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The Fall of First Republic: Are We Done Yet?
Jesse Rosenthal – Head of U.S. Financials / Senior Analyst - Banks and Specialty Finance
EXECUTIVE SUMMARY
- First Republic was (finally) put out of its misery as the bank was placed into FDIC receivership with a purchase and assumption agreement from JPMorgan—investors picked up the misery bill however, with sub debt and preferred holders effectively zero’d in the transaction. Notably, there were no systemic risk exemptions associated with the resolution, unlike the SBNY and SVB failures that included the blanket deposit guarantee.
- The deal cleverly solves the fair value problem for an acquirer, with an FDIC loss-sharing agreement effectively allowing JPMorgan to lever up the assets to hit return hurdles. With the loss-share in place, the acquired FRC assets carry a ~25% risk-weighting, dramatically reducing the amount of capital JPM has to hold against the RWAs and in turn boosting IRRs to make the acquisition pencil. The deal includes JPMorgan paying $10.6 bn to the FDIC and receiving $50 bn in five-year term funding, the combined proceeds of which (plus cash and a smattering of leftover assets) will support the paydown of Federal Reserve borrowings that did not travel to JPM (discount window and BTFP).
- This may well be it. We’ve been on record through this ‘bank crisis’ as doubting its breadth and depth, and 1Q23 reporting has seemed to justify that view, with FRC a massive outlier at nearly 60% core deposit outflows since year-end vs. a ~2% decline in aggregate across thirty of the largest banks. Just as importantly, liquidity pressures are just the first necessary domino to realize downside risk in bank securities; it’s the liquidity pressures crystallizing balance sheet marks that generates these bank investor donuts. And with FRC also a major outlier on asset value—securities weren’t the problem, but the low-risk low-yielding loan book—we see plenty of reasons to justify our bullish view on the space and limited risk that there’s another name out there with similar fragilities.
Sir Jamie to the rescue again, as JPMorgan ended up as the FDIC’s white knight in (finally) resolving First Republic, albeit out of receivership and with no systemic risk exception, unlike SVB and SBNY. The deal, rumored through the weekend and made official on Monday morning, involves JPM acquiring the “substantial majority” of FRC’s assets and assuming the deposits—the big losers here are the FRC securities holders in the sub debt and preferreds, which effectively get zero’d in this transaction (First Republic is also OpCo only, so this is not even an SVB situation where there’s some recovery potential tied up in HoldCo litigation). The deal’s repurcussions and reverberations are more germane on an industry-level amid the lingering bank liquidity panic and the focus of this piece, but in brief: this looks like a decent deal for JPMorgan. The real upside value will be in the ability to retain customers or even re-attract the deposits and relationships that fled the past few weeks, plus potential growth synergies with the wealth management integration, but on its face we think this is a fairly low risk transaction for the industry behemoth.
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