 1975 1980 1985 1990 1995 2000 2001*
Main Offices
Branches
All U.S. Banking Offices
(Main Offices plus Branches)
Fewer banks control a greater fraction of
banking resources.
The largest institutions continue to buy
smaller institutions:
The largest banks (greater than $10 billion in
assets) make up less than 1% of the total
number of banks but control over 70% of bank
assets.
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Number of Banks, Year-End
Total < $100 M $100M - $1B $1B - $10B > $10B
11,330 8,215 2,741 322 52
1993
72.51% 24.19% 2.84% 0.46%
10,242 7,123 2,741 331 63
1995
69.55% 26.76% 3.23% 0.62%
9,451 6,147 2,900 331 73
1997
65.04% 30.68% 3.50% 0.77%
8,580 5,157 3,029 318 76
1999
60.10% 35.30% 3.71% 0.89%
8,080 4,486 3,194 320 80
2001
55.52% 39.53% 3.96% 0.99%

Total Assets ($billions), Year-End
Total < $100 M $100M - $1B $1B - $10B > $10B
1993 3,514 345 669 1,005 1,495
9.81% 19.05% 28.59% 42.55%
1995 4,116 310 668 1,077 2,061
7.54% 16.22% 26.17% 50.07%
1997 4,642 277 711 995 2,658
5.97% 15.32% 21.45% 57.27%
5,735 243 755 915 3,823
1999
4.23% 13.16% 15.96% 66.65%
6,569 222 819 915 4,613
2001
3.37% 12.47% 13.93% 70.22%

Total Deposits ($ billions)
Total < $100 M $100M - $1B $1B - $10B > $10B
1993 2,778 302 592 783 1,100
10.88% 21.32% 28.19% 39.61%
1995 3,028 259 586 734 1,448
8.55% 19.36% 24.25% 47.84%
1997 3,422 230 602 625 1,965
6.73% 17.60% 18.25% 57.42%
3,831 206 612 625 2,389
1999
5.37% 15.97% 16.31% 62.35%
Many factors have lead to the merger
mania of the 1990s in banking.
The 1990s was one of unprecedented
growth in the economy.
Banks experienced record profits from 1990
through 2001.
Bank stocks values soared and this
provided valuable currency for banks in
acquiring other banks.
The elimination of interstate branching
restrictions in the mid 1990s
Repeal of Glass-Steagall in the late 1990s
and the resulting expansion outside
traditional product lines and across
international borders
Changes in the number of banks through
mergers, failures and new charters:
1980 2001.
0
100
200
300
400
500
600
700
1980 1983 1986 1989 1992 1995 1998 2001
N
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New Charters
Mergers
Failures
The impact of the Riegle-Neal Interstate
Branching and Efficiency Act
Interstate branching restrictions were removed in
the mid 1990s and the Riegle-Neal Interstate
Branching and Efficiency Act became fully effective
by June 1997.
Prior the Riegle-Neal Act, each state determined the
degree to which banks could branch across state
lines.
Many states did not allow interstate branching.
Riegle-Neal allowed for nation-wide interstate
branching.
Savings institutions, on the other hand, have
historically been allowed to branch across state
lines.
The impact on the liberalization of
interstate branching restrictions.
The number of interstate branches of commercial
banks increased significantly as they opened branches
and the number of banks declines as they collapsed
independent banks into branches of the home office.
The number of interstate savings institutions branches,
with there more liberal interstate branching laws,
actually declined until finally increasing again in 2001.
Mergers and acquisitions
Formally, a merger is a combination of two or
more separate enterprises, typically involving
the issuance of new securities.
An acquisition occurs when one firm
purchases the stock of another firm.
Prior to the early 1980s, geographic and
regulatory restrictions limited where and how
banks could compete, interstate branching
was prohibited.
Mergers and acquisitions were a natural way to
penetrate new markets, particularly in-states
with no branching.
Liberalization of branching restrictions
combined with a rapidly growing economy
provided banks the opportunity to
consolidate and grow dramatically in size.
At the end of 1996, prior to the enactment of
Riegle-Neal:
the largest U.S. bank was Chase Manhattan
Corp. New York, rank 17th in the world by
assets ($333.8 billion).
the next largest U.S. banks were:
Citicorp, New York (ranked 26st in the world);
BankAmerica Corp., San Francisco and JP
Morgan & Co. Inc., New York
At the end of 1996, six of the ten largest banks
in the world were Japanese banks.
Rankings of world banking companies
prior to full enactment of
Riegle-Neal interstate banking and
branching efficiency act: 1996
Rank Company Name 12/31/1996
1 Bank of Tokyo-Mitsubishi Ltd., Tokyo, Japan $648,161.00
2 Deutsche Bank AG, Frankfurt, Germany 575,072.00
3 Credit Agricole Mutual, Paris, France (2) 479,963.00
4 Credit Suisse Group, Zurich, Switzerland (1) 463,751.40
5 Dai-Ichi Kangyo Bank Ltd., Tokyo, Japan 434,115.00
6 Fuji Bank Ltd., Tokyo, Japan 432,992.00
7 Sanwa Bank Ltd., Osaka, Japan 427,689.00
8 Sumitomo Bank Ltd., Osaka, Japan 426,103.00
9 Sakura Bank Ltd., Tokyo, Japan 423,017.00
10 HSBC Holdings, Plc., London, United Kingdom 404,979.00
17 Chase Manhattan Corp., New York, United States 333,777.00
26 Citicorp, New York, United States (b) 278,941.00
Billions of dollars
Source: The AmericanBanker: http://www.americanbanker.com.
By the end of 2000 the largest banking company
in the world was Citigroup at just under one-
trillion dollars and three of the largest ten
banking companies in the world were U.S.
banks.

World Rankings of Financial Companies (by Assets) after Mergers, the full enactment of
Riegle-Neal Interstate Banking and Branching Efficiency Act and Gramm-Leach-Bliley Act
2000
Rank Company Name
Total
Assets
2000
Total
Assets
1999
%
Change
1 Citigroup Inc , New York $902,210.00 $716,937.00 25.84%
2 Deutsche Bank , Frankfurt, Germany 872,626.68 829,155.67 5.24
3 Bank Of Tokyo-Mitsubishi Ltd. , Tokyo 720,808.94 638,926.83 12.82
4 J.P. Morgan Chase & Co. , New York 715,348.00 406,105.00 76.15
5 UBS, Zurich 673,705.58 615,324.33 9.49
6 HSBCHoldings , London 673,475.21 600,680.41 12.12
7 BNP Paribas , Paris 651,431.86 702,370.25 -7.25
8 Bank of America Corp. , Charlotte, N.C. 642,191.00 632,574.00 1.52
9 Credit Suisse Group , Zurich 612,098.13 451,062.77 35.7
10 Fuji Bank Ltd. , Tokyo 557,111.70 467,410.23 19.19
Note: Assets are in billions of dollars.
Source: American Banker, http://www.americanbanker.com/
Acquisitions have also moved outside
traditional product lines and across
international borders.
Some of the largest lines of business acquisition
from 1998 to 2001:
Chase Manhattan Corp., New York acquired
Morgan Stanley Dean Witter & Co., New York in
1998,
Bank of New York Co Inc acquired Charles
Schwab Corp, San Francisco in 2001,
Washington Mutual Inc Seattle acquired
FleetBoston Financial Corp.s mortgage banking
operation in 2001,
Citigroup, Inc. New York acquired Associates
First Capital Corp. Irving, Texas in 2000, and
Chase Manhattan Corp., New York acquired PNC
Bank Corps trust services in late 1998.

Top line-of-business acquisitions
announced in 19982001
Buyer Name Seller Name
Announce
Date
Assets
purchased Type Of Transaction
Chase Manhattan Corp., New York Morgan Stanley Dean Witter & Co., New York 7-May-98 400,000 Trust Services
Bank of New York Co Inc Charles Schwab Corp San Francisco 18-Apr-01 348,000 Trust Services
Washington Mutual Inc Seattle FleetBoston Financial Corp Boston 2-Apr-01 143,900 Mortgage Banking Oper.
Citigroup, Inc. New York Associates First Capital Corp. Irving, Tex. 6-Sep-00 87,701 Specialty Finance
Chase Manhattan Corp., New York PNC Bank Corp., Pittsburgh 4-Aug-98 55,000 Trust Services
FleetBoston Financial Corp Boston Liberty Financial Cos Boston 4-Jun-01 51,000 Investment Advisory
Mellon Financial Corp Pittsburgh Standish, Ayer & Wood Boston 26-Apr-01 41,000 Investment Advisory
Investors Financial Services BankBoston Corp. 20-Jul-98 41,000 Trust Services
Wells Fargo & Co. San Francisco First Union Corp. Charlotte, N.C. 28-Jun-00 35,700 Servicing Portfolio
Chase Manhattan Corp. New York BT Funds Management Sydney 14-Sep-00 33,380 Trust Services
GMAC Mortgage Corp., Pa. Wells Fargo & Co., San Francisco 2-Apr-98 28,100 Mortgage Banking Oper.
State Street Corp Boston Nationwide Mutual Insurance Co Columbus, Ohio 17-Jul-01 25,000 Investment Advisory
PNC Bank Corp., Pittsburgh Midland Loan Services, Mo. 28-Jan-98 25,000 Mortgage Servicing
Chase Manhattan Corp. New York First Tennessee National Corp. Memphis 19-Oct-00 20,000 Trust Services
JP Morgan Chase & Co New York Advanta Corp Spring House, Pa 8-Jan-01 15,800 Mortgage Banking Oper.
Bank of New York Co Inc FleetBoston Financial Corp Boston 6-Mar-01 15,700 Trust Services
Bank of New York Co. LTCB Trust Co. 22-Jul-99 15,600 Trust Services
GMAC Mortgage Corp. Mellon Financial Corp. 01-Apr-99 14,000 Mortgage Servicing
First Union Corp. Charlotte, N.C. First Albany Companies Inc. Albany, N.Y. 9-May-00 11,400 Securities Brokerage

Today, with interstate banking made permissible
by the Riegle-Neal Interstate Branching and
Efficiency Act and the repeal of Glass-Steagall
by the Gramm-Leach-Bliley Act, the push is to
have a nationwide or even globalwide bank and
to provide a full range of financial products.
NationsBank-BankAmerica merger produced the first large-
scale, coast-to-coast banking franchise (Norwest-Wells Fargo
deal produced the second doing significant business in all 50
states.)
Bank One and First Chicago merger produced one of the largest
credit card banks.
NationsBank and BankAmerica both purchased securities firms
in 1997, expanding the services they could offer.
The Citicorp and Travelers merger produced the first
combination of underwriting and banking, a financial institution
with a global reach, the worlds largest banking organization and
a complete line of commercial banking, investment banking,
and insurance products.
Why is size so important?
Historically, managers of the largest banks in
a market had considerable influence and
received extraordinary attention.
They were compensated well, based to some
degree on the size of the empire they
controlled rather than bank profitability.
They served on community, state, and
national boards that set policy and lobbied
legislators.
The traditional benefits of economies
of scale and scope in business
Size, product diversity, and brand
identification, which generate benefits from
cross-selling more products to more
customers.
Size can reduce the large fixed costs required
for brand identification, distribution of a large
variety of products and services, and the
massive technology expenditure requirement.
Enhanced operating leverage
results from spreading fixed overhead cost
across a larger operating and revenue base.
Reduction in a company's earnings risk
enhances the value of a franchise by creating a
more diversified product and earnings base.

Mergers and cost efficiencies
Even though the rapid consolidation has
improved efficiency ratios in the U.S. banking
industry, these benefits have yet to be realized
by the largest banks as compared with other
smaller banks.
The evidence, however, suggests that average
unit costs are flat across different size banks.
Size essentially represents prestige and
financial power.
Bank Size
< $100M
$100M to
$300M
$300M to
$500M $500M to $1B $1B to $10B > $10B All Comm Banks
Year 2001 1992 2001 1992 2001 1992 2001 1992 2001 1992 2001 1992 2001 1992

Number of institutions 4,486 8,292 2,350 2,141 509 397 335 252 320 329 80 51 8,080 11,462
Total assets (in billions) 221.6 346.0 396.8 350.9 195.0 151.9 227.6 177.4 915.4 1,034.2 4,612.8 1,445.3 6,569.2 3,505.7
Total deposits (in billions) 187.7 306.5 331.2 308.3 158.7 130.3 178.5 148.6 625.0 787.9 2,910.5 1,017.1 4,391.6 2,698.7
Net income (in millions) 1,912 3,487 4,364 3,611 2,351 1,445 2,607 1,611 11,518 10,322 51,559 11,510 74,310 31,987
% of unprofitable institutions 11.19 6.83 3.40 5.93 1.77 8.06 2.09 7.54 3.12 11.25 1.25 7.84 7.54 6.85
% of institutions with earn gains 49.53 78.69 63.28 81.83 71.91 75.82 71.04 80.56 69.06 79.33 62.50 86.27 56.73 79.27
Performance ratios (%)
Return on equity 8.07 11.10 11.62 12.60 13.41 12.26 12.38 12.33 13.77 13.74 13.43 13.33 13.10 12.98
Return on assets 0.91 1.04 1.16 1.06 1.28 0.98 1.20 0.93 1.31 1.02 1.13 0.81 1.16 0.93
Equity capital ratio 10.90 9.38 9.83 8.48 9.45 8.06 9.63 7.75 9.76 7.68 8.77 6.62 9.09 7.51
Net interest margin 4.23 4.74 4.35 4.71 4.37 4.72 4.39 4.83 4.31 4.71 3.71 3.94 3.90 4.41
Yield on earning assets 7.83 8.55 7.93 8.41 7.87 8.32 7.90 8.32 7.76 8.19 7.06 8.62 7.29 8.43
Cost of funding earn assets 3.61 3.81 3.58 3.71 3.50 3.60 3.52 3.49 3.45 3.47 3.35 4.68 3.40 4.02
Earning assets to total assets 91.39 91.16 91.26 91.21 90.88 90.84 91.17 89.69 89.49 88.41 83.03 85.87 85.23 88.08
Efficiency ratio 69.59 66.85 63.70 64.98 62.14 63.82 62.07 64.36 55.75 62.53 56.83 65.96 57.72 64.68
Noninterest inc to earn assets 1.11 1.05 1.42 1.28 1.94 1.27 2.04 1.49 2.62 2.47 3.19 2.64 2.85 2.17
Noninterest exp to earn assets 3.74 3.90 3.71 3.92 3.98 3.87 4.07 4.13 4.02 4.59 4.07 4.42 4.03 4.33
LN&LS loss provision to assets 0.30 0.35 0.34 0.45 0.35 0.57 0.46 0.69 0.66 0.91 0.74 0.85 0.67 0.76
Asset Quality (%)
Net charge-offs to LN&LS 0.34 0.57 0.38 0.64 0.40 0.75 0.48 0.96 1.03 1.38 1.06 1.57 0.94 1.27
Loss allow to Noncurr LN&LS 128.1 114.2 142.3 104.4 161.0 105.9 161.1 102.0 167.7 108.7 123.5 73.3 131.0 87.6
Loss allowance to LN&LS 1.41 1.79 1.39 1.80 1.40 1.85 1.55 2.12 1.79 2.77 1.97 3.16 1.85 2.68
Net LN&LS to deposits 71.11 57.22 75.93 61.35 78.91 67.21 82.95 69.51 88.72 76.10 89.68 80.87 87.06 73.28
Capital Ratios (%)
Core capital (leverage) ratio 10.63 9.37 9.40 8.43 8.93 7.94 8.98 7.57 8.74 7.38 7.23 6.17 7.79 7.21
Tier 1 risk-based capital ratio 15.87 16.33 13.52 13.98 12.50 12.32 12.15 11.48 11.83 10.41 8.86 7.39 9.90 9.84
Total risk-based capital ratio 16.96 17.51 14.66 15.19 13.69 13.61 13.38 12.91 13.77 12.37 12.16 10.75 12.72 12.30

Source: FDIC Statistics on Depository Institutions (SDI), www.fdic.gov (http://www3.fdic.gov/sdi/index.asp).

Summary performance measures by bank
size, 1992 and 2001
Merger value is created in two ways:
The combined bank might be able to generate
increased earnings (or cash flow) compared to
historical norms.
Increasing market share.
Even if earnings rates remain unchanged after a
merger, a bank can position itself as a future
acquisition target by capturing a greater share
of its deposit market.
Source of potential gains
1. Economies of Scale, Cost Cutting
2. Increase Market Share
3. Enhanced Product lines
4. Entry into Attractive New Markets
5. Improved Managerial Capabilities, and
Increased Financial Leverage
6. Financial and Operating Leverage
What makes a merger unattractive?
In financial terms, mergers are problematic when the
buyer does not earn the expected return on investment
in a reasonable period of time.
One broad standard of performance is that a merger
should not produce any dilution in earnings per share
(EPS) for the acquiring bank greater than 5 percent.
EPS dilution is measured as:



Where;
pro forma consolidated EPS is a forecast value for
the upcoming period.
bank acquiring of EPS Current
entity ed consolidat of EPS forma pro - bank acquiring of EPS Current
EPS dilution constraints
The 5% standard suggests that some dilution
is acceptable because:
most transactions are financed by an exchange of stock
EPS for both the target and acquirer are not the same
initially.
Most bank acquisitions do have a negative
short-term effect on earnings, dilute the
acquirers EPS, largely because the acquiring
bank pays a premium for the target.
To be a successful merger, however, this decline in EPS
should be of negligible size and short-lived for a merger
to be attractive to the purchaser.
A second hurdle is whether the acquisition,
when treated as an investment, earns the
expected rate of return over time.
EPS dilution analysis focuses on short-run
performance.
Many firms perform a workout time analysis
that focuses on long-run results.
The analysis essentially computes the time
necessary for the acquirer to earn enough to pay
for the initial investment and meet the
cumulative target return objective.
Obviously, the less that the acquirer pays and
the greater the earnings growth, the shorter the
time required to generate the target return.
Valuations procedures
Any merger or acquisition should be treated
as an investment and evaluated accordingly
Thus, theoretically correct procedure for
determining value is to discount expected
cash flows from the new entity at the
appropriate discount rate.
Because this approach involves estimating
many key components of the present value
model, market participants typically use a
variety of less rigorous techniques to obtain a
range of fair price estimates.
Levels or types of value
there are actually several types or levels of value.
Controlling interest value
the value of the enterprise as a whole assuming
that the stock is freely traded in a public market
and includes a control premium.
Control premium
reflects the risks and rewards of a majority or
controlling interest.
A controlling interest is assumed to have
control power over the minority interests.
Minority interest value
represents the value of a minority interest as if
freely tradable in a public market.
Minority interest discount
represents the reduction in value from an
absence of control of the enterprise.
Controlling interest value and minority
interest value assume that the interest is
freely tradable in a public market.
If the entity were closely held with no (or little)
active market for the shares or interest in the
company, then a nonmarketability discount would
be subtracted from the value.
Nonmarketabiliy Discounts.
represents the reduction in value from a marketable
interest level of value to compensate an investor for
illiquidity of the security, all else equal.
The size of the discount varies base on:
relative liquidity (such as the size of the shareholder
base);
the dividend yield, expected growth in value and
holding period;
and firm specific issues such as imminent or pending
initial public offering (IPO) of stock to be freely
traded on a public market.
Valuation methods
several methods of valuation exist but generally
fall into two broad categories

Comparable analysis
often referred to as comps uses a direct
comparison of the target bank with similar
banks engaged in the same or similar lines of
business.
Discounted cash flow analysis
often referred to as DCF, estimates value by
summing the present value of all future
economic benefits (cash earnings) that will
come to the investors in the future.
Comparable analysis uses several
value metrics
Price to Book Value
many bankers and market analysts discuss merger
prices in terms of book values.
Price to Earnings per Share (EPS)
many analysts prefer to focus on earnings rather
than balance sheet values when estimating a market
price to pay
Price to Total Assets
a bank uses stockholders and depositors funds to
invest in the assets of the bank, theoretically,
therefore, the assets of the bank create value.
Price to Total Deposits
inexpensive core deposits are often seen as a banks
greatest asset.
Price to book value
the book value of a share of stock equals the
book value of a firms stockholders equity
divided by the number of shares outstanding
The book value of stockholders equity
equals the dollar amount of assets minus
the dollar amount of liabilities.
The premium to book value in a transaction
compares the per share price offered to
target bank stockholders with the book
value of the targets stock:


where:
MP
t
= per share market price offered for targets stock
BV
t
= per share book value of targets stock
t
t t
BV
BV - MP
Value Book to Premium =
Example: Premium to book value
If the target banks book value per share
is $12.2 and an acquirer offers $22.2 per
share, the premium to book value equals
81.97 percent.
($22.2 - $12.2) / $12.2 = 0.8197
Valuing a bank using price to book value
calculate the average premium offered for
similar banks and extrapolate an equivalent price
for the target if the same premium is applied.

Average premiums for minority interests are found
by using a comparable companies analysis in
which comparable companies are those in similar
lines of business with similar assets sizes and
profitability characteristics.
Average premiums for controlling interest value are
calculated using data from successful acquisitions
of similar type using a comparable acquisitions
analysis.
The transaction price per share P
bv
is:
t
t
t
bv
BV
BV
MP
P
(

=
avg
Example (continued): Price to book value
If the target banks book value per share is
$12.2 and an acquirer offers $22.2 per share,
the premium to book value equals 81.97
percent.
($22.2 - $12.2) / $12.2 = 0.8197
If average premium on comparable
transactions is 100 percent, the average
purchase price to book value multiple will
equal 2.0x and the transactions price for the
target banks stock should equal $24.4:
(2.0 x $12.2) = 24.4
Merger terms are also described in terms
of exchange ratios
the number of shares of the acquiring banks
stock that target bank stockholders receive for
each share in the target bank.
Exchange Ratio:




where:
e = exchange ratio, and
MP
a
= per share market price of the acquirers stock

a
t
a
bv
MP
Premium) (1 BV
MP
P +
= = e
Example (continued): Exchange ratio
If the target banks book value per share is $12.2
and an acquirer offers $22.2 per share, the premium
to book value equals 81.97 percent.
($22.2 - $12.2) / $12.2 = 0.8197
If average premium on comparable transactions is
100 percent, the average purchase price to book
value multiple will equal 2.0x and the transactions
price for the target banks stock should equal $24.4:
(2.0 x $12.2) = 24.4
If the price of the acquires stock is $55, then the
exchange ratio is 0.4463:
$55
100%) (1 $12.2
$55
$24.4
0.4463
+
= =
Normalized equity capital
capital levels at the target bank are
normalized to a minimum level of capital and
then excess capital is purchased dollar for dollar
One surprise to potential sellers of banks is
the impact of excess capital.
The 1990s produced record profits and
many banks found their capital to asset
levels at well over 10 percent.
Since capital, in excess of what is
required to satisfy regulatory
requirements and insure success of the
bank, can be acquired by simply issuing
stock or injecting this capital into the bank,
potential acquirers will not pay more that
dollar for dollar for excess capital.
Although what is considered normal
capital varies, 8% is often considered
a general guideline.
Multiplying the average price to book
premium by the normalized equity for the
target bank and then adding back excess
capital, determines value.
The normalized book value of equity
(BV
norm
) and excess equity is found by:
Normalized book value of equity (BV
norm
)
= total assets of target bank x normal equity
Excess equity
= total equity normalized equity
The transaction price per share of target
stock under a normalized book value per
share approach (P
nbv
) is determined by:
Transaction price with normalized book
value:
equity excess $ BV
BV
MP
P
norm
t
avg
t
t
nbv
+
(

=
Example: Normalized book value approach
Assume the target bank has:
3 million shares,
$338 million in assets,
$35.5 million in equity,
normal equity is 8 percent, and
the average price to book multiple is 2x.
Normal equity is $27 million and excess
equity is $8.5 million.
The price per share of the company
(assuming 1 million shares of stock) is:
P
nbv
= $20.83 share
= [(2) x ($27 million / 3 million shares)]
+ ($8.5 million / 3 million shares)
Premium to book value procedure
has many weakness:
The most obvious weakness is that book value
may not even closely resemble a banks true
economic value.
Premiums paid on other bank acquisitions
have no relation to the rate of return that an
acquirer can potentially earn on the
investment, and completely ignore risk.
Premium to Adjusted Book Value
Because reported book value may differ
substantially from true economic value, it is
appropriate to compute an adjusted book
value of equity for the target bank that
recognizes the measurement error.
Adjusted book value can be obtained by
adding or subtracting from the stated book
value the following items:
Change in loan loss reserve,
Change in market value of investments,
Change in other asset appraisals,
Value of off-balance sheet activities,
Value of core deposits.
Price to earnings per share
many analysts prefer to focus on earnings
rather than balance sheet values when estimating
a market price to pay for a target bank.
Valuation involves computing the average
purchase price to EPS ratio for similar
banks and then multiplying this mean ratio
by the target banks earnings per share
(EPS
t
).
Average price to EPS ratios for minority
interests are found by using a comparable
companies analysis.
Value for controlling interest is calculated
using data from successful acquisitions of
similar type using a comparable acquisitions
analysis.
Valuing a bank using
Price to earnings per share
Transaction price, P
eps
is:



Premium to book value is:


Exchange ratio is:
t
t t
EPS
EPS - MP
EPS to Premium =
t
t
t
eps
EPS
EPS
MP
P
(

=
avg
a
t
a
eps
MP
Premium) (1 EPS
MP
P
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E
P
S

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A. Pre-Acquisition: December 31, 2001 Bank ABC Bank XYZ
Net income ($millions) $ 160.0 $ 14.0
Number of shares outstanding 32 4
Earnings per share $ 5.00 $ 3.50
Total assets ($billions) $ 22.2 $ 1.5

B. Forecasts for 2002
Assume: i) Net income for both banks increases by 10 percent.
ii) Bank ABC offers a 2-for-1 stock exchange whereby Bank XYZ stockholders receive 2
shares in Bank ABC for every share of Bank XYZ .

Bank ABC Bank XYZ Consolidated
Net income ($millions) $ 176.0 $ 15.4 191.40
Number of shares outstanding (millions) 32 8 40
Earnings per share $5.500 $1.925 $4.785
EPS dilution 13.0%
$5.500
$4.785 - $5.500
=

Summary
1. With no acquisition, Bank ABC's EPS would increase to $8.05 by 2006.
2. Earnings at Bank XYZ would have to increase to $64.4 million in 2006 to increase its EPS to the same
$8.05 by 2006. Thus, earnings would have to grow at a 35.7 percent annual rate for dilution to be
recovered within five years.

One period earnings measure as a base
has numerous weaknesses:
1. An appropriate earnings measure would
reflect the volatility of earnings, which gives
some indication of the riskiness of the banks
operations.
2. It is not clear what time interval is
appropriate.
The current years EPS may be dramatically
different from EPS over the past few years,
and different still from expected EPS.
Analysts get around these problems by using
a weighted average of historical earnings per
share figures, and then using a forecast
average value of EPS over the near future.
Price to total assets
A bank uses stockholders and depositors funds
to invest in the assets of the bank. Theoretically,
therefore, the assets of the bank create value.
Average price per share to total assets per
share for similar banks are calculated using
comparable analysis
These average ratios are multiplied by the
target banks total assets to determine value.
Formally, if we define TA as total assets per
share, the transaction price per share of
target stock under this approach (P
ta
) is
determined by:
t
avg
t
t
ta
TA
TA
MP
P
(

=
Valuing a bank using price to total assets
Calculate the average total asset premium
offered for similar banks and extrapolate an
equivalent price for the target if the same
premium is applied.
Average asset premiums for minority
interests are found by using a comparable
companies analysis
Value for controlling interest is calculated
using data from successful acquisitions of
similar type using a comparable acquisitions
analysis.
Example: Price to total assets
Using the data from the previous example:
3 million shares,
$338 million in assets,
$35.5 million in equity, and
assuming the median price to total asset
multiple is 19.3 percent,
the price per share of the company
(assuming 1 million shares of stock) is:
P
ta
= $21.7 share
= [(0.193) x ($338 / 3 million shares)]
The price to total assets approach
suffers from many weaknesses as well.
Many of these weaknesses are similar to
those of the price to book value procedure
outlined above.
1. Reported total assets may not represent true
economic value.
The book value of assets may be artificially
small in that many banks have significant off
balance sheet activities which enhance
value
2. The prices paid on other bank acquisitions
of total assets have no relation to the rate of
return that an acquirer can potentially earn
on the investment and they completely
ignore risk.
Price to total deposits
Inexpensive core deposits are often seen as a
banks greatest asset
The growth in core deposits is on the
decline today as investors continue to move
their money to mutual funds and direct
equity investments.
As such, a bank could enhance its value as
a future acquisition target by capturing a
greater share of its deposit market.
A larger market share of deposits can also
lead to an enhanced product line and open
new markets.
Valuing a bank using Price to total deposits
Average price per share to total deposits per
share for similar banks is calculated using
comparable analysis and these average ratios
are multiplied by the target banks total
deposits to determine value.
Formally, if we define TD as total deposits per
share, the transaction price per share of
target stock under this approach (P
td
) is
determined by:
t
avg
t
t
td
TD
TD
MP
P
(

=
Example: Price to total deposits
Using the data from the previous example:
3 million shares,
$338 million in assets,
$35.5 million in equity, and
assuming the median price to total deposits
ratio of 24.6 percent, the price per share of the
company (assuming 1 million shares of stock)
is:
P
td
= $22.9 share
= [(0.246) x ($279 / 3 million shares)]
The price to total deposits approach
suffers from many weaknesses as well.
Many of these weaknesses are similar to
those of the price to book value procedure
outlined above.
1. Reported total deposits may not represent
true core deposits.
The bank may have obtained their deposits as
brokered deposits or by offering a premium
rate over the Internet.
2. Just because a bank acquires core deposits,
these deposits will only enhance the
acquiring banks profitability if they are
successful in reinvesting these funds at a
profitable spread and these deposits remain
with the bank.
Discounted cash flow (DCF)
This approach views the purchase of a banks stock as
an investment and compares the present value of
expected cash flows discounted at some target rate of
return with the current equity value.
If the discounted value exceeds the current equity
value, the net present value of the stock purchase is
positive and the investment meets the minimum
required return.
The real value of this procedure is that it provides an
estimate of economic value.
The estimated value or premium to be paid for the target
banks stock is often lower as compared to other
approaches because only realized cash flows are
incorporated in the analysis.
Thus, sellers often ignore this analysis when they have
any market power.
Valuing future earnings
When investors makes an investment, they are
looking for future income, thus, the value of
any investment is the present value of all
future economic benefits (cash earnings).
The analysts must estimate the dollar amount
of earnings available to investors, the volatility
of the earnings, their longevity, and the
certainty of the earnings.
The price (or value) bank investors' are willing
to pay is the present value of all future income
available to investors:
Bank Value
= PV [Expected cash income available to
parent bank]

DCF valuation in practice
In practice, the value to an investor is the present
value of expected future cash income plus the terminal
or salvage value the investor would receive at the end
of the investments life:
value = PV [expected cash income
available to parent over n years]
+ PV [terminal value (TV) in year n]
Application of this method requires estimates of:
expected future cash earnings available to the parent
bank,
the number of years the income is expected,
the terminal value or salvage value of the bank in the
future, and
the required return or discount rate of investors.
Estimating future cash flows
Any application of this method requires
estimates of:
expected future cash income available to the
parent bank
the number of years the income is expected
the terminal value or salvage value of the bank
in the future
the required return or discount rate of investors
Expected future cash income available to
investors (FCF) can, under certain conditions,
be estimated by:
FCF = NI + depreciation
- required capital additions

t
t
1 - t
t t
TA
TA
TE
ratio asset capital required - NI FCF
(

=
equity new TA
TA
TE
- ratio asset capital required
additions capital required
t
t
1 - t
+
|
|
.
|

\
|
=
Required capital additions
Once a bank is purchased, the parent will
presumably try to minimize capital at the subsidiary
bank such that the parent can maximize their return
on investment (equity).
Hence, required capital additions are a function of
existing equity (TE
t-1
), earnings (NI), total asset (TA)
growth, and the required capital to asset ratio:
Ignoring depreciation and new equity issues, future
cash income available to investors (FCF) can be
approximated by:
Estimating terminal value
The life expectancy of the bank is usually
unknown or indefinite, so that the terminal
value of the investment is difficult to
determine.
There are two approaches to this problem:
simply ignore income beyond a certain time
period
employ the mathematical solution to an infinite
stream of future income
Ignore income beyond a certain time period
This method uses the two facts:
1. our estimates will not be perfectly accurate
and accuracy will diminish over time
2. the use of present value reduces the degree
of the error
Example:
the present value of $1 per year as a
perpetuity (infinite number of years)
discounted at 15 percent is $6.67 ($1 / 0.15)
the present value of $1 for only 20 years
(ignoring all flows after 20 years) at a 15
percent discount rate is $6.26
This is a 6.2 percent error.
Solution to an infinite stream
of future income
The second approach used to approximate the
terminal value (TV) is to employ the
mathematical solution to an infinite stream of
future income.
Recall that the present value of a constant
infinite stream of income would be:


The present value of a infinite stream which
increases at a constant rate (g), would be:
g - r
FCF
TV
1 t
t
+
=
r
FCF
TV
1 t
t
+
=
Break the problem into two parts:
1. The first in which explicit FCF estimates are
made,
2. The second in which a stabilized income is
projected to grow at a constant rate into the
indefinite future:
n
n
1 t
t
t
r) (1
TV
r) (1
FCF
Value Bank
+
+
+
=

=
If we assume the target banks stabilized
income will grow at a constant rate, g, then :
n
1 n
n
1 t
t
t
r) (1
g r
FCF
r) (1
FCF
Value Bank
+

+
+
=
+
=

Bank valuation: an application

Western Plains National Bank (WPNB) is
considering buying 100 percent of Citizens
Trust Bank's stock.
WPNB's stock price is currently $60 and
Citizens Trust Bank's stock price is $15.
WPNBs management is also unwilling to
accept EPS dilution beyond 5 percent.
Net income for WPNB is forecast to be $22.6
million in 2002, while net income for CTB is
forecast at $5.2 million.
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Assets 2000 % TA 2001 % TA
Cash and due from banks $ 107 7.0% $ 111 6.9%
Interest bearing deposits with banks 46 3.0% 63 3.9%
Investment securities:
Treasury & U.S. agency 152 10.0% 123 7.6%
Corporate & mortgage-backed 60 3.9% 74 4.6%
Municipals 71 4.7% 67 4.2%
Total loans and leases 993 65.1% 1,070 66.5%
Less reserve for losses 14 0.9% 17 1.1%
Net loans and leases $ 979 64.2% $ 1,053 65.4%
Real estate owned 22 1.4% 27 1.7%
Premises and equipment 27 1.8% 28 1.7%
Other assets 62 4.1% 64 4.0%
Total assets $ 1,526 100.0% $ 1,610 100.0%

Liabilities $0 $0
Demand deposits $ 235 15.4% $ 240 14.9%
Savings deposits 358 23.5% 369 22.9%
Time deposits 504 33.0% 549 34.1%
Total deposits $ 1,097 71.9% $ 1,158 71.9%
Borrowed funds:
Federal funds purchased & RPs $ 166 10.9% 166 10.3%
Other borrowed funds 113 7.4% 128 8.0%
Acceptances and other liabilities 48 3.1% 52 3.2%
Total liabilities $ 1,424 93.3% $ 1,504 93.4%

Stockholders' Equity
Common stock $ 10 0.7% 10 0.6%
Paid-in capital 40 2.6% 40 2.5%
Retained earnings 52 3.4% 56 3.5%
Total stockholders' equity $ 102 6.7% $ 106 6.6%
Total liabilities and equity $ 1,526 100.0% $ 1,610 100.0%

Note: Figures are in millions of dollars.

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Interest Income 2000 Rate 2001 Rate
Loans and losses (includes fees) $ 97.9 10.0% $ 89.5 8.5%
Interest-bearing deposits 2.3 5.0% 2.2 3.5%
Treasury & U.S. agency securities 7.9 5.2% 4.6 3.7%
Corporate & mortgage backed securities 4.1 6.8% 3.9 5.3%
Municipals 3.0 4.2% 2.1 3.1%
Total interest income $ 115.2 $ 102.3

Interest Expense Rate Rate
Deposits 43.1 5.0% 29.4 3.2%
Federal funds purchased & RPs 7.6 4.6% 5.0 3.0%
Other borrowed funds 6.8 6.0% 5.4 4.2%
Total interest expense 57.5 39.7
Net Interest Income 57.7 62.5
% TL % TL
Provisions for loan losses 4.9 0.5% 5.3 0.5%
Net interest for income after provisions 52.8 57.3
% TA % TA
NonInterest Income 30.5 2.0% 32.2 2.0%
NonInterest Expense
Salaries & benefits 32.0 2.1% 30.6 1.9%
Other expense 35.1 2.3% 35.4 2.2%
Total noninterest expense $ 67.1 $ 66.0
Income before taxes 16.1 23.5
Provision for income taxes (avg tax rate) 3.4 21.0% 4.8 20.5%
Net Income $ 12.7 $ 18.6

Dividends paid to Parent $0 $15
Retained Earnings $13 $4
Note: Figures are in millions of dollars.

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Historical
2000 2001
Assets $ 000 % TA $ 000 % TA
Cash and due from banks $23 7.1% $23 6.9%
lnterest bearing deposits with
banks $18 5.4% $19 5.5%
Investment securities:
Treasury & U.S. agency $40 12.3% $40 11.8%
Corporate & mortgage backed $17 5.2% $18 5.4%
Municipals $19 5.7% $20 5.9%
Total loans and leases $187 57.7% $196 58.0%
Less reserve for losses $3 1.0% $4 1.1%
Net loans and leases $184 56.8% $192 56.9%
Real estate owned $3 1.0% $4 1.1%
Premises and equipment $7 2.1% $7 2.2%
Other assets $14 4.4% $15 4.3%
Total assets $324 100.0% $338 100.0%

Liabilities
Demand deposits $67 20.7% $70 20.8%
Savings deposits $99 30.5% $106 31.3%
Time deposits $97 30.0% $103 30.5%
Total deposits $263 81.2% $279 82.6%
Borrowed funds:
Federal funds purchased & RPs $21 6.5% $14 4.0%
Other borrowed funds $3 1.0% $4 1.3%
Acceptances and other liabilities $5 1.5% $5 1.6%
Total liabilities $292 90.2% $302 89.5%

Stockholders Equity
Common stock $15 4.6% $15 4.4%
Retained earnings $17 5.2% $21 6.1%
Total stockholders' equity $32 9.9% $36 10.5%
Total liability and equity $324 100% $338 100.0%
Note: Figures are in millions of dollars.

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2000 2001
Interest income $ 000 Rate $ 000 Rate
Loans and losses (includes fees) $16.2 8.8% $15.2 7.9%
Interest-bearing deposits $0.7 4.1% $0.6 3.2%
Treasury & U.S. agency securities $1.7 4.2% $1.3 3.3%
Corporate & mortgage backed securities $1.3 7.8% $1.2 6.8%
Municipals $0.7 3.9% $0.7 3.3%
Total interest income $20.6 $19.0

Interest Expense Rate Rate
Deposits $7.3 3.7% $6.3 3.0%
Federal funds purchased & RPs $0.9 4.5% $0.5 3.6%
Other borrowed funds $0.2 5.9% $0.2 5.0%
Total interest expense $8.4 $7.0
Net interest income $12.3 $12.0
% TA % TA
Provisions for loan losses $0.9 0.5% $1.2 0.6%
Net interest income after provisions $11.3 $10.9
Noninterest income $6.2 1.9% $6.8 2.0%
NonInterest Expense
Salaries & benefits $6.5 2.0% $6.4 1.9%
Other expense $6.5 2.0% $7.1 2.1%
Total noninterest expense $13.0 $13.5
Income before taxes $4.5 $4.1
Provision for income taxes (avg. tax rate) $0.6 13.8% $0.6 13.9%
Net income $3.9 $3.5

Note: Figures are in millions of dollars.

Summary profit, dividend, asset, deposit
and equity data for WPNB and CTB
A. Summary Profit and Dividend Figures
WPNB CTB
2000
Per
Share 2001
Per
Share 2000
Per
Share 2001
Per
Share
Number of shares
outstanding 4,000,000 4,000,000 3,000,000 3,000,000
Net income $ 12,743,490 $ 3.19 $ 18,645,135 $ 4.66 $ 3,905,666 $ 1.30 $ 3,545,737 $ 1.18
Dividends $ 5,000,000 $ 1.25 $ 14,916,108 $ 3.73 $ 1,950,000 $ 0.65 $ 1,950,000 $ 0.65
Total assets $1,526,000,000 $381.50 $1,610,000,000 $402.50 $324,000,000 $108.00 $337,932,000 $112.64
Deposits $1,097,000,000 $274.25 $1,158,000,000 $289.50 $263,107,786 $ 87.70 $279,131,832 $ 93.04

Excess Equity Calculation
Book value of equity $ 102,000,000 $ 25.50 $ 105,729,027 $ 26.43 $ 32,000,000 $ 10.67 $ 35,545,737 $ 11.85
Pro forma equity / Tot assets 8.00%
Implied normalized equity $ 27,034,560 $ 9.01
Implied excess equity $ 32,000,000 $ 10.67 $ 8,511,177 $ 2.84


Performance Ratios for WPNB,
Citizens Trust, and Peer Banks

Citizens
Trust
Peer
Group:
$300M to
$500M in
Assets WPNB
Peer
Group:
$1B to
$10B in
Assets
ROE 10.04% 13.41% 17.63% 13.77%
ROA 1.06% 1.28% 1.16% 1.31%
Equity multiplier 9.50x 10.58x 15.23x 10.25x
Profit margin (Net income/Total revenue) 13.87% 14.22% 13.87% 14.00%
Expense ratio (expenses excluding taxes / TA) 6.39% 7.18% 6.89% 7.35%
Asset utilization (Total revenue/Total assets) 7.62% 9.00% 8.35% 9.36%
Yield on earning assets 6.58% 7.87% 7.41% 7.76%
Cost of funding earning assets 2.40% 3.50% 2.88% 3.45%
Net interest margin 4.17% 4.37% 4.53% 4.31%
Interest expense/Total assets 2.05% 3.19% 2.47% 3.09%
Noninterest expense/Total assets 4.00% 3.64% 4.10% 3.60%
Provisions for loan losses/Total assets 0.34% 0.35% 0.33% 0.66%
Efficiency ratio 71.83% 62.14% 69.68% 55.75%
Interest income/Total assets 5.62% 7.19% 6.35% 6.95%
Noninterest income/Total assets 2.00% 1.77% 2.00% 2.35%
Earning assets/Total assets 85.50% 90.87% 85.71% 89.27%

Comparable acquisition analysis data


2001 Transaction Multiples
Implied Per Share Values
Citizens Trust Bank
Transaction Group
Number
of
Trans.
Price /
EPS
(LTM)
Price /
Book
Price /
Assets
Price /
Deposits
Price /
EPS
(LTM)
Price /
Book*
Price /
Assets
Price /
Deposits
National Medians
(All transactions)
240 18.90 1.65 0.17 0.20

$22.34 $17.72 $18.86 $18.93
Southern Banks, Assets between $100
MM and $1.0 billion
42 19.62 2.06 0.19 0.24

$23.19 $21.39 $21.41 $22.42
All Banks between $100MM and
$1.0B and ROA Greater than 1.25%
31 16.62 2.16 0.21 0.26

$19.64 $22.30 $24.13 $24.18
All Banks between $100MM and
$1.0B and Equity/Assets Greater
than 10%
36 19.01 1.49 0.20 0.25

$22.47 $16.25 $22.04 $23.35
High 19.62 216.0% 21.42% 25.99% 23.19 $22.30 $24.13 $24.18
Average 18.54 184.0% 19.19% 23.89% $21.91 $19.42 $21.61 $22.22
Median 18.96 185.5% 19.29% 24.60% 22.41 $19.56 $21.73 $22.89
Low 16.62 148.9% 16.74% 20.35% 19.64 $16.25 $18.86 $18.93
*Normalized book value, assuming 8 percent equity as
'normal.'
Source: SNL Securities, 2002.
Southern US includes: AL, AR, FL, GA, LA, MS, NC, OK, SC, TN, TX,
VA and WV

Comparable companies analysis data

Statistics on Comparable Companies Citizens Trust Bank
Multiple of Market Value Per Share Implied Per Share Equity Value
LTM High Low Mean Median ActualValues 3,000,000 High Low Mean Median
Total Assets 0.359x 0.093x 0.162x 0.152x $337,932,000 112.64 40.44 10.48 18.25 17.12
Tangible Book Value* 2.490x 1.155x 1.688x 1.719x $35,545,737 11.85 25.28 13.25 18.05 18.33
LTM EPS 85.000x 10.131x 17.181x 13.085x $3,545,737 1.182 100.46 11.97 20.31 15.47
2002 Est EPS 28.333x 9.350x 13.037x 12.195x $5,172,415 1.724 48.85 16.12 22.48 21.03
2003 Est EPS 14.856x 8.611x 11.288x 11.255x $5,883,841 1.961 29.14 16.89 22.14 22.07
*Normalized book value, assuming 8 percent equity as 'normal.'
Source: SNL Securities, 2002 (Pricing as of 3/25/2002).
Summary of 21 comparable banking companies with similar assets, capital and profitability
characteristics.

Valuation based on alternative procedures
Stockholders equity at CTB at the end of 2001 is $35.5
million, or $11.85 per share.
WPNBs book value per share equals $26.43 in 2001.
Comparable Companies Analysis: Valuing Minority Interests
Price/Share Premium over Book
P
ta
= $17.12 = (0.152) x $112.64 44.48%
norm
bv
P

= $18.33= (1.719) x $9.01 + 2.84

54.68%
P
eps
= $15.47 = (13.085) x $1.182 30.55%

Comparable Acquisitions Analysis: Valuing Controlling Interest
Price/Share Premium over Book
P
ta
= $21.73 = (0.193) x $112.64 83.38%
norm
bv
P = $19.56 = (1.855) x $9.01 + 2.84 65.06%
P
eps
= $22.41 = (18.96) x $1.182 89.11%
P
td
= $22.89 = (0.246) x $93.04 93.16%

EPS Dilution
SNBs management has stipulated that dilution
will not be allowed to exceed 5 percent.
EPS for WPNB is expected to be $5.65 ($22.6
million / 4 million) in 2002.
This constraint means that EPS of the
consolidated bank after acquisition cannot fall
below $5.37:



or consolidated EPS = 5.3675
0.05
$5.65
EPS) ed consolidat - ($5.65
=
Valuing Minority Interests Valuing Controlling Interest
Exchange ratios consistent with the four
valuation procedures

3622 . 0
$60
$21.73
MP
P
a
ta
= =
3260 . 0
$60
$19.56
MP
P
a
bv
= =
3735 . 0
$60
$22.41
MP
P
a
eps
= =
3815 . 0
$60
$22.89
MP
P
a
td
= =
2853 . 0
$60
$17.12
MP
P
a
ta
= =
55 0 3 . 0
$60
$18.33
MP
P
a
bv
= =
2578 . 0
$60
$15.47
MP
P
a
eps
= =
Discounted cash flow approach
Assets at CTB are expected to grow at 10 and 11
percent in 2002 and 2003, respectively.
Asset growth is expected to slow to 7% and then 5
percent by 2005 and thereafter.
The percentage of assets in net loans at CTB is
expected to increase from 57.5% to 60% by 2004.
Interest rates are expected to increase somewhat
CTB is expected to control noninterest expenses and
increase noninterest income slightly.
Return on equity is projected to be 17.4%, 17.8%, and
18.25% percent from 2002 to 2004, respectively.
Return on equity is expected to be approximately
18.4% from 2005 and beyond.
CTB is expected to maintain a minimum capital-to-
asset ratio of 8%.
Earnings available to WPNG after
required additions to capital
Growth in earnings available to WPNB (the parent
bank) stabilizes at 5% in 2006
break the problem into two parts:
explicit forecast period, 2002 through 2005
implicit forecast period, from 2006 and beyond
earnings are expected to grow at approximately 5 percent
beyond 2005
banks required return is 15%
The market value of equity is $45.39 million or
$15.13 per share:
2002 2003 2004 2005 2006 2007
Dividends paid to Parent $ 10.98 $ 2.61 $ 4.13 $ 5.06 $ 5.31 $ 5.57
Dividends per share to Parent $ 3.66 $ 0.87 $ 1.38 $ 1.69 $ 1.77 $ 1.86
Growth in earnings to parent #N/A -76.21% 58.23% 22.30% 5.00% 5.00%
Required return 15% 15% 15% 15% 15% 15%
Present Value of
Dividends per share to Parent
$ 3.18 $ 0.66 $ 0.91 $ 0.96 $ 0.88 $ 0.80

4 4 3 2
1.15
0.05 0.15
1.77
1.15
1.69
1.15
1.38
1.15
0.87
1.15
3.66
15.83 $ share per Value Bank
(

+ + + + = =
Pro forma balance sheet for Citizens Trust Bank
Proforma
2002 2003 2004 2005 2006 2007
Assets
$
000 % TA
$
000 % TA
$
000 % TA
$
000 % TA
$
000 % TA
$
000 % TA
Cash and due from banks $24 6.5% $25 6.0% $26 6.0% $28 6.0% $29 6.0% $31 6.0%
lnterest bearing deposits with
banks $22 5.8% $25 6.0% $27 6.2% $29 6.2% $30 6.2% $32 6.2%
Investment securities:
Treasury & U.S. agency $43 11.5% $41 10.0% $40 9.0% $42 9.0% $44 9.0% $46 9.0%
Corporate & mortgage backed $19 5.0% $21 5.0% $22 5.0% $23 5.0% $24 5.0% $26 5.0%
Municipals $22 6.0% $25 6.0% $26 6.0% $28 6.0% $29 6.0% $31 6.0%
Total loans and leases $221 59.5% $253 61.2% $274 62.0% $287 62.0% $302 62.0% $317 62.0%
Less reserve for losses $7 2.0% $8 2.0% $9 2.0% $9 2.0% $10 2.0% $10 2.0%
Net loans and leases $214 57.5% $244 59.2% $265 60.0% $278 60.0% $292 60.0% $307 60.0%
Real estate owned $4 1.1% $5 1.1% $5 1.1% $5 1.1% $5 1.1% $6 1.1%
Premises and equipment $9 2.3% $10 2.4% $11 2.5% $12 2.5% $12 2.5% $13 2.5%
Other assets $16 4.3% $18 4.3% $19 4.3% $20 4.3% $21 4.3% $22 4.3%
Total assets $372 100.0% $413 100.0% $441 100% $464 100% $487 100% $511 100%

Liabilities
Demand deposits $78 21.0% $87 21.0% $93 21.0% $97 21.0% $102 21.0% $107 21.0%
Savings deposits $119 32.1% $132 32.1% $142 32.1% $149 32.1% $156 32.1% $164 32.1%
Time deposits $121 32.5% $134 32.5% $143 32.5% $151 32.5% $158 32.5% $166 32.5%
Total deposits $318 85.6% $353 85.6% $378 85.6% $397 85.6% $417 85.6% $437 85.6%
Borrowed funds:
Federal funds purchased & RPs $8 2.2% $9 2.2% $10 2.2% $10 2.2% $11 2.2% $11 2.2%
Other borrowed funds $4 1.2% $5 1.2% $5 1.2% $6 1.2% $6 1.2% $6 1.2%
Acceptances and other liabilities $11 3.0% $12 3.0% $13 3.0% $14 3.0% $15 3.0% $15 3.0%
Total liabilities $342 92.0% $380 92.0% $406 92.0% $426 92.0% $448 92.0% $470 92.0%

Stockholders Equity
Common stock $15 4.0% $15 3.6% $15 3.4% $15 3.2% $15 3.1% $15 2.9%
Retained earnings $15 4.0% $18 4.4% $20 4.6% $22 4.8% $24 4.9% $26 5.1%
Total stockholders' equity $30 8.0% $33 8.0% $35 8.0% $37 8.0% $39 8.0% $41 8.0%
Total liability and equity $372 100.0% $413 100.0% $441 100.0% $464 100.0% $487 100.0% $511 100.0%
Note: Figures are in millions of dollars.

Pro forma income statement for Citizens Trust Bank
2002 2003 2004 2005 2006 2007
Interest income $ 000 Rate $ 000 Rate $ 000 Rate $ 000 Rate $ 000 Rate $ 000 Rate
Loans and losses (includes fees) $17.5 8.2% $20.8 8.5% $22.5 8.5% $23.6 8.5% $24.8 8.5% $26.1 8.5%
Interest-bearing deposits $0.8 3.6% $1.0 3.9% $1.1 3.9% $1.1 3.9% $1.2 3.9% $1.2 3.9%
Treasury & U.S. agency securities $2.3 5.3% $2.3 5.6% $2.2 5.6% $2.3 5.6% $2.5 5.6% $2.6 5.6%
Corporate & mortgage backed
securities $1.3 7.1% $1.5 7.4% $1.6 7.4% $1.7 7.4% $1.8 7.4% $1.9 7.4%
Municipals $0.8 3.7% $1.0 4.0% $1.1 4.0% $1.1 4.0% $1.2 4.0% $1.2 4.0%
Total interest income $22.7 $26.6 $28.5 $29.9 $31.4 $33.0

Interest Expense Rate Rate Rate Rate Rate Rate
Deposits $8.2 3.3% $10.2 3.7% $10.8 3.7% $11.3 3.7% $11.8 3.7% $12.4 3.7%
Federal funds purchased & RPs $0.3 3.8% $0.4 4.1% $0.4 4.1% $0.4 4.1% $0.4 4.1% $0.5 4.1%
Other borrowed funds $0.2 5.4% $0.3 5.6% $0.3 5.6% $0.3 5.6% $0.3 5.6% $0.3 5.6%
Total interest expense $8.7 $10.8 $11.5 $12.0 $12.6 $13.2
Net interest income $14.0 $15.7 $17.0 $17.9 $18.8 $19.8
% TA % TA % TA % TA % TA % TA
Provisions for loan losses $1.3 0.6% $1.5 0.6% $1.6 0.6% $1.7 0.6% $1.8 0.6% $1.8 0.6%
Net interest income after provisions $12.7 $14.3 $15.4 $16.3 $17.1 $17.9
Noninterest income $8.2 2.2% $9.1 2.2% $9.7 2.2% $10.2 2.2% $10.7 2.2% $11.2 2.2%
NonInterest Expense
Salaries & benefits $7.1 1.9% $7.8 1.9% $8.4 1.9% $8.8 1.9% $9.2 1.9% $9.7 1.9%
Other expense $7.8 2.1% $8.7 2.1% $9.3 2.1% $9.7 2.1% $10.2 2.1% $10.7 2.1%
Total noninterest expense $14.9 $16.5 $17.7 $18.5 $19.5 $20.4
Income before taxes $6.0 $6.8 $7.5 $7.9 $8.3 $8.7
Provision for income taxes (avg. tax rate) $0.8 13.9% $0.9 13.9% $1.0 14.0% $1.1 14.0% $1.2 14.0% $1.2 14.0%
Net income $5.2 $5.9 $6.4 $6.8 $7.2 $7.5

Note: Figures are in millions of dollars.

Growth in Total Assets 10.0% 11.0% 7.0% 5.0% 5.0% 5.0%
Return on Equity 17.4% 17.8% 18.25% 18.40% 18.40% 18.40%
Return on Assets 1.39% 1.43% 1.46% 1.47% 1.47% 1.47%
Retained Earnings -5.81 3.27 2.31 1.77 1.85 1.95
Dividends paid to Parent 10.98 2.61 4.13 5.06 5.31 5.57
Dividend per-share to parent 3.66 0.87 1.38 1.69 1.77 1.86
Growth in earnings to parent #N/A -76.2% 58.23% 22.30% 5.00% 5.00%
Required return 15.0% 15.0% 15.0% 15.0% 15.0% 15.0%
Present Value of Dividends per share to
Parent
3.18 0.66 0.91 0.96 0.88 0.80

Merger pricing implications
The previous analysis suggests a range of potential
prices for CTB stock.
The final resolution will depend on the negotiating
strength of each party as well as nonfinancial
considerations that have not been addressed.
The relationships observed among the various
procedures are representative of results in many
applications.
From an economic perspective, the present value
approach often produces the lowest price estimate.
If a transaction can be negotiated close to this price, the
acquirer will experience the smallest EPS dilution and
will be able to reach its earnings objectives soonest.
Not surprisingly, sellers prefer to focus on historical
premium-to-book value and premium-to-earnings
valuation approaches.
Buyers and sellers have important nonprice
objectives.
Buyers typically want to
Avoid postmerger financial and operational
complications.
Retain the best employees of the acquired bank.
Keep the acquired banks best customers.
Maintain the beneficial aspects of the acquired
banks culture.
Sellers, in a friendly transaction, typically:
Want to walk away from the deal without any
residual risk.
Want to be indemnified against yet-unrevealed
liabilities or losses that might arise from
decisions under their tenure.
Are primarily concerned with the size of the
premium offered.
BANK MERGERS
AND ACQUISITIONS
Chapter 22
Bank Management, 5th edition.
Timothy W. Koch and S. Scott MacDonald
Copyright 2003 by South-Western, a division of Thomson Learning