What's Going on with First Republic Bank?

Following the failure of Silicon Valley Bank, a lot of other regionals have experienced depositor runs and serious pressure on their stock prices. But there's actually a lot of variation among regionals, and the solutions to SVB's problems don't necessarily fit the other regionals' problems, as the case of First Republic Bank shows.

SVB's problem was straightfoward:  it had short-term, flighty liabilities and long-term assets. Specifically, its liabilities were mainly deposits, and 86% of its deposits were uninsured, making them particularly flighty. When these deposits started flowing out, SVB needed liquidity to honor the withdrawals, and that meant liquidating or borrowing against its assets. Its assets consisted of primarily of securities (56% of assets) and loans (35% of assets). SVB had already in 2022 borrowed heavily from the Federal Home Loan Bank System against the loans (mainly residential mortgages)—$15 billion of advances at the end of 2022, so it's not clear how much more liquidity it could have gotten from its mortgages. Therefore SVB had to turn to its securities. Those securities were almost all being held to maturity (34% of total assets), meaning that they were not marked-to-market, so SVB had to realize the loss upon sale (or borrow with them at market-based valuations).

This is a profile that isn't matched by any other regional. Signature Bank, which also failed, had an even higher percentage of uninsured deposits (89%), but Signature's assets were overwhelming loans (66% of assets), and its HTM securities were limited (only 7% of assets). But after SVB's failure, the fast money was spooked, and Signature didn't have any way to come up with the necessary liquidity in time.

What about First Republic, which has been the bank under the most pressure since the failures of SVB and Signature?

First Republic has a lower (but still somewhat high) percentage of uninsured deposits (67%), but that's still high enough to raise real concerns about depositor flight. And on the asset side, First Republic's balance sheet is mainly loans (78% of assets), with securities being just 15% of assets. Of the securities, however, almost all are held-to-maturity. This suggests that First Republic has a lot more FHLB borrowing capacity than SVB (its FHLB advances were only $9 billion at the end of 2022). Unfortunately, we cannot really tell what its FHLB borrowing capacity is because there are no public lending limits available for the FHLBs--it's very discretionary.

Even if the FHLB discount window is tapped out, there's always the traditional Fed discount window, which makes loans against Treasuries and agency securities, valued at market. That's not going to help First Republic, however, because First Republic's securities holdings aren't Treasuries or agencies. They're long-term munis! In other words, First Republic was really reaching for yield. 

Now the Federal Reserve Board announced a new lending program, called the Bank Term Funding Program. The program is basically discount window lending against collateral. The same type of collateral is eligible as with regular discount window lending:  Treasuries and agency securities. There's just one substantial twist: collateral in the BTFP will be valued at face value, rather than at market value. It's all being done at very low rates:  one-year overnight index swaps rate plus 10bps. There's no Bagehotesque punitive rate being charged. In other words, the BTFP is a bailout of banks that did a bad job managing their interest rate risk by hoarding up on long term Treasuries that they held to maturity.  It's a facility that would have been very helpful to SVB, but it's basically worthless for First Republic Bank given the nature of First Republic's securities portfolio.

First Republic seems to have found some financing from private sources, which is how things ought to work here, but the point I want to close this post with is that when we're talking about bailouts, don't just look at the extension of deposit insurance to uninsured deposits. Look at the Fed's Bank Term Funding Program. No one in the private market would lend against securities at face, rather than at market. But that's what the Fed's doing in order to enable banks that have held-to-maturity securities avoid loss realization. Let's call this what it is: it's a bailout of banks that failed at banking 101—managing interest rate risk. The whole nature of banking is that it involves balancing long-term assets and short-term liabilities. Firms that can't do that well really shouldn't be in the banking business. But instead of their shareholders getting wiped out, they're getting bailed out with below-market lending from the Fed. I really thought we'd moved past that after 2008, but apparently not.