How Dimon and Yellen Helped Secure $30 Billion Lifeline for First Republic
Jamie Dimon and Janet Yellen were on a call Tuesday, when she floated an idea: What if the nation’s largest lenders deposited billions of dollars into First Republic Bank, the latest firm getting nudged toward the brink by a depositor panic.
Dimon was game — and soon the chief executive officer of JPMorgan Chase & Co. was reaching out to the heads of the next three largest US lenders: Bank of America Corp., Citigroup Inc. and Wells Fargo & Co. (…)
Already the rescue spearheaded by Dimon is sparking comparisons to the Panic of 1907, when J. Pierpont Morgan — who built up the company Dimon now leads — corralled Wall Street financiers into his private library and browbeat them into propping up the Trust Company of America, seeking to stop a string of bank runs that threatened to upend the industry.
One reason strong banks stepped forward then was that US authorities had little ability to do so, which led to the creation of the Federal Reserve. (…)
- Biggest U.S. Banks Deposit $30 Billion in First Republic JPMorgan, Citigroup, nine others lead rescue
The bank’s executives came together in recent days to formulate the plan, discussing it with Treasury Secretary Janet Yellen and other officials and regulators in Washington, D.C., people familiar with the matter said.
JPMorgan Chase & Co., Citigroup Inc., Bank of America Corp. and Wells Fargo & Co. are each making a $5 billion uninsured deposit into First Republic, the banks said in a statement, confirming an earlier report by The Wall Street Journal. Morgan Stanley and Goldman Sachs Group Inc. are kicking in $2.5 billion apiece, while five other banks are contributing $1 billion each. (…)
Big banks received an influx of billions of deposits from midsize lenders including First Republic over the past week in the wake of the collapse of Silicon Valley Bank and Signature Bank. JPMorgan and the others are now effectively giving back some of the money they have raked in.
The deposits don’t carry any special deal and earn a rate in line with those of the bank’s other depositors, according to people familiar with the matter. (…)
The pact is an extraordinary effort to protect the entire banking system from widespread panic by turning First Republic into a firewall. (…)
First Republic said Thursday that it had borrowed as much as $109 billion from the Fed one night within the past week. It said that insured deposits have remained stable over the past week and that deposit outflows have “slowed considerably.” (…)
The industry has tried to come together before in times of crises, but with mixed results. In 1998, the hedge fund Long-Term Capital Management suffered steep losses, and most of the biggest banks agreed to bail it out for fear of their own exposures. In 2008, their chief executives tried a similar approach to bail out Lehman Brothers but failed to reach agreement. (…)
The other banks contributing to the First Republic rescue package are U.S. Bancorp, PNC Financial Services Group Inc., Truist Financial Corp., Bank of New York Mellon Corp. and State Street Corp.
(…) But even this novel rescue will raise questions. For one, it may bolster the emerging narrative that the post-2008 regulatory regime has resulted in a two-tier system: Megabanks where it is always safe to deposit and do business, and everyone else.
At the same time, it might not succeed in putting to rest any fears that might arise about other smaller banks still at risk. The biggest lenders might be able to do this for one bank now. But they can hardly play that role systemically, continually sending deposits to whoever is leaking them. It also doesn’t address banks’ longer-term challenges with rising interest rates. (…)
Question? What if First Republic’s problems move from deposit outflows to significant asset impairment.
Most of the bank’s assets consist of commercial and residential real-estate loans. “Our loan portfolio is concentrated in single family residential mortgage loans, including non-conforming, adjustable-rate, initial interest-only period and jumbo mortgages,” its investor report warns, adding these may be vulnerable to defaults as interest rates rise. Uh-oh.
Defaults on commercial real-estate loans have been increasing, especially in First Republic’s chief lending markets. Housing prices have crashed in California’s Bay Area to near pre-pandemic levels, and tech layoffs raise another credit risk. The risk of loan losses could explain the government’s rush to shore up First Republic with a capital infusion. (WSJ)
This is a “cash bailout”, nothing on the equity side if loan losses erupt. Finger in a weakening dike?
(…) The deposit backstop could in theory be a one-off, but it is hard to see how the government can avoid using it again next time a midsize bank wobbles (and many are losing deposits fast amid the current uncertainty). Too big to fail is in the process of being extended to a whole new set of banks. (…)
And regulators seem to have ignored the danger that the Federal Reserve itself would raise rates aggressively and so hit banks that believed its predictions of low rates for a long time. The Fed’s last stress tests didn’t include the danger of soaring interest rates, instead fighting the last war by focusing on a deep recession and counterparty risk.
“Maybe the Fed’s low-for-long promise was the problem—not only did the SVB CFO believe it but the Fed’s stress test designers believed it too,” said Prof. Douglas Diamond, of the University of Chicago’s Booth School of Business, who won the Nobel Memorial Prize in Economic Sciences last year for his work on bank runs. “Supervisors didn’t do their job here.” (…)
More deposit insurance—even if merely implied, rather than written into the rules—means even more regulation, to attempt to counter the moral hazard. More regulation means higher costs, less competition and credit that is harder to obtain, as well as more bureaucracy. (…)
I think that it is a very classic event in the very classic bubble-bursting part of the short-term debt cycle (which lasts about seven years, give or take about three) in which the tight money to curtail credit growth and inflation leads to a self-reinforcing debt-credit contraction that takes place via a domino-falling-like contagion process that continues until central banks create easy money that negates the debt-credit contraction, thus producing more new credit and debt, which creates the seeds for the next big debt problem until these short-term cycles build up the debt assets and liabilities to the point that they are unsustainable and the whole thing collapses in a debt restructuring and debt monetization (which typically happens about once every 75 years, give or take about 25 years). (…)
ECB Defies Mounting Banking Strains With Half-Point Rate Rise The European Central Bank is pressing ahead with its fight against inflation despite concerns it could exacerbate strains in the financial system.
China Cuts Reserve Requirement Ratio To Boost Economy The economy is recovering from pandemic restrictions and a property market slump.
Philly Fed Manufacturing survey: Current Indicators Weaken
- The indicators for new orders and shipments both declined to their lowest readings since May 2020: The shipments index dropped sharply from 8.7 last month to -25.4 this month, and the new orders index fell 15 points to -28.2.
- The employment index decreased from 5.1 to -10.3, the index’s second negative reading since June 2020 and its lowest reading since May 2020.
This one can’t be good, can it?
Yesterday we got the NY Fed survey, also weak across the board. Manufacturing employees are keeping their job but spending a lot more time at home:
HOUSING
- Housing starts increased by 9.8% to 1,450k in February from an upwardly revised January level (+2.5pp to -2.0%). Both single family starts (+1.1%) and the more volatile multi-family starts (+24.0%) increased.
- Building permits increased by 13.8% to 1,524k in February. Both single family (+7.6%) and multi-family (+21.1%) permits increased.
- Completions jumped to their highest level since 2007 but units under construction have yet to decline, which would likely trigger layoffs in construction.
Labor Market Conditions Indicators Momentum has been negative for four consecutive months. However, the level of activity remains high.
The Kansas City Fed Labor Market Conditions Indicators (LMCI) are two monthly measures of labor market conditions based on 24 labor market variables. One indicator measures the level of activity in labor markets and the other indicator measures momentum in labor markets.
Indeed’s Job Postings have also lost momentum through March 10, suggesting that the BLS Job Openings (thick black, last data is January) will also decline meaningfully in coming months. The horizontal line is where we were pre-pandemic.
(…) Nearly 25 million people are behind on their credit card, auto loan or personal loan payments, according to a Moody’s Analytics analysis of Equifax data. The nation has not seen anything that high since 2009 in the midst of the Great Recession. (…)
Many households are also behind on their utility bills: 20.5 million homes had overdue balances in January, according to the National Energy Assistance Directors Association. The number of households applying for help to pay their utility bills is the highest it has been since 2011. (…)
Food stamp benefits were cut on March 1, slashing $182 a month for the average recipient. Mile-long lines at food banks are back in some parts of the country, and families say they can’t afford meat or more than one meal a day. The more generous Medicaid rules are rolling back on April 1. Student loan debt relief is likely to end in the coming months. Tax refunds that many lower-income families rely on all spring and summer are far smaller this year as child tax benefits have been reduced. Goldman Sachs is warning that lower-income households are facing a substantial hit. (…)
The bottom 60 percent of earners contribute about 40 percent of U.S. consumption, which drives growth, Daco notes.
Some charts:
(Jefferies)
Per Edmunds:
- 15.7% of consumers who financed a new vehicle in Q4 2022 committed to a monthly payment of $1,000 or more — the highest it’s ever been — compared to 10.5% in Q4 2021 and 6.7% in Q4 2020.
- 17.4% of new vehicle sales with a trade-in had negative equity in Q4 2022, compared to 14.9% in Q4 2021.
- The average amount owed on upside-down loans was $5,341 in Q4 2022 compared to $4,141 in Q4 2021.
Not just consumers:
With the benchmark Fed Funds rate now parked at 4.57%, compared to 0.2% a year ago, the bottom of the ratings barrel has precious little room for error. Operating income among domestic triple-C-rated firms now covers interest expense by 1.6 times on average, BofA credit strategist Oleg Melentyev relayed last Friday, compared to 5.5 times interest coverage among high-yield as a whole.
Sure enough, the ranks of those unable to service their debts are expanding. Global corporate defaults numbered 15 in February for the busiest single month since November 2020, a Monday analysis from S&P Global finds, while the two-month tally of 23 represents the highest over that stretch since 2009. The bulk of that action comes from the U.S., with 16 defaults in the year-to-date through February, up from six over the same period in 2022.
Stateside restructuring activity remains muted on a longer horizon, however, as the trailing 12-month U.S. speculative-grade default rate sits at 2.02%. That remains well below the long-term average of 4.1%, the rating agency relays, though those figures are up from 1.5% on July 31. Meanwhile, the ranks of so-called weakest links, or firms rated single-B-minus or lower along with a negative credit outlook, stood at 191 at the end of January, up 50.3% from the end of June.
Might the placid default environment that has long predominated be set to give way to some choppier financial seas? A Monday Bloomberg law analysis from Geoffrey Frankel, CEO of Hilco Corporate Finance, notes that total U.S. bankruptcies have been in near-constant retreat since 2009, reaching new cyclical lows in 2021 and 2022. (Almost Daily Grant’s)
But Goldman Sachs keeps it landing softly. Crucially (!), so is Jim Cramer:
I love this collage by PiperSandler…
…which adds this scary one:
But Goldman says a soft landing may not save us:
Despite the prospects for a relatively soft landing, we see little earnings upside in most markets given where profit margins are. So far, corporate margins have been resilient to rising input costs as companies have generally been able to pass on prices.
But we are starting to see signs of deterioration. In addition to input costs such as materials and labour, margins are also coming under pressure from interest costs, regulatory costs, de-globalisation trends, ESG requirements and higher taxes to repay government debt.
We are transitioning from a cycle focusing purely on top-line growth to a cycle in which investors will focus increasingly on profitability and margins. In this ‘Post-Modern Cycle‘, we expect nominal GDP to be higher, and hence top-line growth to be less scarce. Instead, the higher inflation puts greater value on margins.
- Fourth quarter productivity was revised sharply lower from 3% to 1.7%. The culprit was an upward revision to unit labor costs from 1.1% to 3.2%. The data indicates corporate margins may be under pressure due to sharply rising wages. The graph below from John Hussman shows the correlation between labor costs and profit margins. (Real Investment Advice)
- The graph below shows that annualized unit labor costs and the employment cost index are double their pre-pandemic run rate.
How is this bear market doing?
Pretty well compared to previous bears markets… (The Market Ear)
(Tier1Alpha)
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