Bank valuation is the practice of turning a bank’s balance sheet and earnings path into a per-share value. ROTCE is return on tangible common equity; it measures how efficiently a bank turns tangible equity into profits. TBVPS is tangible book value per share. COE is the annual return shareholders require to hold the stock. This guide shows how to connect those metrics to drivers like net interest income, credit costs, capital, and liquidity so you can value banks with confidence.
What actually drives the value
Three questions drive the work: How durable are earnings, how much capital does regulation allow you to deploy, and how steady is funding under rate and credit stress? Your outputs must be comparable across peers: ROTCE, TBVPS growth, payout capacity, and COE. For listed banks, public comps and residual income or dividend discount models usually lead. For private deals, asset and liability fair value marks, core deposit intangibles, and regulatory approvals shape adjusted earnings and capital.
Model the bank from the balance sheet out
A bank intermediates maturity, credit, and liquidity. Therefore, model the balance sheet as the spine and let earnings flow from those positions and their repricing behavior.
- Earning assets: Loans by product and fixed or floating mix, securities (AFS and HTM), and cash or reserves.
- Funding: Noninterest-bearing deposits, interest-bearing deposits by tier and beta, wholesale borrowings, and long-term debt including TLAC where required.
- Capital: CET1, AT1, and tier 2.
Income breaks into NII, fees, expenses, provisions, taxes, and below-the-line items like intangible amortization and purchase accounting accretion. Growth and distributions sit inside regulatory fences: CET1 minimums plus buffers like the CCB, SCB, and any GSIB surcharge. Leverage constraints can bind when liquidity is high.
NII and NIM: the earnings engine you must get right
NII equals asset yields minus funding costs on average balances. NIM is NII divided by average interest-earning assets. To be accurate, split assets and liabilities by repricing buckets and fixed or floating mix, estimate new money rates and deposit betas, and allow for mix shifts as rates move.
- Assets: Floating loans reset off indices with caps, floors, and spreads; fixed-rate loans reprice via new originations, prepayments, and calls. Securities follow duration and cash flow structure, and premium or discount accretion matters to yield.
- Liabilities: Deposit betas pass through part of policy-rate moves to customers and vary by product and franchise strength. Segment noninterest-bearing, interest-bearing checking or savings, money market, time deposits, and wholesale funding.
Run a rate shock matrix at + or -100 to 200 bps, with deposit migration to higher cost tiers when rates rise. Layer in hedges such as pay-fixed swaps or floors at effective durations and accounting designations so NII and OCI move together.
Credit costs under CECL and IFRS 9
Under CECL, the allowance equals lifetime expected losses and the provision is the change in allowance plus net charge-offs and adjustments. Under IFRS 9, staging governs whether loss is 12-month or lifetime and how interest is recognized on credit-impaired assets.
Build provisions by portfolio with macro-driven PD, LGD, and EAD. Calibrate to history, forward scenarios, and overlays. Keep the allowance coverage ratio, net charge-off path, and delinquency or criticized loan migration linked. For retail, use roll-rate models; for commercial, tie to risk grading and collateral behavior. Stress unemployment as in the Fed’s severely adverse path to check downside coherence.
Fees and expenses: drivers behind the line
Forecast recurring fees with explicit drivers: card fees off spend and take rates, mortgage via gain-on-sale, volumes, and MSR marks, wealth or asset management off AUM and basis points, service charges, and any investment banking or advisory. Flag episodic items that are unlikely to repeat.
Split costs into compensation, occupancy and tech, marketing, and other categories. Use the efficiency ratio as a directional check. Strip integration and restructuring to isolate core expenses.
Capital and RWA under changing rules
Calculate CET1 as common equity less regulatory deductions such as goodwill, certain DTAs, and other filters. RWA follow standardized or advanced approaches. Proposed Basel III Endgame would lift large-bank RWAs meaningfully – roughly 16% on average once fully phased in, per the Federal Reserve’s July 2023 proposal. Therefore, build sensitivities to both frameworks if the bank reports both.
Translate earnings to capital with a simple walk: start with CET1, add retained earnings, add or subtract OCI if applicable, then subtract dividends and buybacks. The SCB from the annual stress test governs distributions for covered banks, subject to floors. Track TLAC and long-term debt for GSIBs.
Liquidity and funding you can rely on
LCR requires HQLA to cover 30-day net outflows. NSFR requires stable funding over one year. Beyond the formulas, value the real liquidity ladder: on-balance sheet HQLA, pledgeable securities, central bank access, and deposit stickiness that holds up in stress.
Model deposit stability with granularity: operational vs non-operational, retail vs wholesale, insured vs uninsured. Link uninsured concentrations to outflow rates and pricing pressure. Track collateral encumbrance; what is pledged to FHLB or derivatives counterparties cannot be sold for cash in a pinch.
Accounting choices and OCI in valuation
Security classification drives earnings and capital behavior.
- AFS: Fair value with unrealized gains or losses in OCI.
- HTM: Amortized cost; unrealized changes stay out of OCI unless impaired.
- Trading: Fair value through earnings.
AOCI treatment in capital differs by regime. Many U.S. non-advanced banks elect the AOCI opt-out; advanced approaches banks include AOCI in CET1. Rate moves can create large unrealized losses. Model potential OCI reversals if rates fall, and the practical limits on realizing gains given HTM taint risk.
Acquired loans carry fair value marks. Accretable yield boosts NII over time. Core deposit intangibles recognize below-market funding and amortize through expense. Goodwill does not amortize under U.S. GAAP, is tested for impairment, and is deducted from CET1.
Valuation frameworks that align with bank economics
P or TBV anchored in ROTCE
For deposit-funded lenders, P or TBV is the workhorse. TBV approximates the legacy balance sheet’s liquidation value; the premium reflects excess returns over COE. The residual income identity is helpful: P or TBV approximates 1 plus (ROTCE minus COE) over (COE minus g). If a bank earns 14% ROTCE with a 12% COE and 3% TBVPS growth, P or TBV is about 1.22x. As a sanity check, higher ROTCE or lower COE raises P or TBV, but growth must be feasible given payout and capital generation.
Dividend discount model
For mature, high-payout banks, a DDM works. Forecast dividends limited by capital and the SCB, set terminal growth at or below nominal GDP, and discount at COE. Be explicit about payout limits in stress.
Residual income model
RIM anchors on TBV and avoids cash flow artifacts. Forecast TBV and ROTCE for five to seven years, then a terminal premium over TBV consistent with long-run excess ROE. RIM handles OCI, acquisition marks, and restructuring cleanly.
Sum-of-the-parts when fees matter
SOTP fits banks with sizable fee businesses. Value wealth or asset management on earnings multiples or DCF and lending on P or TBV or RIM. Adjust for capital trapped in broker-dealers or insurance subs. For a repeatable approach, see a sum-of-the-parts layout.
COE and comparable checks
Estimate COE with CAPM using bank betas, a market risk premium, and a risk-free rate anchored to the forward curve. Cross-check with peer-implied COE from P or TBV and ROTCE. As of December 11, 2024, the fed funds target range was 5.25-5.50%. Use volatility-sensible risk premia, not stale averages. For public names, a tight public trading comps set keeps COE and multiples grounded in reality.
Key mechanics to get right
Rate sensitivity and deposit betas
Build a beta matrix by deposit type and cycle. For example, a 100 bp rate hike with a 30% blended beta lifts deposit costs 30 bps. If 60% of loans reprice inside 12 months with near-full pass-through, asset yields rise about 60 bps on that cohort. NIM depends on repricing speed and any mix shift to higher-cost deposits or wholesale. Always stress a case with higher betas, time-deposit migration, and runoff in noninterest-bearing balances.
Hedging overlay
- Fair value hedges: Hedge fixed-rate assets to pull rate changes into current earnings via basis adjustments.
- Cash flow hedges: Hedge floating exposures or forecasted issuance to OCI and reclassify into earnings as NII occurs.
Align hedge designations with the AFS or HTM mix so NII and OCI tell one coherent story.
Allowance roll-forward
Run a simple roll: Allowance(t) equals Allowance(t-1) plus Provision(t) minus NCOs(t) plus or minus FX or other items. Provisions should reflect new originations, seasoning, macro updates, specific reserves, and overlays. Test the model against a severely adverse unemployment shock; tail risk belongs in overlays when you value downside.
Capital walk and leverage
Start with CET1. Add net income less preferred dividends. Subtract common dividends and buybacks. Add or subtract OCI if included in capital. Deduct goodwill and intangibles. Update DTAs and DTLs from provisions and OCI. Recompute CET1 or RWA, tier 1 leverage, SLR if relevant, and TLAC.
Liquidity profile beyond LCR
Track cash at central banks, HQLA after haircuts, and unused pledgeable collateral. Monitor FHLB capacity and haircuts. Align NII shocks with economic value of equity sensitivity to spot structural rate risk.
Acquisition accounting and M&A modeling
- Loans: Split credit and rate marks into accretable vs nonaccretable; accretable yield flows into NII.
- Securities: Mark to fair value through OCI or earnings per classification.
- Deposits: Record a core deposit intangible for stable, below-market funding; amortize over life.
- Goodwill: Recognize if consideration exceeds fair value of net assets; deductible status affects cash taxes.
Run earnback math: accretable yield lifts NII, CDI amortization increases expense, and funding synergies lower interest expense. Marks accrete into earnings and, over time, CET1.
Cleaning earnings for comparability
- One-time items: Remove gains or losses on securities sales or real estate.
- Provision normalization: Reset to steady-state loss rates.
- Purchase accounting: Strip accretion when estimating core ROTCE.
- Restructuring: Exclude integration and severance.
- Tax rate: Set a sustainable tax rate and apply consistently.
Where helpful, use an earnings bridge to reconcile reported to normalized results.
Risk considerations and the edge cases that move multiples
- Funding concentration: High uninsured or non-operational deposits raise outflow risk and beta sensitivity. Reflect that in liquidity and COE.
- OCI trap: Large HTM unrealized losses limit strategic flexibility. Model rate-down AOCI reversal, but keep HTM taint risk in view.
- Model risk: CECL or IFRS 9 overlays can swing provisions; governance and back-testing matter.
- Off-balance-sheet: Commitments and derivatives drive RWAs and outflows; capture them in capital and LCR or NSFR.
- Regulatory change: Basel III Endgame can lift RWAs and operational risk charges. Quantify pro forma impact.
- MSRs: Mortgage servicing values move with rates and hedges add P&L volatility.
- Trapped capital: Country or legal-entity limits reduce fungibility; reflect in SOTP and COE.
Sanity checks that catch mistakes
- TBVPS bridge: Prior TBVPS plus ROTCE less payout plus OCI if included should reconcile.
- RWA density: RWA as a percent of assets should fit peers given mix; standardized U.S. banks often sit around 55-75%.
- NIM vs rate shock: In a +100 bps shock, most asset-sensitive regionals should see year-one NII up unless deposit betas and mix shifts overwhelm it.
- Provision vs cycle: Rising unemployment with falling provisions needs a clear explanation, such as mix, collateral, or model changes.
Comparisons and alternatives you will use
- DCF vs RIM: DCF struggles with deposits and capex analogs in banks. RIM or DDM align with capital and payouts. If you need a recap on mechanics, see a simple discounted cash flow (DCF) build.
- P or E vs P or TBV: P or E flexes with provisioning and purchase accounting; P or TBV normalizes for balance sheet scale.
- EVE vs earnings sensitivity: EVE captures long-duration rate risk; NII is near-term. Carry both views to price OCI risk into COE.
Market context that matters now
As of December 2024, policy rates stood at 5.25-5.50%. Elevated rates lift deposit competition and beta uncertainty. NIM can widen or compress depending on asset sensitivity, and OCI on securities can move sharply. Basel III Endgame points to higher RWAs for large banks and some regionals. Supervisors continue to stress behavioral deposit modeling and non-maturity decay. Model scenarios that pair rate cuts with deposit stickiness fading and credit normalization.
Analyst workflow: data to decision
- Baseline the bank: Franchise, deposit composition, loan mix, and fee businesses.
- Quantify sustainable ROTCE: Normalize NIM, provision, expense ratio, and tax rate; exclude episodic items.
- Map capital constraints: CET1 buffers and SCB; RWA sensitivity to Basel Endgame; TLAC or long-term debt if relevant.
- Assess liquidity durability: LCR or NSFR, pledgeable collateral, and deposit behavior under stress.
- Decide COE: Reflect business mix risk, funding stability, and rate or credit sensitivity.
- Choose valuation lens: RIM with a P or TBV cross-check for most; sum-of-the-parts if nonbank segments are material.
- Test scenarios: Bear rate path with credit normalization and deposit remix; bull rate cuts with OCI reversal but shrinking NIM; regulatory RWA uplift. For process discipline, use scenario planning and formal stress testing.
Rapid screen “kill tests” for idea triage
- Premium to TBV: If P or TBV above 1.5x, require ROTCE to exceed COE by 300+ bps with credible growth and franchise strength.
- Funding fragility: If uninsured deposits above 40% and LCR is tight, raise COE or discount TBV.
- OCI constraint: If AOCI losses above 20% of CET1 and AOCI is included, cut payout assumptions or extend OCI earnback.
- Basel uplift: If Basel Endgame lifts RWAs above 15% with limited offsets, trim growth or increase capital drag.
- Fee cyclicality: If fee income above 30% but transaction-driven, stress cyclicality and lower multiples.
Two fresh angles to sharpen your model
Funding optionality premium
Assign a small valuation premium or COE discount when a bank demonstrably secures contingent liquidity at scale, such as robust FHLB capacity, confirmed discount window readiness, and pre-positioned collateral. In back-tests, that playbook shortens stress drawdowns, which lowers realized equity volatility and supports a lower COE relative to peers with similar mix but weaker access.
AOCI monetization playbook
When rates decline, model tactical OCI harvesting: rotate HTM runoff into shorter AFS, execute modest AFS sales to realize gains, and redeploy at current spreads. Time sales to capital headroom and SCB windows. A disciplined harvest can add 20-50 bps to ROTCE in the first year of a rate-cut cycle without sacrificing liquidity.
Conclusion
Bank valuation is balance-sheet-centric. Integrate rate sensitivity, CECL or IFRS 9 loss dynamics, capital rules, and funding behavior into ROTCE and TBVPS. Use residual-income logic to anchor P or TBV, set COE to reflect liquidity and regulatory risk, and require that payout capacity survives plausible rate and credit paths. When uncertain, assume higher deposit betas, add RWAs for pending rules, and favor surplus liquidity and capital in your model.