First Republic Bank
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Yes, it’s happened again. First Republic Bank, once the 14th-largest bank in the US, is now known as the second largest banking failure in the country’s history. In many ways, FRB’s collapse is a deja-vu to SVBs; both were mid-sized institutions, holding under $229 billion and $209 billion, respectively, just before they went under (for reference, Citigroup has over $2.4 trillion under management). Oddly enough, both were California-based and catered to wealthy clients. But FRB’s story comes with an interesting twist at the end that distinguishes it from the bombardment of financial failures in recent weeks. Behold, the tragedy of First Republic Bank.
Background
In 1985, former CEO of San Francisco Bancorp Jim Herbert founded First Republic as an institution that would deliver “exceptional service by exceptional people.” In Herbert’s view, FRB’s selling point wasn’t the products they sold, which he described as “undifferentiated” from other banks, but the “people and their passion and their caring for clients…and that’s it.” In 2007, First Republic was acquired by Merrill Lynch (the wealth management division of Bank of America) for $1.8 billion.
Keep in mind, however, that Merrill was still its own independent firm at the time. After Lehman Brothers went bankrupt in September 2008, Merrill shareholders took one look at their unhedged mortgage-based CDO portfolio and decided it was best to sell to Bank of America for $50 billion. In an effort to simplify their business model and clean up its balance sheet, BofA felt that FRB’s inclination to high-net-worth individuals didn’t fit with their focus on retail banking. So in 2010, First Republic Bank was sold off to a number of private investors and once again became a public company, raising over $280 million for their IPO.
The crumbling commences
When the trouble took off with SVB, the big banks’ stocks took a hit, and mid-sized banks fell off a cliff. Many turned a scrutinous eye and grew distrustful of them. These were supposed to be places where people’s hard-earned money could be securely stored, and suddenly they learned they may not receive any of it back. In particular, credit ratings agencies, who assess the financial health of companies that issue securities, intensified their reviews of American banks in light of the tumultuous conditions.
After their stock price tanked 62%, Fitch Ratings and S&P Global Ratings downgraded First Republic's credit rating for 2 key reasons. First, a large number of uninsured deposits, stretching to nearly 70%. Secondly, a loan-to-deposit ratio of 111%, meaning that it lent out 111% more than it had in deposits. It goes without saying that downgrading a bank’s credit rating is likely to trigger a bank run, and FRB executives wanted to avoid becoming the next SVB. In other words, they needed liquidity, and fast.
On March 16, a team of 11 American banks including JPMorgan, Goldman Sachs, and Bank of America deposited $30 billion into FRB accounts with the hope of reassuring customers against the possibility of a bank run. Unfortunately, things didn’t go as planned. Not only did FRB’s stock continue to plunge, but S&P went ahead and further downgraded their credit rating from “BB-plus” to “B-plus.” The credit analysts saw the $30 billion deposit as merely a short-term measure to stall any immediate liquidity crises, but not enough to alleviate the “substantial business, liquidity, funding, and profitability challenges…” they believed the bank faced.
Well, they may have actually been correct. On April 24, FRB released their quarterly earnings report, and boy was it ugly: $104.5 billion in deposit withdrawals, most of which were from wealthy clients whose assets exceeded $250,000 and thus weren’t covered by the FDIC. A few days later, the bank went through the painful process of trying to reduce their balance sheet. Selling bonds at a loss, laying off their staff, and desperately looking for any kind of government support available (FRB applied for aid from the Bank Term Funding Program, an emergency lending initiative created by the Federal Reserve after the SVB collapse. The idea is to offer banks 1-year loans if they possess eligible assets that can be used as collateral, such as US Treasury securities. Unfortunately, First Republic had most of their money in municipal bonds, and thus couldn’t qualify for the BTFP).
When the FDIC said that it might seize the bank, share prices fell to $3.50…and sank an additional 42% just before they confirmed the takeover.
The bank’s fundamental problem was their asset-liability mismatch. When the cost of borrowing increases, banks pay depositors a higher interest rate than borrowers, but because First Republic’s assets were mostly mortgages issued at low interest rates (which usually cannot change), the disparity between what they’re earning in interest from the mortgages and what they’re paying in interest to depositors (which increases) is widened. Additionally, since these loans were issued in a low-interest rate environment, that debt is now worth less.
The buyout
JPMorgan has a history of helping out in times of a crisis. In March of 2008, they agreed to purchase Bear Stearns, an investment bank on the verge of insolvency, to soften any ripple effects from the disaster. The following year, they bought all $1.83 billion worth of Washington Mutual’s assets, secured debt obligations, and deposits. And just last week, JPMorgan acquired most of FRB’s assets and deposits for $10.6 billion from the FDIC.
But why are they fond of purchasing failed banks? This specific deal was negotiated by the FDIC, and so there included a number of stipulations that lightened JPMorgan’s load. The FDIC will pay for 80% of losses associated with residential mortgage and commercial loans, and JPMorgan won’t have to take on any FRB corporate debt. To top it off, JPMorgan expects a one-time gain of $2.6 billion on its books from the deal as well as more than $500 million of incremental net income per year.
In exchange, JPMorgan will not only pay $10.6 billion upfront, but they’re also responsible for returning the remaining $25 billion that the bank rescue team deposited in March (the $5 billion that JPMorgan deposited will be eliminated). All in all, the FDIC The FDIC estimates that they’ll be incurring $13 billion in costs as part of this deal.
Econ IRL
Most people can agree that AI is going to significantly impact the labor market in ways no other technology has. But the debates as to whether algorithms will enhance or take over our jobs usually pertains to developed economies; what about developing countries? This week’s paper focuses on just that, and features China as the country of study.
Using occupational and census data, the authors find that Chinese labor markets are less exposed to GPTs (Generative Pretrained Transformers) compared to the US. However, GPTs’ impact varies from city to city in China. Some areas have jobs that fall under “knowledge work” (the kind of work the authors identified as exposed to GPTs. Think positions like programmers, writers, financial analysts, etc) whereas others are concentrated in mining and construction.
But perhaps the most curious finding is that, when breaking down the impact of GPTs on a city-by-city basis, their influence is somewhat correlated to how those places are overseen by the government; the labor markets of direct-controlled municipalities (e.g. Beijing) and provincial capitals (e.g. Zhengzhou) will be most impacted by GPTs.
‘Till next time,
SoBasically