First Republic needs the government's help

One way or another, the U.S. government is going to have to get involved in determining the future of First Republic Bank.

Why it matters: First Republic is currently in a state of limbo, its future highly uncertain — and that can't last forever. When the eventual resolution comes — in a matter of days rather than weeks, if First Republic management gets its way — it will unavoidably have government fingerprints all over it.

• The banking crisis that was precipitated by the failure of Silicon Valley Bank in March is now largely in the past; First Republic is the last major unresolved question mark. If it fails, however, the broader crisis could easily flare up again.

The big picture: First Republic would almost certainly be insolvent if it had to sell all of its assets at their market value. That's eroding trust in the bank, which has lost $100 billion of deposits.

• First Republic's bonds maturing in 2046 are trading at just 43 cents on the dollar, according to MarketAxess' Bondticker — implying that the equity is largely worthless.

Where it stands: Broadly speaking, there are two options for First Republic — either it fails, or it manages to continue as a valuable going concern. From a public-policy perspective, the latter is clearly preferable.

Option 1: First Republic fails.

• In this scenario, the government will face the choice of whether or not to extend FDIC insurance to all uninsured depositors. That would cost more than $40 billion, and most of that money would end up going to the large banks, led by JPMorgan, who deposited $30 billion at First Republic last month. Politically, that's a bad look.
• On the other hand, if the FDIC didn't declare First Republic systemic, then that would almost certainly precipitate another full-blown banking crisis, with deposits fleeing all but the largest banks.

Option 2: The preferable outcome is therefore that First Republic doesn't fail.

• If it's recapitalized over the next few days, it's likely to retain both most of the financial advisers in its wealth-management unit and the loyalty of its enviable existing customer base.
• The longer it exists in its current zombie state, however, the more its franchise value erodes, and the harder it becomes to put together an attractive rescue package.

Between the lines: First Republic is a valuable franchise saddled with a terrible balance sheet. If it managed to offload $100 billion of assets, it would not be hard to find private equity investors willing to recapitalize the remaining bank to the tune of a few billion dollars.

The catch: Those assets are worth much less than book value, thanks to rising interest rates, and First Republic doesn't have enough capital to absorb the loss of selling them at market prices. Therefore, the assets would have to be sold at some midway point — below book value, but above their mark-to-market value.

• The natural buyers would be the big banks, led by JPMorgan, who already have $30 billion on deposit at First Republic. They could hold the assets to maturity — pocketing a profit — and effectively rescuing First Republic by doing so. In return, they would receive warrants or other sweeteners.
• If the banks collectively bought First Republic's assets, either directly or via some kind of special purpose vehicle, that would be better for them as a group than seeing it fail. But there's a collective-action problem here, which is why the government needs to use some moral suasion to push such a solution.

For the record: "The Bank is pursuing strategic options to expedite its progress while reinforcing its capital position," said First Republic in its earnings release Monday.

The bottom line: First Republic is not really in charge of its own fate. Previous Treasury Secretary dealmakers like Hank Paulson, Robert Rubin, Tim Geithner, or Steven Mnuchin would be in their element here. Janet Yellen, however, is not a dealmaker, and it's not clear whether she's inclined to intervene.