What to know about First Republic and the banking crisis

On Monday, First Republic became the third U.S. bank to be seized by regulators in the past two months, once again raising questions about the health of the financial system amid rising interest rates.

Most of the bank's $229 billion worth of assets were acquired by JPMorgan Chase after a competitive bidding process, regulators said. All First Republic customers will have full access to all of their deposits, the Federal Deposit Insurance Corporation said in a statement.

The failure of First Republic follows the collapse of Silicon Valley Bank and Signature Bank in March.

What is First Republic Bank?

The San Francisco-based, publicly traded First Republic Bank opened its doors in 1985 with one branch and fewer than 10 employees, its website says. In 2007, it was acquired by Merrill Lynch for $1.8 billion and sold again in the aftermath of the 2008 financial crisis. By July 2020, it sprawled across seven states with over 80 offices, the company says. Profitable each year since its founding, the bank came to be known for its high-net-worth clients and wealth management services.

What happened to First Republic?

First Republic found itself pinched by the Federal Reserve's move to curb inflation through aggressive interest rate hikes, and experts say it failed to manage related risks.

"Poor risk management, billions in exposure to interest rate sensitive securities and an over reliance on non-FDIC insured deposits made these banks extremely vulnerable to bank runs," said risk management expert Mark Williams, who teaches finance at Boston University.

The bank had invested heavily in long-term assets such as mortgages and government securities at a time when rates were low. When the Fed raised interest rates by nearly five percentage points over 14 months, First Republic was left earning lower interest from those assets while paying more to get fresh funds.

Its problems worsened in March as the failure of two other tech-focused banks ― Silicon Valley Bank and Signature Bank ― contributed to broader concerns about problems in the financial system. Its first-quarter balance sheets showed that its loans were up by 22.6 percent, and deposits had dipped by more than 40 percent as depositors pulled out $102 billion.

In March, it received a $30 billion infusion from large U.S. banks to prop up the bank amid the collapse of SVB and Signature. But the extra cash failed to stem the bank's problems, as its stock continued to slide. As investors became more sensitive to banking risks, shares of First Republic lost 97 percent of their value.

What are the terms of JPMorgan's acquisition?

JPMorgan agreed to pay $10.6 billion to the FDIC to acquire "substantially all" First Republic assets. It also assumes responsibility for all of its deposits, including those above the federal insurance limit of $250,000. First Republic had about $229.1 billion in assets and $103.9 billion in deposits. JPMorgan is not assuming First Republic's corporate debt or preferred stock.

As part of the deal, the FDIC agreed to reimburse JPMorgan for a large portion of any losses incurred on the acquired loans. The agency will cover losses on single-family residential mortgages at 80 percent for seven years, while losses on commercial loans are covered up to 80 percent.

The FDIC will also provide $50 billion in five-year, fixed-rate financing.

On the whole, the failure is expected to cost the FDIC about $13 billion. That money will come out of the regulator's deposit insurance fund, which banks pay into every quarter.

What does this mean for the banking system?

The failure of yet another bank is sure to raise questions about the health of the financial system, but experts said it's unlikely to lead to a repeat of the 2008 crisis, when 12 of the 13 biggest financial institutions in the United States came close to collapsing.

All First Republic depositors will have access to their money, as was the case with the earlier failure of Silicon Valley Bank. First Republic's 84 offices in eight states will reopen as branches of JPMorgan, with depositors able to access their money on Monday.

Three banks failing out of 4,100 banks in the United States is a small number compared with more than 150 bank failures in 2010 as a result of the financial crisis, experts point out.

What is unusual this time, however, are the sizes of the banks that failed, said William Chittenden, a professor of finance and economics at Texas State University. The bank failures this year are the second, third and the fourth largest bank failures in U.S. history, based on data as of the end of December.

All three banks lent heavily in niche areas, had a high percentage of uninsured deposits and had assets with long maturities, Chittenden said. They were at the "extremes in these three areas" and "managed these risks very poorly," he said.

Chittenden sees First Republic, Silicon Valley Bank and Signature Bank as outliers.

"There may be a handful of other banks that fail because they are at the extremes, but overall, the banking system is healthy," he said.

There are also concerns about a broader pullback in credit as loan officers grow more skittish about taking risks. Fewer loans would make it harder for companies to grow, and the Fed's rate-raising campaign has already made loans more expensive. The National Federation of Independent Business, for example, placed its gauge of loan availability at its tightest level in roughly a decade.

It's also possible that other midsize and regional banks could continue to feel pressure. PacWest Bancorp saw its shares fall 3.9 percent, contributing to an overall drop of nearly 60 percent in the past six months.

Regional banking stocks have been pummeled since mid-March, but several of them were little changed in early trading on Monday. Comerica bank stock was up a third of a percentage point in premarket trading by 8 a.m., while Western Alliance fell 1.3 percent.

What does this mean for the economy?

The broader economy faces tremendous uncertainty. Inflation is still too high. Fed economists have warned about a "mild recession" later this year. The economy grew less than expected at the beginning of the year. Officials expect that the spring banking crisis will add to any slowdown somewhat - as banks pull back on lending and businesses have less ability to grow. But policymakers don't know how significant that slowing will be.

We may get a clearer answer on Wednesday, when the Federal Reserve wraps up its two-day policy meeting. The Fed is expected to raise interest rates by a quarter of a percentage point, and then they may decide to hit pause and see how their aggressive policies up to now are working through the economy. (Economists don't think the takeover of First Republic will affect the Fed's rate hike decision.)

Could bank regulation change now?

Regulators have sent clear signals about what needs to be done to prevent another meltdown in the banking system.

In scathing reports on Friday, federal regulators outlined a number of disastrous decisions - including failures by the Fed and FDIC - that led to the collapses of SVB and Signature Bank.

The Fed's 114-page report set the stage for a new, aggressive push to tighten up many of the rules that were eased by Congress in a bipartisan vote in 2018 and further loosened by the Fed in 2019. Specifically, the Fed will reevaluate a range of rules for midsize banks that have at least $100 billion of assets and reconsider how it guards against risks from rising interest rates.

On Monday, the FDIC also released a report mapping out ways deposit insurance laws could change. (Typically, the FDIC ensures deposits up to $250,000, but in when SVB and Signature failed, government officials decided to guarantee all deposits at both banks to avoid a wider catastrophe.)

The report laid out three options: leaving the threshold as-is; shifting to unlimited coverage for any depositors; or using different limits for different types of personal or business accounts. The FDIC made no final decision but showed a preference for the third option.

Even then, though, it did not define every possible kind of account or what possible tiers for coverage would be. Any changes would ultimately require action from Congress, the FDIC said.

WASHINGTON POST