For many years First Republic Bank FRC -32.80%
traded at a premium valuation to most other banks, in part reflecting a view that it served a premium clientele.
Now, the future value of these rich customers is a big question mark. Despite the injection of US$ 30 billion in deposits by megabanks in the First Republic on Thursday, their shares fell sharply on Friday. The bank is now trading at just over 30% of its tangible book value, versus a premium of around 50% for S&P 500 banks overall, according to FactSet.
That’s a big discount. But investors will still struggle to find an anchor valuation. In times of stress, investors often shift from valuing banks based on their future earnings to book value. Book values are generally adjusted to tangible book value, which eliminates assets such as goodwill. And nervous investors will typically make additional adjustments to that, perhaps doing things like eliminating potential losses on held-to-maturity bonds. Investors would also have to assess the likelihood of future equity offerings that could be diluted for them.
First Republic does not have nearly the same scale of unrealized losses on held-to-maturity bonds that SVB Financial Group did. First Republic’s portfolio had a paper loss of about $4.8 billion at the end of last year, against more than $17 billion in equity; SVB took a loss of about $15 billion on this type of stock, against about $16 billion in equity. As of Friday, First Republic is trading at a discount of more than 50% to its tangible common equity, minus pre-tax losses.
But whether that’s an attractive price for an investor still depends on other judgments about the bank’s future prospects. Unrealized bond losses are not the only challenge from rising interest rates. First Republic had $33 billion in fixed-rate residential mortgages at the end of last year. It had $62 billion in hybrid-rate home mortgage loans, which can switch from a fixed rate to an adjustable rate. The bank said the $4 billion of loans within its hybrid and general fixed-rate portfolios will mature within a year or within a year after adjusting its fixed-rate period. First Republic residential property loans yielded 2.89% for the year 2022.
This creates some challenges, first for the bank’s future net interest income, which is the interest it earns on its assets minus the interest expense it pays on financing. Last year, the average rate paid on all First Republic deposits – of which over 40% on average were non-interest-bearing checking accounts – was effectively 0.4%. Now, the First Republic said on Thursday that its recent Federal Reserve borrowings were at an overnight rate of 4.75% and that its increased short-term borrowings from the Federal Home Loan Bank were at a rate of 5.09%.
The ultimate impact on the bank’s net interest income depends in part on how many deposits have been replaced by new loans and how long the bank is forced to borrow at these rates. If you are able to pay off these loans soon, or get more future deposits at lower rates than your new loans, this would help to stabilize and normalize your earnings. The bank said it would pay a “market fee” to megabanks that were depositing $30 billion.
The loan portfolio also poses a problem for a potential buyer who could, in theory, pay off your shares. A bank and its shareholders can sit on paper waiting for them to win or pay. A buyer doesn’t have that luxury. An acquirer would have to consider the fair value of the bank’s assets, notes analyst David Smith of Autonomous Research.
The book value of the bank’s property-backed loans, net of an allowance for credit losses, was $136.8 billion at the end of last year. The fair value of these loans, or what the bank estimates to be their current market value, was just $117.5 billion. That creates a potential hole in the bank’s equity if it is acquired, although the value also depends on what other value the buyer places on the First Republic franchise, Smith says.
The real value of the First Republic, in short, is a moving target. No wonder investors remain nervous even after Thursday’s bailout.
Write to Telis Demos at Telis.Demos@wsj.com
Copyright ©2022 Dow Jones & Company, Inc. All rights reserved. 87990cbe856818d5eddac44c7b1cdeb8