JPM - First Republic: Be Weary Of People Bearing Gifts

2023-03-22 10:50:55 ET

Summary

• First Republic continues volatile trading due to uncertainty regarding the bank's funding sources despite multiple deals.
• The bank was highly dependent on business accounts with an average deposit balance of $490,000 leading to these uninsured accounts likely fleeing the regional bank.
• Any rescue package would be highly dilutive with the market cap down to $3 billion.
• Investors should be wary that all of the recent bank deals have wiped out or diluted shareholders.

First Republic Bank ( FRC ) shareholders have been on a roller coaster ride since the regional bank was first hit by worries of a run on deposits. Federal bank regulators and large domestic banks have all offered solutions to help resolve the deposit run on First Republic, but investors should be weary of these gifts considering other bank resolutions in this crisis. My investment thesis is Neutral on the bank stock with binary outcomes leading to unacceptable risk.

Big Bank Gift

Credit Suisse Group AG ( CS ) was bought over the weekend by UBS ( UBS ) for a nearly 60% discount from the closing stock price for the prior week. Investors incorrectly thought regulators were working on deals to shore up the financial system, but forced deals that wipe out a group of stakeholders in a business tend to only cause more panic.

Only last week, a consortium of large banks funded First Republic with $30 billion in deposits . The money from large banks like JPMorgan Chase ( JPM ), Citigroup ( C ) and Bank of America ( BAC ) were meant to provide stability for the regional bank with deposits that had left the bank and flooded the large banks with excess deposits.

A week later, JPMorgan CEO Jamie Dimon is reportedly leading a rescue package in order to provide fresh capital or sale of some of the bank's assets. As with Credit Suisse, the fact Jamie Dimon is working on a package to raise capital or possibly convert some of the $30 billion in deposits into capital is only going to lead to an additional panic in the regional bank.

The problem is that all of these moves just lead to further destabilize the business and cause deposits to flee. After all, First Republic had announced March 12 that the bank had access to additional liquidity from the Federal Reserve and JPMorgan Chase bringing the unused liquidly of the bank to more than $70 billion before even tapping into the Bank Term Funding Program.

If the bank had stopped here, the crisis might be over. The work with the big banks for $30 billion in additional deposits only likely to led to additional deposits to flee. Every additional move the bank makes to shore up liquidity only suggests the last move didn't work.

Along with the original announcement on March 12, Founder and Executive Chairman Jim Herbert made the following statement:

First Republic’s capital and liquidity positions are very strong, and its capital remains well above the regulatory threshold for well-capitalized banks.

If this was the case, First Republic wouldn't need to work with the large banks to grab $30 billion in additional deposits when a lot of signs suggest deposits outflows from regional banks have stopped. Is it possible that JPMorgan arrived with a gift and it only sowed instability, whether intended or not?

On March 16, First Republic suggested insured deposits were stable and daily deposit outflows have slowed. Of course, the biggest issue with the bank borrowings from the Federal Reserve and the Fed Home Loan Bank are the rates of 4.75% to 5.09%.

The statement from the nation's biggest banks don't add up considering JPMorgan is already working on capital raises that a healthy bank wouldn't need:

This action by America’s largest banks reflects their confidence in First Republic and in banks of all sizes.

What Now

The stock has seen the market cap fall to only $3 billion. For 2022, First Republic reported net income of $1.7 billion alone and a tangible book value per share of $74.19. Any rescue package would be highly dilutive and below tangible book value.

The company had total deposits of $176.5 billion with an average cost of only 99 basis points. The regional bank had limited credit quality concerns with very minimal nonperforming assets of 5 basis points.

Depositors really had no reason to flee the bank. The problem though is that deposits were a low cost source of funds with the bank only having total funding costs of 112 basis points.

Amazingly, the bank even touted their downfall in the January presentation . The regional bank serves HNW clients that recommend their businesses and non-profit originations to use the bank as a primary bank with average deposit accounts of $490,000. The business accounts accounted for $110.9 billion for of deposits at the end of 2022.

With the Federal Reserve and FDIC unwilling to explicitly guarantee deposits above $250,000, these businesses have no choice but to open additional accounts at other banks. In theory, First Republic should've seen deposits flow their way from other regional banks, but the crisis focuses strongly on the regional banks forcing potential business and HNW clients to send excess cash to larger banks like JPMorgan and BoA.

The amazing part about the January presentation is the total lack of focus on uninsured deposits. The regional bank, along with peers and bank regulators, didn't appear to grasp this complete hole in the business model.

Takeaway

The key investor takeaway is that more talks of capital raises and asset sales at First Republic are only likely to cause more weakness in the business. Investors can't be certain on the financial outcomes of these deals with bank regulators closing multiple banks wiping out shareholders and Credit Suisse being taken under by UBS.

The outcome for First Republic is too binary without actual details on deposits and updated costs on other funding sources. With so much potentially bubbling under the surface and the recent regulator deals, the stock has too much of risk of a highly negative outcome. Investors should be very weary of banks like JPMorgan bearing gifts because these deals are likely to require far more favorable terms them deposits that have implicit security.

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