What the First Republic deal means for America’s banks


“Aleif not Knight on horseback,” Logan Roy, boss of Waystar Royco, a media conglomerate, and lead character of “Succession,” a television drama, tells his son, Kendall. He’s warning his offspring that life is about heroes. I’m not in.” It’s a number on a piece of paper. It’s a knife fight in the mud.”

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As usual, the old bastard was right. Almost everything in finance can be reduced to a deal between two parties: a number on a piece of paper. Every time someone buys shares, they are cutting a deal in which they exchange cash for a share of the company; A loan is a deal in which one party pays cash now in exchange for a stream of goods through time. Private-equity investing is the art of striking a good deal; Hence buying the property. Sometimes one person gets a good deal, another a bad one — but not all deals are zero-sum. Both a borrower and lender can happily walk away from a pay-off mortgage.

A healthy financial system, then, is full of deals. not sick. When the system is consumed by uncertainty or fear, it is nearly impossible to get a good deal. that the other bank was willing and able Troubled First Republic Buywhich was seized by the Federal Deposit Insurance Corporation (FDIC) on May 1st, so there is some relief. After a flurry of deals at the start of the 2007–09 global financial crisis, there was much uncertainty and fear that more had to be done. And there was no deal to cut for the entirety of Silicon Valley Bank (svb) in March. When your columnist recently asked a bank boss why he didn’t submit a bid svbHe quipped: “Besides the $20 billion hole in its balance-sheet?”

The First Republic deal consists of three main parts: A $10.6 billion cash payment by JPMorgan Chase FDIC, $50 billion more over the next five years, plus a promise to pay interest at a fixed rate; And JP Morgan is assuming a credit guarantee for the loan. It was structured in such a way as to increase the amount to be paid by JP Morgan and thus reduce the burden on the company. FDICAs is the goal of the regulator.

At first glance, guarantees and loans seem a bit strange. First Republic’s problem wasn’t that it offered substandard mortgages to risky borrowers. Its problem was that it offered 30-year mortgages at 1% interest to wealthy people, which reportedly included Mark Zuckerberg – and rates have since skyrocketed, reducing the value of the loans. Yet credit guarantees serve a purpose. Makes it easier for JPMorgan to meet regulatory capital requirements, one of which assigns a risk-weight to the asset. Guaranteed loans attract less weight.

The funding line also seems a bit redundant. JP Morgan has a lot of money. It has more than $500 billion in cash in deposits with the Federal Reserve and other banks. But to help JPMorgan get the $180 billion or so in assets, the bank will take in $90 billion in new deposits, $30 billion in loans from the Federal Home Loan Bank, plus $50 billion in loans. FDIC, In theory, JPMorgan could just pay FDIC $60.6bn, instead of $10.6bn, now in cash and forgiven debt. The problem is that banks also have to meet a liquidity-coverage ratio (a measure of the amount of cash or cash-like assets a bank has to meet an estimate of outflows in the event of stress). Acquiring new liabilities as well as reducing large cash buffers will make the firm choke on this measure. JPMorgan’s chief financial officer, Jeremy Barnum, on a call with analysts, described the loan as helping the bank manage its “consumption of liquidity” by better matching assets with liabilities.

All of which says the deal was too sweet for JP Morgan to bite. This resulted in no loss to the acquirer and did not require the acquirer to raise fresh equity. Banks from which the properties were bought svb It did so without raising fresh capital. It’s understandable: The problems faced by banks become more acute when they take actions that could lead to runs. Indeed, the fall of svb An equity-issuing announcement followed. Crafting a deal that leaves an acquirer materially worse off could spark a similar situation. It’s hard to imagine such a scenario at JP Morgan; This is not the case elsewhere.

Still, a deal that strengthens an acquirer and reduces regulatory costs leaves nothing for the old bank’s shareholders or bondholders. That’s probably what they’re worth, given that they invested in a bankrupt institution. But it is also that investors of other banks now fear that they too will meet the same fate. Share and bond prices of other smaller regional banks declined. If this scares off depositors, more deals will be needed.

Read more from Buttonwood, our columnist on the financial markets:
Investors have reason to fear a strong economy (27 April)
Warren Buffett Is Shaking Japan’s Magical Money Tree (20 April)
What Luxury Stocks Say About the New Cold War (April 13)

Also: How to Buttonwood Column got its name

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