First Republic threatens to be the SVB of Wall Street

One thing to start: BBC directors have raised concerns that chair Richard Sharp’s position is becoming untenable after they were briefed on the investigation into his appointment, adding to pressure for his resignation as early as Friday.

In today’s newsletter

First Republic on the rocks
Creditors square off over Serta

Wall Street risks losing its own version of Silicon Valley Bank

From Manhattan to Palm Beach and southern California, dealmakers favoured the same “if you know, you know” kind of lender to support the lifestyle of an up and coming Wall Streeter.

San Francisco-based First Republic was for many banking and private equity executives what Silicon Valley Bank was to the venture capital industry. The lender was a one-stop shop for cheap credit to finance everything from purchasing a stake in a private equity fund to a multimillion-dollar beach house.

The leverage First Republic would offer individual partners committing to their newest fund was unmatched and its interest-only mortgages were the favoured financing option for chunky home purchases.

“It was the fastest, best customer service and generally at a very good rate,” a financial executive told DD. Bloomberg recently had an excellent feature on the Wall Street executives such as Goldman Sachs president John Waldron who were customers of the bank.

But First Republic’s days could be numbered as the decades it spent courting wealthy financiers threatens to become its undoing. The lender’s shares have fallen by 95 per cent this year as $100bn in deposits fled the bank, causing it to become the focus of regulators in Washington.

As First Republic spirals, there is a growing worry among dealmakers that they could soon lose their subsidy bank.

“Rich guy lending just changed dramatically,” a wealth management executive told DD. “Leading with cheap lending is over . . . Credit is tightening across the board. People are getting turned down for loans everywhere.”

The bank’s potential demise is in many ways similar to the collapse of Silicon Valley Bank and the rescue of Credit Suisse. These banks courted the deposits of ultra-wealthy clients by offering generous lending terms. But their large deposits exceeded the Federal Deposit Insurance Corporation’s insurance limits and were susceptible to flight.

Worse yet, much of the deposits were invested in low-yielding assets such as agency mortgage bonds that had fallen in value as interest rates rose last year, threatening their solvency.

If the fall of SVB taught us anything, our colleagues at the FT’s Unhedged write, it’s that the combination of uninsured deposits and low-yielding long-duration assets can be lethal.

Which leads DD to the big question: what are First Republic’s options?

First Republic advisers made some progress on Thursday to find a solution that might avert a full-scale bank resolution, according to multiple people briefed about the matter.

This marks a shift in tone compared with Tuesday and Wednesday when its shares fell 65 per cent and fears grew that it was close to being taken over by the FDIC.

JPMorgan Chase, which has been acting as First Republic’s banker, is involved in the conversations and could come up with a solution that includes other large institutions — the same ones that have already infused the bank with $30bn in deposits.

A private market solution, however, is likely to require a loss-share with the government given the size of First Republic’s bond losses.

Any “open bank” plan will require the backing of the Biden administration, which according to other sources remains somewhat sceptical — as of Thursday evening — that a private-sector solution is viable.

A collapse of First Republic is likely to cost large banks as fees paid to the FDIC rise, potentially making them willing to absorb some bond losses.

For now, Wall Street’s biggest lenders, including JPMorgan, Bank of America, Morgan Stanley, and Citigroup, have sat back and generally been the winners of the banking crisis.

Since they are seen as too big to fail, deposits have flooded into these banks. The implicit government support has also calmed markets, giving policymakers the option to take a relatively hands-off approach to First Republic’s woes.

The bankruptcy case dividing the leveraged loan market

Lenders in the $1.4tn leveraged loan market — the lifeblood of the buyout industry — are asking themselves a somewhat unexpected question: will they be able to sit at the cool lunch table?

It’s the latest wrinkle in the evolution of the market, traditionally a sedate corner of the financial system that helps fund private equity buyouts and the operations of relatively risky companies.

The question has been sparked by a recent court decision in the Texas bankruptcy case of mattress maker Serta Simmons, which threatens to escalate creditor-on-creditor fighting, DD’s Eric Platt and Sujeet Indap and the FT’s Harriet Clarfelt report.

While junior bond holders would often get into messy fights wrangling over their recoveries in restructurings, leveraged loan investors could usually watch from the sidelines. They were safeguarded by all the junior capital that ranked below them, there to absorb any losses in a default.

But the Serta ruling blessed a controversial 2020 debt swap that only a slim majority of its senior lenders had approved. Other holders of the company’s loans, including Angelo Gordon and Apollo Global Management, were pushed further back in the queue to be repaid and the value of the loans they held crashed when Serta ultimately went bust.

By confirming that the debt swap and refinancing package did not need unanimous support from all loan holders, Judge David Jones in effect opened the door to more deals that will pit lender against lender, industry veterans say.

“It’s the tyranny of the majority taking advantage of the minority,” one restructuring adviser said. “If you’re in the 51 per cent in the right case . . . it can be very lucrative and it has created this dynamic of people competing. Do you get to sit at the cool lunch table or do you have to sit with the maths majors?”

One distressed debt fund manager told the FT that aggressive investors such as his firm would benefit if other jurisdictions followed the Serta precedent.

“This will completely throw the leveraged loan market into chaos,” he said.

The loan market has changed since the financial crisis, and has become a much bigger part of the financing mix for leveraged buyouts over the past decade. But with that risk — and the loopholes in loan documents that lenders agreed to when times were hot — they are staring at a very different world.

Moody’s estimates first-lien loan holders recovered about 95 cents on the dollar in restructurings from 1987 to 2019. That figure plunged to 73 cents in 2021 and 2022, with the rating agency warning that in this “new world of LBOs . . . even first-lien lenders will experience material impairment”.

With bigger risk comes more incentive to pursue aggressive tactics, and the growth of private credit funds has also brought new players more comfortable with playing aggressively.

One lawyer who has advised on a number of these transactions noted that “no one has smacked down a company or lender group for doing this type of transaction”.

For now, the lawyer added, “no one is putting the brakes on [these] . . . deals”.

Job moves

Vodafone has named Margherita Della Valle, who took over from Nick Read as interim chief in January, as permanent CEO.
JPMorgan Chase has promoted 37 dealmakers to managing director, per Financial News.
HSBC veteran Iain Mackay will join Schroders’ board at the start of next year after he retires as GSK’s chief financial officer.
Separately PwC vice-chair Richard Oldfield will replace Schroders’ CFO Richard Keers following his retirement at the end of this year.
UK betting group Flutter Entertainment has named former Kellogg executive John Bryant as a non-executive director and chair designate, replacing outgoing chair Gary McGann.
Clifford Chance has elected 32 new partners.
Slaughter and May has appointed Matthew Tobin and Guy O’Keefe as co-heads of finance, per The Lawyer.
Bridgewater’s former deputy chief Diana Zhang has joined crypto firm BlockTower Capital as chief operating officer.
Jeff Schenk, the lead prosecutor against Theranos executives Elizabeth Holmes and Sunny Balwani, has joined Jones Day’s investigations and white collar defence practice in Silicon Valley.

Smart reads

Sliding doors What if Credit Suisse had opted for a resolution, rather than a deal with UBS? Reuters Breakingviews imagines an alternative scenario.

Rough seas ahead Charles Schwab executives like to call the company “a safe port in a storm” for its clients. But its bank division is beginning to feel unmoored, Bloomberg writes.

‘Good on paper, bad in practice’ The CBI scandal has exposed gaps in UK whistleblowing rules, the FT’s Helen Thomas writes.