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JPMorgan ends First Republic's turmoil after FDIC seizure

Bloomberg • 8 min read
JPMorgan ends First Republic's turmoil after FDIC seizure
First Republic was the second-biggest bank failure in US history, and the fourth regional lender to collapse since early March. Photo: Bloomberg
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JPMorgan Chase & Co. agreed to acquire First Republic Bank in a government-led deal for the failed lender, putting to rest one of the biggest troubled banks remaining after turmoil engulfed the industry in March.

The transaction, announced in the early morning hours Monday after First Republic was seized by regulators, makes the biggest US bank even larger while minimizing the damage to the Federal Deposit Insurance Corp.’s guarantee fund. JPMorgan agreed to the takeover after private rescue efforts failed to fill a hole in the troubled lender’s balance sheet and customers yanked their deposits.

First Republic was the second-biggest bank failure in US history, and the fourth regional lender to collapse since early March.

“This is getting near the end of it, and hopefully this helps stabilize everything,” JPMorgan Chief Executive Officer Jamie Dimon said on a call with journalists Monday. Regional banks that reported first-quarter results in recent weeks “actually had some pretty good results,” the CEO said. “The American banking system is extraordinarily sound.”

Nevertheless, bank lending will probably suffer for a time in the wake of the failures, Dimon said.

Dimon’s bank acquired about US$173 billion ($229.45 billion) of First Republic’s loans, US$30 billion of securities and US$92 billion in deposits. JPMorgan and the FDIC agreed to share the burden of losses, as well as any recoveries, on the firm’s single-family and commercial loans, the agency said in a statement.

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New York-based JPMorgan was the only bidder that offered to take the entire bank off the the FDIC’s hands in the cleanest way, according to two people familiar with the decision. That was more appealing for the agency than the competing bids, which proposed breaking up First Republic or would have required complex financial arrangements to fund its US$100 billion of mortgages, said the people, who asked for anonymity to describe the private talks.

The other bids would have cost the FDIC several billion dollars more from its insurance fund, one of the people said.

JPMorgan’s stock rose 2.9% at 12.04 pm in New York. Trading of First Republic was halted.

See also: OCBC launches accelerated banking career programme for 500 polytechnic students over next three years

Industry Critics

The transaction makes JPMorgan even more massive — an outcome government officials have taken pains to avoid in the past. Because of US regulatory restrictions, JPMorgan’s size and its existing share of the US deposits would prevent it under normal circumstances from expanding its reach further via an acquisition. And prominent Democratic lawmakers and the Biden administration have chafed at consolidation in the financial industry and other sectors.

“The failure of First Republic Bank shows how deregulation has made the too-big-to-fail problem even worse,” Massachusetts Senator Elizabeth Warren said in a tweet. “A poorly supervised bank was snapped up by an even bigger bank — ultimately taxpayers will be on the hook. Congress needs to make major reforms to fix a broken banking system.”

The failure of First Republic Bank shows how deregulation has made the too big to fail problem even worse. A poorly supervised bank was snapped up by an even bigger bank—ultimately taxpayers will be on the hook. Congress needs to make major reforms to fix a broken banking system.

Ohio Democrat Sherrod Brown, chairman of the Senate Banking Committee, blamed the collapse on First Republic’s “risky behaviour, unique business model and management failures.”

“It’s clear we need stronger guardrails in place,” Brown said in a statement. “We must make large banks more resilient against failure so that we protect financial stability and ensure competition in the long run.”

JPMorgan expects to recognize a one-time gain of US$2.6 billion tied to the transaction, according to a statement. The bank will make a US$10.6 billion payment to the FDIC and estimated it will incur US$2 billion in related restructuring costs over the next 18 months.

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The US$92 billion in deposits includes the US$30 billion that JPMorgan and other large US banks put into the beleaguered lender in March to try to stabilize its finances. JPMorgan vowed that the US$30 billion would be repaid.

For the US$173 billion in loans and US$30 billion in securities included in the deal, JPMorgan and the FDIC signed the loss-sharing agreement to cover single-family residential mortgage loans and commercial loans, as well as US$50 billion worth of five-year, fixed-rate term financing.

The FDIC and JPMorgan will share in both the losses and the potential recoveries on the loans, with the agency noting it should “maximize recoveries on the assets by keeping them in the private sector.” The FDIC estimated that the cost to the deposit insurance fund will be about US$13 billion.

“We should acknowledge that bank failures are inevitable in a dynamic and innovative financial system,” Jonathan McKernan, a member of the FDIC board, said in a statement. “We should plan for those bank failures by focusing on strong capital requirements and an effective resolution framework as our best hope for eventually ending our country’s bailout culture that privatizes gains while socializing losses.”

JPMorgan said that, even after the deal, its so-called Common Equity Tier 1 capital ratio will be consistent with its first-quarter target of 13.5%. The transaction is expected to generate more than US$500 million of incremental net income a year, the company estimated.

Marianne Lake and Jennifer Piepszak, co-CEOs of JPMorgan’s consumer and community banking unit, will oversee the acquired First Republic business. Dimon said on a call with analysts that JPMorgan won’t keep the First Republic name.

JPMorgan was a key player throughout First Republic’s struggles. The bank advised its smaller rival in its attempt to find strategic alternatives, and Dimon was key in marshaling bank executives to inject the US$30 billion in deposits.

“While this represents yet another regional bank failure in the last month or so, we do believe that this should be an idiosyncratic situation and not lead to bank contagion,” David Chiaverini, an analyst at Wedbush Securities, said in a note.

First Republic specializes in private banking that caters to wealthier people, much like Silicon Valley Bank, which failed in March, focused on venture capital firms. Chairman Jim Herbert started First Republic in 1985 with fewer than 10 people, according to a company history. By July 2020, the bank said it ranked as the 14th largest in the US, with 80 offices in seven states. It employed more than 7,200 people at the end of last year.

Read more: First Republic Is Said to Face Potential Fed Borrowing Curb

Like other regional lenders, San Francisco-based First Republic found itself squeezed as the Federal Reserve jacked up interest rates to fight inflation, which hurt the value of bonds and loans the bank bought when rates were low. Meanwhile depositors fled, partly in search of better returns and then in fear as worries spread about First Republic’s health.

The result was a capital hole big enough to deter a full-scale rescuer from stepping forward. A fresh round of concern was set off in April by the bank’s first-quarter report and news of its attempt to sell assets and engineer a rescue. The bank said it would cut as much as 25% of its staff, lower outstanding loans and curb non-essential activities.

Eleven US banks had tried to keep First Republic afloat by pledging US$30 billion of fresh deposits on March 16, with JPMorgan, Bank of America Corp., Citigroup Inc. and Wells Fargo & Co. pitching in US$5 billion each. Goldman Sachs Group Inc., Morgan Stanley and other banks offered smaller amounts as part of a plan devised along with US regulators. On top of that, First Republic tapped the Federal Home Loan Bank and a Federal Reserve liquidity line.

Distressed Debt

It wasn’t enough. The stock, which topped US$170 in March 2022, sank below US$5 by late April. First Republic’s demise imperils not only common-share owners, but also about US$3.6 billion of preferred shares and US$800 million of unsecured notes. JPMorgan said it’s not assuming ownership of either issue, and trading in the preferred was halted. The notes, which had already lost about three-fourths of their face value, were quoted Monday at just pennies on the dollar.

The bank has been bought and sold several times over the years, with Merrill Lynch & Co. paying US$1.8 billion to acquire First Republic in 2007. Ownership passed to Bank of America when it bought Merrill Lynch in 2009, and changed again in mid-2010, when investment firms including General Atlantic and Colony Capital purchased First Republic for US$1.86 billion and then took it public. Trading under the FRC ticker, the stock had rewarded holders with gains of more than 250% by the end of this February.

“The final takeaway, in our opinion, is that FRC believed its business model of extraordinary customer service and product pricing would result in superior customer loyalty through all cycles,” wrote Timothy Coffey, who follows the banking industry for Janney Montgomery Scott. “Instead, too many FRC customers showed their true loyalties were to their own fears.”

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