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FRC, XLF, Buys on Overblow Bank Runs? took small speculative positions in FRC and is considering XLF (a bank ETF) today, on overblown fears of contagion.

With a book value around $75, and an ostensibly solid loan portfolio, we’re taking a small shot on the common equity.  Others have suggested XLF to play the overall sector, or FRC’s Preferred.  Details follow.

Last week, with extreme rapidity, the FDIC took control of SVB in the United States’ second largest ever bank failure.  News outlets indicated that the take over was precipitated by massive depositor withdrawals, triggering forced sales of assets that had been carried on the balance sheet with large unrealized losses.  In short, it was an old fashioned bank run.

Despite the perception of banks as “safe” businesses, the reality is that the majority of bank assets consist of loans that the bank has made to borrowers.  In other words, the majority of assets of banks are promises that borrowers make to repay loans, plus interest.   Generally, loans have long maturities, meaning banks cannot turn those promises into money in a short period of time.  The majority of a bank’s liabilities on the other hand, are deposits; demand deposits.  This means that depositors put their money in checking accounts, savings accounts, CDs and the like.  Aside from CDs, demand deposits can be withdrawn in seconds.  At December 31, 2022, CDs represented 14% of total deposits, or $24.7 bn, and had an average maturity of three months.  [p. 129, FRC 10-k 2022].

Hence, by definition, a bank’s balance sheet is mis-matched.  The assets are long-term maturities, and the liabilities are short-term maturities.

If the reader has seen the classic film, it’s a Wonderful Life, the scene in which James Stewart begs his customers not to withdraw their money, because that money is not necessarily in the bank, but in the homes, businesses and farms of the very people who are demanding their deposits isn’t far from accurate.

It was widely reported that large VC companies and their owners wrote emails urging the start up company depositors to withdraw deposits from SVB.  Did these investors compare their aggregate deposits and loan balances to SVB’s balance sheet?  Did these investors short sell shares of SVB before writing those emails?  We don’t know, but it is not impossible, or even far-fetched.

That gets us to FRC, a lending and depository institution that got “Silicon Valley Banked” over the last two trading days.  FRC is a $17 billion market cap lending and depository institution that at December 31, 2022 had about $166 bn in outstanding loans, up from $134 bn the year earlier.  Of that loan portfolio, $103 bn was secured by residential real estate, $34.6 bn was secured by commercial and multi-family real estate, $7.7 bn was secured by other assets, and the remaining $21.8 bn appears unsecured.   [Note 4, p. 151 FRC 10-K 2022].  Of the loan portfolio 34% is in San Francisco Bay Area, 19% in the New York Metro Area and 21% LA Metro, with 5% in other areas of California and 8% in Boston.   [p. 101 FRC 10-K 2022].

This asset-side of FRC’s balance sheet appears to present a lot of room for losses.  It appears as if LTV, loan to value, across the loan portfolio was something like 59%, meaning that of the secured portfolio, FRC had an aggregate lien interest in 41% equity.  Even if real estate values in aggregate declined 20%, the estimated current LTV would exceed 20%.    Meanwhile the Allowance for Credit Loss in 2022 was $0.784 bn, up from $0.694 bn in 2021, representing 0.47% of total loans.  [p. 116 FRC 10-K 2022].

Bottom line, in the recent past, very few borrowers are failing to pay, and there appears to be a lot of equity in the assets securing those loans, if those borrowers start to fail to pay.  This appears true, even if real property falls significantly in value.

OK, but, that does not really address what made SVB fail.  Again, SVB failed, because depositors withdrew a significant percentage of their deposits in SVB, and banks are required to have a certain amount of raw capital to keep operating.  Fall beneath that capital; the bank is out of business.

At December 31, 2022, FRC’s borrowing capabilities were “$55.2 billion of unused, available borrowing capacity at the
[Federal Home Loan Bank] supported by pledged loans….” and “….$6.7 billion of unused, available borrowing capacity at the Federal Reserve Bank discount window collateralized by pledged investment securities.”  [p. 122 FRC 10-K 2022].  FRC’s Annual report stated that “…[t]his unused, available borrowing capacity at the FHLB and the Federal Reserve Bank discount window equaled 29% of total assets.”  On March 12, 2023, FRC issued a press release stating that it had secured additional capital availability from the FED and JP Morgan and its available credit was $70 bn.

Meanwhile, under the Capital Tier tests, FRC’s Tier 1 Capital was 8.5% at December 31, 2022, down slightly from 8.76% a year earlier.  This compares to 4% minimum, and 5% adequate.  [p. 191 FRC 10-K 2022].  It is important to note that capital appears based on invested equity, and has little to nothing to do with liquidity, or lack of liquidity, which is what caused the SVB demise.

OK, what does all this mean?

FRC is a speculative buy.  Their loan portfolio looks solid, on the balance sheet, at least.  There is room for falling home prices.  In normal times, liquidity would appear adequate.   But times are not normal.

Bottom line, if every depositor withdrew their money from FRC, except for CD holders, and FRC tapped its loans, FRC would have $70 bn cash, plus $24.7 bn in CDs, or $94.7 bn in cash to $166 bn in loans.  Is this enough?  Lawinfo does not know.

Lawinfo speculates that SVB was specifically targeted and attacked by short sellers who had the ability to force large deposit withdrawals, and essentially make SVB fail.  Does First Republic fall into this type of risk?  We don’t know.  Will the FDIC and Fed setp up and protect the institution, we don’t know.

With a book value around $75, and an ostensibly solid loan portfolio, we’re taking a small shot on the common equity.  Others have suggested XLF to play the overall sector, or FRC’s Preferred.




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