On May 1st, 2023, First Republic Bank was taken over by the FDIC, a move which completely wiped out shareholders as well as bondholders. with over 250 billion dollars of assets. First Republic was slightly larger than Silicon Valley Bank and its demise represents the second largest bank failure in U.S History: Immediately after taking over First Republic the FDIC sold it to JP Morgan. While the shareholders were wiped out, depositors were completely protected.

With the resolution of the First Republic issue, JP Morgan CEO Jamie Diamond said. at this stage of the banking crisis is finally over. However, in the days following first Republic's collapse, another Regional Bank called Pacific Western or Pac West Saw its share price Fall by 70 percent. This comes on reports that the bank is exploring strategic options such as selling itself to a large Bank Another Regional Bank called Western Alliance saw its shares more than cut in half on speculation that they too were exploring a potential sale.

Despite this extreme stress in the banking system, the Federal Reserve is continuing its rate hikes with which most economists believe will cause a recession. In this video, we'll take a look at why First Republic failed and what this means for America's increasingly fragile Financial system. For full disclosure: I Have a position in some of the stocks mentioned in this video and none of this should be considered as investing advice. Foreign public specifically targets wealthy people by offering a white glove service at its branches which are located primarily in New York and California.

Many rich people own their own businesses, so they'll have both their business and personal accounts for the First Republic. There are a few benefits to First Republic's business model. Firstly, they can offer far lower interest rates on savings accounts compared to mass Market Banks Wealthy clients want to get the White Glove customer experience and are willing to take a slightly worse interest rate in return. Secondly, First Republic primarily makes loans to wealthy clients who are generally far less likely to default because of this.

First, Republic has industry-leading credit quality. In most years, their net loan losses are so low that they round down to 0.00 Even in 2009, their loan losses were only 0.48 of their total loan book. The downside of lending to rich people with high credit scores is that the interest rates on these loans will be very low. First, Republic's loan portfolio primarily consisted of long duration mortgages with an average yield of about three percent.

As the Federal Reserve started raising interest rates in 2022, the overnight Federal Funds rate quickly surpassed the yield First Republic was making on its loans. However, as long as the bank's wealthy clients were willing to keep their money and non-interest pairing checking accounts or very low yielding savings accounts at First Republic, the bank would be fine. First, Republic's focus on high net worth customers also meant that the vast majority of its deposits were above the 250 000 limit for FDIC insurance. After the collapse of Silicon Valley Bank, people got scared about these uninsured deposits and started withdrawing their funds from First Republic.

Even if the chance of a bank failing is small, the results could be catastrophic for uninsured depositors and there's really no downside to withdrawing your funds just to be safe. This created a classic run on the bank and quickly pushed the bank to the brink of collapse. The Federal Reserve stepped in and created the Bank Term Funding program. This program allows Banks to borrow money from the Federal Reserve by using their Securities portfolios as collateral.

Also, the government convinced some of the country's largest banks including JP Morgan Bank of America and others to collectively deposit 30 billion dollars into First Republic for a minimum term of 120 days. By this point, it was clear that first Republic was in big trouble and the stock price declined by more than 70 percent. The reason that it didn't go to zero was because Invest officers were still holding on to some hope that the FED could somehow save them. On April 24th, the First Republic announced first quarter earnings results, which were a complete disaster.

Their deposits had declined by 72 billion dollars from 176 billion to 104 billion. This even includes the 30 billion dollars in emergency deposits that they received from the larger Banks. Had it not been for that, their deposits would have fallen by 100 billion dollars or well over 50 percent. To make good on customer withdrawals, they were forced to borrow 106 billion dollars from the Federal Reserve and Federal Home Loan Banks And this bailout didn't come for free.

First Republic has to pay a roughly 5 interest rate on these borrowings, representing roughly 5 billion dollars of annual interest expense. Also, First Republic has been forced to increase the interest rate that it pays on the few deposits it has remaining, raising the savings rate from 0.2 percent to 1.5 percent on some of their certificates of deposit. Their rates are as high as 4.95 The cost of their deposits will likely be over 1 billion dollars, so their annualized net interest expense has likely risen to above 6 billion dollars. They have a little under 200 billion dollars of interest bearing assets, such as mortgages, which yield about three percent.

That means they'll generate about 6 billion dollars of interest income per year. Their interest expense will likely be higher than their interest income, giving them a slightly negative net interest margin. First Republic also makes about 1 billion dollars of non-interest income per year from its wealth management business, as well. Goals: Various fees that charges to account holders non-interest income will decrease substantially as they now have less depositors.

So in a best case scenario, First Republic might be able to generate a little less than one billion dollars of net revenue, but it cost them about three and a half billion dollars per year to pay their employees and keep the lights on at their branches. Thus, First Republic will be losing billions of dollars per year. The majority of their loans are fixed interest rate and have a duration of greater than 15 years, so it will likely take many years before their interest income can increase substantially. As it stood, First Republic was condemned to be a money loser for the better part of the next decade.

The emergency 30 billion dollars in deposits from the larger Banks had a 120 day expiration date, so by July First Republic would need to get an additional 30 billion dollars worth of funding. There's really no reason why normal depositors would want to deposit money into a bank which is on the brink of failure, so the only viable option would be for the Federal Reserve to lend them even more money, which would cause their net interest margin to become even more negative. Even if a bank has not yet failed, the FDIC can take it over if they think it is on the brink of failure. This was clearly the case for First Republic seeing as they were already on life support.

From the Federal Reserve If you look at first Republic's balance sheet as of March 31st, 2023, it was still solvent, at least on paper. Even if you measure their investment Securities at fair value, their assets exceeded their liabilities by five and a half billion dollars. However, that's just because their loanbook is measured at amortized cost. JP Morgan Estimated that the loans had decreased in value by 13 due to the fact that interest rates have risen when you mark the loan book to Market Book value Falls to negative 16 billion dollars, making the bank insolvent.

Nobody will buy a bank with negative Book value. Even if you just paid one dollar for it, you would incur a 16 billion dollar loss because you are now on the hook for all their liabilities as well as their assets. That's why the FDIC had to take them over. Immediately after the FDIC took it over, they sold the majority of First Republic's assets to JP Morgan.

The FDIC had to eat some of the losses itself to convince JP Morgan to buy it, and overall it looks like a pretty good deal for the country's biggest bank, which just became a little bit bigger. Her JP Morgan acquired substantially all of First Republic's assets and most of its liabilities. The portion that JP Morgan acquired had positive Book value of about 17 billion dollars and they paid 11 billion through the FDIC valuing the assets at .63 times. Tangible Book JP Morgan itself trades for 1.4 times Book value so the deal is immediately accretive to JP Morgan's tangible book value per share.

They say that they expect the deal to add 500 million dollars to the bank's annual earnings. JP Morgan already makes roughly 40 billion dollars of net profit per year. So the First Republic acquisition is little more than a drop in the bucket. Now all first: Republic's depositors will become JP Morgan depositors, First Republic employees will become JP Morgan employees and they will likely Rebrand the branches as JP Morgan or Chase at some point in the future.

First Republic Shareholders and bondholders were completely wiped out, but no depositor lost a single Cent This should reaffirm confidence in the financial system. In JPMorgan CEO Jamie Dinan said that this deal marks an end to the banking crisis this, but it looks like Diamond may have spoken to soon. In the week following the First Republic takeover, the share prices of other Regional banks have experienced extreme volatility. Specifically, Arizona-based Western Alliance and California-based Pac West are under severe strain.

Foreign California Pacific Western Bank or Pac West has been under severe strain since the failure of Silicon Valley Bank. The main reason is that about one-third of Pacques deposits were from Venture Capital firms and Venture Capital backed companies. Remember that Svb's problems came when their Venture Capital depositors started withdrawing money, ultimately leading to a run on the bank. After the collapse of Svb.

Venture-backed companies in particular became worried about the health of regional Banks so a lot of them started withdrawing money from Pac West By the end of the first quarter, Pac West's total deposits had decreased 5.7 billion dollars or roughly 17 percent to make up for the deposit withdrawals. Pac West borrowed about 10 billion dollars from the federal Home Loan Bank the Federal Reserve as well as a private sector investor, and an average interest rate of 5.3 percent. The amount of new money that they raised is significantly higher than their deposit outflows. so their liquidity position has actually improved since the beginning of the banking crisis.

So, just like with First Republic, the main concern is their net interest margin in as the new borrowings are significantly more expensive than the deposits they replaced. Based on Pak West's first quarter earnings report and other disclosures, I made a rough estimate of their annual borrowing costs based on the current composition of their balance sheet. I Estimate their current annualized interest expense to be about one and a half billion dollars more than five times greater than their interest expense. In 2022, they have about 42 billion dollars of Interest earning assets, which currently yield about 5.35 percent.

However, as old loans mature, they've been making new loans at higher interest rates, so their interest income is gradually increasing. For 2023, a safe assumption is probably a six percent yield, which would give them about two and a half billion dollars of interest income. This would give them about one billion dollars of net interest income, and that's enough to cover their 700 million dollars of overhead costs, which leaves them with 300 million dollars of net profit. Remember that these are all just rough estimates.

Based on these estimations, it looks like Pacwest is in a much better position than First Republic. As long as there is not another unexpected surge of withdrawals, they look to be in a good position to continue operating as an independent company. Additionally, on April 5th, they announced they intend to sell 2.7 billion dollars worth of loans from their balance sheet. This would allow them to pay back some of their expensive Federal Reserve borrowings and improve their net interest margin.

After the Svb collapse pack, what stock lost about half its value for the next few months, the stock was stable, but shortly after first Republic's collapse on May 1st, the stock started tanking again, losing another 70 of its value. The main culprit was media reports that Pacques was exploring strategic options, including a potential sale of some or all of itself. In situations like this, exploring strategic options is usually a bad thing as it could indicate that the bank's senior management team does not believe it can survive as an independent company. On May 3rd, Pac West put out a press release designed to qualifiers.

They said they continued to seek a buyer for the 2.7 billion dollars of loans that they previously said they were trying to sell. Additionally, Pacwest has been approached by several potential partners and investors with whom discussions are ongoing. They will continue to evaluate all options to maximize shareholder value. They also gave an update on the bank's Financial Health Since the end of the quarter, deposits have increased and they've already been able to repay one billion dollars of their borrowings.

so it appears that they are willing to sell themselves to a larger bank if they think it would maximize shareholder value and they're already inactive discussions with potential suitors. First, Republic's acquisition by JP Morgan certainly did not maximize shareholder value as First Republic shareholders were completely wiped out, but Pak West is in a much better financial position than First Republic as it likely still has a positive net interest margin. Given that Pac West's Core Business is stable and their deposits have been recovering over the past couple months, they don't need to sell. Thus, they would likely only accept an acquisition and a substantial premium to their current share price.

As investors came to realize this, the stock price doubled from its lows, although it is still down 75 percent since the beginning of the year. Based in Phoenix Arizona Western Alliance Bank is another Regional Bank whose share price has been under extreme pressure since the collapse of Silicon Valley Bank. Since the beginning of the year, Western Alliance's share price has followed a very similar trajectory as Pac West. Following the collapse of Svb.

Depositors got scared and withdrew about seven billion dollars worth of deposits over the course of the next week. After the Panic subsided, depositors gradually started to come back. As of April 14, their deposits increased by 2.9 billion dollars from the lows. This brings their year-to-date deposit outflows to 4 billion or seven and a half percent.

They had to borrow some money from the Federal Reserve to make up for this deposit shortfall, but not very much as the outflows were relatively modest. Based on their disclosures from the first quarter earnings report. I expect Western Alliance to make a net interest margin of 3.4 percent in 2023, which would give them 2.1 billion dollars of net interest income. This should translate to about 1 billion dollars of net income.

So, just like Pac West Western Alliance is probably still profit of all. In fact, Western Alliance is likely in an even stronger position than Pac West. That's why it came as a huge surprise on May 4th When the Financial Times reported that the Arizona lender had hired outside advisors to explore a potential sale of some or all of his business. the Financial Times cited two Anonymous sources who they claim had knowledge of the matter.

Remember that exploring a sale is a very bad signal because it could mean that the management team thinks that the bank cannot survive as an independent company. This Financial Times report, which has since been deleted, caused Western Alliance's share price to lose more than half its value. In a matter of a few hours later that day, Western Alliance released a statement saying quote the Financial Times report today that Western Alliance is considering a potential sale of all are part of its business is categorically false in all respects. There is not a single element of the article that is true: Western Alliance is not exploring a sale, nor has it hired an advisor to explore strategic options.

It is shameful and irresponsible that the Financial Times has allowed itself to be used as an instrument of short seller and as a conduit for spreading false narratives about a financially sound and profitable Bank We are considering all of our legal options in response to today's article Unquote. As it turns out, Western Alliance was right and the Financial Times was wrong. The outside advisor in question was a law firm named Sullivan and Cromwell Western Alliance had indeed hired them to provide General legal advice, but the law firm said in a statement that their client was not exploring a sale. Just because a news Outlet reports something doesn't mean it's true.

In fact, the Financial Times in particular has a history of disseminating misinformation. Just a few days ago, we made this video about the Eurasian Natural Resource Corporation scandal. In this case, a rogue lawyer selectively leaked false and misleading information to the Financial Times, which ended up causing severe harm to the company. News outlets like The Financial Times often rely on Anonymous sources for information.

In many cases, these Anonymous sources have their own agenda and act with near impunity because their identity is concealed. Since the banking Crisis began, investors have been on edge wondering which bank will be the next shoe to drop. This chaos provides a ripe environment for short sellers to profit off of share price declines. We don't know for sure who the anonymous informants were, but there's a strong possibility that there are short sellers or agents hired by short sellers who wanted to artificially crush the stock price with false media reports.

This type of Market manipulation is especially harmful during a banking crisis. if a bank stock price declines substantially. this can cause fear among depositors and cause withdrawals. Thus, a short seller's market manipulation has the potential to cause a bank run and become a self-fulfilling prophecy.

That's why it's important for banks to stay actively engaged with the public and quickly dispel any rumors or misinformation which could cause Panic amongst their depositors. And that's exactly what Western Alliance did with their almost immediate repudiation of the Financial Times article. All things considered, it appears that Jamie Dimon is correct that the banking crisis is finally coming to an end. The exceptionally weak Banks like Silicon Valley and First Republic have already collapsed.

The remaining Banks appear to be in a much stronger financial position. The stock price volatility that we've seen over the past week appears to be mostly attributable to short sellers in Market Manipulation. All right guys, that wraps it up for this video. Do you think the banking crisis is over? Let us know in the comments section below.

As always, thank you so much for watching and we'll see you in the next one! Wall Street Millennial Signing out.