By James J. Devine
No advance notice was given to the public when the Pennsylvania Department of Banking and Securities closed Republic First Bank on Friday, April 26, 2024.
The Federal Deposit Insurance Corporation (FDIC) was named receive and Fulton Bank, National Association (N.A.), of Lancaster, Pennsylvania, assumed substantially all deposit accounts and substantially all the assets.
Republic Bank’s 32 branches in New Jersey, Pennsylvania, and New York with normal Saturday hours reopened as branches of Fulton Bank on Saturday and the rest opened on Mondays. Republic Bank depositors had access to their money by writing checks, at ATMs or using debit cards. Checks drawn on Republic Bank continue to be processed and loan customers should continue to make their payments as usual.
While the bank’s debtors and depositors might not notice anything special about the Republic Bank’s failure, a finance expert at Florida Atlantic University says warning signs were evident for a while.
Rebel Cole, Ph.D., a Lynn Eminent Scholar Chaired Professor of Finance, has expertise in global financial institutions, commercial banking and small business finance. He spent 10 years working in the Federal Reserve System and has experience at the the International Monetary Fund and the World Bank. He says banks across the country are exhibiting similar warning signs of a risk of failure
The risk factors of Philadelphia-based Republic First Bank’s potential to fail were hiding in plain sight as banks must report the market values of their securities in their quarterly regulatory filings. Republic First Bank reported unrealized securities losses in excess of its equity as early as June 2022.
As of September 2023, US banks had $684 billion in paper losses on their securities investments, with $390 billion in losses on securities classified as “held to maturity” (HTM).
Paul H. Kupiec of the American Enterprise Institute, on February 20, 2024, estimated that as of September 30, 2023, the banking system had accumulated over $1.5 trillion in unrealized losses on its fixed rate securities, loans and lease investments.
This is due to the Federal Open Market Committee (FOMC) decisions to increase interest rates that began in early 2022, which had no effect on inflation caused by supply chain problems or corporate greed.
Congress authorized more than $5.9 trillion in COVID19-related expenditures that fattened business and households’ bank account balances. The Federal Reserve System did its part by reinstating a near-zero interest rate policy and injected trillions of dollars of new bank deposits into the banking system through quantitative easing open market securities purchases.
Many bankers used these deposits to purchase federally guaranteed mortgage-backed securities, US Treasury securities and residential mortgage loans but those assets offered modest interest rates that could not hold their value once inflation spiked.
Paper losses are temporary fluctuations in the value of investments and are only realized when the investment position is closed.
Banks report unrealized losses, but they don’t affect earnings. Instead, banks subtract the deficit from the equity on their balance sheets. The most common cause of bank failure is when the value of the bank’s assets falls below the market value of the bank’s liabilities, which are the bank’s obligations to creditors and depositors.
As of April 2024, the second-largest bank in the world, Bank of America, had paper loss on its HTM bonds was estimated to be $110 billion, up from $98 billion at the end of 2023.
JPMorgan Chase quietly revealed tens of billions of dollars in losses on securities, according to a report on the company’s overall balance sheet. The banking giant is now stuck with roughly $40 billion in unrealized bond losses as of Q3 of this year, which is a 20% rise over the previous quarter, reports Barron’s.
Just as it did during the 2008 financial crisis, JPMorgan emerged larger and more profitable from last year’s regional banking chaos after acquiring First Republic, but the Federal Deposit Insurance Corporation took a $2.9 billion special assessment to replenish a fund that helped uninsured depositors of seized regional banks.
Earlier in 2023, Wells Fargo said it had $40 billion in unrealized bond market losses, while Citigroup had $25 billion in paper losses.
State regulators closed Republic First Bank in April 2024, marking the first bank failure of 2024. Fulton Bank entered into an agreement with the FDIC to purchase most of Republic First’s $6 billion in assets and to assume most of its $4 billion in deposit liabilities.
“The same risk factors, unrealized losses on investment securities and heavy reliance upon uninsured deposits, that brought down Silicon Valley Bank also brought down Republic First,” Cole said. “These risk factors triggered concerns of both investors and depositors about the viability of the banks when the banks announced efforts to raise additional capital before actually securing these additional funds.”
Other banks in the country could be at risk of failure as unrealized securities losses reached $478 billion, the most recently available data shows. Already, 40 banks with more than $1 billion in assets reported unrealized security losses greater than 50% of their equity capital. More than 200 smaller banks have done the same.
Much of the world first became aware of the theory of “too big to fail” (TBTF) in 2008, when the Bush administration demanded that Congress bail out reckless financial institutions that were so large and interconnected that their failure would have dragged down the entire world economy.
These institutions, also known as “systemically important” banks, currently have hundreds of billions or even trillions of dollars in assets and they are linked to almost every sector of the global economy.
When facing failure, the government must bail out these banks to avoid a total economic collapse.
The 2008 financial crisis was triggered by “too big to fail” banks, that had contributed to the subprime loan crash, but while these banks are still risky, they are even bigger and more concentrated than ever before.
During 2020, bank deposits grew by more than 20% ($3 trillion) as depositors placed their government-funded pandemic transfer payments into their accounts; during 2021, deposits grew by another 15% ($2 trillion).
Without profitable lending opportunities during the pandemic, banks put more than $2 trillion into investment securities, an increase of more than 50%. Banks were searching for yield, so they invested in the longest maturities available to them.
Since the end of 2023, the 10-year treasury yield jumped from 3.86% to 4.5% as the Federal Reserve Board has been steadily raising rates to combat inflation, causing the value of long-maturity securities to decrease.
Milton Friedman, the University of Chicago economist and Nobel laureate, famously said: “Inflation is always and everywhere a monetary phenomenon, in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.”
Friedman, who also asserted that the only purpose of a corporation is to maximize profits for shareholders, was wrong.
Since the inflation experienced in 2023 and 2024 was not caused by the usual suspects, but by Covid-induced breaks in the supply chain and clear examples of unbridled corporate greed, raising interest rates created a credit crunch that stunted the recovery and lowered the value of assets, inflicting huge losses on many banks.
“Those numbers of banks reporting security losses 50% greater than their equity capital will swell because of the rise in interest rates since the end of last year,” Cole said. “We could see additional banks fail and will have to see if this will ultimately lead to another banking crisis.”