JPMorgan now holds the distinction of having acquired the first and second largest failed banks in U.S. history from the FDIC.
The FDIC took over both banks before JPMorgan bought them. The FDIC seized the largest — $309 billion (assets) subprime mortgage lender Washington Mutual (WaMu) — in September 2008 before JPMorgan bought it for $1.9 billion, according to the Washington Post.
On May 1, JPMorgan took San Francisco-based First Republic ($229 billion in assets) — which catered to wealthy people — off the FDIC’s hands while taking a multi-billion accounting gain.
Since peaking at $219 in early November 2021, First Republic’s stock has lost most of its stock market value — trading at about $2.35 in May 1 pre-market trade.
CEO, Jamie Dimon, famously regretted the WaMu buy — not as much as he did Bear Stearns. JPMorgan paid $19 billion to settle regulatory disputes related to these deals. In 2015, Dimon wrote in a shareholder letter he would not buy Bear Stearns again and he overpaid for WaMu.
Will JPMorgan — whose shares up 5% in May 1 pre-market trade — have better luck with First Republic? Will more banks fail? Read on for thoughts on these questions and more.
JPMorgan Buys First Republic
JPMorgan just agreed to take on First Republic’s deposits and acquire its assets. The FDIC estimates that the risk-sharing agreement it worked out with JPMorgan will cost its deposit fund $30 billion.
JPMorgan’s takeover followed The California Department of Financial Protection and Innovation’s takeover of First Republic. The California financial regulator appointed the FDIC as receiver following a failed bidding process to convince rival lenders to acquire the bank, according to CNBC.
JPMorgan will reopen First Republic Bank’s 84 offices in eight states as JP Morgan Chase bank branches. “All depositors of First Republic Bank will become depositors of JPMorgan Chase Bank, National Association, and will have full access to all of their deposits,” noted the FDIC.
JPMorgan will assume all of First Republic’s nearly $104 billion in deposits and buy most of its $229.1 billion in assets. The FDIC estimated that its Deposit Insurance Fund (DIF) — which totaled $128.2 billion at the end of March — would take a $13 billion loss from the deal.
JPMorgan — which agreed to share gains and losses on single-family residential mortgages and commercial loans with the FDIC — will report an immediate profit from the transaction which it expects to exceed its future restructuring costs.
Specifically, Bloomberg reports that JPMorgan expects to recognize a one-time gain of $2.6 billion tied to the transaction and to incur $2 billion in related restructuring costs over the next 18 months. JP Morgan is not assuming First Republic’s corporate debt or preferred stock.
Meanwhile, Dimon issued a statement praising the benefits of the deal for JPMorgan and the FDIC. The deal will minimize costs to the Deposit Insurance Fund, “modestly benefits our company overall, is accretive to shareholders, and helps further advance our wealth strategy,” he said in a statement.
Why First Republic Failed
First Republic was the next most at risk bank after the collapse of Silicon Valley Bank. SVB’s failure cratered stock in First Republic — which had a strategy of issuing mortgages to wealthy individuals while requiring them to keep deposits there.
The rescue of First Republic began on March 17 when JPMorgan and other banks deposited $30 billion there in a bid to stop a run on deposits like the one that felled Silicon Valley Bank.
By then First Republic’s stock had lost 88% of its peak value and I thought that not enough had been done to save First Republic and quell investors’ fear about the financial system.
The damage to First Republic became much clearer on April 24 when it reported in a first quarter earnings report that clients withdrew $102 billion in deposits (58% of its December 2022 deposits) — forcing the bank to borrow $92 billion, according to he the New York Times — accounting for 72% of all recent borrowing from the Fed’s discount window, noted BCA Research.
In a conference call, First Republic CEO Michael Roffler withdrew the bank’s “previous financial guidance and opted not to take questions after an unusually brief conference call,” CNBC noted.
Like SVB, First Republic’s failure springs from a bad bet on interest rates. Both banks acted as though the Fed would not raise interest rates as much as it did. As the Washington Post reported, First Republic invested in long-term home mortgages and government securities when rates were low.
With the Fed Funds rate around 5%, First Republic was raising new money to fund its operations from the Fed and the Federal Home Loan Bank at rates some two percentage points higher than the 3% it earned on those long-term investments.
Bert Ely, a banking consultant in Alexandria, Va., told the Post, “Both of them essentially committed financial suicide by putting all these fixed-rate assets on their books and exposing themselves to a rising interest rate environment.”
First Republic has been bought and sold many times in the past. As Bloomberg reported, Merrill Lynch paid $1.8 billion to acquire First Republic in 2007 which Bank of America acquired in 2009. In mid-2010, General Atlantic and Colony Capital
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Will JPMorgan Have Better Luck Than It Did With Its WaMu Buy?
In 2015, Dimon said that JPMorgan’s Bear Stearns and WaMu acquisitions had taught him “expensive lessons that I will not forget.”
In a statement to shareholders he wrote, “in the WaMu case, we thought we had robust indemnities from the FDIC and the WaMu receivership, but as part of our negotiations with the Department of Justice that led to our big mortgage settlement, we had to give those up. The WaMu deal might still make sense but at a much lower price to make up for the ongoing legal uncertainty.”
Investors are bidding up JPMorgan stock in pre-market trade. This suggests that they believe Dimon has learned his lesson and created iron clad limits to how much of First Republic’s asset and loan losses JPMorgan will have to pay.
Are More Bank Failures On The Way?
While it is unclear whether more banks will fail, in March 186 of them shared the traits that caused SVB to fail. That’s because these banks — which were not named in a paper by three economists — had a high level of uninsured deposits and considerable risk of loss to the value of their mortgages and long-term government securities due to rising interest rates.
Meanwhile, banks are still lending but they are tightening their credit standards in the wake of these big bank failures. “Lending is somewhat weaker than before the banking sector turmoil in March, but we haven’t seen a pure credit crunch,” Gregory Daco, chief economist at EY-Parthenon told the Post.
If borrowers can’t renew their loans or must pay higher interest rates, this could lead to loan defaults — which so far have not been the primary cause for 2023’s bank failures.
The challenge for investors is that nobody knows what will happen next to the value of First Republic’s assets and to the broader banking system. Perhaps it would be good for the global banking system if JPMorgan adds considerably to its capital base to protect against unplanned for risks.
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