There's no getting around it. First Republic Bank (FRCB) dished out disappointing first-quarter numbers. Chief among them is the $100 billion tumble in total customer deposits, driving shares 49% lower on Tuesday following Monday's post-close release of the bank's Q1 report. If the decision to lay off one-fourth of its workers is any indication, the bank doesn't know when -- or even if -- it will get this money back.
However, there's a small victory quietly buried in other parts of the bank's balance sheet. Namely, its asset base actually looks a little healthier now than it did headed into last quarter's suspected liquidity crisis sparked by rival Silicon Valley Bank (owned by SVB Financial). This backing is made even healthier (relatively speaking) by the fact that First Republic now has considerably fewer deposits to cover.
It's complicated, but not as complicated as it sounds
On the off chance you're reading this and aren't aware, Silicon Valley Bank collapsed last month due to major liquidity problems. Basically, it was struggling to cover all of its customers' withdrawals. It sold the bulk of its so-called "available for sale" debt securities meant to cover heavy draws from customers' checking and savings accounts. But with rising interest rates driving bond prices lower for the better part of last year, the sale of these securities still wasn't enough to cover its customer withdrawals.
Fearing First Republic Bank was headed into the same fiscal buzzsaw, investors up-ended First Republic shares too.
As it turns out, these investors were somewhat right to be concerned. First Republic suffered a ton of withdrawals last quarter as well. Total deposits of $176.4 billion as of the end of last year fell to only $104.5 billion for the three-month stretch ending in March. Stripping out the additional $30 billion worth of "time deposits" offered up by other big banks, First Republic's total deposits would have been more than halved to $74.5 billion. Yikes.
What's curious, however, is that the assets supporting the potential withdrawals of its remaining customer deposits didn't change much last quarter. Indeed, they actually improved.
First Republic's asset base barely budged in Q1
Banks don't simply keep money deposited into customers' checking accounts, savings accounts, and CDs in a vault until it's needed. They do something interest-bearing with it, only keeping enough of it on hand to fund one particular day's potential withdrawals. Some of this cash is used to purchase highly liquid debt securities categorized as being "available for sale," while another portion of this capital is invested in "held to maturity" assets. As the name suggests, these bonds and paper are intended to be held until they reach their maturity date, when they're cashed in at their par value.
The mix of available-for-sale and held-to-maturity debt securities is determined by the bank, although well-managed banks tend to err on the side of owning more shorter-term, liquid, available-for-sale assets. (That's ultimately where Silicon Valley Bank went wrong.)
Given First Republic's mix of these assets -- like Silicon Valley Bank, First Republic holds a minimal amount available-for-sale debt -- it's a bit surprising it escaped last month's liquidity crisis intact. But it did. Its available-for-sale and its held-to-maturity asset tallies both actually grew, in fact, while its cash and cash equivalent assets tripled to $13.1 billion. That's still far less than the $104 billion worth of customer deposits on its books, but with the additional, currently unused $45.1 billion line of credit it's got open with other lenders, this particular bank could handle a potential wave of withdrawals without any further assistance.
Data source: First Republic Bank. Chart by author. All figures are in millions of dollars.
It wouldn't be easy to fund a wave of withdrawals, mind you. But it would be possible.
Meanwhile, citing "people familiar with the matter," Bloomberg reported on Tuesday that the company is mulling the sale of $100 billion worth of assets to bolster its liquidity.
Better is better, even if by accident
The irony is (and astute bank investors may have already picked up on this), with a smaller deposit base paired with a now-bigger asset base, in some ways First Republic Bank is in a better liquidity position than it's been in several quarters.
There's numerical evidence to support this idea. Case in point? The sequential improvement in its common equity tier 1 ratio, from Q4's 9.17% to Q1's 9.32%. Common equity ratios essentially compare a bank's core equity capital to its risk-weighted assets, and like efficiency ratios, are an indication of fiscal strength. In this instance, the common equity ratio figure is saying First Republic is a little less risky than it was a quarter earlier.
Indirectly pointing to improved stability is the improvement in the bank's efficiency ratio, from 63.9% for the fourth quarter of last year to 70.4% last quarter.
Granted, the company sold nearly 2.9 million shares of the beleaguered stock during the quarter in question to beef up its common equity metrics, diluting existing shareholders as a result, and nearly halving its average return on shareholders' common equity. Given its limited options at the time, though, First Republic did the smartest thing it could to ensure its survival. Now it's got something worth rebuilding.
An interesting speculation for the right kind of investor
Don't misread the message. First Republic's still got a major mess to sort out. Chief among its new challenges is the fact that it ultimately borrowed its way out of short-term trouble.
As the fine print of its first-quarter report explains, "following the recent industry developments, net interest income and net interest margin were, and continue to be, materially impacted due to the unprecedented loss of deposits resulting in higher funding costs." I don't know what these exact costs will be, although it's safe to assume they'll be plenty measurable.
The company suspended its dividend in the meantime, without offering any guidance as to when it might be restored. And again, whispers are circulating that the bank may be looking to sell up to $100 billion worth of assets -- including mortgages on its books -- as a means of raising cash.
None of these prospects are particularly bullish.
With share prices down 93% just since the banking industry's liquidity debacle in March, however, much of this bad news is priced in. Much of the good news, conversely, may not be reflected in the stock's present value.
It's not a great pick for most investors at this time -- there are just too many unknowns. For the few who can stomach the risk and volatility, though, Tuesday's tumble rooted in raw emotion instead of logic translates into a buying opportunity. First Republic shares are being priced like the bank's going to collapse. The updated balance sheet says that doesn't have to be the case.
