The Failure of First Republic Bank, and the Impact on Real Estate.

May 3, 2023

The Clock was Ticking.

There's an old saying that is widely attributed to Warren Buffet:

“When the tide goes out, you can see who is swimming naked.”

This past week, the abrupt failure of First Republic Bank gave us another clear example of which banks are wearing their swim trunks…and which ones aren't.

The failure of First Republic Bank should not have come as a surprise to anyone. In the two months since the failures of Silicon Valley Bank and lesser known Signature Bank in New York, intense scrutiny has been focused on the investment portfolios of other “regional” banking institutions to uncover similar vulnerabilities that were brought on by the rapid rise in interest rates. First Republic's name bubbled to the top of the heap almost immediately.

To understand why First Republic Bank failed, you simply need to look at their investment portfolio in the real estate sector. First Republic developed a very well earned reputation for the first-class service they offered those premier clients with high credit scores and high net worth. This meant offering extremely favorable rates for residential and multi-family mortgages to their top clients — in some cases, large interest-only loans were found on their books for some relatively large loans.

This was all fine until interest rates started to rise dramatically last year. Suddenly, First Republic found that they had to pay out a higher interest rates to get people to continue to deposit money than they were getting from the interest on their real estate loans. This created a large hole in the bucket that quickly drained their assets. This problem alone was not unique to First Republic Bank — other institutions faced the same problem. But the larger, more well diversified banks (like JPMorgan Chase) have multiple investment businesses to offset any such loss, such as brokerage divisions, wealth management, and credit cards.

But First Republic Bank, as it turns out, was not as well diversified and this there was nothing it could turn to patch the hole in the bucket. They took $30 billion lifeline from a conglomerate of other lenders, but that only delayed the inevitable. Just like in the case with SVB, the demise was hastened by the use of social media and the internet. Spooked clients started to withdraw funds at a record rate thus sealing the fate of First Republic Bank. I know this is massively over-simplifying a very complex situation, but you get the idea.

Local Market Impact.

It's still way too early to tell what the impact of losing First Republic will mean to the market, but it's obviously not positive. But like anytime you get indigestion after a lousy meal, it's uncomfortable at first, but it passes. In the near-term, I think the real estate market is going to face some indigestion in the following areas:

  • Consumer Confidence. The ups and downs of the real estate market are joined at the hip with consume confidence. Confident consumers buy homes, while skittish consumers retreat. Bank failures tend to make home buyers nervous, especially those buyers who were pre-approved already with First Republic and who may now have to start the whole process over with a new bank.
  • Less Competition. According to The Real Deal, First Republic was the 8th largest real estate lender in the state of California, taking into consideration residential and commercial loans. Losing that big of a player means less choices for consumers. And less choices may mean higher rates. It's widely speculated that JPMorgan Chase will not be extending the ultra-low interest rates and favorable terms to First Republic's premier clients, as the article suggests.
  • More Failures. It's unlikely that First Republic will be the last bank to fail due to the economic climate. There are at least 6 other regional banks that appear to be battling for their collective lives right now, and their stock prices are reflecting the investor's belief in their ability to recover. Luckily, none of these half dozen banks do much business here, so it won't have a direct effect. But every time a bank failure is announced, we rattle the cage all over again.

This Too Shall Pass.

If there's any good news here, it's that the market will handle this indigestion and move on. Once the home-buying public regains confidence in the system and realizes that this is still a very isolated occurrence, they'll be back in the market. Other banking institutions such as PNC, Wells Fargo, and Bank of America will obviously benefit from gaining new customers that will have jumped ship from the new JPMorgan Chase venture, so hopefully they will continue to offer competitive rates and terms to keep this market pushing through what is already a challenging year.

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