In an Unsteady Banking Industry, First Republic’s Problems Stood Out

Is the worst of the banking crisis over? It may seem a strange question to pose so shortly after the collapse of First Republic Bank, the second-largest such failure in U.S. history, but many industry experts say that its problems were unique to the once high-flying lender.

Investors have also appeared to reach that view: As First Republic hurtled toward collapse, with its stock dropping precipitously, financial markets were far calmer than in mid-March, when the failures of Silicon Valley Bank and Signature Bank provoked a panic that engulfed the industry.

First Republic was seized by regulators early Monday morning and sold to JPMorgan Chase. The S&P 500 stock index rose in the hours after, as did shares of JPMorgan. The moves in smaller banks’ shares, which were shaken by the turmoil in March, were largely muted.

Echoing the failures of Silicon Valley Bank and Signature Bank, First Republic collapsed after depositors and investors abandoned the institution, pulling their money and selling their shares in droves. Its woes also included huge real estate loans that lost value rapidly as interest rates rose and a concentrated customer base of wealthy depositors who withdrew large amounts of money quickly.

Many banks still face tough economic conditions, but no other prominent lenders appeared to have a similar set of urgent challenges. That was underlined over the past few weeks as dozens of regional banks reported their first-quarter earnings, offering a less-grim assessment of their prospects than many investors and analysts had feared.

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

First Republic lost $102 billion in deposits in the first quarter, but withdrawals at other banks stabilized much more quickly. PacWest Bancorp, a Los Angeles lender, lost nearly $6 billion in deposits during the quarter — but by late March, the outflows had reversed, according to executives. Western Alliance, an Arizona bank that has also drawn 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’s stock was in free fall, a signal that investors viewed First Republic as an isolated problem, rather than a harbinger of more trouble to come. That’s a message many bank executives have also tried to send as they distanced themselves from their stricken rivals.

It’s a distinctly different response than investors had in March. After the sudden collapse of Silicon Valley Bank, banking indexes plunged, dragging the broader stock market lower amid fears of a credit crunch and spiraling 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, putting First Republic’s troubles in sharper relief.

Banking analysts say there are no other sizable banks as visibly on the brink as First Republic was, and they consider it unlikely that there will be any other large government takeovers in the coming weeks. That said, banks still face many risks.

Rising interest rates are a blessing and a curse for financial institutions: Banks can earn more on the loans they make, but they’re under greater pressure to offer higher interest rates to encourage depositors to keep their cash where it is. “We’re going to be paying more for our funding than we thought coming into the year,” Bruce Winfield van Saun, the chief executive of Citizens Financial Group, told analysts on April 19, echoing a common refrain among bank leaders.

The biggest fissure threatening regional banks is in their commercial real estate portfolios. Midsize banks are the nation’s largest lenders for projects like apartment buildings, office towers and shopping centers. Higher interest rates are putting stress on that market.

More than $1 trillion in commercial real estate loans will come due before the end of 2025, and as banks tighten their underwriting, many borrowers may struggle to refinance their debts. Regulators and analysts will be watching to see if those challenges balloon into a broader economic problem.

Empty office buildings are a particular pain point: Vacancy rates are climbing nationwide and new construction has plunged as the industry adjusts to the ways that remote work may have permanently altered demand for office space. The delinquency rates on commercial real estate loans are creeping upward, though they remain well below the pandemic peak.

The credit rating firm Moody’s downgraded 11 regional banks in April, specifically citing commercial real estate exposure and “the implications of work-from-home trends” on the office market as a reason for its dimmed 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 that have dropped in value. If commercial real estate defaults climb significantly, hundreds of banks could be in a position in which their assets are worth less than their liabilities, according to Tomasz Piskorski, a Columbia Business School professor who specializes in real estate finance.

In a new working paper, based on research that has not yet been peer-reviewed, Dr. Piskorski and his co-authors calculated that dozens of regional banks could become severely distressed if their real estate portfolios lost value and their uninsured depositors got spooked and fled.

“This is not a liquidity issue, it’s a solvency issue,” Dr. Piskorski said in an interview. That does not mean those banks are doomed — insolvent lenders can survive if they are given time to recover and work through their losses. But it makes those institutions vulnerable to bank runs.

The Federal Reserve has lending programs in place to help struggling banks, including one created last month that offers banks loans against certain distressed assets at their original values. Dr. Piskorski considers that a good short-term intervention, but remains concerned about the consequences later this year if economic conditions worsen.

“The signs are not necessarily encouraging,” he said, citing additional perils like slowing job growth and the nearly frozen housing market. “These are not very favorable conditions for the banking systems.”

Adding to the pressures smaller banks will face in the coming months and years, analysts expect stricter regulatory supervision and, eventually, new rules. Three government reviews released on Friday spotlighted regulatory sluggishness and failures that allowed Silicon Valley Bank and Signature Bank to grow despite clear signs of trouble.

That will probably lead banking regulators to more quickly flag — and more quickly correct — problems that could cause turbulence for banks. “Opposition from the banking industry is probably not going to make much of a difference this time,” said Ian Katz, a managing director at Capital Alpha Partners, a Washington research firm. “The wind is at the back of the regulators to do something.”

For now, any immediate contagion from First Republic appears contained. “Right from the beginning, when Silicon Valley started to collapse, the screens were run and the weak players were identified,” said Steve Biggar, an analyst who covers JPMorgan at Argus Research. “I think the conclusion of First Republic at this point should alleviate a lot of the concerns about the banking crisis. All these banks are in stronger hands now.”

Emily Flitter contributed reporting.