Good morning,
You know things are bad when an earnings call lasts just 12 minutes, the CFO wasn't present, and the CEO won't take questions. That was the case Monday when First Republic Bank reported its first-quarter earnings revealing the massive loss of customer deposits.
“The SVB bank run caused the problem that First Republic is in now, but the structure of their balance sheet and their business model put them in this vulnerable position,” Tim Coffey, an analyst at Janney Montgomery Scott, tells me.
First Republic reported that customer deposits fell 41% to $104.5 billion in the first quarter of 2023, a worse-than-expected drop. This follows the $30 billion boost in deposits about six weeks ago, prompted by the Fed and provided by some of the biggest banks in the U.S. including, JPMorgan Chase & Co., Citigroup Inc., Bank of America Corp., in attempts to stabilize the San Francisco, Calif., lenders’ finances. Like SVB, the vast majority of First Republic's deposits were uninsured.
What First Republic did right that Wall Street loved (for a while)
First Republic (NYSE: FRC) was popular with customers. For example, during an earnings call on Jan. 13, the company said its 2022 Net Promoter Score (a metric reflecting customer satisfaction) was the highest ever. FRC was for some time considered a strong-performing stock. The bank went public toward the end of 2010, and shares were priced at about $27. The all-time high closing price for FRC was $221.91 on Nov. 16, 2021.
Before the regional bank upheaval began in March 2023, FRC closed at $123.01 on Feb. 28. The stock price fell to $13.99 on March 31, reached a 52-week low of $4.76 on April 26, and closed at $6.19 on April 27.
Mike Roffler was appointed CFO in 2014, and president in 2021. His work as finance chief was recognized multiple times. For example, in June 2021, he ranked in the top 28% of BuySellSignals Large MCap performers for the past year.
Roffler became acting CEO at First Republic in January 2022, officially taking on the role in March of that year. When he was promoted, Olga Tsokova, the chief accounting officer, served as acting CFO from January 2022 until Neal Holland was hired as CFO in November, previously Union Bank CFO and Deputy CFO of MUFG Americas Holdings. Tsokova was appointed deputy CFO along with the CAO role.
"Mike fully embodies our culture, has a deep knowledge of our business model, and is highly regarded by our stakeholders,” Jim Herbert, who founded the bank in 1985, served as its CEO, and is now executive chairman, said in the company’s announcement in 2022.
First Republic's specialty is private banking and wealth management, and reports that no sector represents more than 9% of total business deposits. The company has a business model of adding high net-worth clients, Coffey says.
“You lead with the mortgage product, then you do your best to attract their low-cost deposits and their wealth management business,” he explains. Then once you have the personal stuff, you go after nonprofit accounts, and more, he says. “That’s been ingrained in the business for decades, and Mike Roffler was in lockstep with that culture and business model,” Coffey says.
What did First Republic do wrong?
The strategy of offering wealthy borrowers substantial mortgages, usually at low rates, that for a time worked so well, was exquisitely wrong for what appeared in late 2022.
“They put themselves in a risky position by aggressively growing assets in a zero-interest rate environment,” Coffey explains. “Say they’re offering a 3% mortgage, once the Fed Funds rates get to 5% the value of the loans that you aggressively added fall in value,” he says. “They had that brewing already. Between year-end 2019 to year-end 2021, gross loan balances increased $44.1 billion, or 49%.”
First Republic did not respond to a request for comment. The bank ended last year with almost $27 billion in markdowns on loans and several unrealized losses on Treasuries and other long-dated bonds on the balance sheet.
"We are working to restructure our balance sheet and reduce our expenses and short-term borrowings," Holland said in a statement that was included in the earnings report. Only Roffler and Mike Ioanilli, VP and director of investor relations, were on Monday's earnings call. There was no Q&A session with investors.
“Despite the uncertainty of the past two months and while average account sizes have decreased, we have retained over 97% of client relationships that banked with us at the start of the first quarter,” Roffler said on the call. Investors weren't persuaded: The bank’s stock price dropped 49% on Tuesday, 30% on Wednesday.
The Fed hasn’t yet stepped in to take over First Republic, nor have the big banks stepped up again to provide a boost. First Republic was looking to potentially sell $50 billion to $100 billion of assets to big banks, Bloomberg reported.
I asked Coffey what message the short earnings call provided. “I haven’t seen a bank do that since the great financial crisis,” he says. “It tells investors that there's a serious situation going on at First Republic that needs to be resolved as soon as possible.”
Have a good weekend. See you on Monday.
Sheryl Estrada
sheryl.estrada@fortune.com
