Embattled bank First Republic (FRCB) reported its highly anticipated first-quarter earnings results after the market closed on April 24.
While the headline numbers beat analyst estimates pretty easily, I don't think the bank is in any better shape than it was prior to its earnings report. Shares fell significantly after rallying leading up to the release of earnings.
The banking crisis began in the second week of March and therefore only occurred for a short period of time in the first quarter, so its full effect has likely not been felt yet. In fact, I think First Republic's earnings troubles have only just begun. Here's why.
Deposit trends
Heading into earnings, all eyes were on deposits after media outlets had estimated that First Republic had likely seen at least $70 billion of deposit outflows during the crisis. I think the deposit trends came in worse than anticipated.
Right before the banking crisis began, First Republic had $173.5 billion of deposits on March 9. As of April 21, total deposits at the bank were $102.7 billion. The other thing to remember is that the bank still has $30 billion of deposits injected by 11 of the largest U.S. banks in an effort to shore up liquidity, so deposits are really down by more than $100 billion.
These outflows include more than $42 billion of noninterest-bearing (NIB) deposits on a period-end basis, which are deposits the bank pays no interest on, as well as roughly $18 billion of interest-bearing deposits. First Republic also saw close to $20 billion of money market checking outflows.
To replace these deposits, First Republic has had to load up on expensive funding sources such as certificates of deposits (CDs), which rose by $24.6 billion in the first quarter, and short-term borrowings from the Fed, which are up from $6.7 billion at the end of 2022 to more than $80 billion at the end of Q1.
Earnings deterioration has just begun
First Republic actually reported diluted earnings per share of $1.23 but I think the earnings struggles have just started because the banking crisis only occurred for a small part of the first quarter.
First Republic saw its net interest margin (NIM), which essentially looks at the difference between the interest made on interest-earning assets such as loans and paid out on interest-bearing liabilities such as deposits, compress from 2.68% at the end of 2022 to 1.77% in Q1. But this is on a quarterly average basis and does not reflect the current situation.
Image source: First Republic.
The 1.77% NIM includes average NIB deposits of $52 billion and only total borrowings of $39.2 billion. Based on period-end balances and April numbers provided by management, we know NIB deposits are way lower and borrowings are way higher. The bank's average cost of CDs in the quarter was also only 2.93%. But right now, First Republic is offering 30-day CDs of 4.35% and a five-month CD special at 4.95%, so margin compression will likely be much more pronounced in Q2.
What the bank will do
First Republic's goal is to shrink the balance sheet so it can get the higher-cost short-term borrowings off as soon as possible. The bank intends to do this by slowing loan volume or selling originations to investors in the secondary market so they stay off the balance sheet. It is also planning to lay off as much as a quarter of its workforce and explore other strategic alternatives "to expedite its progress while reinforcing its capital position."
The big issue here is that I don't see any good options short of the deposits that First Republic lost returning to the bank, which seems unlikely at this point.
The longer that First Republic keeps the higher-cost borrowings and funding on its balance sheet, the more it will continue to erode profitability and perhaps start to generate losses, which will eat into capital. Plus, I don't think First Republic can really sell assets right now because much of its securities book and large mortgage portfolio are still underwater due to the high interest rate environment.
A lot of this is reflected in First Republic's stock price, which is down more than 90% this year, but I wouldn't recommend buying the dip because I don't see a viable path forward. I suspect that regulators and the bank's management team are hoping to reduce unrealized losses in its bond and loan portfolio to a point where it can make significant asset sales or eventually sell the bank.
