Process

Value, Risk and Return

Bankers address risk and return every day when pricing deposits, funding loans, and purchasing securities. Value as a function of risk and return is the fundamental concept underlying all financial analysis. Financial managers commonly use this as the basis for maximizing shareholder value.

Strategic Financial Planning

Many banks have a formal strategic financial planning process that sets forth specific goals, execution plans, and financial projections. A formal planning process allows management to state its expectations for growth and profitability. It facilitates proactive capital management to increase the per share value of the bank’s common stock.

Capital Management

Once the bank’s core profits are set, capital can be managed to maximize shareholder distributions through dividends, extraordinary distributions, or share buybacks. Measures can be taken to evaluate investments, leverage equity, reduce taxes, and provide shareholder liquidity, all of which can increase shareholder value.

Capital Budgeting

This process is used to efficiently allocate the bank’s capital among an array of available projects. Expansion and new business lines impact shareholder distributions whether the projects are funded internally, through a new stock issue, or through a business combination.

Effective capital budgeting assures that any change in shareholder distributions increases the per share value for existing shareholders.

Trust Preferred Financing

This funding qualifies as Tier I capital, within regulatory parameters, but does not dilute existing shareholders. Dividend payments are tax deductible. Trust preferred financing is a cost effective source of financial leverage that can increase shareholder value.

Sub Chapter S Corporation Tax Election

A company can elect to have its income taxed only at the shareholder level, not the corporate level. Income is taxed only once: shareholders pay no taxes on dividends received. The higher the dividend payout ratio, the greater the tax benefit and increase in shareholder value.

Employee Stock Ownership Plan (ESOP)

An ESOP provides retirement benefits to employees through bank stock ownership. The benefit structure is intended to motivate employees, improve performance, and increase shareholder value. ESOPs are allowed to use debt financing that can provide capital for growth or stock buybacks, and with significant tax benefits. An ESOP also promotes continued independent ownership and potentially provides a ready market for individuals who want to sell their stock.

Management Ownership Plans

These are intended to motivate management, improve profitability, and increase shareholder value. Several alternative plans are available but the accounting and tax treatments can differ. Quantifying the full cost of the plan, primarily the dilution to existing shareholders, is critical when evaluating the net impact to shareholder value.

Succession Plans

Community banks face issues relating to ownership succession as well as management succession. ESOPs and management ownership plans can be used to address management succession. Maximizing shareholder distributions can alleviate some ownership issues. Buy/sell agreements, share repurchases, and an ESOP can be used to maintain ownership with shareholders that share a common goal, such as remaining independent.

Appraisals

Market prices do not exist for closely-held community banks. Independent, objective appraisals provide the bridge between market prices and theoretical values. Appraisals enable management and shareholders to effectively address value issues for internal planning purposes or for external transactions.