Banks — In the past couple of weeks, the economy has been bombarded with several problems, namely within the banking system.
Silvergate Bank and Signature Bank collapsed in March, with Silicon Valley Bank joining the fray.
Investors have grown concerned about the situation, inciting panic.
Lender First Republic Bank is on the brink of a collapse, but there could be a way to avoid the situation.
When banks collapse
If banks were to collapse, it would have severe consequences on the financial system and the wider economy.
Firstly, there would be a loss of confidence in the banking system, leading to panic withdrawals and further bank failures.
This could lead to a credit crunch, as businesses and individuals struggle to obtain loans and finance, which in turn could lead to a slowdown in economic activity and job losses.
Governments would likely have to step in to provide support and bailouts to prevent further collapses, which would be costly for taxpayers.
In extreme cases, bank collapses could even trigger a recession or depression, as seen in the 2008 financial crisis.
First Republic Bank has a chance of avoiding collapse, and it all boils down to how persuasive a group of bankers can be with another group.
According to reports, First Republic advisors will try to persuade big US banks that have already propped it up for another favor.
Bankers aware of the situation will pitch the US banks to purchase bonds from First Republic at above-market rates for a total loss of a few billion.
Otherwise, they would face over $30 billion in Federal Deposit Insurance Corp. fees when First Republic fails.
The proposal is the latest development in the banking situation after Silicon Valley Bank in March.
After the government seized SVB and Signature, mid-sized banks were hit by heavy deposit runs.
The country’s biggest lenders came together to loan $30 billion in deposits to First Republic.
However, the solution was temporary after the gravity around the company’s problems surfaced.
If the First Republic advisors convince big banks to buy bonds for more than they were worth, they would be confident that other parties would join and help the bank recapitalize itself.
According to sources, the advisors have already listed potential buyers of new First Republic stock.
Investment banks are looking to raise the alarm and create a sense of urgency.
This week marks a crucial period for First Republic.
Since Monday, the bank’s stock has been in a free fall after sharing that its deposits recently fell by 41%, which includes big banks’ infusion.
Analysts following the company published negative reports after CEO Michael Roffler refused to take questions after a brief 12-minute conference call.
“Now that the earnings are out, once you’ve got a window to act, it’s time to do it,” said an anonymous banker.
“You never know what will happen if you wait, and you don’t want to be dealing with an emergency situation.”
Sources say that advisors might offer warrants or preferred stock so banks involved can reap part of the upside of helping First Republic, which would help the deal.
First Republic has always been the envy of other banks due to its focus on rich Americans helping growth and allowing it to lure talent.
However, the model broke down after the SVB failure, with customers pulling out uninsured deposits.
The advantage to the advisor’s plan is that it allows First Republic to offload some of its underwater bonds.
When it comes to government receivership, the whole portfolio must be marked down immediately, which results in what Morgan Stanley analysts estimated to be $27 billion.
However, one problem is that advisors rely on the US governments to bring bank CEOs together to come up with other solutions.
There have already been false starts as one of the top four US banks said the government told it to prepare to act on the First Republic situation in the past weekend.
But nothing happened.
Banks and doubts
While any deal is a matter for negotiation and could have a special purpose vehicle or direct purchases, there are several possibilities that could address the bank’s balance sheet.
On Tuesday, Bloomberg reported that the bank is weighing the sale of $50 billion to $100 billion in debt.
First Republic loaded up on low-yield assets like mortgages, municipal bonds, and Treasuries.
When they loaded up, the bank learned it suffered losses of tens of billions of dollars.
By reducing the size of the balance sheet, the bank’s capital ratios would be healthier, paving the way for it to raise more funds and continue as an independent company.
Other decisions they can take include the conversion of the big bank’s deposits into equity or search for a buyer.
However, a suitor has yet to appear, and it’s unlikely as any buyer would also own the losses on First Republic’s balance sheet.
Sources close to the big banks believe the most likely scenario for First Republic is government receivership.
Those close to the banks were hesitant to endorse a plan that would recognize losses for overpaying the bonds.
They are also doubtful about government-brokered deals following pacts from the 2008 financial crisis leading to higher costs than expected.