Company Reports

We are dropping coverage of First Republic Bank.

JPMorgan Chase has acquired First Republic Bank from the FDIC, effectively zeroing out First Republic equityholders. Because the latter bank is no longer a separately traded entity, we are dropping coverage of First Republic. We had assigned a very high probability (84%) that its shares were worth zero well over a month ago and actually dropped our fair value estimate to $0 on April 27. We were at the low end on the Street in both instances.

The Federal Reserve released its review of what went wrong with supervision and regulation of Silicon Valley Bank. There are still no official new regulatory proposals, but this is the first official clue about where the regulators are heading. Our thesis was that regulations were going to change but that they would be manageable changes phased in over a period of several years. This is why we do not think capital raises are likely for the banks under our coverage. We think this is a key point because prices currently seem to be implying permanently impaired profitability or capital raises for multiple banks under our coverage. We think this is too harsh.

We are lowering our fair value estimate for First Republic Bank to $0 per share from $3. While we had previously believed that there was roughly an 85% chance that the shares would be worth zero, we think that percentage is even higher currently. At this point, we feel that there is a material probability that the bank does not make it, and even if First Republic does survive, we think that the dilution of existing shareholders that would be required to resize the balance sheet would get current shareholders close to $0 as well.

First Republic Bank is one of the more unusual banks under our coverage. It has a uniquely focused business model, with a high service offering aimed at wealthy clients concentrated in costal urban areas. The bank was exclusively led by its founder, Jim Herbert, until mid-2021, and has been able to churn out remarkably high organic growth year after year, resulting in compounded asset growth of roughly 20% over the past 10 years compared with an industry growth rate of closer to 5%.

No-moat-rated First Republic Bank reported first-quarter results that shed more light on what has transpired for it since the downfall of Silicon Valley, and it isn't pretty. It appears the bank lost roughly $100 billion in deposits when excluding the $30 billion it received from the group of several large U.S. banks. This means that First Republic lost nearly 60% of its core deposit base. As we adjust our projections and the probabilities associated with different outcomes, our current $3 fair value estimate may change, but we do not expect it to change materially enough that the shares would look undervalued. We do not see any easy solutions for the bank, and we still see a material probability that there is little left for equityholders once this situation fully plays out.

We have updated our fair value estimates for a number of regional banks in our coverage (M&T Bank: $179 to $163, Fifth Third Bancorp: $42 to $38, Regions Financial: $21 to $19, KeyCorp: $24 to $21, Huntington: $17 to $15, Comerica: $86 to $79 , Zions: $66 to $58, Cullen/Frost: $133 to $124 ). We did this based on an expectation of increased funding costs, some pressure on deposit bases (in other words, deposit outflows), and potentially lower securities yields in the future due to potential changes in bank regulations (which would likely force banks to hold more short-term treasuries instead of their current preference for mortgage-backed securities).

Based on a Wall Street Journal report, which stated that First Republic is estimated to have lost closer to $70 billion in deposits (roughly 40% of its fourth-quarter 2022 deposit base), we are lowering our fair value estimate to $3 per share from $34. Previously, our bear case was for the bank to lose roughly 30% of its deposits, and based on this new information, it appears even that was not bearish enough. Based on losing $70 billion in deposits, even with the $30 billion deposit injection from other banks at “market rates,” we think it is very unlikely that First Republic remains a profitable bank, so we believe an Extreme Uncertainty Rating is appropriate.

First Republic Bank is one of the more unusual banks under our coverage. It has a uniquely focused business model, with a high service offering aimed at wealthy clients concentrated in costal urban areas. The bank was exclusively led by its founder, Jim Herbert, until mid-2021, and has been able to churn out remarkably high organic growth year after year, resulting in compounded asset growth of roughly 20% over the past 10 years compared with an industry growth rate of closer to 5%.

While the support from America’s largest banks by injecting $30 billion of deposits into no-moat-rated First Republic Bank might appear to be a positive on the surface, it confirms some of our worries about what has occurred. Prior to this event, we did not know for sure if First Republic had indeed experienced a true run on the bank or if perhaps it would be able to maintain its deposit base relatively intact.

First Republic Bank is one of the more unusual banks under our coverage. It has a uniquely focused business model, with a high service offering aimed at wealthy clients concentrated in costal urban areas. The bank was exclusively led by its founder, Jim Herbert, until mid-2021, and has been able to churn out remarkably high organic growth year after year, resulting in compounded asset growth of roughly 20% over the past 10 years compared with an industry growth rate of closer to 5%.

We are relaunching coverage of First Republic. We emphasize that there is a high degree of uncertainty about the future value of First Republic and have increased our Morningstar Uncertainty Rating for the bank to Very High. The bank could largely maintain its deposit base and eventually recover to previous profitability expectations (fair value estimate of $120), it could only partially maintain the deposit base and suffer more permanent declines to profitability but still remain a viable franchise (fair value estimate of $88), it could see a material and permanent impairment in the profitability and brand of the franchise (fair value estimate of $23), or it could lose enough of its deposit base that under the right circumstances it could be worth $0 for current equityholders.

First Republic Bank is one of the more unusual banks under our coverage. It has a uniquely focused business model, with a high service offering aimed at wealthy clients concentrated in costal urban areas. The bank was exclusively led by its founder, Jim Herbert, until mid-2021, and has been able to churn out remarkably high organic growth year after year, resulting in compounded asset growth of roughly 20% over the past 10 years compared with an industry growth rate of closer to 5%.

We are increasing our Morningstar Uncertainty Rating on our U.S. regional banking coverage (excluding U.S. Bancorp and PNC Financial Services) to High from Medium, to reflect the increased uncertainty associated with predicting what the deposit base, funding costs, and regulatory costs will look like in the future. We’re leaving the Uncertainty Ratings on the largest banks unchanged, as we believe they are less likely to experience deposit base volatility.

With the U.S. banking system coming under heightened liquidity pressure, we had speculated that the Federal Reserve might step in and provide some sort of solution. There was a lot of speculation about what mechanism/s could be used, and one of our favorites was simply allowing banks to exchange their underwater securities, at par, with the Fed. This has the benefit of taking away any concerns about being forced to sell these securities at fair value and therefore taking a hit to capital while also exposing the U.S. taxpayer to minimal risk of loss, as most securities held by the banks are either agency-backed MBS or Treasuries.

We are placing the shares of First Republic under review as emerging tail risks are causing us to re-evaluate the name. While we calculate that the bank could theoretically handle all outflows of "at risk" deposits, several items give us pause.

Bank stocks sold off meaningfully on March 9 as Silicon Valley Bank announced that it would have to take a number of “strategic actions,” including selling off its entire available-for-sale securities portfolio (incurring a $1.8 billion aftertax loss, or roughly 15% of the bank’s tangible common equity as of Dec. 31, 2022), announcing it is seeking to raise $2.25 billion in additional capital, and increasing its use of “term borrowings” (essentially higher-cost but more stable funding). Aside from crypto-related meltdowns, this is one of the first banks we’ve seen that has really suffered a liquidity crunch that has forced it to restructure the balance sheet and realize losses on its securities portfolios.

First Republic Bank is one of the more unusual banks under our coverage. It has a uniquely focused business model, with a high service offering aimed at wealthy clients concentrated in costal urban areas. The bank was exclusively led by its founder, Jim Herbert, until mid-2021, and has been able to churn out remarkably high organic growth year after year, resulting in compounded asset growth of roughly 20% over the past 10 years compared with an industry growth rate of closer to 5%.

No-moat-rated First Republic Bank reported fourth-quarter earnings of $1.88 per share, ahead of the FactSet consensus of $1.79 and just ahead of our own estimate of $1.83. Revenue came in at $1.44 billion compared with our own estimate of $1.49 billion. Net interest margins, or NIM, and the efficiency ratio both deteriorated in the quarter, which was expected. Deposit pricing increased from 0.74% to 1.63% in the period, while the bank’s NIM went from 2.71% to 2.45%.

First Republic Bank is one of the more unusual banks under our coverage. It has a uniquely focused business model, with a high service offering aimed at wealthy clients concentrated in costal urban areas. The bank was exclusively led by its founder, Jim Herbert, until mid-2021, and has been able to churn out remarkably high organic growth year after year, resulting in compounded asset growth of roughly 20% over the past 10 years compared with an industry growth rate of closer to 5%.