Digging Into The JP Morgan Chase - First Republic Transaction

Like the Baltimore Colts, First Republic Bank vanished in the night. On Monday at 3:30am EDT, the FDIC announced that JP Morgan Chase had won the auction and would assume the deposits and acquire substantially all the assets of First Republic. On balance this is very good for the health of the industry; zombie banks create a drag on the entire financial system. It is even better for JP Morgan Chase, for whom likely outcomes range from very good to extraordinary. Management’s assumptions and projections, as discussed on the investor call, are quite conservative. It would not be surprising to see them revised upward, perhaps as soon as JP Morgan Chase’s May 22 Investor Day.

Immediate systemic benefit, long term systemic costs. The long-term effects, on both competition and financial stability, of enabling too-big-to-fail banks to grow bigger still, remain to be seen, though their valence is not in doubt. Regulators assure us that this was the resolution with the lowest cost to the FDIC’s Deposit Insurance Fund, and the result of a competitive bidding process. To paraphrase Mandy Rice-Davies, they would, wouldn’t they? Either the other bidders squandered their opportunity for a strategic coup with foolishly low-ball bids, or the parties involved have a curious definition of “competitive bidding.” Banks, especially large ones, don’t always behave like traditional shareholder-owned companies because they also function as instruments of economic policy, but in this crisis we seem to have broken some new ground. G-SIBs began to look almost like GSEs. That is a problem for another day, perhaps far into the future, perhaps not, but given all the attention being paid to the advantages of the transaction - which are many and great – we feel compelled to note the existence of the other side of the ledger.

First Republic is a great but unusual transaction. The most unusual thing about the First Republic transaction is, of course, the terms; rarely are acquisitions quite so favorable to the buyer. It is also unusual because of where the value resides. First Republic brings JP Morgan Chase little in the way of new geographies or capabilities (though Jamie Dimon did call out opportunities to learn from First Republic’s customer service practices). There are branch consolidation opportunities, which we explore in some detail in this report, and any acquirer would have gained the benefit of reducing First Republic’s unsustainable funding costs, which we detailed last week. But the real long-term value to JP Morgan Chase lies in First Republic’s HNW customer list (and by extension, in the FAs and bankers that maintain those customer relationships). In this report we will review some data that don’t figure directly into estimating earnings accretion, but rather afford some insight into why First Republic’s customer base is so valuable.

Term and revolving loan agreements. Figure 1 shows a list of term and revolving loans in which First Republic is among the banks listed in the loan documents, organized by sector and by client. The list is short (piecing together a bank’s balance sheet from the bottom-up, at the customer and instrument level, inevitably offers an incomplete, but nonetheless very useful, picture), but skewed toward investment services, consistent with the bank’s focus on entrepreneurs and professionals.

Figure 1: First Republic Selected Term and Revolving Loan Participations

Source: FactSet 

SBA loan originations. Figure 2 shows a list of First Republic’s SBA loans originated in 2022, including individual borrowers and their NAICS codes and descriptions. Here again one sees many professional practices of the sort that not only are attractive bank customers themselves, but have the potential to generate streams of equally attractive referrals.

Figure 2: First Republic 2022 SBA Loan Originations

Source: FactSet 

Mortgage originations. One must be circumspect is assessing First Republic’s mortgage business; it was a big part of why the bank failed, after all. But the reason matters; First Republic’s mortgage problems were related to interest rate risk, and not to credit risk. As Figure 3 shows, First Republic’s mortgages were mainly in their core markets, and on the large side. Figure 4 shows that around 15% of originations were cash-out refis – readers may recall these as red flags during the mortgage bubble that burst in 2008, but in this case, these loans underscore the strength of First Republic’s customer base. Here, cash-out refis tend not to be for overleveraged borrowers paying down credit cards, but rather for HNW customers who don’t necessarily need to borrow money to pay for their house, but who prefer to, for tax and/or liquidity reasons.

In other words, these mortgage loans didn’t sink First Republic because they were at risk of default; they are money good. They sunk First Republic because they carry low fixed rates, which created a slow-moving problem as the Fed began raising rates, and turned into a fast-moving problem when, in March, the bank suddenly found itself funding a 3% mortgage book with 4-5% wholesale borrowings. It’s tough to make that up on volume. On JP Morgan Chase’s balance sheet, however, they have been appropriately marked, are appropriately funded, and bring the bank a lot of desirable customer relationships.

Figure 3: First Republic Mortgage Originations by State

Source: FactSet 

Figure 4: First Republic Mortgage Originations by Loan Purpose

Source: FactSet 

Wealth management AUM and client data. Figure 5 shows assets under management by client type in First Republic’s wealth management subsidiary, First Republic Investment Advisors. This data is as of year-end 2022, so reflects neither AUM and client growth from year-end through mid-March, nor the attrition since mid-March. Nonetheless, it offers a reasonably accurate snapshot of First Republic’s customer mix, skewed heavily toward HNW individuals and businesses (many of the latter being owned by HNW clients). Figure 6 shows the healthy AUM per client in the HNW segment, as well as the non-HNW individual segment, which accounts for roughly half of total clients, but a de minimis share of AUM – likely reflecting investment services provided to large groups of employees of the businesses that account for about 30% of total AUM.

Figure 5: First Republic Investment Management AUM by Client Type

Source: FactSet 

Figure 6: First Republic Investment Management AUM per Client by Client Type

Source: FactSet 

Branch overlap is near total. First Republic and Chase branches are almost literally on top of one another. Some 39 First Republic branches are within a quarter mile of a Chase branch, and 75 are within a mile of a Chase branch. In Manhattan, most branches are close enough that customers can reasonably be expected to walk to the new one should their current one be closed. In California, First Republic customers could walk, were they so inclined, to two of the two banks’ branches as they are separated by just two blocks in Santa Monica, and three blocks in Beverly Hills.

As the following maps show, this is the case in every part of First Republic’s non-contiguous footprint. Bear in mind, however, that this will not be a transaction in which the target’s branches are more likely to be closed. Jamie Dimon made the point himself on the investor call that many First Republic branches are in good locations, well appointed, and worth keeping. This is apt to be especially so on the west coast, where the Chase branch network is largely the old Washington Mutual network, which itself was cobbled together from various thrift acquisitions. Suffice to say that the typical thrift branch is not the optimal channel with which to serve a wealthy clientele seeking high-touch service. In many cases, First Republic customers are likely to keep their existing branch, and current Chase customers may be delighted to join them there.  

Figure 7: Bay Area

Source: FactSet 

Figure 8: Southern California

Source: FactSet 

Figure 9: New York City

Source: FactSet 

Figure 10: Boston

Source: FactSet 

Figure 11: Florida's Gold Coast

Source: FactSet 

Figure 12: Manhattan

Source: FactSet 

Figure 13: San Francisco

Source: FactSet 

Figure 14: Santa Monica (also walkable to the Pier)

Source: FactSet 

Figure 15: Beverly Hills

Source: FactSet 

Figure 16: Prudential Center (Boston)

Source: FactSet 

Figure 17: The Yield Curve Remains Inverted

Source: FactSet 

Figure 18: Fed Funds Futures Discount 94% Probability of 25bp Hike on May 3, up From 50% at March 31 

Source: FactSet 

What We’re Watching

Key upcoming data points. Beyond ongoing financial sector earnings releases, a few key things we are watching:

• May 3: FOMC Meeting, which is expected to yield another 25bp hike, pressuring bank margins further (particularly those that just had to replace demand deposit outflows with Fed borrowings).

• May 4, 10am: Senate Banking Committee hearing: Holding Executives Accountable After Recent Bank Failures, featuring testimony from Ms. Da Lin, Assistant Professor of Law, University of Richmond School of Law; Mr. Thomas Quaadman, Executive Vice President, Center for Capital Market Competitiveness, U.S. Chamber of Commerce; and Professor Heidi Mandanis Schooner, Professor of Law, Columbus School of Law, The Catholic University of America.

• Expected sometime this week: The quarterly Senior Loan Officer Opinion Survey (SLOOS) which may offer some additional insight into the effect of the bank crisis on both lending standards and loan demand.

• May 8-9: The Gulf South conference, featuring managements from many southeastern banks, and generally well attended by both the buy side and sell side.

• May 22: JP Morgan Chase’s Investor Day, which promises to offer useful read-throughs across the financial sector, in addition to incremental detail on the First Republic integration.

Weekly Federal Reserve Balances

April 26 Federal Reserve balances show stable but elevated reliance on Fed liquidity. Figures 19 and 20 highlight the key data points from last week’s release of Federal Reserve balances (Release H.4.1). Combined bank usage of the Discount Window and the BTFP climbed for the second consecutive week, up 7.8% to $155 billion or just 6% below the March 15 peak. This will drop with JP Morgan Chase’s acquisition of First Republic, but it would be encouraging to see a broader trend of banks replacing this expensive funding with deposits.

Figure 19: Federal Reserve Balances

Source: FactSet 

Figure 20: Bank Reliance on Fed Liquidity Remains Elevated

Source: FactSet 

Money market assets bounce. Money market assets erased the prior week’s decline, rising $54 billion (1.0%). In the week ended April 26. Since March 8, that leaves money market assets up a total of $369 billion (7.5%).

Figure 21: Money Market Fund Assets ($Trillions)

Source: FactSet 

Total commercial bank deposits tick up. Total deposits saw their second increase in three weeks in the week ended April 19, rising $21 billion (12bps) although small banks saw a small (2bp) decline. With another Fed Funds hike expected this week, this uptick is likely to prove an aberration.  

Figure 22: Small Bank Deposits Stabilized While Large Bank Outflows Leapt

Source: FactSet 

Figure 23: Total Bank Deposits by Week ($Trillions)

Source: FactSet 

Total loans rose nominally. Total loans were up $15 billion (12bps) in the week ended April 19, which left them up 32bps 2Q-to-date, which translates to about 5.5% annualized growth. C&I loans were down slightly for the week but remain in line with total loans QTD. Commercial real estate loans were up $5 billion (17bps) for the week, which puts them on pace for roughly 3% annualized growth QTD, a sharp deceleration from the 10%+ year-over-year growth rate.

Figure 24: Total Loans Rose Slightly In The Most Recent Week

Source: FactSet 

Figure 25: Total Bank Loans by Week ($Trillions)

Source: FactSet 

This blog post is for informational purposes only. The information contained in this blog post is not legal, tax, or investment advice. FactSet does not endorse or recommend any investments and assumes no liability for any consequence relating directly or indirectly to any action or inaction taken based on the information contained in this article.