SBNY - First Republic Bank: The Pain Is Getting Worse

2023-03-13 10:59:11 ET

Summary

• First Republic Bank investors are not taking any chances here after the Silicon Valley Bank fallout, sending its shares down more than 60% pre-market.
• Management upsized its unused liquidity to $70B, on top of the Fed's $25B Bank Term Funding Program.
• However, First Republic Bank investors will not be bailed out in a failure, worsening buying sentiments.
• Moreover, the sudden seizure of Signature Bank could have heightened their concerns, threatening to wipe them out at unpredictable moments.
• Investors still holding the ball are in for real pain here.

There is absolute mayhem (down 64% at writing in pre-market) at First Republic Bank ( FRC ) as it continues to suffer from the fallout of the collapsed SVB Financial Group ( SIVB ). This is despite the joint action by the Fed, Treasury, and the Federal Deposit Insurance Corporation or FDIC as it created a funding vehicle to backstop other bank runs.

The $25B Bank Term Funding Program, or BTFP , which is not considered a government bailout and not funded by taxpayers, was thought to have provided relief to FRC and its regional bank peers.

Moreover, management highlighted that it had increased its liquidity capacity in collaboration with the Fed and JPMorgan Chase & Co. ( JPM ). As such, FRC's unused liquidity was upgraded to $70B from $60B.

But why is the market still battering FRC? Wasn't the confidence booster by the Fed-Treasury-FDIC sufficient to backstop depositors?

Depositors, yes, but investors, no. The sudden takeover of Signature Bank ( SBNY ) by New York regulators could have spooked investors. Barney Frank, a former congressman who " formed one half of the landmark Dodd-Frank financial law after the 2008 financial crisis," weighed in on the surprise closure. He highlighted that "regulators had moved too fast to seize Signature, which he said was otherwise strong."

Moreover, this came after the bank's deposit outflows " had stabilized by Sunday." With the closure, equity holders should expect to be wiped out. The government has also clarified and emphasized that it will not bail out investors and owners.

Hence, we believe FRC holders are likely in full panic mode now, trying to get out as soon as possible. They are likely planning for the worst outcome, as the Fed and the U.S. government will leave them in the lurch, with the risk of sudden seizure to consider, too. That's a highly risky proposition to even think about.

Does it make sense? Does the $70B in unused liquidity sufficient to stem a bank run? Moreover, it could still tap the $25B BTFP.

First Republic Bank reported assets worth about $212.6B for the year ended 2022. In addition, FRC posted deposits of $176.4B. As such, its unused liquidity of $70B adds to its cash and equivalents of $4.3B, covering about 42% of its deposit base.

Its investment securities portfolio accounted for 15% of its total assets, with about $3.3B (carrying value) of available-for-sale or AFS securities, accounting for 1.6% of its asset base.

The held-to-maturity securities were worth $28.4B (carrying value), with unrealized losses of $4.8B. As such, while it doesn't seem like FRC could run out of money in the near term, investors are not taking any chances.

But does it make sense?

Despite last week's selloff, FRC still traded at an NTM P/E of 13.5x at the close of Friday's trading. It was still well above its peers' median of 8.1x, per S&P Cap IQ data.

We believe the threat of significant deposit migration could continue to threaten FRC, even with the upgraded lifeline provided by the Fed and JPMorgan.

It's a simple question. Is there any risk for depositors to move funds out of FRC to JPMorgan or Bank of America ( BAC ), for example?

Likely not, unless such terms are tied with significant credit lines for business banking or for their preferred/private banking arrangement that require them to pay back the funds. Hence, deposits are probably not as sticky as investors thought, as seen in the SIVB case. Intangible assets, like banking relationships, can go up in smoke very quickly in a panic.

As such, investors will need to consider that deposit migration could hit FRC really hard, which might need the bank to steeply mark down its ability to recover its earnings growth momentum.

Moreover, the Fed and the policymakers could be in discussions to reverse at least some part of the easing in 2018 by the Trump Administration. It allowed some banks not designated as systemically important banks, or SIB, to operate with less stringent regulation and monitoring.

If the revisions were to create a more stringent approach to regulating FRC and its regional banking peers, it could also weaken its competitiveness against the big banks.

First Republic Bank also highlighted such heightened regulatory risk in its filings:

Depending on the company's levels of capital and liquidity, stress test results, and other factors, it may be limited in the types of activities it can conduct and how it can use its capital, including with respect to dividends. - FRC 10-K.

We observed that the pre-market battering had sent FRC down to lows last seen in December 2012, wiping out more than 10 years of gains.

Therefore, the market is pricing for the fallout to worsen significantly. It appears that investors are not taking any chances here, even though a speculative opportunity could be in the making if FRC survives.

With its implied NTM P/E down to 5.2x, the First Republic Bank opportunity looks attractive if it survives. However, given the multitudinous headwinds outlined previously, the market needs to take a steep discount against its peers' median.

However, the sudden seizure of Signature Bank has thrown investors a curve ball, which could hold back any buying sentiments to define the level. As such, we believe investors should wait patiently for a buy point to appear if they intend to add exposure.

Rating: Hold (On Watch)

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