First Republic Could Make Failure Safe Again

By Breakingviews

When Silicon Valley Bank (OTC:SIVBQ) and Signature Bank (OTC:SBNY) failed in March, U.S. authorities bailed out their depositors regardless of size. The response signaled that when a mid-sized U.S. lender collapses, doing anything less might spark a systemic crisis. The slower destruction at First Republic Bank (FRC) could provide an opportunity to reverse the regrettable precedent.

First Republic has lost 60% of its market value in the three days since it said $100 billion of deposits, or more than half, fled during the first three months of the year. Without dramatic action, the San Francisco-based lender’s days look numbered. Its loans and securities on average yielded 3.7% in the latest quarter, but its borrowings cost was 4.3%. Generating a sustainable profit looks unlikely.

The stricken lender might survive if a rival, or several, injected new equity. But why would they? The United States has thousands of banks with proven business models and more stable funding. JPMorgan (JPM), the country’s biggest, made an 18% return on equity to start 2023, and trades at 1.4 times book value, a discount to its five-year average. Boss Jamie Dimon can buy back his own bank’s shares rather than investing in others.

There’s enough in what’s left at First Republic to safeguard the most important creditors, at least. The bank had roughly $230 billion of assets at the end of March. Say those are worth 85% of face value, or $195 billion. If the Federal Deposit Insurance Corp were to take First Republic into receivership, it would have enough to repay the $55 billion of insured depositors and $105 billion owed to priority lenders like the Federal Reserve.

After that, things could get awkward. There would be only $35 billion to cover $50 billion of uninsured depositors, namely those with balances over $250,000, and less if assets have to be sold at a bigger discount. That’s not a catastrophe. Unlike at SVB and Signature, the bulk of First Republic’s uninsured depositors aren’t small businesses with workers to pay, but other banks. JPMorgan, Citigroup (C), Wells Fargo (WFC) and Bank of America (BAC) led a $30 billion deposit in mid-March. The loss would sting but not turn off their lights.

Those mega-banks may yet take one for the team by converting their deposits into equity. It’s a longshot, however, as they’d become co-owners of a lender in need of a new strategy in an overcrowded market on the cusp of a credit-cycle downturn.

And while it’s never good when a business fails, there’s a potential benefit to letting First Republic go. The FDIC has so far created the impression that depositors without insurance have protection anyway. That’s dangerous, unsustainable and potentially expensive for the banks feeding the FDIC’s bailout fund. This time there may be a chance to send a stronger and more responsible message.

Context News

First Republic Bank’s shares fell 60% in three days of trading, after disclosing on April 24 that it had lost more than $100 billion of deposits in the first quarter of the year, a period when two mid-sized U.S. banks failed, and a third one moved toward a voluntary wind-up. First Republic had $233 billion of assets at the end of March, and $104 billion of deposits compared with $176 billion at the end of December. Around $30 billion of its deposits at the end of the first quarter came from a funding injection by big lenders including Citigroup, JPMorgan, Bank of America and Wells Fargo in mid-March. Silicon Valley Bank, owned by SVB Financial, was taken into receivership on March 10, while Signature Bank was closed by the Federal Deposit Insurance Corp on March 12. Silvergate Capital (SI), a bank with clients including several large cryptocurrency firms, had said on March 8 that it intended to liquidate its banking operations after a sharp loss in deposits.

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