In late March, First Republic Bank became the focus of the U.S. regional banking crisis after wealthy clients began withdrawing their deposits, resulting in first-quarter outflows of over $100 billion. This marked the third major U.S. bank to fail in just two months after Silicon Valley Bank and Signature Bank. In this article, we explore why First Republic Bank failed and how JP Morgan's recent deal will impact the industry.
Why First Republic Bank Failed and How JP Morgan's Deal Impacts the Industry
First Republic's Business Model and Growth
Founded in 1985 by James "Jim" Herbert, First Republic initially focused on providing big loans at low rates. After being acquired by Merrill Lynch in 2007, the bank was listed on the stock market again in 2010. First Republic's business model was to attract high net-worth customers with preferential rates on mortgages and loans. Its customers included notable figures such as Apoorva Mehta, Chamath Palihapitiya, and Stephen M. Ross. The bank also served schools and non-profits, which accounted for 22% of its business loans.
In January, First Republic reported that its shareholder returns were compounded at 19.5% annually, more than double its peers. However, its strategy made it more vulnerable than regional lenders with less-affluent customers, as U.S. deposit insurance only guarantees $250,000 per savings account. Additionally, First Republic had a high level of uninsured deposits.
Unwinding and Failure
First Republic started amassing paper losses in 2022 when the U.S. Federal Reserve bank raised interest rates to combat inflation. Gross unrealized losses in its held-to-maturity investment portfolio, primarily government-backed debt, rose to $4.8 billion at the end of December from $53 million the previous year. By March, analysts and investors estimated that its paper losses were between $9.4 billion and $13.5 billion. First Republic's annual report warned investors that over half its loan book comprised single-family residential mortgage loans, which are challenging to offload.
JP Morgan's Deal and Industry Impact
JP Morgan, the biggest U.S. bank, recently acquired most of First Republic's assets in a deal that will make it even bigger. The bank paid $10.6 billion to the U.S. Federal Deposit Insurance Corp as part of the deal. Its 84 offices in eight U.S. states will reopen as branches of JPMorgan Chase Bank from Monday. JP Morgan also entered into a loss-share agreement with the FDIC on the residential and commercial loans it purchased. However, it did not acquire First Republic's corporate debt or preferred stock.
In conclusion, First Republic Bank failed due to its business model's vulnerability and high levels of uninsured deposits, combined with rising interest rates that led to significant paper losses. JP Morgan's acquisition of most of its assets will further increase its size and influence in the banking industry.
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