Pressure mounts on First Republic as stock continues plunge

The stock of First Republic (FRC) plunged again Wednesday as pressure on the San Francisco lender intensified following a depositor exodus in March and new attempts to sell some of its underwater assets.

The bank’s price dropped nearly 30%, after plummeting 49% Tuesday, and its stock was halted several times for volatility. Other regional bank stocks were up, reinforcing First Republic’s predicament. They include PacWest (PACW), which said Tuesday it gained back some deposits in April after losing billions during the first quarter. Its stock ended Wednesday up 7%.

First Republic and its advisers are now considering a variety of alternatives to save the lender without being seized by US regulators, from the creation of a so-called "bad bank" to divesting $50 billion to $100 billion of long-dated securities and mortgages to make an eventual capital raise easier. It said Monday that it was pursuing "strategic options" after losing more than $100 billion in deposits during last month's banking system turmoil.

First Republic has a potential to avoid being seized by regulators, a source familiar with the matter told Yahoo Finance, but it will require assistance from the US government.

"There is an open bank path solution here, but it's a matter of the government needing to convene to bring all the parties together to make it happen," this person said. First Republic declined comment.

CNBC reported Wednesday that First Republic's advisers will try to persuade some of the same banks that participated in a $30 billion rescue in March to purchase First Republic's underwater bonds at above-market rates, meaning they absorb the losses. That March rescue came from JPMorgan Chase (JPM), Bank of America (BAC) and nine other giant institutions.

The argument in favor of that approach is that the losses those banks assume as part of this new rescue would be less than what they would have to pay to the Federal Deposit Insurance Corporation if regulators were to seize First Republic. The FDIC recoups the costs of resolving such failures via a levy paid largely by the nation's biggest banks.

The dilemma for the big banks, said another person familiar with the talks, is that they could end up helping First Republic again only to see it get seized anyway. This person said there is still a chance of a government-supported rescue but that a receivership seems more likely.

There doesn’t appear to be a willingness from the White House or Treasury to pressure banks to try to formulate an asset sale, CNBC reported. Bloomberg also reported Wednesday that regulators are considering downgrades of their internal First Republic assessments and that could make it more difficult for the bank to borrow money from the Fed.

Bank stress back 'on the front-burner'

The market reaction to First Republic's woes "puts bank stress back on the front-burner" for policy makers in Washington, EvercoreISI’s Krishna Guha said in a new research note, and creates "fresh complexities" for the Federal Reserve as it prepares to decide on the possibility of another interest rate hike in May.

"You’ve got a large super regional bank with a limited number of prospective acquirers. It’s a situation I think that needs to be quickly addressed," said John Popeo, a principal at financial consulting firm Gallatin Group.

The bank, which is already being advised by Lazard and JPMorgan Chase, is also bringing in some new experts. Bloomberg reported the Messina Group, a consulting firm started by former Obama Administration official Jim Messina, has been hired to help First Republic in its talks with the Biden Administration. Lazard is also in contact with the Treasury Department about all possible options, said a person familiar with the situation

When the bank began to wobble in March following the failure of Silicon Valley Bank on March 10, it tried to weather the turmoil by borrowing from the Federal Reserve and the Federal Home Loan Bank system while also taking in the $30 billion in uninsured deposits from 11 of the country’s largest banks.

The goal was to give the bank time to avoid the same fate of Silicon Valley Bank, perhaps by finding a buyer on its own. The challenge is that any buyer would have to pay billions to absorb all of the unrealized losses on First Republic’s loans and securities. Those losses were $27 billion as of the fourth quarter, according to Evercore.

Some of the new ideas now being considered also have drawbacks, according to Evercore, including the sale of some underwater assets.

First Republic may be hoping it can convince other big banks to buy some of those assets in exchange for equity warrants, but such warrants would dilute existing shareholders and thus could put more downward pressure on the bank's stock.

The future value of any warrants also depends on how many low-cost depositors First Republic is able to keep. "The clear risk – not certainty - is that the plunge in First Republic’s stock price and further adverse headlines and tweets on social media results in further rapid deposit outflows that make the notion of a warrant-subsidized sale non-viable," Evercore said.

Policy makers have some decisions to make, according to Evercore. The Fed could extend more liquidity to First Republic via a new program it created in March to deal with regional bank stress, or its traditional discount window.

The FDIC could also seize First Republic, as it did with Silicon Valley Bank and Signature Bank in March.

"The attraction of going down the FDIC seizure route is that it would allow the authorities to subsidize a quick rescue sale of First Republic assets and liabilities on to another bank" and then pass on the costs to the rest of the banking system. Two failures last month are expected to cost the FDIC more than $22 billion, and it has said existing banks will likely have to pay a new fee to cover those losses.

A seizure, through, would create another set of political challenges for regulators. If they repeat what they did with Silicon Valley Bank and pledge to cover all uninsured depositors, the nation's biggest financial institutions will get their $30 billion back. That could be viewed as a big-bank bailout.

Could the renewed stress on First Republic also cause the Fed to pause its rate hikes? Only in an extreme scenario, Evercore said. "Certainly, it is unlikely that the Fed would hike right in the middle of an unresolved renewed depositor run on First Republic or any other bank that was generating material real-time spillovers to the wider banking system."

But "we think the Fed has a strong bias to hike in May and will be wary of deferring that move to June or July."

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