How First Republic ended up as the second-largest bank takeover in history after Washington Mutual

By Steve Gelsi

A quick rise in interest rates, a large amount of uninsured deposits and a first-quarter update that revealed further weaknesses in its business all contributed to the demise of First Republic Bank, now the second-largest bank blowup since Washington Mutual.

As of Dec. 31, First Republic (FRC) was ranked as the 14th largest bank in the U.S. by the Federal Reserve with consolidated assets of nearly $213 billion. Washington Mutual had $307 billion of assets as the largest bank failure in U.S. history during the global financial crisis.

Also read: First Republic customers will keep all their money, but company's stock is worth zero in its current form

First Republic's fight for survival began in early March when Silicon Valley Bank disclosed a run on deposits and said it would be forced to raise more capital after selling assets at a loss.

That run was caused partly by a quick rise in interest rates, which made Silicon Valley Bank's assets worth less and also created a need for more cash by its clients in the venture capital world who found it more expensive to borrow money.

While First Republic's footprint includes New York and other wealthy areas, its headquarters in San Francisco and its overall business had many of the same vulnerabilities as Silicon Valley Bank. It had exposure to the technology sector and a clientele of wealthy depositors and borrowers that owned assets that exceeded the $250,000 insurance limit by the Federal Reserve.

In the thirst for cash during the downfall of Silicon Valley Bank, First Republic also suffered a run on deposits and uncertainty about the value of its assets as well as a large percentage of uninsured deposits.

In an unprecedented move, 11 banks last month deposited $30 billion to backstop First Republic's balance sheet.

From March: First Republic stock is getting battered. Here's how the bank's tailspin started and why it hasn't stopped

The move failed to provide much of a lift to First Republic's stock, but its slide started to stabilize in April until the bank's first-quarter results on April 24 revealed a $100 billion drop in deposits and other troubles.

Sifting through the numbers, Wall Street grew even more sour on First Republic.

Janney analyst Timothy Coffey cut his rating on First Republic Bank to sell from neutral after he said the bank's first-quarter results, released on April 24, were far worse than we expected.

"We believe the company will have to complete a major pivot very soon to survive," Coffey said. "[First Republic] needs to drop the growth-at-all-cost business model that defined the company and focus on profitability, which could be an epic undertaking."

The stock's losses mounted last week as reports surfaced of efforts under way to sell the bank. At first, regulators and banks tried to resolve the situation in a so-called open bank deal, which would avoid a government takeover of First Republic.

But no bank wanted to step in and assume all of First Republic's obligations and liabilities in its portfolio.

"The market value of FRC's investments and loans were below the carrying value, which is an unrealized loss until they're sold and then it becomes a realized loss," Janney analyst Coffey said in an email to MarketWatch. "As a result, selling either through an open transaction would have resulted in the buyer recognizing those losses. That's problematic in normal times and almost a nonstarter in the current environment in which banks are encouraged to maintain capital."

JPMorgan Chase (JPM) then prevailed in a government-brokered acquisition of First Republic, in a move that will cost the Federal Deposit Insurance Corp. about $13 billion to cover the bank's losses. That $13 billion will be paid back to the government's Deposit Insurance Fund by member banks.

As the buyer, JPMorgan Chase can offset unrealized losses with a $2.6 billion payment from the FDIC and a loss share agreement, Coffey said.

Asked by analysts whether the $30 billion deposit worked, JPMorgan Chase CEO Jamie Dimon said it provided enough stability for the FDIC to put together a bailout of the bank.

"We didn't know at the time whether [an open bank sale] would be possible," Dimon said. "Some thought yes and some thought no, but we wanted to give them the time. It did in fact calm things down and stop the run, and it did give them time to look at it. They couldn't get there."

The FDIC, however, did avoid having to pursue the more drastic measure of a Systemic Risk Exception (SRE), a tactic used during the global financial crisis to expand FDIC insurance coverage without congressional authorization.

The results was a "very good outcome for everyone because this is how the system was meant to work," Dimon said. "It was put up for bid. It was a competitive bidding....You're never going to have no bank failure. So, if this is how these things work in the future, that's a rather good thing."

-Steve Gelsi

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05-01-23 1230ET

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