First Republic Bank is dead! Long live JPMorgan! JPMorgan’s acquisition of failed First Republic Bank
JPMorgan’s role in the American financial industry harkens the days of J.P. Morgan rescuing the U.S. government in 1895 and later saving banks in 1913. While JPMorgan’s acquisition of First Republic may placate markets momentarily, it should bring up important discussions for U.S. legislators, policymakers, and bank regulators. Clearly, the Too Big To Fail problem is now worse than it was in the years running up to the 2007-2009 financial crisis. JPMorgan is now more than twice the size it was in 2006.
After the California Department of Financial Services and Innovation closed down First Republic Bank this weekend, the Federal Deposit Insurance Corporation was appointed as the receiver. JPMorgan’s purchase includes about $173 billion in loans, $30 billion of stocks and bonds at fair value, $92 billion of deposits (which includes $25 billion from other big banks), and $28 billion of Federal Home Loan Bank Board (FHLBs). The FDIC is providing loss-share agreements and $50 billion in financing; JP Morgan did not disclose the rate in this morning analyst call. JPMorgan will pay the FDIC $10.6 billion, which means netting about a $2.6 billion after-tax gain.
Risk To Look Out For
Investors and bank regulators should take out a magnifying glass and look carefully at JPMorgan’s increased operation risk exposures. Operational risk is the potential loss in earnings due to problems with people, process, systems, and external events. JPMorgan will now have to spend time really taking a look at how it will integrate people, technology, and data from First Republic Bank. Given the First Republic failed due to serious mismanagement of interest rate and liquidity risks, JPMorgan will have to comb through all of First Republic banks’ policies, processes, and data quality. JPMorgan should use its own internal auditors and compliance officers to conduct serious due diligence of First Republic assets and liability.
Determining JPMorgan’s added interest rate risk is also important to note. A significant amount of First Republic’s loan book consisted of jumbo mortgages. It will be important to monitor how the current higher interest rate environment will impact the mark-to-market on these relatively illiquid assets. If the loans sour, JPMorgan would share loan recoveries with the FDIC. If the losses are due to interest rate risk, it is unclear if the loss sharing arrangement is the same. The FDIC prepared a Frequently Asked Question page that is expected to be updated later today with more information.
Also, due to JPMorgan’s even more enormous size and added complexity, the bank’s regulators, the Federal Reserve and the Office of the Comptroller of the Currency are likely to require it to increase its G-SIB capital surcharge to help it sustain unexpected losses. Given JPMorgan’s significant interconnections to other financial institutions and the American economy, it is more important than ever that it is more capitalized.
Too Big To Fail
Clearly, the Too Big To Fail problem in the U.S. is not only alive and well but is now an even bigger problem for the financial industry and the American government. Some analysts have stated that the First Republic Bank failure is idiosyncratic. Three banks have failed in the U.S. in less than two months; they are amongst the largest bank failures in U.S. history. This is serious. What may not end up being idiosyncratic is poor risk management amongst regional banks. As I mentioned last week on Bloomberg Surveillance, as well as this morning, many regional bank have forgotten, or are intentionally ignoring the basics of managing risks at a bank.
Silicon Valley Bank, Signature Bank
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