May 6, 2023

Artifice and the failure of First Republic Bank

       A recent bank failure shows the importance of candor in the securities markets. Please let me start by providing a timeline.
  • On March 10, Silicon Valley Bank failed after customers rushed to withdraw their money, causing its deposits to fall to an unsustainably low level.
  • On March 12, Signature Bank failed for the same reason.
  • As a result, investors became concerned about the deposits at other banks, including (a) Western Alliance Bancorporation, whose stock price fell by 63% between March 8 and March 13, (b) PacWest Bancorp, whose stock also fell 63% between those two dates, and (c) First Republic Bank, whose stock fell 73% between those two dates.
  • To assuage concerns, First Republic Bank issued a statement on March 16 titled, "Reinforcing Confidence in First Republic Bank." It said the bank would receive $30 billion of deposits from a coalition of eleven large banks committed to preserving confidence in the banking system. Notably, it did not reveal how much deposits they had lost, only that $30 billion of deposits had been added.
  • Based on a google search, its press releases, and its Securities and Exchange Commission filings, First Republic did not issue a single additional statement on its deposit situation in the ensuing month.
  • On Monday April 24, First Republic was due to announce quarterly earnings in the afternoon. It would now have to disclose the amount of deposits it had lost. Presumably because the bank had said nothing for a month -- investors were optimistic and pushed the stock from $14.27 in the morning to $16.00 right before the earnings release, a 12% increase in one trading day.
  • The earnings release shocked investors. Analysts had expected on average $145 billion in deposits, but the bank only had about $103 billion of deposits. And this was after the $30 billion injection from the large banks. In addition, deposits had fallen to $104.5 billion on March 31, so the bank was sitting on this information for almost a month. 
  • During the earnings call, the bank said "deposits ha[d] stabilized" and that it had plenty of liquidity. It also announced a three-part plan to "strengthen [its] business" for the future. But having lost trust in the bank's word, investors sold their positions. That night its stock fell by about 25%, and it just kept falling until the bank had to be taken over by the FDIC a few days later.
       One wonders what would have happened if the bank had adopted a more honest communication strategy, rather than painting an overly rosy picture until it was forced to reveal everything. What would have happened if, rather than only touting the $30 billion infusion -- it also disclosed how much it had lost via deposit outflows?  

       It's possible that if the bank's messaging was more trustworthy, investors would not have run for the doors in that final perilous week. If a company is honest with you, you can assess their plan and estimate a value for their stock. But if you can't trust what they say, that adds a layer of uncertainty that makes investing unworkable. (I should be clear that there were no outright lies in First Republic's releases; they were more like half-truths, i.e. they left out what some might consider relevant and important information.) 

       You're probably wondering what any of this has to do with O'Melveny & Myers. Well, it might have nothing to do with them, but a few days go, it was revealed that O'Melveny started advising the bank in March. Per Monday's Bloomberg Law article:

Following First Republic Bank’s issues back in March, a committee of the independent directors was convened and represented by O’Melveny & Myers, led by partners Daniel Petrocelli, Jarryd Anderson, Matthew Close, and Andor Terner.

       Of course this doesn't prove that O'Melveny had anything to do with the bank's disclosure decisions. Granted, public confidence was the sole determinant of whether the bank would survive, so a lawyer advising the bank's directors might want to share a thought on that. And as you can see from the posts here, O'Melveny is not always the most trustworthy actor, so it might have had a hand in the bank's messaging. But I don't know what role O'Melveny played; maybe none; or who knows, maybe they tried to get First Republic to be more forthright and were turned down. Any comment on O'Melveny's role would be baseless speculation.

       I'll try to remember to check the regulatory reports to see if they reveal who devised the communication strategy. Regulators issued multiple reports on the failure of Silicon Valley Bank and they might issue one here as well. Whoever was responsible, it shows you how banks are the only type of business that can be celebrated one day, and impaired to the point that they have to be taken over by the government just a few days later.