White Star Capital Digital Assets Fund - newsletter #126
First Republic Bank: From wealth magnet to rapid collapse
First Republic Bank: From wealth magnet to rapid collapse
First Republic Bank, the (former) 14th-largest U.S. commercial bank, has long been considered a successful banking institution with a reputation for providing exceptional service to wealthy depositors. First Republic Bank has built a reputation for offering five-star service to its wealthy clientele, attracting affluent customers who maintained large balances and engaged in various transactions such as mortgages and small-business loans. This customer-centric approach has been instrumental in the bank's continued success over the years.
Unfortunately for FRB, this wouldn’t be enough to attenuate the coming blow. Bank failures began in March following the collapse of two large U.S. regional banks, Silicon Valley Bank and Signature Bank. Silicon Valley Bank failed due to the combined effects of its core business losing funds and the devaluation of its long-term bond investments, which were heavily impacted by the Federal Reserve's interest rate hikes. As the bank tried to raise cash, depositors with accounts exceeding the $250,000 FDIC protection limit became alarmed and withdrew their funds. While reasons for Signature’s shuttering weren’t as clear - the results were all the same.
The failure of Silicon Valley Bank caused a panic that reverberated throughout the banking system, causing depositors to scrutinise other institutions. First Republic Bank, which had about two-thirds of its deposits in uninsured accounts, became a prime target for concerned customers. At the end of 2022, the bank had $176.4 billion in deposits, with 68% exceeding the Federal Deposit Insurance Corp.'s $250,000 insurance limit. Deposits accounted for 92% of the bank's funding.
To attract customers and retain deposits, First Republic Bank attempted to offer higher interest rates on certificates of deposit. However, this strategy proved difficult to execute due to the prevailing climate of fear. Rising deposit costs were an especially big problem for First Republic because much of its income came from low-yielding, fixed-rate mortgages that wouldn't mature for years. The bank didn't expand into other products, such as credit cards and auto loans, which could help balance out a bank's loan book. Simply put, it was too late.
The Federal Reserve's rapid series of interest rate increases further exacerbated First Republic's issues, as depositors sought better returns elsewhere. This forced the bank to pay more to keep its customers, just as rising rates were eroding the value of its mortgage portfolio. More than half of First Republic's loans were residential mortgages with an average interest rate of 2.89%. The rising rates caused some $22 billion in market value losses for these mortgages.
The closure of Silicon Valley Bank and Signature Bank led to an unprecedented outflow of deposits at First Republic Bank. In just a few days, the bank lost more than half of its deposits, around $100 billion. First Republic's struggles accelerated after reporting first-quarter results on April 24, which showed its deposits fell by $100 billion during the banking crisis, and net income dropped by a third.
In response, the bank took measures to secure additional liquidity by leveraging its high-quality loan and securities portfolios as collateral to borrow from other sources. On March 16, a group of large banks agreed to deposit $30 billion in First Republic, aiming to turn it into a firewall. However, this move proved insufficient. The deposit run forced the bank to rely heavily on money borrowed from government and government-backed facilities at rates that largely exceeded what it was earning on its assets. Borrowing reached a staggering $138 billion on March 15.
On Friday 28th of April, it appeared that First Republic's fate was sealed, as federal regulators prepared to seize the bank and sell it to a larger lender. On Monday morning, First Republic Bank was seized by regulators, and the majority of its operations were promptly sold to JPMorgan Chase & Co., the largest bank in the United States. The goal of this acquisition was to stabilise the situation and safeguard both insured and uninsured deposits of First Republic's customers. To this end, First Republic Bank's 84 branches reopened as part of JPMorgan on the same day, with deposits remaining insured by the FDIC. Customers were assured that they could maintain their banking relationship without losing their deposit insurance coverage, up to the applicable limits, as stated by the FDIC.
JPMorgan Chase agreed to take over all of First Republic's deposits, both insured and uninsured, amounting to $92 billion. Furthermore, they acquired the majority of the bank's assets, which included approximately $173 billion in loans and $30 billion in securities. In a message directed at First Republic's customers, JPMorgan emphasised that they would leverage their financial strength, capabilities, and capital to support the bank's clients and the U.S. banking system as a whole. To minimise the potential risks associated with First Republic's problematic assets, the FDIC agreed to share losses with JPMorgan on the bank's loans, as part of the acquisition deal.
Following a massive deposit flight, First Republic was left with limited options. Typically, banks generate revenue by charging higher interest rates for loans than what they pay to depositors or lenders (a spread). In the first quarter, First Republic reported an average earnings rate of 3.73% on its loans. Unfortunately, the emergency funding required to replace the fleeing deposits cost the bank over 4.5%. Given its weakened state, First Republic could not replace this funding with cheaper deposits. A larger bank, such as JPMorgan, had the capacity to replace the emergency funding with less expensive deposits, an option that First Republic could not achieve.
The abrupt downfall of First Republic's stock resulted in the loss of billions of dollars in shareholder wealth. The shares, which had previously been trading as high as $147 earlier in the year, fell to a closing price of $3.51 on the Friday before the acquisition. While investors faced significant losses, top executives of First Republic Bank appeared to have fared better. As per reports, they had sold millions of dollars' worth of company stock in the two months leading up to the sharp decline in the share prices. Additionally, the bank paid millions of dollars to family members of its founder, James Herbert, for work at the lender in recent years, including consulting services related to interest rates and risk. These facts may not sit well with many who saw their investments in the bank vanish this spring.
🔦 White Star & Portfolio Spotlight
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🏦 Enterprises & Institutions
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⚖️ Government & Regulation
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💰 Funding & Exits
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🚀 Project Launches & Updates
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🔥 Other Bits We're Excited About
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