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Fall of First Republic: here we go again?

Author: ICAEW Insights

Published: 05 May 2023

Following the fourth bank failure since March, Polly Tsang, Financial Services Regulatory Manager at ICAEW, examines the collapse and acquisition of US regional bank First Republic and renewed 'too big to fail' concerns.

Another month, another bank failure, but First Republic Bank is one you may not have heard of until this week if you’re not based in the US.

Following a nail-biting week for US regional bank First Republic, which saw its share price freefall by 75%, US regulators took possession of the beleaguered bank on Monday after putting the bank to auction over the weekend.

JPMorgan Chase emerged victorious, having successfully bid for all of First Republic’s deposits and a “substantial majority of assets”.

This is the fourth bank failure since March. What happened?

A brief timeline of First Republic

Following the collapse of Silicon Valley Bank (SVB) in March, the market was sniffing for the next weakest link. Enter First Republic, Credit Suisse, and a raft of regional banks, including Signature Bank, whose demise closely followed.

While SVB’s investor base included mainly tech start-ups, First Republic was the bank for wealthy clients in California, including many techies.

The common link between the three banks was their inability, perceived or otherwise, to cope with the rising interest rate environment dictated by the US Federal Reserve in an effort to curb inflation.

SVB’s largely unhedged balance sheet was dominated by long-term US treasury bonds that were underwater as a result of climbing interest rates. First Republic’s balance sheet was largely made up of cheap mortgages to wealthy customers, which left it sitting on large paper losses on its mortgage books. Added to that, depositors were pulling out their deposits in search of higher interest rates elsewhere. Many of the deposits were uninsured as it exceeded the threshold of $250k guaranteed by the Federal Deposit Insurance Corporation (FDIC).

An overreliance on non-FDIC-insured deposits made these banks extremely vulnerable to bank runs. All of these losses started to materialise when spooked investors began pulling their money out in droves and the banks needed to sell their assets to accommodate.

In the days following SVB’s collapse in March, large banks (including JPMorgan) rallied around First Republic injecting $30bn of deposits in an effort to contain the panic.

This panacea was short-lived. At the end of April, First Republic released its Q1 earnings showing deposit outflows of more than $100bn. This equated to a drop of over 50% in deposits from 31 December 2022 (excluding the emergency cash injection), while its net interest income dropped 19.4% year over year at the end of the first quarter.

First Republic’s chief executive Michael Roffler not taking questions on an analyst call didn’t help the cause and the culmination sent an already jittery market over a cliff, leading to the death spiral in share price that we saw last week, and ultimately, seizure of the bank by the regulators.

Acquisition by JPMorgan and the 'too big to fail' debate

JPMorgan’s acquisition of First Republic is not without controversy. For months, it acted as adviser to First Republic and then became a potential buyer over the weekend, albeit at the behest of the FDIC.

Under the deal, it will pay the FDIC about $10.6bn for First Republic’s $92bn in deposits (which includes the $30bn that it and other large banks put into First Republic last month), $173bn in loans and $30bn in securities. As a sweetener, the FDIC has agreed to absorb most of the losses on mortgages and commercial loans being transferred and will also provide $50bn in financing. All in all, the transaction will cost the FDIC’s Deposit Insurance Fund an estimated $13bn, according to the regulator. By way of comparison, the SVB process cost the fund about $20bn.

JPMorgan’s size means it falls within a law barring acquisitions by banks with more than 10 per cent of US domestic deposits. Yet, under an exception for deals involving failed banks, JPMorgan acquired both Washington Mutual (the biggest banking failure in US history) in 2008 and First Republic (the second-biggest banking failure in the US).

Following the acquisition of First Republic, JPMorgan now controls around 12% of US domestic deposits, leading US Senator Elizabeth Warren to comment: “The failure of First Republic Bank shows how deregulation has made the too big to fail problem even worse. A poorly supervised bank was snapped up by an even bigger bank − ultimately taxpayers will be on the hook. Congress needs to make major reforms to fix a broken banking system.”

There is also a bigger question whether government and regulators’ stepping in at the eleventh hour to guarantee all deposits with failing banks ultimately encourages risky behaviour by the banks.

Needless to say, the markets are breathing a sigh of relief following JPMorgan’s acquisition. JPMorgan’s CEO, Jamie Dimon, has suggested that this part of the crisis is over, stating: “There may be another smaller one, but this pretty much resolves them all.”

Late on Wednesday, PacWest became the latest bank to seek a financial lifeline amid the turmoil. Its shares plunged 50 per cent in after-hours trading following reports it was exploring strategic options including a potential sale.

Will it be another busy weekend for the US regulators and the banks? Time will tell. 

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