How JPMorgan Chase could make the most of First Republic's servicing
May 3, 2023 5:00 AM
Jason Henry/Bloomberg
While the loans in question were a concern for First Republic given their mismatch with high-rate deposits, a government-supported risk sharing agreement minimizes that downside. That leaves the acquiring bank the right to service what otherwise are high-quality mortgages made to wealthy, sought-after clients.
"Maybe their management of their balance sheet wasn't great, but First Republic certainly knew how to take care of customers from what I understand," said Jon Van Gorp, chairman at law firm Mayer Brown.
The net benefit JPMorgan Chase will get from this depends on whether it can manage remaining risk outside loss sharing, maintain boutique service levels and keep total MSRs below the level that triggers the need for additional capital.
Remaining risks
The Federal Deposit Insurance Corp. will cover 80% of the losses associated with JPMorgan Chase's single-family loans over seven years, and has similarly agreed to cover commercial exposures for five.
Loss sharing has traditionally been applied to situations where borrowers have trouble paying, but it's a little different in this case, said David Stevens, CEO of industry advisory firm Mountain Lakes Consulting.
"In this transaction, it's also based on pools of assets," he said. "So if JPMorgan has to put some of those mortgages out to market, if there's any difference between the value at time of acquisition to when they actually do the transaction over the next seven years, the FDIC would then take a portion of that loss."
The FDIC had to step in to address this concern even thougha facility aimed at broadly addressing a similar problem with underwater assets at other banks already existed. That's because First Republic's loans weren't eligible for it. The pre-existing facility addressed issues with government-related mortgage-backed securities , as opposed to private "jumbo" loans above so-called conforming limits like First Republic's.
So long as JPMorgan Chase can cover the remaining 20% of the risk in any situation where it has to sell the high-balance loans, it won't have the kind of troubles First Republic had.
Whether this kind of risk sharing has implications for taxpayers remains to be seen.
So far, the FDIC's $128 billion deposit insurance fund, which bank customers fund through monthly fees, has provided adequate coverage for risks but it has limits, said Thomas Hogan, a senior member of the research facility at the American Institute for Economic Research.
"Losses to the DIF from the failures of Signature Bank and Silicon Valley Bank are estimated at $22.5 billion, plus another $13 billion for First Republic Bank, which together has already depleted about 28% of the DIF. If such failures continue, it is quite possible that taxpayers will end up bearing some of the losses," he said.
Loss sharing has traditionally been applied to situations where borrowers have trouble paying, but it's a little different in this case, said David Stevens, CEO of industry advisory firm Mountain Lakes Consulting.
"In this transaction, it's also based on pools of assets," he said. "So if JPMorgan has to put some of those mortgages out to market, if there's any difference between the value at time of acquisition to when they actually do the transaction over the next seven years, the FDIC would then take a portion of that loss."
The FDIC had to step in to address this concern even though
So long as JPMorgan Chase can cover the remaining 20% of the risk in any situation where it has to sell the high-balance loans, it won't have the kind of troubles First Republic had.
Whether this kind of risk sharing has implications for taxpayers remains to be seen.
So far, the FDIC's $128 billion deposit insurance fund, which bank customers fund through monthly fees, has provided adequate coverage for risks but it has limits, said Thomas Hogan, a senior member of the research facility at the American Institute for Economic Research.
"Losses to the DIF from the failures of Signature Bank and Silicon Valley Bank are estimated at $22.5 billion, plus another $13 billion for First Republic Bank, which together has already depleted about 28% of the DIF. If such failures continue, it is quite possible that taxpayers will end up bearing some of the losses," he said.
A high bar for service levels
While the terms of the deal generally mitigate the aforementioned risk, JPMorgan Chase will have to take some other steps as well to generate value from the servicing it'll be acquiring with First Republic's loans
One challenge in doing that will be ensuring it keeps wealthy customers who may've been drawn to First Republic by its boutique servicing culture will make the transition to JPMorgan Chase.
"We're going to fight hard to keep all the clients," JPMorgan Chase CFO Jeremy Barnum said in a call about the acquisition.
While competition for the loans and their servicing has reportedly been thin, — with some banksincreasingly wary of the jumbo market following First Republic's woes in addition to rising concerns about credit — there will still be some.
"First Republic's level of customer service was very unique and that's why they had a wealthy high end-clientele," Stevens said. He noted that JPMorgan Chase, while rebranding, is keeping some of FRB's facilities and staff.
Fitch Ratings has noted that FRB had a model in which the bank linked the fortunes of its relationship managers on the origination side with servicing, including "personal involvement" with delinquent or defaulted loans.
This included "a clawback feature that can negatively affect the relationship manager's commission structure," according to the Fitch report.
History suggests First Republic's loans have strong credit, said Jack Kahan, a senior managing director at Kroll Bond Rating Agency whose team analyzed First Republic's private-label residential MBS exposures.
"First Republic is known for stellar mortgage performance," Kahan said, noting that the bank's 30-day-plus delinquency rate in KBRA deals was just 0.3% vs. 1.3% for the larger universe of loans in the deals it was involved in.
Although First Republic's been less involved in the small private label RMBS market more recently, many of its loans refinanced out of pools when rates were low, and banks more often portfolio jumbo, it's been a significant contributor.
One challenge in doing that will be ensuring it keeps wealthy customers who may've been drawn to First Republic by its boutique servicing culture will make the transition to JPMorgan Chase.
"We're going to fight hard to keep all the clients," JPMorgan Chase CFO Jeremy Barnum said in a call about the acquisition.
While competition for the loans and their servicing has reportedly been thin, — with some banks
"First Republic's level of customer service was very unique and that's why they had a wealthy high end-clientele," Stevens said. He noted that JPMorgan Chase, while rebranding, is keeping some of FRB's facilities and staff.
Fitch Ratings has noted that FRB had a model in which the bank linked the fortunes of its relationship managers on the origination side with servicing, including "personal involvement" with delinquent or defaulted loans.
This included "a clawback feature that can negatively affect the relationship manager's commission structure," according to the Fitch report.
History suggests First Republic's loans have strong credit, said Jack Kahan, a senior managing director at Kroll Bond Rating Agency whose team analyzed First Republic's private-label residential MBS exposures.
"First Republic is known for stellar mortgage performance," Kahan said, noting that the bank's 30-day-plus delinquency rate in KBRA deals was just 0.3% vs. 1.3% for the larger universe of loans in the deals it was involved in.
Although First Republic's been less involved in the small private label RMBS market more recently, many of its loans refinanced out of pools when rates were low, and banks more often portfolio jumbo, it's been a significant contributor.
The capital question
As portfolio lenders, banks aren't typically big sellers of jumbo assets, but as private label RMBS history shows, it's not unheard of; and certainly with First Republic finding itself in a situation where it was necessary, it's possible.
For First Republic's servicing in particular, the limits to the amount of MSRs that can be held before more punitive risk weightings kick in may be a consideration for offloading them.
"The issue that JP Morgan Chase would have to look at is whether this shifts the MSR percentages on their capital structure," said Les Parker, managing director at Transformational Mortgage Solutions and an independent industry consultant.
The acquiring bank indicated that it didn't expect the acquisition to put inordinate pressure on its capital levels.
"It's worth noting that the loss sharing agreement reduces the risk weighting on the covered loans to an average of about 25%, which significantly contributes to the capital efficiency of the deal," Barnum said.
For First Republic's servicing in particular, the limits to the amount of MSRs that can be held before more punitive risk weightings kick in may be a consideration for offloading them.
"The issue that JP Morgan Chase would have to look at is whether this shifts the MSR percentages on their capital structure," said Les Parker, managing director at Transformational Mortgage Solutions and an independent industry consultant.
The acquiring bank indicated that it didn't expect the acquisition to put inordinate pressure on its capital levels.
"It's worth noting that the loss sharing agreement reduces the risk weighting on the covered loans to an average of about 25%, which significantly contributes to the capital efficiency of the deal," Barnum said.
