This morning we woke up to the news that JP Morgan has purchased the vast majority of the assets and deposits of First Republic with the help of the FDIC bank-funded insurance fund.  This deal removes the last lingering overhang from the panic-induced bank runs that we saw in early March, which led to the receivership of both SVB and Signature.  First Republic was a pretty good bank overall, but their management team made a crucial mistake by investing far too heavily in long-duration assets at ultralow interest rates, despite being overly concentrated with uninsured deposits, which is really what made these banks that failed unique to the rest of the industry.  For example, $FRC pursued many high-net-worth clients such as Mark Zuckerberg, that pose very little credit risk.

They would attract them with below-market offers on loans such as mortgages.  They might offer a 30-year mortgage at 1.5% with a promise from the client to give them their wealth management business and/or deposits, or they also offered interest-only loans which have become increasingly rare.  On the plus side, these loans have extremely low credit risk, but because the rates are so low, they are virtually impossible to sell without realizing huge losses.  As interest rates have increased, the loans have declined in value, creating large mark to market losses.  Ultimately, those loans will likely mature at par, but due to the March panic, many uninsured depositors took their business elsewhere creating an enormous duration mismatch between these long-term mortgages and bonds, and the depleting deposit base.  Banks are able to pledge assets to the FHLB or the Fed’s Discount Window, but the cost of this liquidity is far higher than low-cost deposits.  This was going to lead to a major profitability decline for First Republic.

The ramifications of this deal are very positive for both JP Morgan and the overall banking industry.  Once again depositors lost nothing, and JPM picked up very valuable assets at a very low cost.  The banks pay for the FDIC insurance fund via fees charged, so I wouldn’t expect taxpayers to lose any money.  This removes a large overhang that has been lingering over both the market and financial stocks in general.  The banks that attempted to assuage depositor fears by depositing billions into First Republic are being made whole.

After reading just about all earnings reports I could from regional banks, most are in way better shape than the panic propagandists predicted.  We mostly own the big banks and have had very little exposure to regionals, but we’ve taken advantage of the panic to build some smaller, but attractively priced positions where we think we should do quite well.  The big thing is this clears up something that has been clouding the sector, as the underlying business performance for the industry has been quite good.


Here is a link to the investor presentation from JPM if you are interested in learning more about the details: Microsoft PowerPoint – JPMorgan Chase Presentation


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