Evening Brief – 05.01.23
US regulators unveiled a hybrid solution for First Republic Bank over the weekend – after all other attempts at a private rescue effort failed – where the FDIC seized the insolvent bank, the 14th largest US bank by assets, making it the second biggest bank failure in US history, and immediately sold it to JPMorgan.
JPMorgan will assume all of First Republic’s $92 billion in deposits, insured and uninsured, including the $5 billion in deposits given by JP Morgan to First Republic on March 16. It is also buying most of the bank’s assets, including about $173 billion in loans and $30 billion in securities.
As part of the agreement, the FDIC will share losses with JPMorgan on First Republic’s loans. The agency estimated its insurance fund would take a hit of $13 billion in the deal, which is precisely the hole that prevented a private sector solution from being reached. JPMorgan also said it would receive $50 billion in financing from the FDIC to consummate the deal.
More importantly, the FDIC and JPMorgan also entered a loss-share transaction on single family, residential and commercial loans it purchased from the former First Republic. As part of this transaction, the FDIC as receiver and JPMorgan will share in the losses and potential recoveries on the loans covered by the agreement.
The latest event is an unusual situation in the sense that all the incentives were aligned among the three big participants: the banks, the FDIC and the Federal Reserve. But the results also have unintended ramifications. We are making the “big” banks bigger. It turns out the banks that were once viewed as “too big to fail” are now considered the “safe” banks. We have increased moral hazard.
When Silicon Valley Bank and Signature Bank failed, it was possible to pin the crisis mostly on the unique profile and decisions of a couple of extremely unique banks – most financial institutions were not so dependent on concentrated deposits or had lost so much on their assets as interest rates rose.
Credit Suisse’s failure was less unique but still represented the collapse of an institution that had fundamental flaws for more than a decade. First Republic is much more of a normal bank than any of those institutions and its failure indicates how much stress is still pervading in the US banking system.