Financial Institutions Groups (FIG) 101: Got Book Value?

If you want to be a bit different from all the other bankers out there, financial institutions coverage just might be for you:

• Valuation is completely different.
• You need to understand the finer points of accounting and spot small details.
• No one else outside of FIG understands what’s going on.
• And hey, you might even learn how to cause a financial crisis or two.

As an added bonus, you’ll be busy regardless of whether we’re in a recession (banks consolidate to cut costs) or an expansion (banks consolidate to expand and new banks go public).

You just need to wrap your head around all the tricky concepts first and crack the FIG success code.

Read on for all of that and more – including how you can optimize your chances of getting placed in FIG, the most common deal types, how valuation differs, and whether or not you can ever get non-FIG exit opportunities.

Breaking Into FIG

Q: Let’s start from the beginning: how did you find your current role in your group?

A: I went to a top four school and networked through the alumni who were active in campus recruiting. They were very helpful in my process.

I was originally intrigued by my firm’s restructuring team, but through the selection process was placed into the financial institutions group.

It has been a great experience so far, and being in my group has really opened my eyes in terms of valuing companies and being a part of an active team.

In any phase of the economic cycle, you want to be in a group that is active with deal flow. I lucked out and was placed in a group that always seems to be busy.

Q: How does that matching process work? Is it based on sell days or just your preferences?

A: You hear presentations about the different groups and afterward you attend a short mixer of some sort.

You’ll need to make quality connections so that your favorite group members can vouch for you and make your case.

If you have too many connections but not enough depth, you can easily get placed into a group you didn’t even list as one of your choices.

It’s not necessarily a bad thing, but it will make your career path more non-linear, especially if you have one mapped out already.

It’s a mutual fit – groups that have a greater need will have more spots open.

Q: Okay, but what about if I’m not an entry-level hire?

If I’m a lateral hire, what could I do to increase my chances of being placed in the FIG team?

A: One of my favorite movie scenes is this one right here. You cannot arrive at the table with a “clean slate” when you go in for a FIG interview.

My Managing Director once said, “It’s much easier to write a term paper with stuff written on the document already than it is to write from a blank sheet of paper.”

So you need to read up on FIG analysis, including how valuation differs, how the industry is divided, and you need to be able to speak intelligently about industry trends.

For an academic approach, take a look at NYU Professor Aswath Damodaran’s work and some of the papers he makes available on valuing financial services firms.

Other resources I recommend for more of an applied / hands-on approach:

• The Breaking Into Wall Street Bank & Financial Institution Modeling program
• American Banker (trade publication for FIG professionals)
• Financial Institutions, Markets, and Money

Go through those and absorb everything you can, and make sure you can talk about a few recent FIG deals, what motivated them, and what you think about the valuation and deal terms. Maybe even produce a one-page summary…

They don’t expect you to know everything walking into the interview, but they do expect you to be enthusiastic and a fast learner.

Both elements come across in how you talk, how you interact with your interviewers, and through the quality of your work (or responses).

FIG Newton? How the Industry Works

Q: Wow, thanks for all of these tips. These are very helpful for anyone looking to join the FIG scene.

So what exactly do you cover? How is the industry divided, and are certain banks stronger in certain areas?

A: Historically, FIG has been the biggest revenue generator for many investment banks – so they devote a lot of resources to it.

Here are the main divisions within financial institutions, as well as a few middle-market and boutique banks that specialize in some of the areas:

• Banks, Thrifts, and Depositories: Sandler O’Neil, Stifel Nicolaus Weisel (former Keefe Bruyette Woods), and Jefferies (former Barclays team)
• Specialty Finance
• Insurance: Macquarie (formerly: Fox Pitt Kelton)
• Broker-Dealers
• Investment / Asset Management
• Financial Technology: FT Partners, Freeman + Co.

Of these areas, Banks, Thrifts and Depositories, Specialty Finance, and Insurance are by far the most different from “normal companies” because metrics like EBITDA and Enterprise Value simply don’t apply.

The other three sectors are not nearly as different, although there are some industry-specific metrics.

Here’s a brief overview of the business models in each of these sub-industries:

• Banks, Thrifts, and Depositories: You deposit money, they pay you a certain interest rate, and then they issue loans to businesses and other individuals at a higher interest rate.
• Specialty Finance: These are companies that provide “alternative lending” models – credit card companies, mortgage banks, commercial finance, leasing, mortgage REITs, asset-backed lending, and so on.
• Insurance: You pay a premium to cover yourself or your property in case of emergency, and they pay you when emergency strikes; when it doesn’t (or until it does…), they invest the money to earn additional profits.
• Broker-Dealers: They earn commissions on each trade or each deal (investment banks, stock exchanges, and so on).
• Investment / Asset Management: They raise money from investors, invest it, and earn a return on their investment. Or, they may simply manage client funds and charge a percentage fee for that.
• Financial Technology: Payment and transaction processing, card networks, financial software, and so on. The business models vary: commissions, recurring subscription fees, and more.

Q: OK, so those are a lot of areas and they all sound pretty different in terms of business models.

How does staffing work in FIG?

A: Depending on the firm, you can either be a generalist and receive assignments from any of the verticals, or be a specialist and just cover one area very well.

You just need to be flexible in your expectations – just because you like a certain sector doesn’t mean it’ll be incredibly busy.

As I said above, banks, insurance, and specialty finance are the most different sectors in FIG, so you’re more likely to be a specialist if you happen to work in one of those.

FIG Valuation: Book Value, Dividends, and… Regression Analysis?

Q: Right, so the experience is dependent on the sector but you’re more likely to be a specialist in certain areas than in others.

What about valuation? A lot of readers are curious about this one because it’s so dramatically different for FIG.

A: Most practitioners who cover Financial Institutions argue that valuation is very different from all the other sectors’ valuations (ex: consumer retail, industrials, etc.).

The reality is that the valuations are different in calculation, but not in approach.

You still use both intrinsic valuation and relative valuation, including methodologies such as trading comparables and precedent transactions.

If you take a look at the Fairness Opinion for BlackRock / Barclays Global Investors (see page 20), you can see how the measures are evaluated in practice.

That is an example of an asset management valuation, and you can see the metrics and multiples they use: P / E, EV / EBITDA, and EV / AUM (Assets Under Management).

It’s not dramatically different from normal companies because asset management firms don’t make money with the interest rate spread as banks and specialty finance firms do.

As for the actual methodologies used, let’s break them down by sub-sector:

Discounted Cash Flow: Most applicable for broker-dealers, investment / asset management, and fin-tech. The same as your standard DCF.

• Dividend Discount Model: FCF is meaningless for banks, specialty finance, and insurance firms, so you use dividends as a proxy for their free cash flow instead.
• Multiples – P/E: You could use this for almost anything.
• Multiples – P /BV and P / TBV: More applicable for banks, insurance, and specialty finance since their market values should be close to their book values. Sometimes Tangible Book Value is used, so you subtract Goodwill & Other Intangibles (which can artificially inflate Book Value).
• Multiples – EV/EBITDA: Applies more to asset management, broker-dealers, and fin-tech; EBITDA is not used for the other sub-industries.
• Multiples – EV / AUM: An important metric for asset management.
• Multiples – Price Per Share / Embedded Value Per Share: This one’s specific to life insurance; embedded value is an intrinsic value methodology there.
• Multiples – (Debt + Preferred Equity) /  Total Capital: specific to insurance
• Regression Analysis (Net Flows): Asset Management Inflows that are directed to a firm’s AUM divided by the firm’s Assets Under Management, graphed against P/E. This metric tells you how price is related to the firm’s ability to attract new money.

• Regression Analysis (Price / Book Value vs Return on Average Equity): Here you are keeping an eye for the premium (discount) of companies’ datapoints to the curve itself.
  • Nationwide Financial: prepared by UBS
  • Wesco Insurance: prepared by Greenhill

• Pro Forma Analysis (Merger Consequences Analysis or Accretion-Dilution): Pretty standard, but it can get complicated with banks (deposit divestitures, regulatory capital adjustments, and so on).

See page 18 here if you’re interested in an investment firm case study.

For a reinsurance client presentation on valuation, try:

Fairfax Financial / Odyssey Re:

• Preliminary Valuation: prepared by Bank of America Merrill Lynch
• Opinion to Special Committee: prepared by Sandler O’Neil (begins pg 23)

On the bank/thrift side of things, geographic presence is a big motivation to engage in M&A, as illustrated here.

Taking a look at a transaction between stock exchanges, you can see that the valuation measures are very similar to the standard set.

Q: That all seems pretty straightforward except for the regression analysis part – I didn’t think we’d see that used much outside of research / econometrics.

Anything else we should know about valuation in FIG?

A: Another big aspect here is working with and analyzing regulatory capital.

All banks and insurance firms must keep a certain amount of “capital” (basically, shareholders’ equity, adjusted for a few other items) on their balance sheets at all times.

That plays into the valuation because, for example, in a dividend discount model you can’t just blindly assume a 10% or 20% growth rate.

You have to check to make sure that the bank has the minimum amount of regulatory capital required, and then tie all growth and dividend issuance assumptions to that ratio.

So if you’re assuming that they issue a certain percentage of net income as dividends each year, their capital levels must remain above the minimum percentages even after they issue those dividends.

Bonus: Check out this comprehensive tutorial on Bank & Insurance Modeling to learn even more.

Brokers & Dealing

Q: I see, so it sounds like a tweak to the traditional DCF where you can just make the assumptions you want to make, within reason.

What types of deals are most common in your group?

A: Generally the split is pretty even among equity, debt, and advisory assignments. If the market is not doing so well, expect regional depositories to be acquired by larger players.

When times are good, expect a higher proportion of equity deals.

It’s consistent with corporate finance theory – if a firm issues equity, it’s a sign of good times within the issuer.

If a firm issues debt, it means that they need the funds for something more specific than general corporate funding.

Q: That’s interesting to see a more even split compared to other sectors.

What do the industry pages look like in pitch books?

A: Your pages differ depending on the sector you’re covering.

The financial sector is greatly affected by policy updates and regulations, so you might even be staffed on government presentations.

A set of pages might reference major developments and how these developments translate into challenges or opportunities.

Here’s what you might expect to see discussed in the different sub-sectors (just the ones I’m familiar with):

Banks, Thrifts, and Depositories:  Benchmarking pages include a segment on how well-capitalized depositories are. For regional banks, you’re likely to see something on the geographic concentration of branches.

In Manhattan, there’s always a fight between Bank of America and Chase over the number of physical branches and that’s the type of information you might see.

Investment Management: Trends on where money is going will be important to mention (types of investments and the level of overall net new money). The retention of clients through strong customer service and a track record for solid returns is crucial.

Insurance: The main areas concern life, auto, and property insurance. Factors that affect an insurance company include consumer confidence, employment levels, and interest rates.

For more specific forms of insurance, you might even see something on changes and trends in social attitudes (e.g. peoples’ views on work ethic and stability for disability insurance).

Exchanges: Believe it or not, exchanges do face competition. How other firms are able to out-innovate (process, price, etc.) the economies of scale poses a risk to exchanges. Some banks actually internalize trades and take away this trade volume from exchanges.

Exit Opportunities: What Exit Opportunities?

Q: Interesting to note all that. It sounds like you learn about the broader trends in the economy, but do you also get broader exit opportunities?

Some people say FIG is an incredibly specialized group and that you can’t do anything outside of FIG afterward – true or false?

A: It is, and it isn’t. Some people say being in FIG is a handicap for private equity recruiting.

If you’re in FIG, however, you have a much better story in terms of getting into strategy / corporate development roles at financial institutions.

You are definitely more specialized, and that can limit PE opportunities – but you’re also in a much better position for funds that invest in financial institutions.

Most normal PE firms won’t even touch financial institutions because they don’t understand them – but there are a few specialized PE firms that focus on FIG (e.g. JC Flowers) and they’re not likely to recruit someone without FIG experience.

And if you want to stay in a financial center, FIG experience can be very helpful even if you move into another group, another firm, or another industry altogether.

So much business in places like London and New York depends on financial firms that understanding them in-depth and having contacts there can make a big difference in almost any field – if you start your own company one day in one of those cities, guess who your main customers might be?

Q: Right, those are great points and I hadn’t thought through that one about FIG being central to business in financial centers.

So how can readers tell if FIG is right for them?

A: If you like reading up on the sector and you enjoy following financials you’re good to go.

The quality of your work is dictated by how badly you want to perform, and how interested you are in your work.

Some of the top leadership on Wall Street today actually had some background in the sector – for example, Morgan Stanley CFO Ruth Porat was originally a tech banker who then worked in financial sponsors / financial institutions.

And so I don’t think you can really argue with FIG as a solid way to start off your career.

Q: Awesome, thanks for your time.

A: Sure thing – enjoyed speaking with you!

Luis Miguel Ochoa has worked in investment banking for several years covering the industrial sector. In addition to being an avid mentor for his alma mater, he volunteers for the Association of Latino Professionals in Finance and Accounting. In his spare time, he is fencing, and attends networking events in New York. He has graduated from Stanford with a BA in Economics.

Regression Analysis (Net Flows): A

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