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FRC (First Republic Bank) Explained for Newbies - Twas Written in the Stars
Level 1 - Definitely NGMI
Welcome Avatar! If you are new here this will be the last crash course on the banking debacle… Until of course 1 month from now as more banks fail if President Powell raises rates.
Today, as a bonus, we’ll cover First Republic Bank FRC 0.00%↑ in newbie terms. If interested in the entire debacle we suggest reading our older free posts from this month.
Part 1: Quick Review
There are various types of banks: 1) global “strategically important” too big to fail mega banks like JP Morgan, Bank of America and HSBC (simple list here); 2) Upper middle tier banks that are big but could be consolidated: Credit Suisse (explained here) was about as close to the top as you could get and when combined with UBS is likely at the “too big to fail” level now and 3) the rest which include: community banks, regional banks and mid-tier investment banks.
Autist Note: When we talk about banks we are *NOT* referring to pure advisory firms. Pure advisory firms would be places like Qatalyst. If the “investment bank” is 90%+ all advisory fees on M&A deals none of the above applies. They are negotiators and deal makers - not involved with loaning money out.
Why All the Different Banks?
Well it’s quite simple.
If you only had one bank you’ve effectively nationalized the entire financial system (this is practically what Switzerland has done by forcing UBS to buy CS without shareholder approval - not a perfect explainer but good enough).
The small banks are usually there to offer *better* loan rates. If you have never heard of FRC 0.00%↑ you probably haven’t been in California (or lived there). It is a popular bank for the West Coast that has offered cheap mortgages vs. the mega banks (Wiki history of FRC)
In short, with regional/community banks you create more competition for loans so the typical person (home buyer for example) can get a rate of say 3.0% vs. 3.5% that the mega banks would offer. The mega banks deal with huge numbers and corporations so they don’t really care about winning every single $300K mortgage loan that the average American wants to take out.
Small banks exist because they take on more risk (lower rate = more risk for the bank of course!). They offer better customer service (typically) and keep the large banks honest (prevent them from colluding to keep mortgage rates higher than they should be - for the rabbit hole google LIBOR manipulation by the largest banks in the world).
Per usual this is simplified and someone can enter the exact word salad that explains the existence of every single small/regional bank in the USA.
Part 2: Stock Price Spike? Usually Means Terrible Loans
Spot the Trend in 2021-2022!
Massive Outperformance? High Risk Loans: That’s the simplest way to explain it. When you see the stock price of a small/regional bank suddenly spike over the course of a year it usually means they are taking on a BOAT LOAD of risky loans.
Reminder: lending out money to you for 3% for 30-years is great for *you*. Not so great for the bank if interest rates go to 5% for the US Treasury bill.
As you’re already seeing, why would you hold $1M in a bank account at 2-3% when you can be guaranteed by the federal government at 5% and get a better return? Massive outflows from the banks.
Now the Ugliness: There is no where to hide. Now the news is saying FRC will raise money by selling shares (source).
In simple terms: If there are 100M shares of FRC, they want to issue another 20M shares of FRC (this means any owners of the stock get screwed since their ownership percentage would go down). They are considering this because if they sell say 20M shares at $10, that would be $200M in additional cash on the balance sheet to pay out deposits (which don’t exist since people are sending money out of FRC at a record pace - Source)
End of The Road
First Republic Bank took deposits of ~$200B. They loaned out this $200B in 3% mortgages (and other real estate type deals) while interest rates are at 5%. Depositors are now trying to take their money out.
If they sell the mortgages they gave out, the value is going to be down some 40-50% (simple example), so even if they sell *all* their bonds they will have say $100B
If everyone asks for their money back to go buy treasury bills (occurring now) the bank will be a zero
Solution? Either raise money (if anyone crazy enough will invest in the stock) or be acquired in a “take-under” like we saw with Credit Suisse
Note: FRC is heavy real estate/commercial which is why you’re seeing the small/regional banks take a bath. This example of RE was done on purpose since that is how it differs from Credit Suisse.
A Ray of Hope
As you can see we wouldn’t be touching FRC 0.00%↑ stock and we certainly wouldn't be holding money in the bank north of $250,000 (FDIC level). Just replace the below Tweet from October of 2022 with FRC and it's exactly the same message.
The Ray of Hope? If President Powell drinks a bunch of kool-aid this week and lowers interest rates to under 2% they would be safe (all those mortgages they gave out would have value again!).
The chances of that are next to none. But like they said in dumb and dumber “you’re telling me there’s a chance”.
To End on a Positive Note: Since the total amount was about $200B and the Fed stepped in for Signature bank (~$100B), it’s highly likely that deposits will be safe. The problem is that you’re dealing with cash flow issues, payment issues and other headaches to get your business running properly again.
Also. Anyone with $250,000 or less has nothing to worry about in terms of Deposits.
Conclusion in Bullets
First Republic bank is trapped unless interest rates go down substantially. If they do not? The bank run will continue due to incentives:
Customers put in ~$200B
That ~$180B is *already* given out in 3% mortgage loans - keeping it simple
As customers pull funds they have to sell their mortgage loans and much more than $20B is being wired out to buy treasuries
Without a substantial rate decrease the bank will be under constant with-drawl pressure
New Catch Phrase: “Interest Rates Go Up, More Banks Go to Zero” (consolidation).
Note for the Financiers: Notice. “The smartest people in the world” Wall Street CEOs, didn’t raise a dime at the peak stock price of $200. They ran a lean balance sheet instead and put the company at risk.
After the stock price has cratered, now they want to raise money.
Why? Well if they raise money via a stock sale they lose *personal* wealth since their stock exposure goes down in value! Funny how that works. Gotta make sure you collect your shares at $200 so you can sell it before the blow up.
Now that you’re up to speed on what has transpired today as it related to FRC 0.00%↑ . Remember that this article is opinion only and the authors may or may not be homeless (never take financial advice from a homeless cartoon character on the internet).
On that note, we’re also going to move more questions to paid only subscriptions. If the number of sign ups remains sky high (as it has been) free posts may be locked from comments.
On that note, back to the tent.
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