FRC - First Republic Bank: The Preferred Dividend Is Gone

2023-04-10 18:40:54 ET

Summary

• First Republic Bank made a new 8K disclosure on Friday.
• In it, the bank informed markets that it was suspending its dividends for its preferred stocks.
• The dividend suspension is designed to conserve liquidity.
• I don't expect the suspension to have a material effect on the bank's valuation and I continue to believe that FRC is a recovery play with an asymmetric risk profile.

First Republic Bank ( FRC ) made a regulatory disclosure on Friday in which the bank announced that it was going to suspend its dividends on its outstanding preferred stock. The dividend suspension comes shortly after First Republic Bank, facing an unprecedented liquidity crisis following the shutdown of Silicon Valley Bank in March, suspended the dividend on its common stock last month as well. I believe that the bank's upcoming Q1'23 earnings release could be a catalyst for First Republic Bank since investors have very low expectations. FRC remains a high-potential, high-risk investment for investors with a high risk tolerance, despite the dividend suspension!

My position in First Republic Bank and background

I currently have a long position in First Republic Bank, which I established after the bank crisis evolved in March. First Republic Bank offers, in my opinion, an asymmetric risk profile that favors the upside.

The community bank suffered the most in the U.S. regional banking market after the financial crisis unfolded in March, due to First Republic Bank's large share of uninsured deposits. The bank has enacted numerous measures to bolster its liquidity situation, including tapping the Fed's Bank Term Funding Program ((BTFP)) and raising $30B in deposits from top tier banks in order to calm investors. The BTFP makes short term loans available to U.S. depositary institutions which have to pledge collateral in order to access the Fed's emergency liquidity facility. Since First Republic Bank had a large (63%) share of deposits from companies , FRC was especially at risk of deposit withdrawals. Since the Fed provided an effective deposit backstop and other banks came to the rescue of First Republic Bank, I believe the liquidity situation has been effectively resolved.

Latest 8K disclosure and evaluation

First Republic Bank announced in an 8K disclosure on Friday April 7 that it was suspending its dividends on its outstanding noncumulative perpetual preferred stock. Noncumulative means the bank has no obligation to pay dividends in the future that it suspended in the past. For First Republic Bank, the suspension is an easy way to save liquidity fast and management clearly stated that it wants to save cash "as a measure of prudent oversight." The preferred stocks of First Republic Bank that are affected by the dividend suspension are shown in the table below.

The move to suspend preferred stock dividends was sort of expected and should not make a big valuation impact on the bank's valuation this week... so my opinion on FRC hasn't changed. First Republic Bank already suspended its common stock dividend back in March in a bid to stem cash outflows. In FY 2022, First Republic Bank paid $190 million in common stock dividends and $158 million in preferred stock dividends... which implies that the total savings potential translates to approximately $348 million annually.

Q1'23 earnings release, EPS trend and catalyst potential

The upcoming earnings release for the first-quarter may be a catalyst for First Republic Bank's shares as investors will get a detailed look at the bank's financial statements. Investors will also be able to see the true impact the financial crisis had on the bank's deposit base and how many deposits actually left the bank's ledger. The earnings release is scheduled for April 24, 2023, after the market closes.

EPS estimates have corrected sharply to the down-side in March which ironically raises the odds of First Republic Bank being able to beat predictions in about two weeks. Estimates now call for just $0.51 per-share in Q1'23 earnings, showing a 75% decline year over year. The EPS trend is profoundly negative which also makes it likely that better than expected results could have a big valuation impact on FRC. I believe a bad earnings report is fully priced into First Republic Bank's shares at this point and the bank could easily surprise the market if earnings or deposits come in stronger than expected.

First Republic Bank’s valuation

Not much has changed regarding First Republic Bank’s price to book valuation in the last week, and I do not expect the preferred dividend suspension to have a material impact on the community bank's valuation ratio. First Republic Bank continues to have an excessive discount to book value in the community banking sector and FRC has an even larger BV discount than PacWest Bancorp ( PACW ) and Western Alliance Bancorporation ( WAL ). From a valuation point of view, I continue to believe that First Republic Bank is a potentially very lucrative investment, but only for investors with a high risk tolerance.

Before the financial crisis, FRC traded at an average price-to-book ratio of 1.81 X while the bank now trades at merely 0.19 X book value: the market clearly prices FRC for disaster right. If the bank were to report on April 24, 2023 that some deposits were already coming back to the bank, I believe the bank's shares could re-rate higher. The discount to book value is by far the largest in the sector, reflecting (potentially exaggerated) concerns about the bank's deposit and liquidity situation.

Risks with First Republic Bank

First Republic Bank faces two big risks right now which are interrelated: (1) The bank may see more withdrawals of (uninsured) deposits, and (2) The bank may be forced to bolster its capital base... which may result in a dilutive equity raise. In the worst-case, First Republic Bank may have to sell itself to a top tier commercial bank such as Bank of America ( BAC ) or Wells Fargo ( WFC ), but I believe the probability of this happening is very low. What would change my mind about FRC is if the bank saw continual deposit withdrawals in April and a massively shrinking balance sheet.

Final thoughts

The suspension of First Republic Bank's preferred stock dividends was kind of expected after the bank already suspended its common stock dividend in March in order to conserve cash at a time when a larger liquidity crisis developed in the U.S. financial system. Therefore, I believe the suspension of preferred stock dividends should not have a larger impact on the bank's valuation this week. What will have a much larger effect on First Republic Bank's valuation is the upcoming earnings release on April 24, 2023 which will show investors exactly how many deposits the community bank has lost during the March meltdown. Considering that the market has calmed down since the shutdown of Silicon Valley Bank and that EPS expectations are extremely low, FRC remains a highly promising asymmetric bet on a broader recovery in the U.S. community banking market!

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