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Toward the middle of last week, we had asked a rhetorical question: will the First Republic Bank (FRC) defy the dreaded Cramer curse or enter into an FDIC receivership? Well, just days later, we now have a surprise outcome, where the bank evaded receivership but has, nonetheless, ceased to exist.
Let’s backtrack and review how things got so bad so quickly for First Republic Bank. When interest rates were at multi-decade lows a few years back, the bank targeted the so-called crème de la crème throughout the US and offered these ultra-rich individuals very cheap interest-only mortgages – where the principal amount of the mortgage does not factor into the interest payments, often for a period of ten years.
Obviously, as the Federal Reserve embarked on an aggressive campaign to hike interest rates in 2022, the market value of these ultra-cheap mortgages declined, given the negligent cash flow that they entailed. Concurrently, First Republic Bank was forced to borrow around $100 billion on a short-term basis to fund a gargantuan deposit outflow, which was spurred by the collapse of the Silicon Valley Bank in March. The bank was paying around 5 percent in blended interest (on an annual basis) on these borrowings. This is patently unsustainable.
While it was quite clear that First Republic Bank was hemorrhaging deposits, the scale of the problem became clear only in April, when as part of its earnings for the first quarter of 2023, the bank disclosed that its deposits declined from $172 billion at the end of 2022 to just $104.5 billion toward the end of Q1. Critically, this figure was inclusive of the $30 billion deposit from a consortium of banks. In reality, therefore, FRC lost around $100 billion in deposits within the span of a few weeks!
The First Republic Bank is No More
This brings us to today’s topic. Over the weekend, the FDIC engaged in frantic negotiations to find a viable path to traversing First Republic Bank’s now-certain insolvency. There were only two options: either the bank entered into an FDIC receivership, or some of its counterparts offered a bailout.
We had noted last week that there was no political appetite to subsume another bank into an FDIC receivership, especially as it might spur another round of damaging deposit outflows from mid-sized banks. In order to retain financial viability, First Republic Bank tried to offer its preferred shares and warrants to a consortium of banks, who were then expected to acquire between 50 billion and $100 billion of its distressed loans at above-market prices. This clearly proved to be a herculean task.
The FDIC estimates its loss on First Republic will be
$13bn. That takes total losses to $35.5bn – a quarter of the Deposit Insurance Fund. It leaves the insurance fund at 0.92% of insured deposits (vs stat min of 1.35%). Big levy on the big banks to build that back up.— Marc Rubinstein (@MarcRuby) May 1, 2023
The final solution is quite neat: JP Morgan – the largest bank in the US – has now agreed to acquire a large majority of First Republic Bank’s assets, including $173 billion of loans and $30 billion of securities, as well as $92 billion in deposits. For reference, the bank had total assets worth $229.1 billion and deposits of around $103.9 billion.
*FDIC ACCEPTS JPMORGAN DEAL TO ACQUIRE FIRST REPUBLIC $JPM $FRC
Full Details:
- JPMorgan to pay $10.6B to FDIC
- FDIC to provide $50B, 5-YR fixed-rate financing
- JPMorgan to repay prior $25B deposit injection from large U.S. banks
- First Republic 84 branches in 8 states will…— Stock Talk (@stocktalkweekly) May 1, 2023
JP Morgan and the FDIC have also entered into an agreement to share losses as well as recoveries on First Republic Bank’s portfolio of single-family and commercial loans. To do so, JP Morgan will make a payment of $10.6 billion to the FDIC, which would then provide the largest bank in the US a new $50 billion 5-year term financing on a fixed rate basis. JP Morgan would use this financing to repay $25 billion of deposits that other commercial banks had provided to First Republic Bank a few weeks back. JP Morgan agreed to eliminate its own $5 billion deposit to FRC.
JPMorgan will have a one-time gain of $2.6 billion tied to its First Republic acquisition, and $2 billion in related restructuring costs over the next 18 months. The FDIC estimated that the cost to the deposit insurance fund will be about $13 billion. https://t.co/19ZJPEx0X0
— Lisa Abramowicz (@lisaabramowicz1) May 1, 2023
The FDIC has estimated that its loss from this transaction would amount to $13 billion. All First Republic Bank branches are scheduled to open on Monday under JP Morgan’s banner.
FIRST REPUBLIC BANK SHARES DOWN 50.4% PREMARKET AFTER U.S. REGULATORS SEIZE LENDER
JPMORGAN CHASE & CO SHARES UP 3.8% PREMARKET ON BUYING MAJORITY OF FIRST REPUBLIC'S ASSETS
— 🅰🅻🅴🆂🆂🅸🅾 (@AlessioUrban) May 1, 2023
JP Morgan has disclosed that it would recognize an upfront, one-time, post-tax gain of around $2.6 billion. The bank also expects this transaction to be “modestly EPS accretive and generate more than $500 million of incremental net income per year.” It is hardly a surprise, therefore, that JP Morgan shares are rallying today even as First Republic Bank shares collapse.
Jim Cramer, March 10: "FRC is new focus... very good bank"
Jim Cramer, April 26: "I don't know who stays with them"
— zerohedge (@zerohedge) April 26, 2023
Meanwhile, CNBC’s Jim Cramer now has his pound of flesh. In recent years, investors have been focusing on the inverse Cramer strategy, which involves flipping the CNBC host’s recommendations in the light of his unceasing ability to parrot the consensus view, where there is hardly any alpha. Cramer had endorsed First Republic Bank back in March, suggesting that it was a “very good bank.” To the inverse Cramer crowd, this was a clarion call to short the bank’s stock. In light of this weekend’s development, that call turned out to be prophetic.
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