When a company in a tight spot wants to reassure shareholders and lenders, one really good way of doing exactly the opposite is to refuse to take questions on an earnings call. First Republic Bank’s executives did just that on Monday evening. The effect on its share price was predictably horrible.
Owners of the $20 billion of uninsured deposits still at the bank are likely to be incredibly nervous, if not already moving. The 11 big banks that loaned First Republic $30 billion in the form of unsecured term deposits last month will equally be watching this slow motion implosion with gritted teeth. Goldman Sachs Group Inc seemed to signal wariness over its $2.5 billion share of those loans in its first-quarter results when it said it had booked a loss provision on a term deposit.
The one bright spot in this story is that the rest of the banking system doesn’t seem to be reacting with the same panic as during the collapse of Silicon Valley Bank just over a month ago. First Republic shares dropped 49 percent on Tuesday as the KBW banks index slid only about 3 percent. They tumbled more than 20 percent to a record low Wednesday — with the gauge mainly unchanged — on a CNBC report that it was lining up potential buyers of new stock as part of a rescue plan.
This didn’t seem inevitable a month ago. In March, some analysts thought First Republic was suffering unfairly from the SVB contagion: It had nothing like the concentration of venture capital industry deposits and its bond holdings – both mark-to-market and held at cost – were relatively small.
SVB had 57 percent of its assets in bonds – 14 percent held at market value as available for sale and 43 percent booked as hold-to-maturity. The unrealised losses on these portfolios is what spooked its depositors. At First Republic, only 15.5 percent of its assets were in bonds and they were mostly held to maturity: The bank wouldn’t have to recognise the losses from rising interest rates unless it was forced to sell.
However, it turned out that First Republic had a lot of other assets that caused exactly the same problem as big bond holdings: Interest-only home loans that weren’t due to get any principal repayments for 10 years. That’s functionally pretty similar to a 10-year bond and they are also booked at face value in the accounts.
“The primary strategy was to provide below market-rate jumbo non-conforming mortgages with a request to the borrower that they bring in and maintain a portion of the loan value in the form of deposits,” Arren Cyganovich, an analyst at Citigroup Inc, wrote on Tuesday. “This created a higher-than-normal level of uninsured deposits and with no real agreement to maintain the deposits, which led to the bank run.”
First Republic lost more than $100 billion of customer deposits in the first quarter — 41 percent of the total it had at the end of last year. It is left with $55 billion of insured deposits, $20 billion of uninsured deposits and $30 billion of those term deposits from other big banks.
Ultimately, First Republic was very similar to SVB: It had a lot of fixed-income assets held at cost and a high reliance on a fairly homogenous group of uninsured depositors who were highly motivated to watch their money.
The bank’s problem now is how to get out of its hole. No one is going to buy its mortgages at face value, but selling much of the book at fair value could be ruinous. It might be able to convince someone to take some mortgages and bonds at face value with the gift of some warrants on the equity of First Republic, so that the buyer would profit on the seller’s hoped-for recovery, as Bloomberg News reported Tuesday.
Maybe. First Republic’s core strategy is a big part of what got it into trouble, which leaves big questions over what its new strategy would even be and how would shareholders value that? And that’s aside from the questions not only about how much its mortgages are currently worth but also what their credit performance will likely be over their lifetimes, especially if a recession arrives and high-end homes lose value.
It’s very hard to see a good outcome in First Republic’s story.
Paul J Davies is a Bloomberg Opinion columnist covering banking and finance. Previously, he was a reporter for the Wall Street Journal and the Financial Times.
Credit: Bloomberg
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