In March 2023, American financial institutions Silicon Valley Bank and Signature Bank collapsed (second- and third-largest US bank failures precisely), then it was followed up by the Swiss government-orchestrated merger of UBS and Swiss Bank to prevent the unfolding of another crisis.
However, the fear of the repetition of a 2007-08 like scenario looked like a far-fetched one, as the central banks around the world continued their rate hiking process.
Just when it looked like the situation was easing out, came the First Republic Bank crisis.
Knowing The Crisis In Detail
JPMorgan Chase & Co will take over the First Republic. Markets have remained calm, but it needs to be whether JPMorgan gets additional support from the Joe Biden government, while First Republic Bank’s 84 branches in eight states reopen as branches of JPMorgan Chase Bank.
JPMorgan holds over 10% of the nation’s total bank deposits. Although federal law prevents a large bank from an acquisition deal that would put it above a threshold of 10% of total deposits, in the case of First Republic Bank, a special waiver has been given, since JPMorgan is buying a failed bank.
JPMorgan will “assume all deposits, including all uninsured deposits, and substantially all assets” of First Republic, stated the California Department of Financial Protection and Innovation. With this, JPMorgan, America’s largest bank grows even bigger, thus leading to a consolidation in the financial industry.
JPMorgan was also a key player, as wheels came off from the First Republic. The bank reportedly advised its smaller rival in its attempt to find strategic alternatives, and Chief Executive Officer Jamie Dimon was the key figure in marshalling bank executives to inject USD 30 billion in deposits into the troubled American bank to shore up its finances amid heavy withdrawals in March 2023.
A Brief History Of First Republic
The California-based bank’s expertise lies in wealth management services, with high-net-worth individuals being its prime customers. The bank, founded in 1985, had USD 166 billion in outstanding loans receivable, as of December 31, 2022.
First Republic started its operations on July 1, 1985, as a California-chartered industrial loan company and became a public company via an Initial Public Offering on the NASDAQ in August 1986. In 1993, First Republic acquired Silver State Thrift, a savings and loan association in Nevada. It was followed by more mergers and acquisitions.
In 2007, First Republic was acquired by Merrill Lynch. Three years later, Bank of America acquired both Merrill Lynch and First Republic, and sold the latter to a group of private investors. This consortium infused USD 800 million into the First Republic. In December 2010, the bank once again became a public company.
And on May 1, 2023, JPMorgan took over the First Republic Bank’s administration.
How The First Republic Got Into Trouble?
During March 2023, Fitch and S&P Global downgraded First Republic’s credit rating, citing “a high proportion of uninsured deposits” from wealthy customers who are more likely to move their money elsewhere and a loan-to-deposit ratio of 111%. It meant that the bank had lent out more money than it had in customers’ deposits. On March 16, 2023, eleven American banking biggies deposited USD 30 billion with the First Republic. However, the troubled bank’s shares kept on declining.
On March 19, First Republic’s credit rating got downgraded further into junk. The bank’s capital shortfall stood at USD 13.5 billion. In its first quarterly earnings release of 2023, First Republic noted that its customers withdrew USD 104.5 billion in deposits, but claimed that outflows had stabilized in April.
The outflows mostly came from the bank’s high-net-worth clients. This declaration further plunged the bank’s stock price by nearly 50%. On April 28, the bank announced plans to sell its bonds and securities at a loss to raise equity, apart from laying off staffers.
The news of FDIC considering seizing the First Republic further caused the bank’s stock price to plunge to a record low of USD 3.50. When the news became true, FDIC approached various banks and asked them to bid for First Republic’s takeover. On May 1, JPMorgan emerged as the winner of the process.
Erie Similarity With The SVB Saga
As per Moneycontrol, SVB had 57% of its assets in bonds, with 14% of it being held at market value as available for sale and 43% booked as hold-to-maturity. The unrealised losses on these portfolios spooked its depositors. At First Republic, only 15.5% of its assets were in bonds and they were mostly held to maturity, and the bank had no urgency to recognise the losses from rising Fed rates unless it was forced to sell these bonds.
However, First Republic had other assets that caused the ‘Big Bond Holdings’ problem. For example, it had interest-only home loans that weren’t due to get any principal repayments for 10 years, something similar to a 10-year bond, booked at face value in the accounts.
As per another Bloomberg report, these interest-only home loans were made at cheap rates to customers like the other bank CEOs, as part of First Republic’s strategy of growing its wealth-management business.
The bank used this lending to win deposits and help grow both sides of its balance sheet. As per experts, the whole business model looks like a fallible one.
“The primary strategy was to provide below-market-rate jumbo non-conforming mortgages with a request to the borrower that they bring in and maintain a portion of the loan value in the form of deposits,” commented Arren Cyganovich, an analyst at Citigroup Inc.
“This created a higher-than-normal level of uninsured deposits and with no real agreement to maintain the deposits, which led to the bank run,” the expert stated further.
In simple mathematics, First Republic lost over USD 100 billion of customer deposits in the 2023 first quarter, 41% of which came at the 2022 end. The bank is currently left with USD 55 billion of insured deposits, USD 20 billion of uninsured deposits and USD 30 billion of those term deposits from other big banks.
While First Republic’s mortgage book had a carrying value of USD 136.8 billion in 2022, the bank estimated its immediate resale value at USD 117.5 billion, resulting in USD 19 billion loss. The loss amount was well over First Republic’s core regulatory capital of USD 13.9 billion.
So, First Republic’s crisis story is very similar to that of SVB, with a lot of fixed-income assets held at cost and a high reliance on a fairly homogenous group of uninsured depositors.
The Road Ahead
The above information shows the hole the First Republic is in. Despite JPMorgan taking the bank over, analysts are expecting the bank’s mortgages not to find buyers.
First Republic’s ‘Big Bond Holdings’ fiasco puts American banking practices under the scanner. Will the authorities intervene and amend the laws further to avoid the repetition of a similar tale in the future?
That’s one question which needs a quick answer.