First Republic Bank on the brink!

It is anticipated that an announcement will be made Sunday night regarding the acquisition of First Republic Bank. The FDIC has expressed its desire for the deal to be publicized before the Asian markets open this evening.

First Republic Bank (FRB) has faced recent difficulties similar to those of Silicon Valley Bank (SVB) due to their Bay Area roots and strong ties to the tech industry. FRB’s business loan portfolio has lent to venture capital and private equity firms, which are the primary industries employing their clients. Non-profits and schools, on the other hand, only account for 22% of their portfolio.

Strong headline numbers? But similar asset profile perception and risks to SVB driving deposit withdrawals

FRB currently holds $212.6 billion in assets, making it the 14th largest commercial bank in the US as of the end of 2022. In 2022, FRB generated $5.9 billion in revenue, resulting in $1.7 billion in profits. The bank’s wealth management division generated $877 million in revenue, and its wealth management assets grew from $41 billion in 2013 (the year after the acquisition) to $140 billion by March 2019.

First Republic Bank (FRB) has suffered losses on its long-duration fixed income portfolio due to the Federal Reserve’s aggressive interest rate cycle, highlighting poor risk management. However, FRB’s situation worsened when it disclosed a loss of over $100 billion in deposits on Monday. This drop exceeded expectations and raised concerns about the bank’s survival. By Friday, FRB’s stock had plummeted to $3.50, a 97% decline from the previous year, and the bank’s market value had fallen from $40 billion to just $640 million.

This raises questions about whether the FDIC (Federal Deposit Insurance Corporation) can continue to backstop all $17 trillion worth of deposits at regional banks in the US. Will this be the last time such a large-scale failure occurs, or will there be more to come?

At first, J.P. Morgan, Bank of America, US Bancorp, Citizens, PNC, and other entities were among the initial bidders. However, J.P. Morgan and Bank of America are not eligible to acquire First Republic Bank due to US regulations that prohibit a bank holding more than 10% of deposits from acquiring another bank that accepts deposits. It is possible that the FDIC may make an exception in this case.

Percentage of Deposits Controlled by US Banks:
1. JP Morgan: 16.1%
2. Bank of America: 14.8%
3. Wells Fargo: 10.9%
4. Citibank: 5.8%
5. US Bank: 3.4%
6. Truist: 3.4%
7. PNC Bank: 3.3%
8. TD Bank: 2.9%
9. Charles Schwab: 2.7%
10. Capital One: 2.6%

The top 15 banks control 75% of deposits in the US !

The FDIC is currently reviewing the offers on the table from potential buyers. Regulators aim to secure a deal for the struggling institution to calm markets before the open. First Republic has been through a turbulent month, with 11 banks investing $30 billion to support it following the collapse of Silicon Valley Bank. The San Francisco-based bank had $212 billion in assets as of last year-end, but its stock price has plummeted by 87% in the last two weeks due to significant deposit withdrawals. A buyout by another financial institution could prevent the need for a bailout, similar to what happened with Silicon Valley Bank’s failure in March.

Concerns of contagion are on the rise, with the bank runs that caused the collapse of Silicon Valley Bank and Signature Bank leading to worries that First Republic could be the next to go. However, regulations and the potential for larger banks to gain an unfair market share would normally impede any buyout of First Republic.

The bank has seen substantial outflows and losses, with wealthy depositors moving their money to larger institutions considered less likely to fail. Approximately $100 billion in deposits have been withdrawn since Silicon Valley Bank’s collapse, primarily due to 68% of First Republic’s deposits being uninsured, a higher rate than many regional banks. This all equates to a staggering 56% of their total deposit base!

In the short term to help plug the funding gap of c$100Bln, FRB secured repo agreements with the Fed Reserve of c$80Bln and a further $25Bln in FHLB advances, $8.8Bln in short term and $9.9Bln in long term.

Interesting to note the profile of their lending book of $173Bln, which is made up of $100Bln in lending to single family homes and residential investment. Other loan books consist of $22.7Bln in multifamily, CRE of $11Bln, and other HNW business lines.

However, where investors have been spooked is the fact that the exposure is distinctly in the San Francisco area, where SVB was and a lot of the borrowers are in the same area. And this has still been seen as damaging, with a low LTV of 60%.

Not to forget that the bank has not endured any significant credit impairment charges or losses, or even has a substantial amount of NPLs on its books, actually <0.05%.

Also they have had a consistent CET 1 ratio of c9.3% over the past three years, well above the capital regulatory requirement of 4.5%.

Similar to Silicon Valley Bank, First Republic is also dealing with significant unrealized losses on long-term Treasury bonds and other investments that fell after the Federal Reserve increased interest rates.

JP Morgan Chase CEO Jamie Dimon and other bank executives are exploring additional options to support First Republic, with one plan being to convert a portion of the $30 billion in deposits into a capital infusion to provide more flexibility for the bank’s spending. According to a note to shareholders, no single business sector represents more than 9% of First Republic’s total deposits, with diversified real estate being the largest at present. Technology-related deposits only account for 4% of total deposits. While the bank has a higher uninsured deposit rate than most competitors, it is still lower than that of Silicon Valley Bank (94% uninsured) and Signature Bank (90%).

Regulators are reviewing bids for First Republic and are expected to choose the offer that results in the smallest financial hit to the FDIC. However, the bank’s receivership is not seen as a systemic risk and invoking a systemic risk exception to protect uninsured depositors from losses is not expected to be necessary.