First Republic Is A Zombie Bank
It looks like the regional banking crisis is about to claim a fourth victim.
The U.S. government doesn’t want us to have a zombie problem.
You might remember that in March three regional banks in the U.S. collapsed in a matter of days, which caused everyone to worry that we might get a full-scale banking crisis. And then the government stepped in and backstopped all the deposits at those banks, which calmed things down.
Well, that worked for the most part.
But one bank wasn’t able to escape the turmoil without taking a big blow.
A few days ago, San Francisco-based First Republic Bank reported that it had lost over $100 billion of deposits in the days after Silicon Valley Bank collapsed. That’s 60% of its deposits!
Now, the fact that First Republic had lost a lot of deposits wasn’t a surprise. We knew that it faced a run on the bank similar to SVB because it had a similar customer base as SVB—a lot of high-net-worth clients with deposits well over the $250,000 FDIC insurance limit.
But we didn’t know that the bank was in such bad shape.
In fact, on March 16, eleven of the nation’s largest banks—including JPMorgan Chase, Bank of America and Wells Fargo— banded together and collectively deposited $30 billion of their own money into First Republic as a show of confidence in that bank.
But after we got the latest deposit figures from First Republic this week, we now know that that confidence was misplaced.
First Republic, for all intents and purposes, is a zombie bank.
A zombie bank is a financial institution that is insolvent but continues to operate thanks to government support.
If you ask me, that sounds a lot like First Republic.
The bank is sitting on a pile of assets that are worth much less than what it bought them for, and as a result, it owes its creditors more money than it could raise by selling those assets.
Fortunately for First Republic, it hasn’t had to sell those assets, not even to repay the customers who withdrew $100 billion from the bank in March.
That’s because it got a lifeline from the big banks and from the government. In addition to the $30 billion from the big banks, First Republic has borrowed $77 billion from the Federal Reserve and another $28 billion from the Federal Home Loan Bank system.
It used that money to repay the depositors who took money out of First Republic bank.
Without that money, First Republic would have been toast, just like Silicon Valley Bank.
But just because First Republic didn’t collapse in the way SVB did, doesn’t mean it isn’t in really bad shape.
It’s a zombie that’s surviving only because of an enormous amount of government support. If the government— or even the big banks— take their money back, First Republic would almost certainly go under.
Obviously, First Republic doesn’t want that to happen. It would love to muddle along in a zombie state, hoping that its fortunes improve.
If the bank could just wait it out, the prices of its assets would likely recover over time since they’re primarily made up of high-quality mortgages.
The main reason the assets have dropped in value is because of rising interest rates, not because First Republic made loans to borrowers who can’t pay it back.
Over time, the company might also be able to attract more customers and more deposits to replace the high-cost loans it’s gotten from the Fed and the FHLB. On average today, First Republic pays around 2% in interest on its deposits versus around 5% on the loans from the government.
So, if First Republic can somehow bring customers back, its situation could improve.
But unfortunately for the bank, U.S. banking regulators don’t seem willing to allow First Republic to wait it out—and for good reason.
The loans that the Fed and FHLB provide to banks are generally meant to help them whether short-term rocky economic and financial conditions. They’re not designed to be used as permanent sources of funding.
A privately-owned bank that exists only because of massive government support isn’t good for the economy.
It ties up money that could be better used elsewhere. And it creates perverse incentives that might cause the bank to take too much risk (hoping that its risky bet pays off and it can get out of its hole), or conversely, to restrict lending too much (a zombie bank is less likely to make new loans).
Zombie banks were commonplace in Japan in the 1990s and in Europe in the 2010s and contributed to the weak economic growth those regions saw during those periods.
That’s why banking regulators in the U.S., like the FDIC, are unlikely to allow First Republic to remain in a zombie state for long.
Pushing For A Sale
Over the past few days, they’ve been pushing for the bank to sell itself.
Unsurprisingly though, no one’s been interested in buying First Republic outright for obvious reasons—at current market prices, it’s insolvent; its assets are worth much less than its liabilities.
Instead, what’s most likely to happen is First Republic will be taken over by the FDIC, the same way that Silicon Valley Bank and Signature Bank were taken over.
After that, another bank will buy First Republic’s assets from the FDIC at a discount, similar to what we saw with SVB and Signature.
You might recall that two other regional banks—First Citizens Bank and New York Community Bank—got very attractive deals to acquire SVB and Signature banks’ assets from the FDIC (the FDIC insurance fund ultimately ended up taking a $22.5 billion hit from the failure of SVB and Signature).
It’s looking like we’re going to see something similar this time around. Sources are saying that JPMorgan Chase, PNC Financial, and Bank of America are interested in making a bid for First Republic’s assets after the potential government takeover.
So we’ll see what happens. It looks like the regional banking crisis is about to claim a fourth victim, but fortunately, this isn’t a sign that things are getting worse.
The body blow to First Republic took place in the days immediately following the collapse of SVB in March.
The crisis didn’t get worse in April; it’s just that one bank—First Republic bank—took a fatal blow in March but has been surviving up until now in a zombie state.
That’ll probably come to an end soon.
Regional banks as a whole seem to be in a much more stable position today than they were in March. Let’s hope it stays that way.