First Republic Bank $FRC… some closing thoughts — part 4
I have exited my FRC position in light of Q1 Earnings and recent developments at $8.2
It is entirely possible for FRC to go into receivership, which will completely wipe out commons and preferred. This may especially unfold sometime this week, as FRC is already holding discussions with the Fed, White House, and regulators.
They have also recently announced that they are looking into strategic alternatives, specifically offloading 50–100B of their assets. This is concerning as we don’t know how much are they planning to unload and what this means for realised losses in the loan book — how many hybrid and fixes loans will they tap in?
The fact that they haven’t been able to sell any part of their loan books within the past month is highly concerning. If no sales occur, a receivership will most likely suffice. Even if they do find buyers for their 100B loan books, it will most likely result in negative book value due to their low interest and the distressed nature of the sale.
The net interest margins will shrink and it is hard to say if they will be profitable or even survive the next few quarters if they are unable to sell their assets to cover their short-term lending. So as we approach the 120 days date for the 30B uninsured deposits, it is ever more difficult to predict whether they can successfully deleverage and reorganise their balance sheet in time.
Being on the front page headline will worsen the sentiment and may lead to further deposit withdraws… there are just too much irrationality and unpredictability at play for an institution that depends on these very pillars.
Lastly, the earnings call was disappointing and disastrous, the management has not made any attempt to ease business and investor sentiments. By skipping the Q&A section, it’s as if they know it’s going to fail (avoid getting lawsuits with forward-looking statements), in addition, they did not present any solid plans to work on. No initiative, no plan, and no action, which is abysmal compared to the tone of the $WAL report where they announced a structured plan, with actions to show for it.
For these reasons, I am losing faith in the management’s competence and believe the investment thesis has changed, with a high likelihood of it going to 0. Of course, it is possible for them to pivot through these hard times and reach the tangible book value I stipulated in my previous articles (e.g. 30), but this scenario is becoming dimmer and dimmer.
Some lessons I’ve learnt:
- Don’t bet against the credit and bonds market (FRC bonds were and are priced to a common/preferred wipeout). The bond market is always smarter than the equities.
- Don’t be blinded by the payout, think about how much you can lose.
- Do not underestimate the downside risk, your forecasted “worst case scenario” is much better than the actual “worst case scenario”
- Avoid “0 sum” stocks (stocks that can go to 0, or go to 100 with similar probability)!
- Hopium is one hell of a drug
- Never bet against fear and human irrationality for institutions where they depend on trust, loyalty, and rationality. Confidence and fear are above whatever the financials point towards for banks. It’s very hard to predict consequences and the extent of fear.
- If a bank loses confidence, nothing will save them.
- Recognise the loss and sell when your investment thesis changes. I sold when they announced they were actively looking to sell 100B assets which are greater than what I’d previously estimated.
- Buy after earnings, don’t bet what the earnings entail!
- Effective percentage of allocation and diversification to fit the risk profile
- Should’ve diversified with other regional banks at least, and hedged my position.
