Why First Republic shares went on a rollercoaster ride

Here's a riddle for you. Shares in First Republic Bank closed at $31.21 on Monday, and opened at $49.69 on Tuesday — an overnight spike of 59%. There was no news about the bank over the course of the intervening hours. So why did the stock move so much?

The answer: The stock moved so much because there was no news about the bank over the course of the intervening hours. But also, once banks start to get into trouble, the share price naturally becomes incredibly volatile, just because their balance sheet leverage is so enormous at that point.

Between the lines: There are a lot of possible futures for any given company, and a stock price can be thought of as a kind of weighted average of all of them, discounted by a similarly probabilistic range of discount rates.

• At times like these, certain banks start to become the subject of worries that they might get taken over by the FDIC overnight and ultimately sold to a new owner.
• When that happens, depositors (account holders) are generally unaffected, while shareholders are generally wiped out. The bank lives on — do a blood test on JPMorgan and you'll find WaMu DNA in there somewhere — but that's no solace to its former owners.
• In other words: It doesn't matter how valuable Signature Bank or SVB end up being to their future owners, whoever that might be. All that value accrues to the new shareholders, while the old shareholders remain zeroed out.

How it works: When markets closed on Monday, there was some non-negligible chance that federal authorities would look at First Republic's deposit outflows and take it over before markets opened on Tuesday.

• That possibility was reflected in its Monday share price — so when Tuesday morning arrived and nothing had happened, the stock price, no longer reflecting the probability of a Monday-evening failure, went up.

The big picture: Banks are some of the most levered businesses in America — they have vastly more debt than equity. That's just how fractional-reserve banking works.

• Debt is normally a combination of total deposits, bonds outstanding, and various other instruments like repos; equity is normally gauged using measures like Tier 1 capital.
• Take a typical boring bank like PNC Bank. Its capital is about $43.5 billion, while its deposits alone — all of which are unsecured liabilities of the bank — are ten times that sum.

The bottom line: Because equity value is such a small sliver of a bank's overall capital stack, bank shares tend to be particularly volatile, especially when market capitalization falls well below book value.

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