First Republic: pricey Fed support sets bank an earnings challenge

First, the worry was about liquidity. Does a bank have enough cash on hand to weather a wave of withdrawal requests? Second came the issue of solvency. Does the accounting value of assets exceed that of liabilities? The third, equally crucial question for besieged banks is whether there will even be a profitable business after a rescue.

Emergency liquidity is expensive. This is a problem for First Republic, a US bank whose total assets stood at more than $200bn at the end of 2022. Amid panicked deposit flight, it has required heavy government support.

Between March 10-15, First Republic borrowed as much as $109bn from the Federal Reserve at an annualised cost of 4.75 per cent. The $10bn in funds lent from the Federal Home Loan Bank cost more than 5 per cent. Rating agency S&P has stated in a downgrade note that the bank’s asset book, largely of long-dated mortgages, was yielding just 3.5 per cent annually in its 2022 fourth quarter.

As recently as January First Republic was trumpeting its low-cost deposits. It said these cost it just 55 basis points last year, less than other midsized regional lenders. The bank had been popular with affluent customers on both US coasts who appreciated its high-touch service. But this was not enough to keep their money parked there in the last week.

At the end of 2022, First Republic’s book value was $75 per share. In January, the shares were trading at almost twice that. They have since slumped. They were trading at just $19 even after US Treasury secretary Janet Yellen said the government could insure deposits of troubled banks fully.

There is much talk of Wall Street rescuing First Republic. Investors seeking to inject equity into the bank or buy it outright should understand that the earnings capacity of First Republic is highly opaque.

Cheap deposits are far superior to wholesale borrowing even from the federal government, especially in a high interest rate world. Fateful deposit flight has now become both a liquidity and an enterprise value challenge.