How Mortgages Crushed First Republic. The Mother of All Pivots.

How did this happen and what it means for regionals.

"FRC's existence still very much hangs in the balance"

-Wells Fargo analyst Jared Shaw

The bank “needs to pull off the mother of all pivots to survive”

-Timothy Coffey, a Janney analyst

Give the headlines, I wanted to share the latest on First Republic. I will write a full market review tomorrow.

Now back to First Republic. I really thought First Republic couldn’t surprise the world anymore. I was wrong. Many were wrong. So the stock fell another 40%!

Apparently investors were equally shocked by the earnings and filed a lawsuit yesterday against First Republic and KPMG.

Everyone expected issues and cut forecasts for bad surprises. It turns out the were even worse.

Customer deposits fell 41% to $104.5 billion. That was well below the $137 billion average of analyst estimates.

But that pales in comparison to the mortgage issue. And maybe why First Republic refused to answer any questions on the conference call 👇

Mortgage Mayhem

First Republic has been aggressively courting the wealthy by providing mortgages at rock bottom prices (2-3% interest rate). Sometimes lower than the market rate. But what is really bad is that some mortgages are structured so borrowers can wait an entire decade before they start repaying the balance.

As we all know First Republic had to borrow to plug the deposit hole after depositors stampeded out of the bank post SVB. To plug the hole First Republic had to borrow money at 5% for tens of billions of dollars in funding from the Federal Reserve and Federal Home Loan Bank.

So now First Republic has homeowners paying them 3% while they need to shell out 5% on borrowed money.

And my third grader understands that:

3% - 5% = how long can this bank survive??!!

So What Next For First Republic?

First Republic refused to answer questions, only saying they are considering “all strategic options”.

They did announce that the are trying to sell the loans at fair value. But who wants assets paying 3% for a decade?!

The large banks already bailed them. The government already stepped in. So neither is particularly motivated to figure this out.

My guess is however that they have no choice and a backstop will be provided that buys more time to sort this out. This problem is particularly unique to First Republic and is not present in other large regional banks.

And that brings up the question of the rest of the banking system 👇

Are Banks Are Going Under?

They got ahead by chasing money with complete disregard to the risks they were amassing.

I analyzed the earnings of all major commercial banks and regional banks here (it does not include First Republic or PacWest yet. Still in progress as a few remaining earnings come out later this week).

There is nothing to hide at the other banks. Many have grown deposits or at worst had a very mild decline. All have ample funding from the Fed. Their loan books are diversified and their funding sources (deposits) are highly insured. Many are still running strong, profitable franchises.

Overall they look strong and can survive a recession. There are a few weak ones but those are smaller in size and pose little threat to the system.

None others share the common characteristics of First Republic, Silicon Valley Bank, and Signature Bank. Large regional banks that supersized a unique business model by taking on risks no other banks attempted. They got ahead by chasing money with complete disregard to the risks they were amassing.

Regional bank stocks may stay down for some time but in the long run many will bounce back as the economy wrings out its excesses and recovers.