Why First Republic failed, and what it means for the rest of the banking industry

• First Republic was bought by JPMorgan Monday after regulators took control of the bank.
• Withdrawals by customers in the first three months of 2023 doomed the San Francisco-based bank.

First Republic's failure and rescue Monday is a jarring reminder that US banks continue to navigate a crisis nearly two months after Silicon Valley Bank collapsed.

But despite a speedy takeover by JPMorgan, First Republic's failure shows the banking crisis is far from over.

What's happened to First Republic?

First Republic was taken over by the Federal Deposit Insurance Corporation (FDIC) at a cost of about $13 billion to the regulator. The lender suffered a flight of deposits in the first quarter of 2023, leaving it scrambling to address a liquidity crunch.

JPMorgan stepped in to buy the bank after regulators took control, saying in a press release that it would acquire $92 billion of First Republic deposits.

Why did First Republic fail?

Its core customer base was very wealthy clients who rarely defaulted on loans. But that also meant many held much more than the $250,000 deposit limit insured by the FDIC.

At the end of 2022, two-thirds of First Republic's deposits were uninsured. When SVB and Signature Bank failed, these wealthy customers fled First Republic in droves for fear of losing their cash.

Deposits dropped 41% to $104.5 billion in the first three months of this year. They appeared to have fallen by another $12 billion by the time of JPMorgan's acquisition, based on the $92 billion deposit figure it cited.

In addition, First Republic sought to woo its wealthy clients with very cheap mortgages when interest rates were at rock-bottom, offering interest-only home loans in 2020 and 2021. This included an $11.2 million mortgage to a senior Goldman Sachs executive, per Bloomberg.

But as the 30-year fixed mortgage rate more than doubled in the space of a year, these mortgages became far less valuable to First Republic than when they were initially offered.

The combination of falling deposits and rising losses on its mortgage book doomed the regional lender. The parallels with SVB, where a large share of deposits was uninsured and losses linked to rising interest rates became untenable, were stark.

What does First Republic's failure mean for other banks?

The combined failure of SVB, Signature and First Republic is a reminder of the problems affecting the banking system. The Dow Jones US Bank Index has fallen about 16% since SVB's collapse because of this uncertainty.

While market conditions appear to have wiped out the three most exposed banks, others remain vulnerable.

Lenders' emergency borrowings from the Federal Reserve increased for the second week in a row through April 27, according to data released by the central bank.

And there are still about $1 trillion in uninsured deposits held by US banks. Meanwhile, higher interest rates will likely continue to strain those banks heavily exposed to bonds and mortgages.

What's next for the banking sector?

First Republic's rescue should restore some calm to markets. Indeed, shares in JPMorgan rose as much as 4.2% in pre-market trading following the announcement.

But the road ahead is much more daunting than before the bank failures began. The New York Federal Reserve said financial conditions had "deteriorated sharply" in in its regions in an April summary of broader economic conditions.

More caution is likely, meaning it will probably be harder to get a loan at the same time as wider money supply shrinks, threatening a recession, according to a BlackRock note reported by Bloomberg.

Whether this stops more banks from getting into trouble too remains to be seen.