First Republic Bank $FRC — part 3
*Since my last article, the price has tanked to 12.18 at the market close (20th March 2023).
*I will proceed with this article with the assumption that you’ve read my previous 2:
Part 2: https://victorinvesting.medium.com/first-republic-bank-frc-part-2-582565f8aba0
Dissecting the News Developments:
On Sunday, WSJ revealed:
Customers have pulled some $70 billion in deposits, almost 40% of its total, according to people familiar with the matter. But the withdrawals stabilized Friday, after the country’s biggest banks came to its aid, the people said.
In my opinion, more deposits may have been pulled since this announcement because:
- The stock plummeted on Monday
- FRC made headlines (yet again), causing further panic
- Depositors' sentiments and general uncertainties
- Further downgrades by credit agencies
Of course, it is also entirely possible deposits have remained relatively stable. Also, it is entirely possible that deposits get re-injected in the common weeks/months as the “panic” and negative sentiment subsides. However, I will assume the worst for now, and a total of 90B have been withdrawn. This figure is calculated by subtracting the 30B deposits (from the 11 banks) from the total value of uninsured deposits (119.5B).
What the deposit withdrawal means:
Assuming 90B was withdrawn, this implies FRC has spent 90B cash as well. Hence the net loss of assets and liabilities cancel each other out. Now, here is the problem I overlooked in part 2 of my article (and I sincerely apologise for this): Now, they have to deleverage.
On the bright side, however, since my calculation assumes all uninsured deposits are withdrawn, other than the 30B from the 11 big banks, that means the bank doesn’t have to reserve a significant level of additional level of cash to prevent further bank runs as the insured deposits are secure (this is an assumption, and backed with what the company announced in their 8-K), Hence, I will assume they will keep 5B in cash just in case.
As for the 30B deposits from the 11 major banks, their problem will essentially be pushed back towards the 120 days agreement date. I assume by then, many of the previous deposit withdrawals will return gradually (as I said in my previous article, clients of FRC are loyal and adore their service), if not, I wouldn’t be surprised if the 11 banks keep it there by discussing new terms.
Borrowings in their Balance Sheet:
Now for the fun bit…
Assuming 90B was withdrawn, and the bank requires an additional 5B in cash. As 90B and 5B are “locked or gone”, their leftover cash reserve is:
109B federal reserve borrowings + 10B FHLB loan — 95B = 24B
This 24B leftover cash value will be able to pay off the debt principal and leave us with a short-term debt of 95B in a state of limbo, for now.
The problem with this 95B debt is the interest it produces, at 4.75% interest (logically, FRC would pay off the 5.09% FHLB loan first due to its high interest, so the rest will be the federal reserve borrowings at 4.75% interest). This results in an interest payment of 4.5B per year which they cannot sustain since their net income is only 1.67B (This is an oversimplification since the interest expense on deposits will decrease as they are withdrawn, but either way, it’s lower than their net income as their deposit interest expense only accounts for a fraction of their total expense).
Hence, there are two scenarios that FRC can take:
- Scenario 1: Pay off all their debt by selling their assets, many of which are at a loss. This will reduce future interest burden but at the cost of realising the unrealised loss.
- Scenario 2: Pay some of the debt just enough for the interest expense to be under the net income so they can still earn positive net income.
I believe FRC knows what’s the best approach to maximise their profit as they understand their loan books the best. Furthermore, the 8-K revealed that:
The Bank is focused on reducing its borrowings and evaluating the composition and size of its balance sheet going forward.
Thus, I am confident they can manage through this tumultuous period.
Scenario 1:
Paying off the 95B debt + interest by selling their assets (i.e. AFS, HTM, Loan Book (Adjustable, Hybrid, Fixed)).
First, what is the interest on the debt for scenario 1?
I will calculate the 6 months' interest as I presume deposits will flow back in gradually as the panic rests.
Increase in Interest from borrowings:
- 95B * 4.75% = 4.5125B
Decrease in Interest from deposits being withdrawn (deposits at 0.99% interest)
- 90B * 0.99% = 0.891B
Net increase in interest:
4.5125–0.891 = 3.62B
So, FRC has to pay 3.62B in interest assuming they pay back their borrowings 6 months from now. Hence, the total debt + interest to pay is 98.62B.
Available-for-sale (AFS):
Assuming another 2% loss since 31st December, their fair value can be sold at 3.28B, with an assets loss of 67M.
Debt to pay = 98.62B-3.28B = 95.34B left
Held-to-Maturity (HTM):
Assuming another 4% loss since 31st December on their HTM assets, this implies a proceed of 22.64B, and an assets loss of 5.7B.
Debt to pay = 95.34B-22.64B = 72.7B
Adjustable Loans:
Per their 10–K:
The Bank’s loan portfolio includes: (1) adjustable-rate loans tied to Prime, LIBOR, COFI Repl Index (which is based on Federal COFI plus/minus a spread adjustment equal to the five-year historical median spread between COFI and Federal COFI), and other reference rates, including a 12-month average of 1-year CMT, which are currently adjustable; (2) hybrid-rate loans, for which the initial rate is fixed for a period from one year to as many as ten years, and thereafter the rate becomes adjustable; and (3) fixed-rate loans, for which the interest rate does not change through the life of the loan.
31.16B of Adjustable Rate at a 3% loss implies a proceed of 30.23B and a net assets loss of 935M.
Debt to pay = 72.7B-30.23B = 42.47B
Hybrid Loans:
Assuming a 15% loss for every Hybrid loan that the bank sells:
By selling 42.47B worth of Hybrid loans to pay off their short-term borrowings:
Assets loss = (42.47/(1–0.15))-42.47 = 7.5B loss
In summary, the total net asset loss is 67M + 5.7B + 935M +7.5B = 14.2B
Thankfully, we haven’t tapped into fixed-rate loans yet.
Valuations:
Very Bearish Case:
Assuming FRC encountered a loss of 13.27B
187M shares = common + preferred
TBV = (212,639–195,193–218–14200)/187 = $16.19
First of all, the risk of a fire sale is very possible, and we have no control over this, so again, my articles are not financial advice, please please please do your own research and I want to especially stress that this is a very speculative and risky bet!
Second of all, the assumptions stated in this assumption are very pessimistic (although not the worst case, i.e. fire-sale or nuclear war). This assumes that all uninsured deposits are withdrawn (other than the 30B from the 11 Major Banks). If we use even 80B instead of the 90B figure for the deposit withdrawn:
This leaves a “debt to pay” figure of 83.62B. And after assuming AFS, HTM and adjustable rate loans are sold, this leaves an outstanding “debt to pay” figure of 83.62–3.28–22.64–30.23 = 27.47B. This is covered by selling 32.3B worth of Hybrid loans at a 15% discount, translating to an asset loss of 4.84B from the balance sheet. So in summary, this leaves a net assets loss of 67M + 5.7B + 935M + 4.84B = 11.542B, hence:
TBV = (212,639–195,193–218–11,542)/187 = $30.4
Basis Case (Assuming Sunday’s figures remain unchanged):
If we only assume 70B deposits have left like on Sunday, and the bank has to pay an interest of 3.62B. This leaves a “debt to pay” figure of 73.62B.
After adjusting for AFS, HTM, and Adjustable loans, this leaves a “debt to pay” outstanding figure of 73.62–3.28–22.64–30.23 = 17.47B. This produces an asset loss of 3.08B assuming a 15% discount on their Hybrid loans. This leaves a net asset loss of 67M + 5.7B + 935M + 3.08B = 9.782B.
TBV = (212,639–195,193–218–9782)/187 = $39.8
Takeaway:
The difference between a TBV of $39.8, $30.4 and $16.19 is stark and it all has to do with how much of the Hybrid Loans they tap into, this depends on how many deposits have been withdrawn. In my opinion, I believe deposits will return once the panic subsides (we will see if other banks announce further rescue deals in the coming days, and a plausible Fed rate pause). As deposits return, this will have a multiplier effect on the share price by allowing more cash reserves to pay off their short-term federal reserve borrowings. Hence, Their goal now is to introduce confidence back to their depositors.
Assumptions:
- There haven’t been any updates on the 70B credit facility with JPM, so I cannot speculate on this.
- Private Share Offering
- Inability or failure to raise equity. Again, there’s very limited info on this and may only be rumours or fake news, I will delve into this when there’s more info, however.
- Risks I mentioned in Parts 1 & 2
- Fire-sale risk, take under risks
- Regulatory risks
- Again, I want to stress this is a highly risky bet so please be careful!
Closing Comment:
I hope you enjoyed the article! It’s getting late now so I will go over scenario 2 in the next few coming days, so until then, invest safely!
Disclaimer:
The information provided on this blog is for educational and informational purposes only and should not be considered financial or investment advice. The content is not tailored to any particular person’s financial situation, and the ideas expressed may not be suitable for everyone.
It’s important to conduct your due diligence and seek professional financial advice before making any investment decisions. Any investment involves risks, including the potential loss of principal, and past performance does not guarantee future results.
Disclosure:
The author of this blog has positions in the stocks mentioned and may purchase or sell these stocks at any time without notice. The author will not be held responsible for any losses or damages that may occur as a result of any investment decisions made based on the information provided on this blog.
