First Republic handed out billions in ultra-low-rate mortgages to the wealthy. It backfired horribly.

brownstone stoop — Lucas Jackson/Reuters

First Republic is teetering, with the stock down 93% in 2023 and the bank exploring strategic options.
The bank won wealthy clients with the offer of jumbo mortgage loans that required no principal payments for a decade.
The bank is now reversing course as it fights for survival.

First Republic is racing to strengthen itself.

The bank said Monday that it will cut as much as 25% of staff, and is pursuing strategic options after revealing that deposits plunged by more than $100 billion in the first three months of the year.

That sent the stock as much as 48% lower on the day, with First Republic now down 93% for the year to date. Gillian Tan and Matthew Monks at Bloomberg subsequently reported that the bank is exploring an asset sale in the range of $50 billion to $100 billion.

First Republic first moved into focus back in the March banking crisis that claimed Silicon Valley Bank, Signature Bank, and Silvergate.

Like SVB and Signature, a large percentage of First Republic deposits were not insured by the FDIC, making it especially susceptible to deposit flight. Like SVB, First Republic had seen deposits boom in the low-rate pandemic era. And like SVB, First Republic has been sitting on large unrealized losses, as the value of the bonds it’s marked as being held-to-maturity has dropped as rates have gone up.

But while the FDIC seized SVB and Signature, a group of major banks parked $30 billion in deposits with First Republic, helping to shore it up in a period of where depositors opted to move their money to the biggest banks.

One of the causes of First Republic’s troubles is a strategy to woo rich clients with huge mortgages that offer sweet terms, as detailed in this story from Noah Buhayar, Jennifer Surane, Max Reyes, and Ann Choi at Bloomberg.

In particular, First Republic would offer interest-only mortgages, where the borrower didn’t have to pay back any principal for the first decade of the loan. In 2020 and 2021, it extended close to $20 billion of these loans in San Francisco, Los Angeles, and New York alone, per Bloomberg’s analysis.

Many of these loans went to ultra wealthy types in finance, tech, and media. For example, one of the most senior executives at Goldman Sachs took out an $11.2 million mortgage with First Republic with no principal payments in the first 10 years and an interest rate below 3%, per Bloomberg.

The quality of these loans isn’t in question, as the borrowers are extremely safe bets.

But the loans are worth a lot less now than when First Republic wrote these deals, with the average mortgage rate on a thirty-year fixed rate loan now at around 6.3%. (Bond prices go down as interest rates go up, and vice versa.)

Wealthy clients can easily move their deposits away from First Republic while keeping their mortgage with the firm, which creates a liquidity challenge.

And these loans are hard to sell to other lenders, given Fannie Mae and Freddie Mac are limited to only purchasing mortgages up to just over $1 million. Should they successfully sell, it would also create a hole in First Republic’s balance sheet. The bank would be forced to recognize the current value of these loans, and what are currently unrealized losses could suddenly wipe out the bank’s capital.

First Republic is now backtracking from this strategy, saying it will focus on writing loans that are guaranteed by Fannie and Freddie.

More immediately, the bank is trying to find a way to convince buyers to take on some of its assets, including finding ways to sweeten the deal with equity-like instruments so buyers pay a higher price for the loans, according to Tan and Monks at Bloomberg.

The coming days will show whether First Republic was successful.