Financial Services Firms

ZABIHOLLAH REZAEE, PHD, CPA, CFE, CMA, CIA, CGFM, is the Thompson-Hill Chair of Excellence and Professor of Accountancy at the University of Memphis and has served a two-year term on the Standing Advisory Group (SAG) of the PCAOB. He is a prolific writer, having published six books and 190 articles in a variety of accounting and business journals.

• Preface xiAcknowledgments xviiPart I: Financial Services Industry: Its Markets, Regulations, and Governance 1Chapter 1: Fundamentals of the Financial Markets and Institutions 3Introduction 3Financial Markets 3Financial Information and Capital Markets 4Financial Crisis and Financial Regulatory Reforms 5Types and Roles of Financial Markets 15Financial Services Firms 21Conclusion 24Notes 25Chapter 2: Introduction to Financial Institutions 27Introduction 27Landscape of the Financial Services Industry 27Structural Changes in the Financial Services Industry 28Historical Perspective of American Banking 42Current Trends in the Financial Services Banking Industry 43Regulatory Reforms 46Valuation Process 55Conclusion 56Notes 57Chapter 3: Corporate Governance 61Introduction 61Corporate Governance Effectiveness 62Global Regulatory Reforms 66Sarbanes-Oxley Act of 2002 70Dodd-Frank Act 74Corporate Governance Functions 75VI & Contents Board of Directors and Its Committees 78Audit Committee Roles and Responsibilities 80Executive Compensation 84Conclusion 86Notes 86Part II: the Foundation: Financial Institutions, Valuations, Mergers, Acquisitions, and Regulatory and Accounting Environment 89Chapter 4: Overview of the Valuation Process 91Introduction 91Valuation Services 92Valuation Profession 94Valuation of the Business 97Attracting Valuation Clients 105Accepting a Client 109Pricing Valuation Services 111Importance of the Engagement Letter 112Planning an Appraisal Engagement 114General Planning 118Appraiser’s Traits 121Appraiser’s Due Diligence Process 124Risk Assessment 125Conclusion 126Notes 126Chapter 5: Overview of Mergers and Acquisitions 127Introduction 127Historical Perspective of Mergers and Acquisitions 128Recent Trends in Mergers and Acquisitions 130Regulations of Bank Mergers 136Players in Mergers and Acquisitions 142Motives for Business Combinations 146Determinants of Mergers and Acquisitions 148Perceived Shortcomings of Mergers and Acquisitions 152Studies on Mergers and Acquisitions 155Leveraged Buyout 159Post Mergers and Acquisitions Performance 160Shareholder Wealth and Effect of Mergers and Acquisitions 161Joint Ventures and Strategic Alliances 162Ethics in Mergers and Acquisitions 163Governance in Mergers and Acquisitions 164Mergers and Acquisitions Process 165Conclusion 181Notes 183Chapter 6: Regulatory Environment and Financial Reporting Process of Financial Institutions 187Introduction 187Consolidation 187Regulatory Environment 192Bank Supervision 198Financial Modernization: The Gramm-Leach-Bliley Act 205Financial Reporting Process of Financial Institutions 208Statement of Financial Accounting Standards No. 115 212Auditing Proper Classifications of Marketable Securities 214Tax Consideration of Fair Value 215Recent Development of Fair Value Accounting 218Financial Reporting Requirements of Financial Institutions 222Corporate Governance of Financial Institutions 228Conclusion 237Notes 238Part III: Fundamentals of Valuations: Concepts, Standards, and Techniques 241Chapter 7: Value and Valuation: A Conceptual Foundation 243Asset-Liability Management 243Investment Management 245Lending Management 246Liquidity Management 247Nature of Value 249Twelve Concepts of Value 250Types of Property that Can Be Valued 260Relationship among Different Types of Value 261Principles of Valuation Theory 262Pricing Value versus Reporting Value 263Limitations of the Valuation Process 264Conclusion 264Notes 264Chapter 8: Approaches to Measuring Value 267Overview of the Valuation Process 267Cost Approach to Valuation 268Market Approach to Valuation 270Income Approach to Valuation 273Special Topics—Approches to Intangible Asset Valuation 291Special Topics—Business Valuation 294Valuation and Business Concentrations 300Special Topics—Closely Held Stock 301Special Topics—Valuing Widely Traded Companies 304Conclusion 305Notes 305Chapter 9: Valuations for Tax and Accounting Purposes 307Tax Aspects of Mergers and Acquisitions 307Typical Tax-Oriented Valuations 310Accounting Aspects of Mergers and Acquisitions 313Typical Accounting-Oriented Valuations 319Acquisition Method 320Presentation, Disclosure, and Transition Requirements of Business Combinations 324Convergence in Accounting Standards on Mergers and Acquisitions 327Conclusion 328Notes 329Chapter 10: Intangible Asset Valuation 331Nature and Types of Intangible Assets 331Amortizable versus Nonamortizable Intangible Assets 334Measuring the Useful Life of an Intangible Asset 336Establishing Value of Intangible Assets 338Amortization Methods 341Supporting Intangible Asset Valuation and Amortization 341Goodwill Impairment 342Conclusion 343Notes 344Part IV: Assessment of Financial Institutions 345Chapter 11: Financial Analysis of Banks and Bank Holding Companies 347Types and Sources of Financial Data 347Overview of Financial Statements 351Composition of Bank Assets 355Composition of Bank Liabilities 359Off–Balance Sheet Items 361Composition of Bank Capital 362Regulatory Capital Components 364Risk-Based Capital 367Value-at-Risk Models 370Composition of Bank Income 371Composition of Bank Expenses 373Balance Sheet Analysis Illustration 376Income Statement and Profitability Analysis Illustration 381Loan Risk Analysis Illustration 385Liquidity and Investment Portfolio Analysis Illustration 389Portfolio Equities Analysis (REALM Model) 390Special Bank Holding Company Considerations 391Liability Management 392Conclusion 392Notes 392Chapter 12: Internal Characteristics Assessment 395Objectives and Benefits of an Internal Characteristics Assessment 396Ten P Factor Framework 396Shareholder Value Creation 405Conclusion 412Notes 413Chapter 13: External Environment Assessment 415Impact of External Environment on Value 415Political Analysis 416Economic Analysis 416Social Analysis 417Technological Analysis 420Other Analysis 421Conclusion 423Notes 423Part V: Valuation of Mergers and Acquisitions 425Chapter 14: Bank Merger and Acquisition Process 427Strategy Phase 427Negotiation and Investigation Phase 435Finalization and Integration Phase 439Other Considerations 443Conclusion 446Notes 446Chapter 15: Valuing a Bank as a Business Enterprise 447Business Enterprise versus a Collection of Assets 447Concept of the Banking Franchise 448Difference between Strategic and Tactical Valuations 449Why the Cost Approach Is Not Used for Strategic Bank Valuations 450Application of the Market Approach to Valuing a Bank 450Application of the Income Approach to Valuing a Bank 454Sensitivity of Value Estimate to Assumption Changes 461Value-Creation Opportunities and the Acquisition Price 463Valuation Methods for Mergers and Acquisitions 465Sophisticated Valuation Techniques for Mergers and Acquisitions 470Relation between Price and Value and Effect on Stockholders 475Conclusion 478Notes 478Chapter 16: Valuation of Tangible Bank Assets 479Tangible Physical Assets 480Tangible Financial Assets 481Tangible Assets in Bank Mergers and Acquisitions 486X & Contents Intangible Assets in Bank Mergers and Acquisitions 486Conclusion 487Chapter 17: Core Deposits as a Special Type of Intangible Asset Valuation 489Concept of Core Deposit Base as an Intangible Asset 489Internal Revenue Service Position on Core Deposits 490Important Core Deposit Tax Court Cases 490Deposits to Be Included in Valuation 497Alternative Approaches to Valuing a Core Deposit Base 497Core Deposit Base Life Estimation 499Application of the Cost Savings Approach 502Application of the Future Income Approach 505Systemically Important Financial Institutions 508Conclusion 511Notes 511Chapter 18: Derivative Financial Instruments 513Authoritative Guidelines on Derivatives 515Derivative Markets 516Derivatives Risk Management 518Derivatives Risk Management Policy 519Accounting for Derivatives 528Tax Considerations of Derivatives 535Audit of Derivative Transactions 535Sources of Information on Derivatives 537Derivatives Valuation Models 538Derivatives under the Dodd-Frank Act of 2010 542Conclusion 543Notes 543Chapter 19: Real-World Bank Valuation Complications 547Banks Experiencing Recent Losses 548Banks with Low Equity Capital 551Banks with Uncertain Future Loan Loss Exposure 554Preferred and Common Stock 556Highly Leveraged Banks 557Branch Acquisitions 557European Banking Model 559Initial Public Offering 561Islamic Banking System 562Emerging Issues in the Financial Services Industry 564Conclusion 568Notes 568About the Author 569Index 571