After Silicon Valley Bank and Signature Bank last March, First Republic Bank has just been declared bankrupt, paving the way for JP Morgan to take over its deposits and most of its assets. Can the depositor panic, which caused the first fall of regional banks a couple of months ago, be avoided, and above all, what lessons can we now draw from the bankruptcy of the First Republic?
First Republic Bank was created in 1985. It was acquired by Merrill Lynch in 2007 and then Bank of America in 2010 before going public. It is placed on high net worth clients to whom it gives loans and mortgages at preferential rates. In the United States, the deposit guarantee limit is $250,000. 68% of the deposits of its wealthy clients easily exceed this limit, and therefore are not insured by the FDIC (or Federal Deposit Insurance Corporation), the American deposit insurance organization.
The federal government has a double constraint: it must first avoid repeating the mistake made in 2008 by not looking for a solution to the bankruptcy of Lehman Brothers, to the detriment of creditors, starting with depositors, which was the source of the financial crisis at that time. A global economic crisis unprecedented since 1929. He must then avoid a taxpayer bailout that would anger Republicans. The way Treasury Secretary Janet Yellen applied it at the time of SVB’s bankruptcy is clear: putting the bank under FDIC supervision prior to its liquidation involving the transfer of deposits and assets to a private actor.. For SVB, it is another US regional bank, Citizen First, that avoids remake From a Lehman Brothers text. Thus all deposits from SVB clients are saved.
As customers and investors get anxious, 11 major US banks, at the initiative of JP Morgan, deposited $30 billion in First Republic Bank last March. This step was to avoid new bleeding in the deposits. Despite this, First Republic Bank’s quarterly financial report, released last week, showed a $70 billion drop in deposits. So customers got back $100 billion in deposits, which constituted an almost free financial resource for the bank. So the situation was no longer viable because First Republic Bank then had to replace deposits with loans, which rose in cost as interest rates rose. Thus, the return on equity (ROE), of less than 7%, is well below its cost of over 12%.
The market then expects a scenario similar to that of SVB. Thus, its market value, which reached $40 billion in November 2021, fell to less than $0.6 billion during the Friday session. And this time, JP Morgan is taking over the deposits and assets of First Republic Bank.
The main reason for the failure of banks is known: huge withdrawals of deposits by customers. The latter, in fact, wants to take advantage of higher interest rates that allow more profitable financial investments; In addition, they fear losing their uninsured FDIC deposits.
Lehman has been criticized for investing in a securitization product: collateralized debt obligations (CDOs). consolidated debt obligations) on the asset side of its balance sheet, financing loan buybacks Mortgage, that is, the criteria for which the solvency of borrowers was not of the first order. Today the situation is different: cash from deposits of regional banks such as SVB, Signature Bank or First Republic Bank is invested in sovereign bonds (Treasury bonds or T-Bonds), sometimes long-term while deposits are due at any time. The rise in interest rates regulated by the Fed automatically caused the value of Treasury bonds to drop. These securities present almost no credit risk, but they do expose their holders to interest rate risk: if they could wait until maturity, they would redeem the face value of the bond; On the other hand, if he has to meet unforeseen liquidity needs, he resells them at the market price, which will fall further as prices rise. And this fall is even more important because the deadline is so far away.
The losses recorded by SVB, at the time of the massive resale of T-Bonds to allow depositors to get their money back, have consequently resulted in significant capital losses. The rise in rates and the corresponding decrease in the value of bonds has not been recent since the Federal Reserve Chairman, Jerome Powell, initiated it in March 2022. However, this decrease in value does not result in a decrease in the value of accounts when the investor intends to hold these securities until the date due. In France, these bonds are then classified on the balance sheet under the heading ‘Securities at amortized cost’. Moreover, hedging by financial instruments is not theoretically necessary: in fact, the fall in their market value caused by the rise in interest rates is offset by the rise in the margin on unpaid deposits. This just assumes that these deposits are not withdrawn by clients.
Classifying these bonds as “financial assets at fair value” would have made capital losses more predictable. However, this could have led to a deterioration in the prudential position of the banks and, in fact, in their rating. It is possible that the increase in their financing terms, which is transmitted to customers, has contributed to their weakening, which leads to an increase in the cost of risk for banks, and thus accelerates the deterioration of their solvency.
the bank runThat is, the rush of customers in SVB agencies and then First Republic Bank to redeem their deposits made their downfall inevitable. The actions systematically taken by the federal government, jointly with the Federal Reserve Bank, did not prevent bank failures but made it possible to avoid any financial crisis.
Olivier Levine studies Finance at HEC Paris
