With First Republic on the brink, all eyes are on uninsured deposits

First Republic’s deposits plunged 40.8% between the end of last year and March 31 — and were down by more than $100 billion when excluding an effort by big banks to shore up its balance sheet.

Jeenah Moon/Bloomberg

U.S. regulators were reportedly pushing over the weekend to finalize a plan to seize First Republic Bank, with its deposits to be assumed by a larger bank in a last-minute deal that would solve the problem of how to handle the San Francisco company’s uninsured depositors.

Fears about First Republic’s health have deepened since Monday, when the bank disclosed a massive drop in deposits during the first quarter, spurring regulators and big banks to engage in talks about rescuing the troubled firm.

Its stock sank after the earnings report and fell further later in the week as a failure looked increasingly likely. The share price fell below $4 on Friday, a staggering drop from its highs of nearly $220 in 2021.

Regulators and banks spent the weekend discussing options, with the Federal Deposit Insurance Corp. asking banks to place bids for the company by Sunday, according to Bloomberg News. JPMorgan Chase, PNC Financial Services Group, U.S. Bancorp and Bank of America were weighing bids, the news outlet said. Reuters also reported that Citizens Financial Group was interested.

First Republic has been struggling since the March 10 failure of Silicon Valley Bank triggered large deposit outflows. At the end of the first quarter, the bank’s deposits had plunged 40.8% since the end of last year — and were down by more than $100 billion when excluding an effort from big banks to shore up its balance sheet.

“First Republic was like the person waiting at the crosswalk when a drive-by shooting occurs on the corner,” said Todd Baker, a senior fellow at the Richman Center for Business, Law & Public Policy at Columbia University. “They essentially would not have had anywhere near the kind of problems they had if Silicon Valley Bank had not failed because there was significant crossover in the types of customers, and it all happened in the Bay Area.” 

Eleven big banks — including JPMorgan, Citigroup, Bank of America, Wells Fargo and several large regional banks — deposited $30 billion at First Republic last month in a show of confidence. Those funds comprised roughly 60% of the uninsured deposits at the bank as of March 31.

The bank’s position became dire early on Friday, after efforts to negotiate a deal that would avoid the need for government intervention failed and regulators realized the bank’s options were limited, according to The New York Times.

The last-minute talks were complicated by a provision in federal law that prohibits regulators from approving mergers of banks from different states that would result in the acquiring bank controlling more than 10% of all insured U.S. deposits. The law provides an exception for deals involving banks that are “in default or in danger of default,” but the deposit cap was still seen as an obstacle to either JPMorgan or Bank of America acquiring First Republic.

The worries over First Republic came only weeks after similar concerns emerged over the now-failed Silicon Valley Bank. Regulators stepped in and deployed a systemic risk exception for Silicon Valley and Signature Bank, a crypto-friendly bank that also collapsed in March, in the hopes that covering their uninsured deposits would curb contagion throughout the banking system.

An agreement by a larger bank to assume First Republic’s deposits would ensure that uninsured depositors will be covered. If First Republic failed through the FDIC’s normal process, without a buyer lined up for the bank’s deposits, there would be no way to ensure that uninsured depositors would be made whole without again invoking the systemic risk exception.

Such a designation would be politically fraught in the case of First Republic, since the 11 large banks that had $30 billion of uninsured deposits at the bank would be major beneficiaries. Critics would likely frame such a move as a bailout for some of the nation’s biggest banks.

First Republic, long known for catering to wealthy clients, was caught off guard last year by the rapid rise in interest rates. 

As the housing market thrived during the pandemic, the bank’s business had boomed, as wealthy customers took out mortgages at ultralow interest rates. Once rates rose, those mortgages proved to be the bank’s undoing, since it was saddled with long-term assets whose value had fallen.

“There’s a lesson in that for all finance that what seems like a darling and a wonderful winner at one moment seems like the opposite only a little while later,” said Alex Pollock, a former Treasury Department official.

In addition to its large mortgage portfolio, the value of which cratered once rates started rising, First Republic also held long-term municipal bonds that faced similar woes. 

The losses on First Republic’s balance sheet have made a rescue difficult, since potential buyers would have been forced to reckon with the bank’s massively underwater assets. The bank’s $137 billion of mortgages were worth $19 billion less at the end of last year, according to its annual report. Those losses would have materialized if the mortgages were sold.

“Obviously there’s a very generalized problem of people making the most classic financial mistake, which is investing in long-term fixed-rate assets and funding them with floating-rate money,” Pollock said. “They were lulled into it by the actions of the central banks — by keeping interest rates both long and short-term very low for very long periods of time, and convincing people that it was going to continue.”

The large sums of money that First Republic’s wealthy clientele stuck at the bank also made it more vulnerable to a depositor panic. Nearly 68% of its deposits at the end of last year weren’t covered by the FDIC. Many customers fled when they realized their money was at risk.

“Throughout its run, First Republic filled a niche,” said Gene Ludwig, a former comptroller of the currency and current managing partner of Canapi Ventures.. “It was a private banking business for comfortable but not the wealthiest Americans. Yes, other banks do this, but the loss of competition in the marketplace and the disruption to clients is unfortunate.”

In recent weeks, the bank’s prized wealth management business has also been bleeding staff as advisors have defected to competitors.

During the bank’s quarterly earnings call on Monday, First Republic President and CEO Mike Roffler laid out plans to slash 25% of its staff, cut executive pay and reduce its corporate office space. First Republic also said that it was “pursuing strategic options.” But Roffler did not take questions from analysts, underlining the bank’s troubled status.

Earlier this year, Roffler had told the Federal Reserve and the FDIC that he expected the bank could be resolved without extra oversight or government requirements. Those comments came in response to an advance notice of public rulemaking on the possibility of extending resolvability measures like total loss-absorbing capacity or long-term debt requirements to midsize banks.

“In the event of failure, it is expected that the bank could be resolved in an orderly fashion in accordance with its resolution plan,” Roffler wrote in a January letter to regulators.

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