PNC - First Republic Bank: Seems Done

2023-04-30 08:17:20 ET

Summary

• First Republic Bank has been troubled since the March turmoil.
• First quarter results, and notably deposit outflows, seemed to have sealed the fate of the bank here.
• A zero pay-off for (common) equity holders seems most likely here.

Earlier this week I concluded that uncertainty was all that investors could expect from shares of First Republic Bank ( FRC ) . This came after first quarter results showed huge deposit outflows.

While the impact of these outflows was clearly seen in the first quarter ending balances, the impact of higher cost of funding was only seen really late during the quarter (as the banking crisis really emerged by mid-March).

Given the dire situation, the bank was in a very serious position, no longer controlling its future (entirely) itself.

Some Background

Founded in 1985, the San Francisco based bank has seen solid growth over time, posting total assets in excess of $200 billion in 2022, reporting a simple common equity ratio around 8%. The bank has fallen victim (in part self-inflicted) by the current turmoil in the banking sector as higher interest rates made that securities are trading underwater, as the related concerns of this made that many depositors have withdrawn money from the bank.

This came as the bank has mismanaged its asset and liability mix from a duration point of view, but moreover was overrepresented in the technology sector and offered quite exotic products to high net worth individuals as well.

Shares of the bank traded as high as $220 in 2021, granting the company a $40 billion market capitalization and while shares were down to $140 at the start of the year, it has gone quickly downhill from here. The SVB crisis in March triggered shares to fall to the forties, as shares quickly lost value from here despite $70 billion in liquidity provided by the Federal Reserve Bank and JPMorgan Chase ( JPM ) .

The first quarter results, as released earlier this week, showed the massive moves in the deposit base. Deposits fell from $176 billion to $104 billion, with the bank taking on more than a hundred billion in short- and long term borrowings to fund the deposit hole. Moreover, the $104 billion in deposits even included some $30 billion in deposits held by other banks!

While the company announced a mere 2% decline in the deposit base between March 31 and April 21, the situation was simply too dire as the company was borrowing at very high rates (higher than it lends money out to customers and assets) to plug the deposit deficit, setting the company up for dire second quarter results. Moreover, I was amazed by the fact that the bank only offered depositors about 1.5% on its website, when I looked at the website during the week.

With shares down to $8 and change in the immediate aftermath of the results, the company was trading at a fraction of its reported book value, a testament to the lack of confidence by investors in the bank.

Given this uncertainty I believed that the likely outcome was some kind of resolution in which the bank was taken over by the Fed, and with that I do not mean the Federal Reserve Bank, but generally a governmental-related institution (or FDIC receivership), for instance. If the company could handle its problems, upside might be seen, but it was very late in the game, with renewed uncertainty arising every day, hurting the value of the franchise and reducing time to save the bank.

Moreover, the question was if regulators and politicians would allow the bank to dwindle around so long, as the repercussions of this uncertainty go beyond the bank of course.

What Now?

Since the release of the first quarter results, which triggered another round of concerns, shares have fallen to just $2 and change in after-hour trading on Friday as the bank heads into the weekend.

Troubles started on Wednesday after reports surfaced that the bank's access to Federal Reserve facilities might become more limited following potential cuts in the credit rating, as the bank reportedly was looking to sell off tens of billions in assets as well. This was highly troublesome as the government has no interest in trying to bail out a bank, given the political scrutiny. Banks like JPMorgan, which has been heavily involved with the bank since the March woes, has not made a move either as it got more familiar with the operations.

Towards the weekend reports surfaced that an FDIC takeover was imminent, causing shares to plummet further as such a solution does not bode well for (common) equity shareholders. Investors can only hope that a reported bidding race between JPMorgan Chase and PNC Financial ( PNC ) are realistic, potentially leaving some upside for common equity holders, but a likely scenario is that one of these banks takes receivership of the assets, with or without a contribution made by the FDIC or Treasury.

Death Spiral

Given the nature and frequency of the developments surrounding First Republic Bank, the likely outcome is some kind of final solution in the coming days, and the reality is that the outlook for (common) equity holders looks very dire, with the likely scenario being a zero pay-off, as assets are likely taken over by other investors, providing stability for the remainder of the banking sector.

Given all this, we likely see some kind of solution which should provide some stability for the sector at large here, but it shows that not all banks are out of the woods yet. After all, we might see a new liquidation event two months after the whole uncertainty broke out in the sector.

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