Explained: Why did First Republic Bank collapse?

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First Republic Bank collapse

First Republic Bank joined Silicon Valley Bank and Signature Bank in a list of recent US banking collapses, which ended with JP Morgan buying First Republic for $10.6 billion.

While the core reason for the recent failures can be pegged towards multiple interest rate hikes made by the US central bank over the past few months, hurting the balance sheet of smaller banking players,  let’s try to delve deeper into the other issues affecting First Republic. 

First Republic Bank Earnings: Weak Financials

During the latest quarter ending March 2023, the bank reported one of its weakest quarters on record. The bank’s net interest income, margins, revenue and net profit all witnessed a serious downfall during the quarter. 

Revenues dropped 14%, net interest incomes fell 20% and the bank’s net profit fell 33% for the quarter ended March 2023. 

According to data from Refintiv, the bank beat net interest income expectations for the quarter ended March, but failed to meet them over the past two consecutive quarters.

First Republic Bank failure: Deposit mix issue?

First Republic began as a bank to purely cater to high net worth individuals - individuals and corporations maintaining big ticket deposits compared to regular retail or salaried class of customers.

There are two parts to the bank’s deposit mix issue, surging interest rates and the ripple effect from the fallout of the Silicon Valley Bank. Let’s decode both these aspects. 

Effect of surging interest rates:

Whenever a central bank of any country hikes interest rates, banks generally pass on the added cost of the rate hike to its customers. This makes applying for new loans as well as the cost of repaying existing loans more expensive for customers. 
When interest rates rose, the bank witnessed a slowdown in demand for new loans, bringing down the value of its total assets, hampering chances for future fundraising. 

For a bank, loans are considered to be assets as it earns money from loan interest and deposits are considered as liabilities as the bank has to pay interest for such deposits. 

Skewed deposit mix and aftermath of Silicon Valley fallout

Ever since the collapse of the Silicon Valley Bank, many investors and big ticket depositors began pulling out their deposits from banks. 

An important factor to know here is the US government insures deposits upto $250,000. That means in case a bank goes under and you have deposits with that said bank, you are liable to receive only $250,000 back. 

So naturally, anyone having deposits above the mentioned threshold withdrew all their deposits to safeguard their financial interests. Majority of First Republic Bank customers were high net worth individuals who pulled out all their money since the fallout of Silicon Valley Bank.

This is not investment advice. Investments in the securities market are subject to market risk, read all the related documents carefully before investing. Past performance is not indicative of future returns.