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Shortly after Silicon Valley Bank disclosed on March 8 that it was running short of cash and needed to raise capital, First Republic Bank’s epic stock slide began.
The stock
FRC,
has lost 90% of its value in less than two weeks, hitting an all-time low of $12.18 a share on Monday.
Supportive comments from Treasury Secretary Janet Yellen helped it snap back on Tuesday, but it’s hovering between positive and negative territory on Wednesday as investors await a key Federal Reserve decision on interest rates.
First Republic finds itself in a tough spot with a low share price and fresh debt downgrades and not even efforts to inject $30 billion into the company’s deposits in a scheme backed by JPMorgan Chase & Co.
JPM,
and a backstop from the U.S. Federal Reserve seem to be helping.
The bank’s troubles stem from its overlap both in clientele and parts of its balance sheet with doomed Silicon Valley Bank, which is being sold off this week by the Federal Deposit Insurance Corp. after it officially failed on Friday, March 10. Silicon Valley Bank suffered a classic run on a bank, when depositors, nervous that it needed to raise capital, yanked their deposits.
First Republic has suffered the same deposit flight.
As a San Francisco bank with a focus on serving high-end clients, First Republic has acted as wealth manager for the greater Silicon Valley region of executives, managing directors and startup CEOs, as well as their counterparts on the East Coast.
The list incudes Facebook
META,
Founder Mark Zuckerberg, who has a large mortgage courtesy of First Republic, as the Wall Street Journal has reported. Few of its loans ever sour — it had $213 billion in assets at the end of 2022 and $176 billion in deposits.
With its sophisticated lending products and access to the technology startup world, Silicon Valley Bank was also known for its a customer base from the venture capital and private equity world.
Also Read: 24 bank stocks that contrarian bottom-feeders can feast on now
Those well-heeled clients of both banks started running into problems as interest rates rose last year, pundits warned of an economic slowdown and investors switched to a risk-off strategy of conserving cash and containing costs.
The collapse of FTX and strain in the crypto world also fed the need for cold, hard government-backed currency. Rising interest rates made it more expensive to borrow and put a chill on the deal-making environment.
All of this and other factors led to a drain on deposits at Silicon Valley Bank and others as it faced “elevated client cash burn” at a rate that was double pre-2021 levels, even as venture capital and private equity funds were slowing down their capital raising activities, the company said in an ill-fated mid-quarter report.
On March 8 after the market close, Silicon Valley Bank said it planned to sell $2.25 billion in common stock and a type of preferred stock, with one of its major clients, private equity firm General Atlantic, in line to buy $500 million worth. Goldman Sachs Group Inc.
GS,
was handling the deal.
The company also disclosed that it had lost $1.8 billion on the sale of $21 billion in available-for-sale securities on its balance sheet to cover deposit withdrawals.
It was this last part that caused big trouble for First Republic. Not only did its clientele overlap with Silicon Valley Bank, its holdings included some of the same securities that Silicon Valley Bank sold at a loss.
Wall Street investors quickly started bidding down shares of First Republic and other regional banks and the credit rating agencies moved in, cutting the bank’s rating from investment grade deep into junk in just a few days.
None of this helped First Republic hold on to its deposits.
As one longtime banking official said recently, money from Silicon Valley types typically comes in the form of uninsured deposits, which means they’re in excess of the $250,000 that the FDIC will guarantee if a bank goes out of business. This so called hot-money is great for banks when times are good, but can move away quickly if the environment changes.
“When hot money gets nervous, it runs,” former FDIC chairman Bill Isaac told MarketWatch recently.
While an unprecedented effort on March 16 by 11 banks to inject $30 billion into First Republic’s deposits temporarily provided a lift to its stock, the move apparently wasn’t enough.
First Republic said last Thursday that it had borrowed between $20 billion and $109 billion from the Federal Reserve during that week. It also increased short-term borrowing from the Federal Home Loan Bank by $10 billion at a rate of 5.09%.
Jefferies analyst Ken Usdin said the numbers revealed that First Republic’s total deposits had dropped by up to $89 billion in the week ended March 17 past week—or about three times more than the $30 billion injection from the bank.
“With [First Republic’s] earnings profile clearly impaired, the new deposits effectively bridge the estimated $30.5 billion of uninsured deposits still on [the bank’s] balance sheet, providing time for [it] to likely explore a sale,” Usdin said.
Janney Montgomery Scott analyst Tim Coffey said First Republic’s stock drop in recent days reflects uncertainty around what a potential second bailout would look like, or how the bank’s balance sheet is faring after a steep run in deposits and the falling value of its long-dated securities.
Another unknown is the company’s latest Tier 1 capital Ratio, a key measure of a bank’s balance sheet strength.
Like Silicon Valley Bank, First Republic’s balance sheet has had more than the usual exposure to long-dated securities, which have been falling in value as interest rates rise.
A typical mix for a bank of comparable size is to hold about 72% of securities as available for sale. The remaining 28% are held to maturity. First Republic’s mix is reversed with 12% available for sale and 88% held to maturity.
The bank’s mix of longer-dated assets now commands a lower market value, given where interest rates are. The bank’s emphasis on long-dated securities provided a better return when interest rates were near zero, but they have been a liability in the current environment.
“They’ve had duration risk where the value of their securities started going down as interest rates rose,” Coffey told MarketWatch.
Another problem for First Republic is that many of those long-dated securities are in the mortgage business, which has been ailing as interest rates rise.
Plenty of questions remain about First Republic’s situation and whether it could have been avoided. The challenges facing First Republic as well as the demise of Silicon Valley Bank and Signature Bank will be the focus of hearings on Capitol Hill next week.
Wall Street is also awaiting comments from the U.S. Federal Reserve when it updates its interest rate policy later on Wednesday.
And JPMorgan Chase continues to work with First Republic on a potential bailout, even as the bank has reportedly hired Lazard
LAZ,
to weigh strategic alternatives.
All of these factors add to the uncertainty swirling around First Republic, giving investors little reason to go long on the stock for now.
Also Read: 24 bank stocks that contrarian bottom-feeders can feast on now
Related: Senate Banking Chair Sherrod Brown sees bipartisan support for changes to deposit insurance
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