2023-03-13 11:42:17 ET
Summary
- First Republic Bank has lost 80% of its value over the last three trading days.
- This presents an opportunity as First Republic is highly profitable with just 4% of its deposits from technology-related companies.
- Whilst a bank run would likely only be possible if there is mass panic, their deposit base is significantly more diversified.
I'm buying First Republic Bank ( FRC ) on the back of an intense shroud of fear that has spread across the financial markets. In times of chaos, rare opportunities to create alpha often materialize for a short period of time and I think First Republic has become a victim of fears that if not contained could become a self-fulfilling prophecy. There are legitimate concerns about the health of the US financial system following the sudden collapse of Silicon Valley Bank ( SVB ). This came in a week that also saw another FDIC-insured bank Silvergate ( SI ) liquidate. Hence, the music might be about to stop and the specter of cascading bank runs now haunts us all.
Bank runs are hard to stop and First Republic's sudden 80% move from $122 per share to $25 per share in three trading days reflects near-visceral market angst around the potential contagion effects from the liquidation of Silicon Valley Bank. Silicon Valley Bank was the 16th largest bank in the US and its collapse was catalyzed by factors that are not reflected by First Republic. Silicon Valley Bank's deposits were majority constituted from VC-funded technology firms against just 4% of total deposits coming from technology-related companies for First Republic. No single sector formed more than 9% of First Republic's total deposits.
Dual Beats And Heavy Cash Flow Generation: The Material Differences
A bank run is hard to stop when it's underway and becomes terminal when demands for short-term deposits are greater than the illiquid assets held by a bank. The prospect of this happening with First Republic is low in my view, but there is undoubtedly uncertainty around the potential of unrestrained fear to snowball. What's the difference? Firstly, Silicon Valley Bank had unrealized losses on its bond investments that were more than 120% of its tangible equity as of the end of its fiscal 2022 fourth quarter. This figure for First Republic was 35% with 68% of deposits also being above the FDIC insurance limit. Again, this figure was greater than 90% for Silicon Valley Bank. Further, First Republic's business depositors had an average account size of less than $500,000 whilst its individual account depositors had an average account size of less than $200,000.
First Republic recently reported earnings for its fiscal 2022 fourth quarter saw revenue come in at $1.46 billion , a huge 40% increase versus the year-ago quarter and a beat by $510 million on consensus estimates. This was driven by a net interest income of $1.2 billion, up 4.9% from the year-ago comp. The bank originated $15.6 billion worth of loans during the quarter.
The bank's year-over-year financial comps were impressive with loans growing by 23.6% , total revenues growing by 16.5% with tangible book value per share reaching $73.07 , a growth of 10.6%. So what exactly is the controversy? Indeed, the bank held a tier 1 leverage ratio of 8.51% with non-performing loans at only 5 basis points of total assets. To be clear here about my bullishness, First Republic recorded a net income of $386 million during the quarter with an EPS of $1.88, a beat by $0.08 on consensus estimates.
What Recovery Could Look Like
The VC network effect and subsequent crowding in of negative sentiment led to the collapse of Silicon Valley Bank. It's a large but highly interconnected industry and this compounded the bank run on Silicon Valley Bank. That this happened on the same week that Silvergate Bank ( SI ) collapsed was too much too quickly. Fears, shorts, and bears now state we stare at a crisis likely to mirror 2008 but I believe this view is unnecessarily alarmist.
The current fears are not entirely unjustified with two US FDIC-insured bank failures in a week. However, First Republic is not Silicon Valley Bank and the intervention by the Fed to guarantee the deposits of uninsured depositors will likely calm fears and reduce the probability of a run on First Republic. To be clear here, First Republic is collapsing on fears around a potential bank run and the health of its balance sheet, but the quick intervention by the Fed and the company's enhanced access to liquidity should reduce the probability of this scenario playing out.
I now own First Republic's common shares with my near-term view that these will recover once the current shroud of fear clears. The key risk here is that the company faces a run on its deposits as described by the bears and is forced to enter FDIC receivership. Hence, I see this as a nearly binary high-risk high-return play. First Republic is now trading at a $15.23 billion market cap and trailing 12-month price-to-sales multiple that's the lowest since it went public. Of course, bears could flag that capital flight away from regional banks to systemically important banks would reduce forward revenue growth for First Republic. Indeed, the probability of businesses keeping their funds in the bank has been lowered with the risk of liquidation versus the relative safety that would come with an account at JPMorgan Chase ( JPM ), Wells Fargo ( WFC ), Citi ( C ), and Bank of America ( BAC ). This could unfortunately be the likely scenario to be realized by First Republic, with my position more of a play on current fears moderating.
For further details see:
First Republic Bank: I Think The Fear Will Pass, I'm Buying