[blake1]

It was mainly just the mortgages. The quirk is that they marketed to extremely high-net worth homeowners—I think this is the penthouse condo crowd. In order to attract them, they offered 3% interest-only loans. Without principal pay down, these mortgages are more sensitive to interest rate rises, leaving the bank with roughly $35bn in losses as interest rates have been rising. They have been insolvent for several months, but a typical bank didn’t have losses on their mortgages which were nearly so steep.

As compared to SVB, this is the same basic situation: interest rate losses led to insolvency, which could be temporarily ignored because they were “small” banks. However, once deposits started fleeing, the losses could not be ignored when they needed to sell the impaired assets for actual cash.

They have been in limbo for a few weeks thanks only to the injection of $30bn from other banks.

Another similarity in the two banks’ situations is that the same catalyst of rising interest rates cause asset losses and drive deposit flight.

It’s a weird quirk of accounting that they are allowed to ignore these losses for the life of the assets. But the other extreme is weird too, because sometimes the market value of assets can undergo a “V” shaped dip before recovering, and it would be bad to make a bank insolvent because some flash crash. The accounting rules try to split the difference by letting the bank partition its assets into buckets that take losses immediately, or at the end of life of the asset. This is an easily abused system.

It seems, hopefully, that the three failures were exceptionally badly run banks, and that this doesn’t indicate a wider wave of bank failures. Not yet.

[dehrmann]

> They have been in limbo for a few weeks thanks only to the injection of $30bn from other banks.

This will be weird/interesting. JP Morgan know what it's doing. It looked at First Republic's books before doing this. So either JP Morgan was wrong or there was a deal that they'll be made whole if First Republic goes under. It almost has to be the latter because JP Morgan's only incentive to make the deposit is promoting the appearance of financial stability.

[KirillPanov]

Or JPM coldly calculates that, after this all shakes out, they will account for 30% of the banking sector, and burning $30b now is better than burning >$100b later.

FDIC rescues are paid for by (essentially) a levy on the banks.

[in_cahoots]

Genuinely curious: How are these mortgages more sensitive to interest rate rises than average? I’m sure I’m missing something but it seems like a mortgage on the books is a done deal, so long as the homeowner pays up.

[SamReidHughes]

Because the principal isn't paid down, the weight of the future loan repayments is more years away, and they get more affected by interest rate changes.

[blake1]

Exactly. As an example, a typical 30-year fixed will be halfway paid off after 15 years, and so is about half as sensitive to interest rates as a 30-year interest-only.

This should not be a surprise to the management of First Republic.

[makomk]

In theory that's true, but a substantial proportion of all US mortgages are fixed rate and originated in the last few years when interest rates were at record lows, so they're still going to be pretty sensitive to interest rate changes and the bulk of the repayments still pretty far into the future assuming they're structued in the usual way with fixed repayments.

[jsemrau]

Wild. I wrote a "junior equity analyst" autonomous agent and this was the reply a couple of days ago "First Republic Bank's growth prospects may be limited by its narrow focus on high net worth clients, which may not provide sufficient diversification in the event of an economic downturn. Additionally, the bank's high cost structure and low efficiency ratio may make it vulnerable to margin compression and increased competition. Finally, the bank's exposure to the California real estate market may pose significant risks in the event of a housing market downturn. "

[graeme]

That isn’t at all what the person you’re replying to wrote. the key to what they wrote is the loans were highly vulnerable to interest rate swings as there were no principal repayments.

The bank didn’t bust due to HNW people going bust.

[jsemrau]

I was more focusing on the last part about the real estate market.

[graeme]

That's still not right though. They didn't hit trouble because the market had a downturn. They hit trouble because when the loans were highly sensitive to rate rises.

If you have $1,000,000 in principle, at 3% you pay $2500 per month. At 9% you pay $7500 per month. Even if the house is still worth a million you can't necessarily afford the payments.