The bankers’ offer to save the First Republic: Help us now, or pay more later when you fail

Best hope for avoiding the collapse of a sick lender The first republic Depends on how well one group of bankers can convince another group of bankers.

The First Republic’s advisors will try to convince the big US banks that have already supported them to offer another service, CNBC has learned.

According to bankers familiar with the situation, the offer would go something like this: Buy First Republic bonds at above-market rates for a total loss of a few billion dollars — or face up to nearly $30 billion in Federal Deposit Insurance Corp. Fee when First Republic fails.

It’s the latest twist in a weeks-long saga sparked by the sudden collapse of the Silicon Valley Bank Last month. Days after the government takeover of SVB and Signature mid-sized banks were hit by severe deposit inflows, the country’s largest lenders banded together to inject $30 billion in deposits into First Republic. This solution proved ephemeral after the depth of the company’s problems became known.

If First Republic’s advisers succeed in convincing the big banks to buy the bonds for more than they’re worth — to bear the investment losses for the benefit of the banking system, as well as for their own well-being — they are confident that other parties will. Escalation to help the bank recapitalize itself.

According to sources, advisors have already preformed potential buyers of First Republic’s new shares in this scenario.

These investment bankers are now seeking to create a sense of urgency. CNBC’s David Faber, who first spoke about the bailout on Tuesday, said the coming days will be crucial for the First Republic.

The bank’s stock has been in freefall since revealing Monday that its deposits had fallen by a staggering 41% recently, leaving it with $104.5 billion in deposits, including deposit infusions from major banks. Analysts covering the company published downbeat reports after CEO Michael Roffler chose not to take any questions after a brief 12-minute conference call.

“Now that the earnings are out, once you have a window to act, it’s time to do it,” said one of the bankers, who asked not to be named to speak frankly. “You never know what will happen if you wait, and you don’t want to be dealing with an emergency situation.”

To help seal a deal, the sources said, the advisors may offer notes or preferred stock so that the banks involved in the bailout can reap some benefit from the First Republic bailout.

For years, First Republic was the envy of its peers because its focus on wealthy Americans helped drive growth and allowed it to snap up talent. But this model collapsed in the wake of SVB’s failure as its wealthy clients quickly withdrew uninsured deposits.

Media reports said Lazard and JPMorgan Chase were hired last month to advise First Republic.

The main advantage of the advisers’ plan, they say, is that it allows the First Republic to offload some, but not all of its bonds underwater. In government receivership, the entire portfolio would have to be reduced at once, resulting in what Morgan Stanley analysts have estimated at $27 billion.

One complication, however, is that the advisers are counting on the US government to call the bank’s chief executives together to explore possible solutions.

There were false starts already: One of the US’s Big Four banks said the government told it to be ready to act on the First Republic situation last weekend, but nothing happened.

While the exact form of any deal is subject to negotiation and could include special purpose vehicles or outright purchases, there are several possibilities that address a bank’s ailing balance sheet. Bloomberg reported Tuesday that the bank is considering selling between $50 billion and $100 billion in debt.

First Republic loaded on low-yielding assets including Treasurys, municipal bonds and mortgages, making what was essentially a bet that interest rates wouldn’t go up. When they did, the bank found itself suffering tens of billions of dollars in losses.

By significantly reducing the size of its balance sheet, the bank’s capital ratios would suddenly become much better, paving the way for it to raise more money and continue as an independent company.

Other possible, but less likely, moves include converting the big bank’s deposits into equity, or even finding a buyer. But no bidder has turned up in the past month, not likely because any buyer would bear the losses on First Republic’s balance sheet.

This has led sources close to the major banks to believe that the most likely scenario for the First Republic is government receivership, and this is what the SVB and Signature Solved.

Those close to the banks were reluctant to endorse a plan in which they would have to admit the losses of their overpayment on the bonds. They also expressed a lack of confidence in government-brokered deals after some deals from the 2008 financial crisis turned out to be more expensive than expected.

But the failures of SVB and Signature — the two largest since the 2008 financial crisis — have cost the FDIC several billion dollars, which are being paid by member banks. First Republic advisors noted that they also benefited from buyers who were able to pick out the best assets while the FDIC held bonds underwater.

Consultants have referred to private market solutions as the “open bank” option, while government custodianship is the “closed bank” scenario.

But there is a third possibility: the bank continues as it is, slowly losing more value amid potential quarterly losses, talent flight and lingering doubts.

“Time, by the way, is not a bank’s friend,” analyst Don Bilson wrote on Tuesday. “If anything, last night’s disappointing update will make it difficult for First Republic to keep what it has.”