The failure of Republic First is a blip — in a rising tide of blips

Chana Schoenberger

Leo Tolstoy famously said in Anna Karenina: "All happy families are alike, but each unhappy family is unhappy in its own way." The same may be said of banks — all healthy and solvent banks are the same, but each distressed bank is unhappy in its own way.

Republic First in Philadelphia, the troubled $6 billion-asset institution that has been circling the bowl for more than a year, finally failed last Friday. Much of the bank, including $4 billion of deposits, was acquired by Fulton Bank, a $27 billion-asset rival based in Lancaster, Pennsylvania. Republic First customers woke up Monday morning as Fulton customers, and by all accounts the failure was routine, even mundane.

Certainly, Republic First was unhappy in its own way. Not one but two activist investor groups led a charge to oust then Chairman Vernon Hill back in 2022, a feat that was ultimately accomplished a few months later. But arrangements to raise capital and/or arrange a sale came to naught, and ultimately the pressure of underwater securities and a lack of investor confidence left regulators no choice but to tell the bank that its time was up.

The failure of Republic First, then, is on the one hand a blip — banks fail all the time (or at least they should), and when they do there is usually a boring, happy bank willing to step in and ensure that life goes on. But what is striking about the failure of Republic First is that there are many unhappy banks out there that are unhappy in substantially the same way — and may be facing the same inevitable demise.

Since the banking industry began walking in the Silicon Valley of death last March, it has been apparent that there are many small and midsize banks out there with big portfolios of underwater assets, big exposures to now-undesirable commercial real estate loans and a disproportionate reliance on low-cost uninsured deposits. 

Those seem like boneheaded mistakes, but a lot of banks made them for good reasons: Intelligent people said a few years ago that inflation was transitory and that long-dated bonds were a safe play; uninsured deposits are cheap and the risk of failure is low (ha ha!); and CRE is one of the few industry sectors in which smallish regional banks can compete head-to-head with their bigger competitors.

Second-guessing how and why these banks got in this place is perhaps a column for another day. A bigger and more pressing question is what these banks — and, by turns, the Biden administration and bank regulators — are going to do to get to the other side of whatever this is. From a bank's perspective, there are four choices: Do nothing, self-liquidate, merge with a perhaps also-distressed peer or be acquired by a larger bank. Doing nothing runs the substantial risk of having one of those remaining three choices made for you, so even though that is what many banks are likely to do, let's leave that aside for a moment. Self-liquidation likewise will result in one's assets being acquired by either another healthy (likely larger) bank or another unhealthy (likely peer) bank, so we can leave that one aside, too.

Failures

Fulton details Philly boost it's getting from Republic First takeover

April 29, 2024 5:45 PM

So the real question is: Should these banks be acquired by the larger banks, or should such an acquisition be discouraged? Politically, there is a great deal of resistance to the idea of helping the biggest banks get even bigger — when JPMorgan Chase acquired most of First Republic's portfolio last year, regulators got a lot of heat about it from the banking-hawk wing of the Democratic Party. But when much smaller New York Community Bank acquired the assets of the failed Singature Bank around the same time, it proved to be more than NYCB could handle, leading to an emergency cash infusion, a new CEO and a lot of work left to be done.

An unfortunate truth about banking is that when two troubled banks merge, they just become one bigger troubled bank. The most reliable way to make the trouble go away is for troubled banks to merge with larger, healthy banks. That may not be a popular opinion within the administration — and to be sure, that may not be the inevitable outcome for each case — but closing the off-ramp for troubled banks for primarily political reasons will likely do more harm than good.

Allowing larger banks to take over banks that are in these dire straits may also offer regulators a silver lining. If the biggest banks are going to get bigger, their status as critical nodes of the U.S. economy is all the more enhanced — were they to fail, such a failure would be all the more systemically significant. That would give the argument for higher regulatory capital standards on the largest banks — something that has been notably unpopular of late — a new and legitimate rationale. 

But before we even get there, regulators have to think about how to approach what will likely be a trickle of similar bank failures and/or acquisitions over the coming months and years. If that regulatory quiver includes letting big banks buy troubled, smaller peers, I suspect that would be useful in bringing the banking industry into a brighter tomorrow even if there is a political price to pay. After all, as Tolstoy also said in Anna Karenina: "It's much better to do good in a way that nobody knows anything about it."