Why First Republic failed. Are other US banks to follow?

First Republic Bank has become the second large US regional bank with assets over US$200 billion to fail in just a few weeks.

US authorities seized control of the troubled lender on Monday before selling most of the assets to JPMorgan Chase.

The largest bank failure since the 2007-2008 financial crisis, it comes on the heels of Silicon Valley Bank and Signature Bank’s demise in March which sent shock waves through markets and sparked contagion worries.

Here are some things to know about the collapse of First Republic Bank.

First Republic grew rapidly through deposits from wealthy individuals and companies. It used those deposits to make large loans, including jumbo mortgages, when interest rates were at historically low levels in hopes of then convincing customers to expand into more profitable products like wealth management.

Many of the bank’s accounts had deposits well north of the federally-insured US$250,000. Once Silicon Valley Bank went under, clients pulled their money, fearful their deposits were in danger. First Republic said last week that depositors had withdrawn more than US$100 billion, most of it during a few days in mid-March.

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“Too many (First Republic) customers showed their true loyalties were to their own fears,” wrote Timothy Coffey, an analyst with Janney Montgomery Scott, in a note to investors.

What’s more, the large loans on First Republic’s books dropped in value as the Federal Reserve rapidly raised interest rates last year. So, if the bank tried to sell the loans to raise capital, it would do so at a loss. Similar circumstances had doomed Silicon Valley Bank.

First Republic planned to sell off unprofitable assets, including low interest mortgages that it provided to wealthy clients. It also announced plans to lay off up to a quarter of its workforce, which totalled about 7,200 employees in late 2022. But those plans were seen as too little, too late, by analysts.

By the middle of last week, it became clear government intervention in First Republic was necessary. Treasury officials asked banks to submit bids for First Republic, and bankers and regulators worked through the weekend to find a way forward.

For now, analysts expect the banking system will be spared any more large bank failures, saying the problems at Silicon Valley, Signature Bank and First Republic were unique to those companies.

Other midsize banks suffered large withdrawals of deposits and were forced to borrow from federal programmes to shore up their balance sheets, but none were hit as hard as First Republic.

For example, Comerica, based in Dallas, said deposits fell by US$3.7 billion after March 9 and the company borrowed US$13 billion from federal programmes “to provide a buffer in excess of normal operating levels”. Still the company earned US$324 million in the first quarter, down slightly from the fourth quarter, but up from US$189 million in the year-ago quarter.

Comerica shares dropped 37 per cent in the week after Silicon Valley Bank failed, but have remained steady since. On Monday, the shares slipped almost 2 per cent.

Shares of most midsize banks fell Monday, but the drops were moderate compared to the steep double-digits losses for many of them on March 13.

The trading “suggests little or no spillovers – consistent with the notion that there is no surprise” with the seizure of First Republic, said Krishna Guha at Evercore ISI.

First Republic’s stock traded at US$115 on March 8, then plummeted in the following days and weeks and closed Friday at US$3.15. About US$20 billion in market value has been wiped out. Trading in the stock was halted before US markets opened Monday.

JPMorgan Chase, which has agreed to buy the deposits and most of the assets of First Republic, stressed that it is not assuming any of First Republic’s corporate debt or preferred stocks.

After a bank’s failure, bondholders are among the last to get paid – stockholders are at the very end of the line. The FDIC does not give estimates on how likely any creditor is to get repaid.

But the agency did say that its deposit insurance fund, which banks pay into, could take a US$13 billion estimated loss as a result of First Republic’s failure.

While conditions could change over time, that likely leaves nothing left over for investors to recoup. Stockholders at Silicon Valley Bank and Signature were wiped out.

The outcome was just fine with one interested observer.

“While depositors are being protected, shareholders are losing their investments,” said President Joe Biden during a Rose Garden event focused on small businesses, when asked about the bank seizure. “Critically, taxpayers are not the ones who are on the hook.”

Additional reporting by Agence France-Presse