What Happened to First Republic Bank?

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5/4/2023Updated: 5/4/2023

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On May 1, First Republic Bank became the second-largest bank failure in U.S. history. Its failure is second to Washington Mutual (2008) and just ahead of Silicon Valley Bank recently. The result was another disruption in the banking industry.

Trouble was on the rise in February 2023 when First Republic’s shares had a 98 percent drop. They went from $147 per share to $3.50. But how did this happen? What contributed to the demise of First Republic Bank?

First Republic’s Emphasis on Service

The business model for First Republic was simple: give wealthy customers high-touch service. The thinking was that these customers wanted service over a few dollars of interest on their deposits.

They attracted these clients and paid them minimal interest on their deposits. First Republic then used the deposits to fund mortgages. The average interest paid to depositors was 0.12 percent.

As part of the business model, First Republic limited the number of depositors. In addition, they touted their ability to provide excellent service to their small customer base. The result was First Republic’s deposits were around 20 percent of what other banks their size had.

Low-Interest Jumbo Mortgages

Loans, including jumbo loans, were given to the wealthy if they opened checking and savings accounts. Many made deposits so they could earn discounted interest rates.

For example, Mark Zuckerberg, founder and CEO of Facebook, was given a $5.9 million mortgage for a starting rate of 1.05 percent.

It created a demand for loans during the pandemic because wealthy buyers seeking mortgages increased. And First Republic gave interest-only loans to these high-income buyers with exceptional credit scores. Generally, the buyer didn’t have to pay the principal back for 10 years.

The demand for these loans contributed to First Republic doubling its assets in four years. But these were low-yielding fixed-rate loans that wouldn’t mature for years.

Because the bank was mainly interested in large loans, they didn’t expand into other products. These included auto loans and credit cards. This would have helped balance out the bank’s loan book.

Outsized Proportion of Deposits

It’s risky to have uninsured deposits, and two-thirds of First Republic’s depositors were uninsured. The limit for the Federal Deposit Insurance Corporation (FDIC) is $250,000.

And although Silicon Valley Bank had more, with 94 percent of their depositors uninsured, at the end of 2022, First Republic had a hefty 111 percent loan-to-deposit ratio. In other words, they loaned out more money than they had in deposits.

Most big banks like Bank of America or JPMorgan diversify their deposit base. These are called “sticky deposits.” Those under the $250,000 FDIC threshold are less likely to withdraw their funds if a bank has problems. The larger depositors could pull their funds because they might lose them.

Inflation Drives Interest Rates

Inflation took a bite out of deposits as the wealthy started withdrawing their funds to take advantage of higher interest rates. With Series I Savings Bonds earning over 4 percent, the interest that First Republic was offering didn’t make fiscal sense. First Republic experienced a 41 percent drop in assets in first quarter 2023.

The problem was First Republic was in desperate need of those deposits.

Failure of SVB and Signature Banks Cause Panic

Depositors started looking hard at regional banks when Silicon Valley Bank (SVB) and Signature Bank failed. And although the Feds stepped in to cover all deposits for SVB because the market became volatile, there was no guarantee the FDIC would cover the excess again.

Shoring Up First Republic

All of these factors contributed to First Republic’s stock plummeting. Other banks stepped into help shore up the losses. A group of large banks deposited $30 billion into First Republic Bank—but that couldn’t stop the bleeding.

There was a run on the bank. And although First Republic borrowed from the government and government-backed facilities, the bank’s assets were less than the borrowed money’s rates. So first Republic borrowed $138 billion, to no avail.

Regulators Seize First Republic Bank

On May 1, 2023, the California regulators shut down First Republic Bank. The FDIC became the receiver and struck a deal with JPMorgan.

The FDIC agreed to share losses with JPMorgan. But the Deposit Insurance Fund is expected to take a $13 billion hit.

And although First Republic had $103.9 billion in deposits on April 13, it has dropped to around $92 billion.

What Happens to Failed Banks?

A bank fails when it becomes insolvent. Insolvency consists of not having enough funds to cover all its depositors and creditors. If the bank is insured by the FDIC and the bank isn’t sold to another bank, and it is dissolved, the FDIC will cover a depositor up to $250,000. Any deposits over $250,000 are not insured. Covered depositors of a failed bank receive checks from the FDIC within a few days.

If a failed bank is sold to another bank, the depositors become customers of the new bank. They will immediately have access to their money.

First Republic Grew Too Fast

The collapse of First Republic can be attributed to the weight of investments and loans that lost billions of dollars. And when the Federal Reserve raised interest rates, depositors started withdrawing their funds, looking for greener grass.

First Republic Bank grew too fast when interest rates were low and didn’t diversify its loan products and customers. They also shot themselves in the foot with low-yielding fixed-rate loans.

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