Recently, JPMorgan Chase (JPM 0.24%) acquired most of the assets and certain liabilities from First Republic (FRCB), which was seized by state regulators and placed into receivership under the Federal Deposit Insurance Corp. (FDIC).
There were lots of reasons to do the deal, whether it was to try and stabilize the banking sector or lessen the blow to the FDIC's Deposit Insurance Fund (DIF), which banks are on the hook for.
But after losing more than $100 billion of deposits in the first quarter and now sitting on a large portfolio of mortgages and securities that have been significantly marked down, First Republic is a shell of its former self. Here's the real reason JPMorgan Chase wanted to buy the bank.
Wealth management
First Republic's business model involved catering to high-net-worth individuals, which made wealth management a big part of the business. JPMorgan Chase and most of its peers are all interested in growing and scaling wealth and asset management right now because it's a capital-light business that can generate superior returns on equity.
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At the end of the first quarter, JPMorgan Chase had total assets under management (AUM) of more than $3 trillion and total client assets, which includes AUM, of more than $4.3 trillion in its wealth and asset management business at the end of the first quarter of the year. The business generated a 34% return on equity in the first quarter and a pre-tax margin of 35%.
At the end of the first quarter, First Republic had about $290 billion of AUM, which would boost AUM at JPMorgan Chase by about 10%. However, First Republic said it had seen wealth advisors responsible for less than 20% of its wealth assets leave the bank, although it expected to retain some of the assets from departing wealth advisors.
On a conference call following the deal announcement, JPMorgan Chase's CFO Jeremy Barnum said First Republic still had nearly 150 wealth advisors and that the bank had been seeing "unsolicited" outreach from other wealth advisors."
"We believe that our brand, the investment platform, the banking capabilities and our research [team] can make us a firm of choice for many of these advisors," said Barnum, adding that "we do understand that these are really good teams of high quality advisors who have choices."
First Republic is known for having some of the best customer service in the industry, so there is a lot to gain from the business, although First Republic was also known for offering cheap interest rates on jumbo mortgages to high-net-worth individuals as part of its model. JPMorgan Chase certainly has no interest in doing this because mortgage loans have higher capital requirements and are difficult to make money on.
Execution will be key
The real benefit for JPMorgan in this deal is First Republic's wealth management business and the relationships that come with it, as well as the attractive wealth markets that First Republic already has a foothold in.
But JPMorgan Chase's ability to retain advisors in the near term will be important, as will its ability to scale the business on more of a longer-term basis.
The acquisition does look attractive when you think about the FDIC loss coverage on First Republic loans that comes with the deal, as well as the fact that it will immediately benefit the bank's earnings and tangible book value, or net worth. The longer-term merits of the deal will be all about execution, but given JPMorgan's track record investors should be optimistic.
