A few years ago I was searching for a job and interviewed with First Republic Bank. I had just left another bank that focused on high net worth people and this seemed like the perfect fit for me. My potential new boss was a very pleasant young man. Even when he told me that they expected me to book one hundred million dollars in mortgage loans each year. I’m a writer and that makes me a little delusional. But not that delusional. I didn’t even like mortgage lending. We both decided I should talk to other banks.
The First Republic model then, as now, was to give rich people very cheap fixed-rate loans for long periods of time. As you can guess, their primary markets were New York, San Francisco and LA. Mark Zuckerberg was reported to have received a 30-year mortgage with a fixed rate of 1.05%. First Republic also insisted that clients keep their cash deposits with them. No wonder the bank grew so fast. Deposits nearly doubled between 2019 and 2022, deposits that funded more cheap loans. It was just a matter of time before the bombs inside their business strategy would detonate.
Like at Silicon Valley Bank, the owners weren’t stupid. Sure, all banks to some extent, fund multiple-year loans with short-term deposits and CDs. But a big percentage of those deposits at other banks are below the $250K limit that is insured by the FDIC. Those smaller depositors are less likely to pull their money when things turn sour. At First Republic, 68% of the deposits were above the insurance limit. Those clients didn’t get wealthy by taking risks with their money. They liked First Republic’s personalized service and sweetheart mortgage rates, but…they pulled out $100 billion in deposits. Where could the bank get cash to pay them out? They could borrow from other lenders or the Fed or the Federal Home Loan Bank, but those rates were above the rates the they received from their own loans. Paying more to fund your assets than what your assets earn tends to destroy a bank. First Republic could also sell their mortgage loans, but then they’d have to book losses that would wipe out their capital.
So what about management at First Republic? The pay of its founder, James Herbert, was way above that paid to executives at similar institutions. Between 2019 and 2021 he received about 1.5% of profits. Net income in 2021 was $1.3 billion. Herbert also reportedly paid family members millions for consulting services, consulting that, by the way, looked at interest rate risk. His brother-in-law apparently earned millions to advise on portfolio risk, the risk that is a huge reason for the bank becoming insolvent. The press says that other family members were paid similar amounts.
Over the weekend, the FDIC auctioned off the bank and JP Morgan won with its bid. But only after the FDIC covered $13 billion in losses and loaned $50 billion to JP Morgan. The shareholders lost everything. Except the Herbert family. Not only did they get high salaries and fees, but they also reportedly cashed in more than $11 million in stock this year. That was before the stock price cratered. Looking out for number one, I guess.