In an unstable banking industry, the First Republic’s problems stood out

Is the worst of the banking crisis over? It might seem odd to ask a question after the collapse of First Republic Bank, the second-largest of its kind in U.S. history, but many industry pundits say their troubles lay solely with the once high-flying lender.

Investors seem to have reached the same conclusion: as First Republic raced toward collapse and stocks fell rapidly, financial markets were far calmer than in mid-March, when the failures of Silicon Valley Bank and Signature Bank sparked a panic that Industry captured .

First Republic was seized by regulators early Monday morning and sold to JPMorgan Chase. The S&P 500 stock index rose in the hours that followed, as did JPMorgan stock. Movements in smaller bank stocks, rocked by the turmoil in March, were broadly muted.

Echoing the failures of Silicon Valley Bank and Signature Bank, the First Republic collapsed after depositors and investors left the institution, dumped their money, and sold their shares in droves. Its woes also included huge real estate loans that quickly depreciated in value as interest rates rose, and a concentrated client base of wealthy depositors who were quick to withdraw large amounts of money.

Many banks continue to face difficult economic conditions, but no other prominent lender appeared to face similar pressing challenges. This has been underscored in recent weeks, as dozens of regional banks released their first-quarter results, assessing their prospects as less gloomy than many investors and analysts had feared.

“The problems at First Republic were already visible on March 10,” said Nicolas Véron, a senior fellow at the Peterson Institute for International Economics, referring to the day the Silicon Valley bank collapsed. “To me, it’s just a holdover from the previous episode. The only surprise here is that it took so long.”

First Republic lost $102 billion in deposits in the first quarter, but withdrawals from other banks stabilized much faster. PacWest Bancorp, a Los Angeles lender, lost nearly $6 billion in deposits during the quarter — but by the end of March the outflows had reversed, according to executives. Western Alliance, an Arizona bank also under scrutiny, added $2 billion in deposits in the first half of April.

The KBW Regional Bank Index, an index of smaller regional lenders in the United States, lost little ground even as First Republic stock was in freefall, a signal that investors viewed First Republic as an isolated problem rather than a harbinger of others problems considered coming. That’s a message that many bank executives have also tried to send as they distanced themselves from their struggling competitors.

It’s a markedly different reaction from investors in March. After the sudden collapse of Silicon Valley Bank, bank indexes plummeted, dragging the broader stock market lower amid fears of a credit crunch and a deepening economic crisis. In the weeks since, including the first trading session after First Republic’s demise, the S&P 500 has posted a series of gains, highlighting First Republic’s woes.

Banking analysts say there are no other big banks on the brink as visibly as First Republic, and they think it’s unlikely that there will be any more major government takeovers in the coming weeks. However, banks are still exposed to many risks.

Rising interest rates are both a blessing and a bane for financial institutions: banks can earn more on the loans they lend, but are under greater pressure to offer higher interest rates to encourage depositors to keep their money where it is. “We’re going to start the year paying more for our funding than we thought we would,” Bruce Winfield van Saun, chief executive officer of Citizens Financial Group, said on March 19.

The biggest crack threatens the regional banks in their commercial real estate portfolios. Mid-sized banks are the country’s largest lenders for projects such as apartment buildings, office towers and shopping malls. Higher interest rates weigh on this market.

More than $1 trillion in commercial real estate loans will mature before the end of 2025, and as banks tighten their lending, many borrowers could struggle to refinance their debt. Regulators and analysts will be watching as these challenges escalate into a broader economic issue.

Empty office buildings are a particular pain point: Vacancy rates are rising nationwide and new construction has slumped as the industry adjusts to the fact that remote work may have permanently altered demand for office space. Default rates on commercial real estate loans are rising, although they remain well below the pandemic peak.

Rating agency Moody’s downgraded 11 regional banks in April, citing exposure to commercial real estate and “the impact of work-from-home trends” on the office market as reasons for its gloomy view of the banks’ prospects.

The average bank has around a quarter of its assets tied up in real estate loans. Rising interest rates have already left thousands of banks with loans and securities falling in value. If commercial real estate defaults increase significantly, hundreds of banks could find themselves in a position where their assets are worth less than their liabilities, according to Tomasz Piskorski, a professor at Columbia Business School who specializes in real estate finance.

In a new working paper based on previously peer-reviewed research, Drs. Piskorski and his co-authors predicted that dozens of regional banks could be in serious trouble if their real estate portfolios declined in value and their uninsured depositors were frightened to flee.

“It’s not a liquidity problem, it’s a solvency problem,” said Dr. Piskorski in an interview. That doesn’t mean these banks are doomed – failing lenders can survive if they’re given time to recover and absorb their losses. But it makes these institutions vulnerable to bank runs.

The Federal Reserve has instituted lending programs to help struggling banks, including one created last month that offers banks loans against certain distressed assets at their original value. dr Piskorski thinks this is a good short-term intervention but remains concerned about the fallout later this year if economic conditions worsen.

“The signs are not necessarily encouraging“ he said, citing additional dangers such as slowing job growth and the near-frozen housing market. “These are not very favorable conditions for the banking systemS.”

In addition to the pressures smaller banks will face in the coming months and years, analysts expect tighter regulatory oversight and eventual new regulations. Three government reviews released on Friday pointed to regulatory inertia and failings that allowed Silicon Valley Bank and Signature Bank to grow despite clear signs of trouble.

That will likely prompt banking regulators to be quicker to identify — and fix — problems that could throw banks into turmoil. “The resistance from the banking industry probably won’t make much of a difference this time around,” said Ian Katz, managing director at Capital Alpha Partners, a research firm in Washington. “The wind is behind the regulators to do something.”

For now, any direct contagion from the First Republic appears to have been contained. “From the very beginning, when Silicon Valley started to collapse, the screens were checked and the weak players identified,” said Steve Biggar, an analyst who oversees JPMorgan at Argus Research. “I think the closing of First Republic at this point should allay many concerns about the banking crisis. All of these banks are in stronger hands now.”

Emily Flitter contributed to the coverage.