M&A FIG Interview PDF

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Entrevista Off-Cycle M&A FIG PART I – VALUATION METHODS 1. -

Metodos de Valoracion Dividend Discount Model FCFE Discount Model Excess Return Model

2. Otros modelos de valoración - DCF - LBO

3. EY Valuation of Financial Services: Ey has a published report with a lot of information on the valuation of financial institutions 4. Damodaran Valuation of Financial Services Firms Damodaran has a paper on valuation of financial institutions. A brief summary can be found below: Financial services firms are best valued using equity valuation models (with actual or potential dividends being better than FCFE.

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The two value drivers are: Cost of Equity: function of the risk that emanates from the firm’s investments Return on Equity: determined by company’s business choices and regulatory restrictions Income for Financial services firms: Banks: spread between interest rates at which it borrows and interest rates at which it lends. Insurance companies: premiums collected from those who buy insurance and income investment portfolios that they maintain to service the claims Investment banks: advice and products for other firms to raise capital from markets or to consummate deals such as acquisitions or divestitures Investment firms: advisory firms and sales fees for investment portfolios

4 Key Differences between Financial Services Firms and others: (AND PROBLEMS) a) They operate under strict regulatory constraints on operations and capital requirements (as follows) a. Regulatory capital ratios (computed based upon book value) to protect claimholders & depositors b. Restrictions on where to invest and their growth c. Entry in the market and mergers care controlled by regulators This is relevant because assumptions about growth and reinvestment have to pass regulatory constraints and because changing regulatory environment / expectations of change increase uncertainty risk b) Accounting rules for asset book values and earnings differ to the rest of the market 1. Assets normally are traded on an active marketplace 2. Financial services have long periods of profits and short periods of big losses. Because of that, accounting standards smooth earnings 3. Mark to market: most assets in a financial services firms are marked to market (because there is an active market), unlike most other companies. Two problems: i. Comparing ratios (both book and market ratios) across financial and non-financial firms

ii. The interpretations of these ratios once computed: RoE is return on originally invested on assets but not for financial companies (where RoE doesn’t measure investment, but an updated market value). This is a big problem of financial institutions, you cannot measure the returns on investments (book value = 100 and after-tax earnings = 25, hence a ROI of 25%) 4. Loss provisions are used to smooth earnings: risk that borrowers may default varies widely (low in good environment and high in bad econ environment). The provisions for this default risk depend on the bank (aggressive bank will set aside less = it will report higher earnings in good econ times). c) Debt is a raw material, not so much a source of capital -> cost of capital and EV may be meaningless 1. Non-financial services firm can raise funds through debt or equity. When we value a firm, we value the assets the firm possesses, not its equity. For a bank debt is something that can be transformed into products that are sold at a higher price to make a profit. Hence, financial service firms are defined to have only equity capital. 2. Definition of debt: difference between debt issued by the bank and interest-bearing deposits by clients. If this was categorized as debt, the operating income should not include the interest paid to depositors (biggest expense for a bank) 3. Degree of financial leverage: higher than non-financial companies (because of more predictable earnings and the regulatory framework). Since equity is small compared to debt, a small change in the firm´s asset value can translate into big swings in equity value d) Defining reinvestment (net CAPEX and WC) is difficult / impossible -> CF cannot be computed 1. Net CAPEX: financial services firms invest mainly in human capital and brand name unlike investments in fixed assets, PP&E that normal firms do. Investments for future growth are normally categorized as operating expenses. 2. Working Capital: large proportion of the Balance Sheet is in Current Assets / Liabilities so changes in this number can be very large and not represent re-investment for future growth. If we are unable to determine re-investment:  We cannot estimate cash flows (we don’t know real reinvestment for future growth)  Estimating expected future growth becomes more difficult

Bad things about valuation: Effects on valuation of the peculiarities we mentioned above: a) Debt: very difficult computation of cost of capital as defining debt is a difficult thing & using low cost of debt for that whole debt generates a very low WACC. b) What to use as substitute for cash flows: I. Earnings: financial companies cannot pay 100% of earnings in cash flows because reinvestment is needed: investment in regulatory capital, acquisitions and other investments needed to grow II. Pseudo-Cash Flows: adjusting by calculated CAPEX and WC, but not a realistic thing to do. III. Dividends: assumption that they are sustainable and reasonable (not always true) o Some banks pay less dividends than they could and put the excess for capital ratios (we will undervalue) o Others pay too much and try to compensate by issuing new shares (we will overvalue) IV. Book Values: marked to market because there is an active market and because banks don´t tend to hold assets until maturity and tend to securitize their loan portfolios and sell them to investors (so market prices are more relevant). However Book Value ≠ Market Value as i. markets make mistakes ii. No observable price, but a model used by the appraiser (evaluator) and there is often a lag in recognizing changing value. c) Regulation and Risk: we assume regulators are keeping banks in check but when computing ratios we have to assume all loan portfolios are as risky. When doing comparison we have to consider differences when valuating.

For all that has said in the above, we value banks equity by discounting cash flows to equity investors at the cost of equity For this, we estimate the Free Cash Flow to Equity: FCFE = Net Income – Net CAPEX – Change in non-cash working capital – (Debt Repaid – New Debt Issued) but we cannot estimate Net CAPEX or Working Capital. A solution for this is i.

Use Dividends and assume that firms pay the FCFE as dividends (and avoid having to consider how much is being reinvested) Adapt FCFE considering reinvestment needed for future growth (make more loans in the future) Focus on excess returns and value these.

ii. iii.

Dividend Discount Models Value per share of equity in stable growth =

DPS 1 (Ke−g) e 1+ K ¿ ¿ ¿n ¿

We can also have, if there is a period of extraordinary growth =

(K e (stable growth) −g)¿ DPSn +1 DPSt + n ¿ (1+ Ke (high growth )) n

¿ ∑ i=1 Here we consider a period of extraordinary growth followed by a period of stable growth In order to have a consistent dividend discount model, there are a series of important metrics to consider: i.

Risk & Cost of Equity: cost of equity has to reflect the risk that a marginal investor cannot diversify a. Use bottom-up betas: regression betas have standard error noise and the chance of the bank having changed during the time of the regression. b. When estimating betas for non-financial firms, we use unlevered betas and then levered them considering the debt to equity ratio

PART II – FIG SPECIFIC QUESTIONS

5. Working in FIG – MUY IMPORTANTE Mirar aqui: https://www.wallstreetoasis.com/forums/working-in-fig-financial-institutions-group-an-overview https://www.mergersandinquisitions.com/financial-institutions-groups/

6. LO MAS IMPORTANTE: QU’E HACE FIG Y QUIENES SON SUS CLIENTES Mirar aquí: https://corporatefinanceinstitute.com/resources/careers/jobs/financial-institutions-group-fig/

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Different clients of the FIG Team: (check?) Banking Insurance Specialty Finance Financial technology

8. Exampleo of Responsibilities of FIG Trainee in SOC.GEN a. Assisting in origination and execution of M&A transactions across FIG sector b. Industry and company research, quantitative analysis, company valuation and financial modelling c. Making presentations for clients and investors 9. Aprender sobre el dealflow en el equipo: a. Bear Market: restructuring? b. Bull Market: new products, IPOs, etc PART III – BEHAVIOURAL QUESTIONS 10. Back-up story for Investment Banking & FIG A 11. Temas macroeconomicos que afectan a la valoración de financial institutions o Maybe more stringent regulations might change the way banks finance operations (which may affect balance sheet) 12. Other fit questions (use STAR Technique) a. Why do you want this job? (why work endlessly for us?) b. Why FIG? The failure of the banking system also made us more aware of how dependent the entire economy is on the health of financial service firms. Without banks lending money, investment banks backing acquisition and financing deals, and insurance companies pooling risk, the rest of the real economy came 4 to a standstill c. Why this particular firm? Muy importante i. What makes M&A FIG in specific company youre applying to stand out d. What interests you outside work? (see you are a fun person) e. What is your number one achievement? f. Example of dealing with a conflict-based situation?

13. What happens to the net income statement when one company acquires another? It depends on the type of acquisition: - Stock Deal: major adjustment is the additional shares the acquirer issues diluting the acquirer’s pro forma share count. Offsetting this is the target net income that is consolidated onto the acquirer’s income statement. - Cash Deal: no impact on the acquirer’s share count. The major adjustment is the incremental interest expense assuming cash was financed with debt OR interest income forgone if deal is financed with existing cash balances....