© etienne laurent/EPA/Shutterstock Charles Kindleberger's classic "Manias, Panics, and Crashes" describes the temptation of too-easy credit through the ages. If the historian were alive today, he might feature First Republic Bank, whose troubled business model is a case study in the bad incentives of easy money.
First Republic's stock sank another 49.3% Tuesday after it reported an outflow of some $100 billion in deposits during the March bank panic. The San Francisco-based bank's wealthy clients rushed to withdraw their money after learning the bank was sitting on unrealized losses twice as large as its capital cushion.
The Treasury Department in March arranged a $30 billion deposit infusion from big banks to cover the funding hole. But this is a stopgap, and First Republic is paying much higher interest on its borrowing than it is earning on assets.
CONSTELLATION BRANDS, INC.The bank is reportedly exploring a large asset sale to raise cash, but who's going to buy its underwater super-prime mortgages without a government guarantee? Silicon Valley Bank's assets were mostly vanilla government bonds and mortgage-backed securities. First Republic's are more flavorful. Loans make up 75% of its assets, including $101 billion in single-family mortgages. These loans carry interest-rate and credit risk that is hard to assess in the current economy.
First Republic developed a business niche by marketing mortgages to the titans of Wall Street and Silicon Valley with rates starting below 3%. Bloomberg News reported that Mark Zuckerberg in 2012 refinanced a 30-year $5.95 million mortgage on a Palo Alto home with an interest rate starting at 1.05%. Sweet.
The bank's lending ballooned during the pandemic as the Federal Reserve expanded its balance sheet and kept interest rates near zero. This created a nice financial arbitrage opportunity. Low interest mortgage payments (which are also tax deductible) freed up money for the affluent to invest in higher-yielding stocks.
High-rollers could surely afford to buy multi-million dollar homes without borrowing. But why sell stocks to buy a home when the market is booming? The S&P 500 surged 40% between February 2020 and December 2021. Its attractive loan terms spread through Greenwich, Conn., the Hamptons and Napa Valley. Even Goldman Sachs President John Waldron took out an $11.2 million mortgage from First Republic.
The catch was that to get more attractive terms, the wealthy had to move their cash to the bank. "To get to our best relationship pricing, we want the full deposit relationship," First Republic executive Robert Lee Thornton told investors last November. "It's a very key focus and one of the reasons we've been able to grow deposit balances so quickly."
First Republic's deposits nearly doubled between the end of 2019 and 2022, which supported more loans to the rich as well as to commercial real estate and private equity. Those industries and loans are now struggling amid rising interest rates. The easy-money mania was fun, but the panic is painful.
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