First Republic Bank (NYSE: FRC) was down 49% yesterday with no great sign of any recovery after hours. We'll have to see what happens in early trade (which starts at 4 am NY Time). The basic problem here is that all banking is a confidence game. Not in the sense of anything criminal, not that sort of game. But in the sense that if the customers lose confidence in the bank then the bank itself is lost. For it's extremely difficult to stop depositors leaving if they're worried they won't get their money back.
First Republic does have backstops. The Feds and the other major banks have decided that they'd very much prefer that what happened at Silicon Valley Bank doesn't happen to First Republic. So far and no further sort of idea. The big banks have deposited at FRC to provide liquidity. That should be enough, could well be enough, but will it? As we got in the results and as is causing this meltdown in the share price, First Republic lost $102 billion in deposits. There comes a point in such a process that nothing can help.
First Republic share price from NASDAQ
The real, real, problem is that if deposits continue to flee then First Republic must also shrink its loan book. But given that most loans aren't callable (the borrower gets to pay back when the contract says, not when you want) that means they must be sold. And interest rates have risen recently, so many such loans would sell for less than their book value. Don't forget that loans to be carried to maturity aren't marked to market - those interest rate cycle losses are not crystallised as yet. But if they're sold they have to be. So, this is a problem: “Options include an asset sale of up to $100 billion” because “Any bank or investor group interested in taking over the bank would have to take on First Republic's loan portfolio, which could saddle them with billions of dollars in losses based on the recent interest rate moves.” And of course that also means that those losses would have to be booked against First Republic's capital base if such a sale took place.
Which is exactly what happened to Silicon Valley Bank of course. The hunt for liquidity meant selling the portfolio, booking the losses and therefore having no capital left.
Now, if the depositors regain confidence in FRC then the deposits stop fleeing and there is no problem. Which is that confidence game. With depositor confidence First Republic is just fine. Without it, well, banks can and do go bust….
