S&P downgrades First Republic's rating on deposit outflows risk; stock dips 16%
3 min read . Updated: 15 Mar 2023, 09:46 PM IST
Premium- The rating agency has placed the First Republic on ‘CreditWatch with negative implications.’
- In its rationale report, S&P said, ‘we believe the risk of deposit outflows is elevated at First Republic--despite actions by federal regulators.’
Following the liquidity concerns in US banks, S&P Global Rating downgraded its long-term issuer credit rating on First Republic Bank to 'BB+' from 'A-'. The rating agency also trimmed its senior unsecured issue rating to 'BB+' and the subordinated and preferred stock issue ratings to 'BB-', and 'B', respectively. Further, it has placed the First Republic on "CreditWatch with negative implications." The main concern in the First Republic would be the risk of deposit outflows.
At the time of writing, First Republic Bank stock traded at $33.35 down nearly 16% on Wednesday.
In its rationale report, S&P said, "we believe the risk of deposit outflows is elevated at First Republic--despite actions by federal regulators."
Due to recent bank failures over liquidity issues and the ensuing market stress, the Federal Reserve Board announced on March 12, 2023, certain emergency liquidity measures, including the creation of the Bank Term Funding Program (BTFP) and an easing of terms offered through the discount window.
S&P said, the BTFP offers loans of up to one year in length to banks pledging eligible securities. Still, if deposit outflows continue, it expects the First Republic would need to rely on its more costly wholesale borrowings. This would encumber its balance sheet and hurt its modest profitability.
Further, it said, " we believe that First Republic's deposit base is more concentrated than most large U.S. regional banks, which presents heightened funding risks in the current environment."
By end of December 2022, First Republic's total deposits stood at $176.4 billion -- of which 63% were commercial.
As per the bank, its number of deposit accounts is about one-fifth that of the average U.S. bank with $100 billion to $250 billion in assets, which highlights its higher-than-average account sizes.
Also, the bank's business deposits have an average account size of less than $500,000, while consumer deposits have an average account size of less than $200,000, as the company reported on March 10, 2023.
Recently, the bank reported that it has over $70 billion in contingent borrowing availability to meet liquidity needs.
S&P believes that the portion above the Federal Deposit Insurance Corp. insurance limit of $250,000--about 68% of the total, or $119.5 billion--is most susceptible to withdrawal, despite the bank's historically excellent depositor loyalty.
Also, S&P pointed out that the $70 billion in contingent borrowing availability -- does not include capacity through the Federal Reserve's BTFP.
On March 12, First Republic said, its unused contingent liquidity sources increased to over $70 billion, consisting of borrowing capacity from the Federal Reserve, Federal Home Loan Bank (FHLB) of San Francisco, and additional financing from J.P. Morgan Chase & Co.
S&P expects First Republic to use wholesale funding to alleviate liquidity pressures in the near term, thereby encumbering its balance sheet.
This could weaken funding metrics relative to peers, and S&P expects the ratio of loans to deposits--already high at 95% as of year-end 2022--may rise above 100%.
Additionally, S&P expects earnings pressure to intensify given our expectation for reliance on wholesale borrowings, which are more costly than deposits. First Republic's total profitability is more weighted toward net interest income than most regional bank peers since its fee income (mostly fees related to wealth management) is less than 20% of total profit.
Further, S&P thinks these issues have arisen in the wake of the recent bank failures, particularly as it pertains to uninsured deposits, and not because of regulatory capital concerns or the bank's excellent track record on asset quality.
In February 2022, the bank added $397 million of common equity, which we expect to bolster capital levels.
Following this, S&P highlighted that the bank's asset quality history has been excellent given the affluent nature of its customer base. That said, the large mortgage portfolio has fallen in fair value as interest rates increased and may provide less financial flexibility if rates remain higher for longer.
Lastly, S&P believes that First Republic's business position is weaker following the events of the past week.
It said, "we believe the bank's business position will suffer after the volatile swings in its stock price and heightened media attention surrounding deposit volatility. We think its business stability has weakened as market perceptions of its creditworthiness have declined."
