Steven Senne/AP Photo
A First Republic Bank branch location in Boston on April 26, 2023
First Republic Bank is likely in its last day as a going concern. The stock has plunged since Tuesday, when its earnings announcement showed a loss of $100 billion in deposits in just one month, after the Silicon Valley Bank collapse triggered flight from several large regionals. The stock did rally a bit on Thursday, but since early March, investors are down 90 percent.
The good news for the bank, if there is any, is that most of the uninsured depositors, the most likely to flutter away, have already left. But regulators have discussed downgrading the bank, which would cut it off from Federal Reserve lending. At the height of the crisis on March 15, First Republic had borrowed $138 billion; it’s now down to $104 billion, a quarter of that from the Federal Home Loan Banks, which are the lenders of second-to-last resort.
Moreover, the high interest rates associated with federal borrowing have put First Republic in an untenable situation where they are paying more to service debt than they are bringing in with revenue. The bank’s specialty was low-rate mortgages to rich people, kind of a concierge for the ruling class. Those mortgage loans don’t offset the penalty-rate borrowing from the government.
There’s just $10 billion in cash left. That leaves essentially no margin for error. And First Republic admitted in its earnings report that its loan portfolio has dropped $22.2 billion from its initial market value, while its held-to-maturity securities are likely down another $4 billion or so. Investors are doing the math; hence the stock price has gone through the floor.
Nobody really wants to step in and either save First Republic or wind it down. That’s why the bank has hired the consulting firm of former Obama adviser Jim Messina as a kind of forcing agent to get regulators to act. It might seem strange for a failing bank to spend even more money on elite consultants, but there’s a logic to the decision.
Here’s why the Messina icebreaker is necessary. A whopping 30 percent of First Republic’s remaining deposit base comes in the form of a cash infusion from JPMorgan Chase and ten other big banks handed over last month, during the height of the large regional crisis. Those are considered uninsured depositors, more than doubling the banks’ total. First Republic has suggested converting those deposits to equity, but that would merely transfer their losses to the big banks, with seemingly no upside for them.
According to CNBC, executives at the bank want the big guys to dip in for more, specifically to overpay for First Republic bonds above market value. Currently those assets, mostly municipal bonds, have plummeted in value, and if First Republic had to sell them for cash on the open market, it would reveal its insolvency.
These impossible choices are a direct descendant of the era of light supervision of the nation’s banks.
Federal regulators thought they had taken care of this with the Bank Term Funding Program, which federal regulators put in place after the SVB fiasco. Under that program, banks can borrow for one year against their long-term assets at par value, which allows them to handle funding issues without realizing losses. However, the eligible collateral must be assets that the Fed can purchase, like mortgage-backed securities or government bonds. Most of First Republic’s long-term assets are in municipal bonds, which are not eligible. That’s why, while the extraordinary Fed action to allow struggling regional banks to “extend and pretend” for a year has stabilized much of the system for now, it does next to nothing for First Republic.
That in turn is why the bank has turned to the private sector. Its explicit reasoning to the big banks is that any FDIC assessments that would be levied to replenish the deposit insurance fund would end up higher for them than the cash infusion they could give to First Republic right now. It sounds like a hostage situation—pay up now, or the bank gets it and you’ll pay more later. In the Crisis of 2023 version of Dog Day Afternoon, the stickup artist is actually the bank’s own leadership.
Another point is that accounting rules dictate that a purchaser of First Republic would have to mark down its assets to the market value upon the acquisition. That’s to say nothing of the capital raises that the purchasing bank would have to take on. “It might cost you $30 billion of capital to buy the bank for free,” one analyst told The Wall Street Journal.
Because it might be better for all the big banks if just one of them takes the losses, there’s a lot of brinkmanship over which one has to be the fall guy. If one bank takes the plunge and ponies up the cash, then the JPMorgans of the world don’t have to accept any further losses. So they’re all waiting for someone to step forward, hoping it won’t have to be them.
This game of chicken involves the regulators too. It would cost the FDIC more to recognize and cover losses rather than let them sit there. The FDIC operates on a least-cost basis, and not having to rescue First Republic would certainly present the least cost.
So what we have is a dead bank that everyone involved is reluctant to pronounce dead. This is a problem that was revealed most acutely in the financial crisis: “tight coupling,” or interconnectedness of the financial system, means that a loss for one is a loss for all. The system can work to forestall that loss, and there are clearly incentives to do so.
With all this reluctance, First Republic needs someone to tell regulators that there would be worse trouble ahead if the bank delays the inevitable. The executives want that to come in the form of something that will allow them to stay in their jobs; maybe facilitating a buyer that can stabilize the bank, for example.
But the potential downgrade suggests that the FDIC is poised to pull the plug very soon. What happens then? That would still involve an eventual purchaser of company assets. What sweeteners will it offer to whatever bank decides to take them on? And will the FDIC pay back the big banks their $30 billion investment? Will it once again invoke the systemic risk exception to allow a depositor bailout, which would in this case be a big-bank bailout?
These impossible choices are a direct descendant of the era of light supervision of the nation’s banks. The FDIC is First Republic’s primary regulator. But the general climate of regulation in the Trump years was “don’t do any.” We’re going to get more insight into that today with the release of the Fed’s report on supervision of Silicon Valley Bank, but we already know that the Fed board was micromanaging time spent on supervision, weakening regulatory guidance, and reducing use of Matters Requiring Attention, which are bulletins given to banks to fix their practices.
The FDIC, also governed by a laissez-faire majority in the Trump era, likely experienced the same tensions. And in this case, of course, the Fed’s kamikaze mission to raise interest rates led directly to regional bank struggles, without the strong supervision in place to address that.
Bank regulation often exists on a pendulum, swinging toward strictness after a crisis and back toward leniency when memory of the crisis fades. We have not fixed this troubling dynamic, and now another bank will be sacrificed as a result.
