Why First Republic Bank Collapsed (2024)

In February, First Republic Bank’s well-heeled customers were yanking money from their accounts. The bank tried to stem the tide by offering higher rates on certificates of deposit. Even that was a tough sell.

Jim Herbert, the bank’s 78-year-old founder, usually a reassuring presence, slammed his hand on the table during an all-hands meeting. We’ve got to get more deposits, he said, according to people familiar with the matter.

That was before the March banking panic that toppled two of First Republic’s peers, Silicon Valley Bank and Signature Bank. Its troubles only worsened after that.

Early Monday morning, regulators seized First Republic and struck a deal to sell the bulk of its operations to JPMorgan Chase & Co., the largest bank in the country.

The collapse of First Republic marks the second-biggest bank failure in U.S. history. It also spells the end of what was considered one of the most successful strategies in banking: luring wealthy depositors and giving them five-star service.

Few could have predicted the speed and magnitude of the March bank run. First Republic lost more than half of its deposits, around $100 billion, in just a few days. Yet as Mr. Herbert’s urgent message reveals, the bank’s business was already fraying.

First Republic’s undoing was triggered by the Federal Reserve’s rapid series of interest-rate increases, which led depositors to seek better returns elsewhere. That meant it had to pay more to keep them, just when rising rates were battering the value of its mortgage portfolio. It was a problem obvious in hindsight, but First Republic, among others, thought they would survive the Fed’s inflation fighting just fine.

“Clients stay with us," Mr. Herbert told investors last November. “They grow, they compound, their deposits compound, their loans compound, and they bring their friends. It’s not a complicated model, and it works in all environments."

A spokesman for Mr. Herbert declined to comment.

Customer focus

This wasn’t supposed to happen. First Republic, based in San Francisco, was a big bank with a small-town feel, the ultimate relationship bank. Wealthy customers, the thinking went, wanted high-touch service more than a few extra dollars in interest on their deposits.

First Republic gathered these clients, paid them minimal interest and used their deposits to fund mortgages. More deposits meant more loans for condo projects in Manhattan or second homes in Hawaii. First Republic got back far more from these borrowers—3.03% in interest charged on average in 2021—than it paid out to depositors, 0.12% on average.

These loans often had bespoke features, and they almost never went bad.

In a world of ultralow interest rates, this old-fashioned model was lucrative. First Republic’s annual profit quadrupled in the decade through 2021. The bank became one of the 20 largest in the U.S. and, by a couple of standard measures, traded at a valuation well above the likes of JPMorgan Chase & Co. and Bank of America Corp. Those two banks, America’s biggest, tried to copy it by opening branches in rich suburbs and upscale urban areas.

“Deposits, deposits, deposits" and “checking, checking, checking" were mantras former co-CEO Hafize Gaye Erkan was known to repeat at the end of weekly all-hands meetings, according to former employees. The bank published weekly reports that showed deposit growth by region. A representative for Ms. Erkan declined to comment.

The bulk of bankers’ pay was tied to the amount of deposits or loans they brought in, said Anthony Sherman, who worked in a midtown Manhattan branch until 2018 and now runs a startup. “They just cared about if you were producing," he said.

Daniel DiCicco, a 40-year-old lawyer living in Portland, Ore., became a First Republic customer last year when the lender offered him a $100,000 credit line at an interest rate of 2.95%. The catch: His line-of-credit rate would rise if his deposit balance fell below $20,000.

He wasn’t earning much interest but other perks made up for it. When Mr. DiCicco and his wife were planning a trip to Japan last fall, First Republic offered to courier him thousands of dollars of yen at no cost.

“I don’t have to lift a finger," said Mr. DiCicco. “I can email my banker and say I need something and it literally shows up at my doorstep."

First Republic made a particular effort to harness rapidly growing tech wealth in Silicon Valley. Peter Herz, who runs a venture-capital firm that invests in food startups, became a First Republic customer in 2002 when the bank gave him a mortgage to buy a Menlo Park, Calif., home.

He opened a checking account and paid his mortgage out of it because that earned him a discount on his rate. The service he got from First Republic prompted him to bring over most of his personal and professional accounts. Bankers at his local branch are familiar with his unusual signature and have fixed problems it has caused over the years, Mr. Herz said.

The bank struck deals with companies to target their employees, and staffers of Alphabet’s Google who set up an account earned a signup bonus of more than $2,000, said people familiar with the matter. It set up a branch inside Facebook’s headquarters and routinely offered wealthy tech employees long-term mortgages at 2.5% or less.

One customer was Mark Zuckerberg. In 2012, First Republic gave the Facebook founder and CEO a $5.95 million mortgage with a starting rate of 1.05%, The Wall Street Journal previously reported.

Growing pressure

Mr. Herbert’s return coincided with the early days of the Fed’s inflation-taming campaign. First Republic doubled down. The bank thrived during the Fed’s series of relatively modest rate increases between 2015 and 2018, and there was no reason to think this time would be different, it told investors in public presentations.

Behind the scenes, pressure was growing. With Treasurys and money-market accounts suddenly offering 4%, the best customer service in the world would have a hard time convincing wealthy clients to stick with a checking account yielding next-to nothing.

People familiar with the matter say bankers who handled balky clients would in some cases raise deposit rates to try to keep the business.

Customers taking out home equity and other lines of credit were encouraged to park those funds in First Republic deposit accounts, according to former First Republic employees. Until then, clients would often transfer the money to different banks.

In late 2022, the bank slowed down hiring and by the end of the year was replacing very few employees who left, according to investor presentations and former employees. Susie Cranston, the bank’s chief operating officer, was among the executives leading cost-cutting efforts. Ms. Cranston, through a bank spokesperson, declined to comment.

At the end of 2022, the bank had $176.4 billion in deposits, 68% of which exceeded the Federal Deposit Insurance Corp.’s $250,000 insurance limit, which meant customers were not guaranteed to get that cash back if the bank failed. Deposits accounted for 92% of the bank’s funding.

In an investor presentation in mid-January, the bank touted its small number of deposit accounts—about 20% of what other banks of its size had. The setup allowed it to devote more time to customers and “provide extraordinary service per relationship."

First Republic increased deposits 13% in 2022. But it paid dearly for them. In the fourth quarter, First Republic paid $428 million in interest on deposits, up from $20 million a year earlier.

Rising deposit costs were an especially big problem for First Republic because much of its income comes from low-yielding, fixed-rate mortgages that won’t mature for years. It didn’t expand into other products such as credit cards and auto loans that can help balance out a bank’s loan book.

In 2022, more than half of First Republic’s loans were residential mortgages with an average interest rate of 2.89%. Rising rates shaved some $22 billion off their market value. The paper losses weren’t much of a problem—as long as the bank didn’t have to sell the loans. If, however, it needed to meet withdrawals, the realized loss would have eaten away at the capital the bank needed to operate.

Analysts were raising concerns about the company’s interest-rate mismatch. The stock ended 2022 down about 40%. It plunged after Silicon Valley Bank failed on March 10.

Customers, no longer content to earn nothing on their deposits, had begun to move their money—slowly, at first, then all at once. Their relationship with the bank, after all, was purely a financial one.

First Republic tried to stem the panic. On March 10, the lender released a statement saying that it had a diversified group of depositors and “over $60 billion of available, unused borrowing capacity at the Federal Home Loan Bank and the Federal Reserve Bank." Two days later, executives emailed customers to reassure them about the bank’s finances.

Later that day, banking regulators announced they had closed another bank, New York-based Signature. The Fed set up an emergency-lending program to help banks meet withdrawals. A few hours later, First Republic announced it had shored up its finances with additional funding.

The stock continued to slide. On March 16, a group of large banks agreed to deposit $30 billion in First Republic, a move designed to turn First Republic into a firewall. It wasn’t enough. The deposit run forced the bank to rely heavily on money borrowed from government and government-backed facilities at rates that largely exceed what it was earning on its assets. Borrowing hit a staggering $138 billion on March 15.

“An upside-down funding base is unsustainable," Chris McGratty, head of U.S. bank research at Keefe, Bruyette & Woods, wrote in a research note.

As part of the deal reached Monday morning, JPMorgan said it will assume all of First Republic’s $92 billion in deposits—insured and uninsured. It is also buying most of the bank’s assets, including about $173 billion in loans and $30 billion in securities. The FDIC will share losses with JPMorgan on First Republic’s loans. First Republic’s 84 branches will reopen as part of JPMorgan Monday during normal business hours, and customers will have full access to their deposits, the FDIC said.

The Oregon Jewish Community Foundation banked at First Republic for years. Last week, the nonprofit started moving all of its deposit accounts to Bank of America, said David Forman, president and CEO. Even though its balances were under the deposit-insurance limit, the organization didn’t want to deal with the potential hassle of having money stuck at a failed bank, he said.

“A month and a half ago, First Republic had a halo effect on everything you did," Mr. Forman said. “Now it’s the opposite."

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