The Federal Deposit Insurance Corporation seized First Republic Bank overnight and then sold a select portion of its assets and liabilities to JPMorgan as it imposed an orderly wind down of the troubled regional bank.
The most recent bank seizure and sale of assets should bolster confidence in the government and major banks to address subsequent landmines among small and midsize lenders.
The action should bolster confidence in the ability of the federal government and systemically important financial institutions to address any subsequent landmines among small and medium-size lenders as interest rates rise and commercial real estate troubles are addressed.
It is critical to note that the recent turmoil among local and regional banks is not a 2008-type crisis. Its origins, causes and impact are several orders of magnitude smaller than the economic catastrophe the crippled the economy from 2008 to 2010.
Rather, the challenges inside the domestic banking sector are likely to evolve in a slow and nonlinear fashion over the next few years, with other problems possible.
The action taken by the FDIC does not address the larger question around the guarantee of deposits inside the banking system.
Given the strong probability of further challenges inside the local and regional banking system, Congress and the regulatory authority will need to address the $250,000 guarantee on deposits under current law.
Many small and medium-size firms have deposits in sweep accounts that are greater than the legal limit—sometimes in the millions of dollars to cover operations and payroll. These large deposits demand policy attention given the risks around the outlook linked to those local and regional banks.
The seizure of First Republic can be traced to several factors: its lax risk management, a business model under duress as large loans lost value and a supervisory failure at the Federal Reserve.
First Republic’s seizure will not only add to the pressure on other local and regional banks to reduce lending to the real economy, but will also prompt regulators to require those banks to build up capital buffers.
Tighter lending and increasing regulatory activity will, in turn, affect small and midsize firms and their ability to invest, continuing the fallout from the banking turmoil that has taken place over the past two months.
Terms of the deal
In our estimation, the seizure of First Republic Bank by the FDIC and its sale to JPMorgan is a constructive development.
JPMorgan will take over roughly $173 billion in loans, $30 billion in securities and $92 billion in deposits, according to JPMorgan and Bloomberg.
JPMorgan paid $10.6 billion to close the deal and was given an exemption to expand its deposit base above the upper limit allowed by the federal government.
JPMorgan will obtain a one-time gain of $2.6 billion and will incur approximately $2 billion in restructuring costs through the end of next year. The FDIC has provided a $50 billion five-year, fixed-term financing to JPMorgan, presumably to close the deal.
The FDIC and JPMorgan have entered into an unspecified loss-sharing agreement to address single-family residential mortgage loans and commercial loans on the books of First Republic.
Economic implications
The recent turmoil among regional banks will most likely show up in the real economy over the next 60 to 90 days.
This most recent seizure, though, is not likely to change the Federal Reserve’s monetary policy. We still expect the Fed to hike its policy rate by 25 basis points on Wednesday.
As banks tighten lending standards and pull back on the provision of credit, growth in the economy will slow further as small and medium-size firms that depend upon local and regional banks for financing further reduce productivity-enhancing investments and reduce hiring.
Tighter lending will play a greater role in the economic narrative in the second half of the year as hiring slows, corporate investment pulls back further and the combination of tension over the debt ceiling and tighter financial conditions weigh on U.S. households that are propping up the economy.
