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Financial Bulletin

With its hands full of wealthy West Coast customers, why hasn't a white knight arrived?

Release Time:2023-04-28

For years, First Harmony Bank had a reputation as one of the favorite banks for the wealthy on the West Coast. This week, the bank was again at the centre of the regional banking crisis after its deposit outflows in the first quarter were worse than markets had expected.

Despite Thursday's sharp rebound, the stock is still down more than 50% so far this week and about 95% since the start of the year, with a market value of only about $1 billion. Behind this is the unwillingness of regulators, big banks and potential bidders to help it.

One might think that a bank with wealthy clients such as First Harmony might be suitable for any bank looking to develop a wealth management business. Its assets, such as government securities and mortgages to wealthy customers, also seem mostly solid. But the reality is that selling the bank for $1 a share, or even giving it away, could mean tens of billions of dollars in losses for a new buyer. So the "white knight" of the first peace has still not appeared.

While 1st Aggregate may wish to ride out the crisis over time, waiting for its bonds and loans to mature or be repaid in full, for the acquirer, under consolidated accounting rules, the buyer must immediately write down the assets it acquires to fair value.

In its first-quarter results, the company did not update its fair value estimates for its assets. It had a paper loss of about $4.8 billion on securities it held to maturity at the end of last year, and the value of those assets should recover as yields on government bonds fell in the first quarter. In addition, the fair value of First Harmony's real estate mortgages is about $19 billion below its carrying value. Many of these mortgages paid fixed interest rates, much lower than today's rates.

Based on these asset estimates, even after adjusting for lost tax benefits, the amount of writedowns required by potential buyers could wipe out all of the first sum's equity. The company had $18 billion in equity at the end of the first quarter.

That means a potential buyer would have to spend a significant amount of extra money to bring its own capital ratios into line with regulatory minimum requirements. "Buying the bank for free could cost you as much as $30 billion," analysts were quoted as saying.

In a typical bank deal, the acquirer can rely on intangible assets to offset the reduction in the value of bonds and loans. For example, the acquirer will often recognise some additional value in the acquired bank's deposits, which may be more valuable than the book value suggests because they are cheap or stable. However, it is hard to say how much this part of the bank, which faces deposit flight problems, is worth. Moreover, intangible assets like these do not count towards the regulatory capital required to run a bank.

In fact, there are other ways. Banks that buy assets at fair value can then quickly sell them to repay expensive government borrowing or $30bn of unsecured deposits bailed out by big banks. This would reduce banks' size and capital needs. Over time, the value of the assets acquired will rise or be paid off, benefiting the acquirer. However, this method is extremely complicated for the acquirer to calculate.

Another option, as reported in the media on Wednesday, is to have several banks buy assets from the first bank at above-market prices, effectively spreading the cost that would otherwise be borne by a single buyer. Yet the reason behind the banks' reluctance to act is that it may only get a good deal for one eventual buyer, rather than a "universal benefit".

(Note to Wall Street: Getting several banks to buy assets from First Bank at above-market prices was possible because the banks' $30 billion in deposits with First Bank were not insured. If they think First Harmony is about to go bust, they risk losing the money altogether. Moreover, even if the federal government uses emergency powers to guarantee those deposits, large banks would need to replenish the Federal Deposit Insurance Corporation.)

Hence the later modification plan. As part of the deal, several of the rescued banks could receive some form of equity in the form of warrants or preferred stock that could help them all benefit in the future, sources said yesterday. But that would dilute existing shareholders, which is why the bank's shares fell sharply on Wednesday.

If none of these plans are resolved, it is possible that the government will arrange a sale, with the acquirer receiving federal support for its losses. But as a Wall Street Journal article noted last week, U.S. officials could call in the banks to try to hammer out a deal, but few believe they can force them to participate. Post-financial crisis rules have greatly limited regulators' ability to provide financial assistance to troubled companies before they fail, for example, by creating programs that benefit only one bank.

Many believe the FDIC may ultimately be able to provide assistance only if it takes over banks, wipes out shareholders and changes management. However, the details and scope of the FDIC's support will depend on whether they use the same tool that allowed the FDIC to guarantee all depositors at two institutions that failed last month.

Whatever the outcome, someone will have to pay for the failure of the first deal.

Risk warning and disclaimer clause

The market is risky and investment needs to be cautious. This article does not constitute personal investment advice and does not take into account the particular investment objectives, financial situation or needs of individual users. Users should consider whether any opinion, opinion or conclusion in this article fits their particular situation. Invest accordingly at your own risk.

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