Free Response - District Court of Federal Claims - federal

Case 1:95-cv-00517-GWM

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Filed 06/12/2007

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IN THE UNITED STATES COURT OF FEDERAL CLAIMS FIRST FEDERAL SAVINGS AND LOAN ASSOCIATION OF ROCHESTER, Plaintiff, v. UNITED STATES, Defendant. ) ) ) ) ) ) ) ) ) )

No. 95-517 (Judge George Miller)

REPORT OF DR. DAVID P. ROCHESTER IN RESPONSE TO THE REVISED DAMAGE CALCULATION BY DR. DONALD M. KAPLAN 1. At the request of counsel for the Government, I have prepared this report to respond to the "Revised Damage Calculation by Dr. Donald M. Kaplan" dated May 14, 2007 ("Revised Damage Calculation"). This report reviews and addresses the appropriateness of the assumptions and calculations in Dr. Kaplan's Revised Damage Calculation. In preparing this report I do not retract my previous testimony which asserted that, because of several key flaws in his pricing methodology, Dr. Kaplan's valuation related to the hypothetical 1993 standard conversion of First Federal is speculative, unreliable and overstated. 2. I believe that Dr. Kaplan's recalculations of First Federal's standard conversion proceeds reflect critical flaws in his valuation methodology that warrants the filing of responsive calculations, as provided for by the Court's Opinion and Order. Dr. Kaplan's Revised Damage Calculation includes the faulty assertions that the pro forma price/book ratio is the exclusive ratio to focus on and that First Federal's price/book ratio must be held constant at 59.0 percent in the recalculations. 3. Dr. Kaplan's two recalculated conversion valuation figures for First Federal, $211.750 million under his "No Tax Benefit" scenario and $220 million under his "$7.4 million Tax Benefit" scenario, also reflect a critical flaw because the valuations ignore another important pricing ratio, the pro forma price/earnings ratio. Largely as a result, Dr. Kaplan's two conversion valuation figures are overstated because they don't properly 1

Case 1:95-cv-00517-GWM

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reflect the impact of the 17 percent decline in pro forma pre-conversion earnings that are provided in Dr. Kaplan's recalculations. The overstatement of Dr. Kaplan's conversion values are reflected in his high pro forma price/earnings ratios (10.7x and 10.9x, respectively), which ratios reflect a notable and inappropriate increase from his price/earnings ratio presented at trial (9.4x). 4. While my testimony at trial also acknowledged the importance of the price/book ratio in the valuation process (see Rochester Tr.4786-4787), my testimony also asserted that appraisers focus on several ratios, including price/earnings ("P/E"), price/book ("P/B") (and price/tangible book value) and price/assets ("P/A"). I further stated that normally, the greatest weight in the valuation process is given to the price/earnings ratio (see Rochester Tr.4416-17). Also, in my Expert Report, I cited the OTS' Guidelines for (Conversion) Appraisal Reports. These guidelines set the valuation methodology standards for all conversion appraisers. The guidelines state that conversion appraisers generally should employ the three fundamental pricing ratios (i.e., P/E, P/B and P/A) mentioned above. The guidelines go on to state: "when both the converting institution and the comparable companies are recording "normal" earnings, a P/E approach may be the simplest and most direct method of valuation." 5. I cite my above-mentioned testimony and the conversion guidelines to emphasize that Dr. Kaplan's valuation methodology of focusing exclusively on the price/book ratio is not appropriate when, as in this case, First Federal and the comparative group are reporting positive earnings. Therefore, I have ample justification to challenge Dr. Kaplan's

recalculated valuations by providing the Court with alternative values that are lower than Dr. Kaplan's. My alternative valuations place appropriate weight on both the price/earnings ratio and price/book ratio, as well as appropriately reflect the impact of a 17 percent decline in First Federal's pro forma earnings stream. 6. In this report, I have attached my recalculation of First Federal's standard conversion valuations based on the two revised scenarios presented in Dr. Kaplan's Revised Damage Calculation. Dr. Kaplan's first revised scenario does not reflect the $7.4 million tax benefit and his second revised scenario reflects this tax benefit. My valuation

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recalculations utilize the same input assumptions and dollar figures that have been utilized by Dr. Kaplan in his recalculations, including the same dollar figures for pro forma pre-conversion net worth, pre-conversion trailing twelve month earnings and preconversion assets. My two valuations, however, also reflect corrections to the critical flaws in Dr. Kaplan's valuation methodology. My two recalculated conversion values for First Federal are presented in the attached Exhibit 1. 7. As presented in Exhibit 1, my recalculated conversion value for First Federal is $190 million under the "No Tax Benefit" scenario and $195 million under the "$7.4 Million Tax Benefit" scenario, versus Dr. Kaplan's recalculated values of $211.750 million and $220 million, respectively. Contrary to Dr. Kaplan's assertions, my lower valuations for First Federal reflect the argument that: · The valuation process should not place exclusive weight on the price/book ratio, to the exclusion of the price/earnings ratio; and · It is not valid to maintain a constant price/book ratio (Dr. Kaplan maintains his ratio constant at 59%) if the institution being valued shows a substantial decline in earnings. Dr. Kaplan's recalculations for First Federal reflect a sharp 17% decline in pre-conversion earnings, which he ignores by holding constant the price/book ratio in his valuation model. 8. As a result of Dr. Kaplan's flawed pricing methodology, his valuations under his two scenarios are overstated, as they reflect price/book and price/earnings ratios which are too high. My valuations for First Federal correct the flaws in Dr. Kaplan's methodology and, as a result, reflect more appropriate price/book and price/earnings ratios. The attached Exhibits 2-A and 2-B compare my recalculated valuations to those of Dr. Kaplan under the two scenarios.

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*****
9. My work is ongoing and any opinions are subject to revision basedon new information

(including new reports or testimonyby Plaintiffs experts),which subsequently may be providedto, or obtainedby me. Respectfullysubmitted,

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David P. Rochester Date: June 12,2007

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Response- 2007-06-] 2.DOC

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EXHIBIT 1 First Federal of Rochester Conversion Proceeds, Earnings and Market Pricing Ratios
(AS RECALCULATED) Financial Data as of or for the year ended 12/31/1992
Recalculted - No Tax Benefit Pro Forma Stockholders' Equity Gross Proceeds Offering Expenses: Fixed Expenses Commissions (2.75% on 80% of stock sold) Reverse Professional Fees for CT Acquisition
($000)

Recalculted $7.4 Million Tax Benefit
($000)

190,000 2,500 4,180 (880) 5,800 7,600 13,300 20,900 163,300 3,000 (12,800) 153,500 188,186 341,686 (96,536) 245,150

195,000 2,500 4,290 (880) 5,910 7,800 13,650 21,450 167,640 3,000 (13,150) 157,490 195,793 353,283 (96,536) 256,747

Management Recognition Program (MRP) (4% of total) Employee Stock Ownership Program (ESOP) (7% of total)

Net Proceeds Plus: Warrant Payment to FDIC in 1991 Less: Value of Warrants for IPO Net Increase in Capital Plus: Pre-Conversion Net Worth (GAAP) Total Pro Forma Net Worth Less: Goodwill Pro Forma Tangible Net Worth Pro Forma Earnings Gross Return (6%) After Taxes of 41% (3.5%) MRP Amortization over 5 years (after taxes) ESOP Amortization over 10 years (after taxes) Trailing Twelve Months Earnings at Pro Forma 41% Tax Rate Total Pro Forma Earnings

5,434 (897) (785) 3,752 15,655 19,407

5,575 (920) (805) 3,850 15,772 19,622

Pro Forma Assets: Pre-Conversion Assets Plus: Net Increase in Capital Total Pro Forma Assets 6,522,629 153,500 6,676,129 6,530,236 157,490 6,687,726 Recalculted $7.4 Million Tax Benefit 9.9x 55.2% 76.0% 2.9%

Pro Forma Ratios Price/Earnings Price/Book Price/Tangible Book Price/Assets 9.6x 54.7% 55.2% 6.6% 8.9x 78.4% 88.7% 6.5%

Recalculted - No Tax Benefit 9.8x 55.6% 77.5% 2.8%

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EXHIBIT 2-A
First Federal of Rochester Dr. Kaplan's Recalculated 1993 Valuation vs. Dr. Rochester's Recalculated 1993 Valuation - NO TAX BENEFIT SCENARIO -

Dr. Kaplan's 1993 Valuation Value of $211.75 Million
($170.9 Million Net Increase in Capital)
Discount (Premium) to All Publicly Traded Thrifts at 7/28/1993

Recalculated First Federal Pricing Ratios

Discount (Premium) to 1993 IPOs

Price/Earnings Price/Book Value Price/Tangible Book Value Price/Assets

10.7x 59.0% 80.7% 3.2%

-6% 40% 21% 61%

11% 1% -27% 61%

Dr. Rochester's 1993 Valuation Value of $190 Million
($153.5 Million Net Increase in Capital)
Discount (Premium) to All Publicly Traded Thrifts at 7/28/1993

Recalculated First Federal Pricing Ratios

Discount (Premium) to 1993 IPOs

Price/Earnings Price/Book Value Price/Tangible Book Value Price/Assets

9.8x 55.6% 77.5% 2.8%

3% 43% 24% 65%

18% 7% -22% 66%

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EXHIBIT 2-B
First Federal of Rochester Dr. Kaplan's Recalculated 1993 Valuation vs. Dr. Rochester's Recalculated 1993 Valuation - $7.4 MILLION TAX BENEFIT SCENARIO -

Dr. Kaplan's 1993 Valuation Value of $220 Million
($177.5 Million Net Increase in Capital)
Discount (Premium) to All Publicly Traded Thrifts at 7/28/1993

Recalculated First Federal Pricing Ratios

Discount (Premium) to 1993 IPOs

Price/Earnings Price/Book Value Price/Tangible Book Value Price/Assets

10.9x 58.9% 79.5% 3.3%

-8% 40% 22% 59%

9% 1% -25% 60%

Dr. Rochester's 1993 Valuation Value of $195 Million
($157.5 Million Net Increase in Capital)
Discount (Premium) to All Publicly Traded Thrifts at 7/28/1993

Recalculated First Federal Pricing Ratios

Discount (Premium) to 1993 IPOs

Price/Earnings Price/Book Value Price/Tangible Book Value Price/Assets

9.9x 55.2% 76.0% 2.9%

2% 44% 26% 64%

18% 7% -20% 65%