First Republic Bank Credit Rating Downgraded to Junk, Causing Stock to Plunge
First Republic Bank’s (FRB) credit rating was downgraded to junk by two rating agencies, causing its stock to dive.
Fitch Ratings and S&P Global Ratings announced their concerns on March 15 that there was a risk that depositors could pull their funds from the California-based bank, despite promised federal intervention.
S&P Global lowered the bank’s credit rating into speculative-grade territory at BB+, down four notches from its previous A- rating.
“We believe the risk of deposit outflows is elevated at First Republic—despite actions by federal regulators,” wrote S&P in its report, stating the bank remains on negative credit watch.
Fitch Ratings also downgraded First Republic, to BB from A-, placing the bank under a similar watch status over deposit concerns.
FRB shares tumbled 21 percent at the end of trading following the downgrades, and the price share is down 75 percent this year.
San Francisco-Based Bank Facing Similar Deposit Problems as SVB
Trade in First Republic’s stock has been volatile since the rapid collapse of Silicon Valley Bank (SVB), Signature Bank, and Silvergate Bank over the past week, which sparked concerns about the health of the U.S. banking sector.
Fitch put another regional bank on notice, PacWest Bancorp, to prepare for a potential downgrade in its credit rating.
Moody’s Investors Service also lowered its outlook for the entire U.S. banking system and placed six American banks on review for potential credit rating downgrades, including First Republic.
Many economists now fear that the recent news may cause depositors to pull their cash, despite government intervention and the Federal Reserve’s creation of the bank term funding program (BTFP).
The two credit ratings firms warned that disproportionate number of deposits in the unassured category above the $250,000 Federal Deposit Insurance Corp’s (FDIC) limit puts First Republic at a similar risk as SVB last week.
FRB’s high concentration of deposits among wealthy clients on the coasts is now seen as a “rating weakness” in the current environment, because it is more susceptible to outflows.
Nearly two-thirds of the bank’s base are commercial clients, with 68 percent of deposits above the $250,000 insurance limit, reported Barron’s.
“This not only drives a high proportion of uninsured deposits as a percentage of total deposits but also results in deposits that can be less sticky in times of crisis or severe stress,” Fitch reported.
Fitch “believes this feature of the business model has resulted in franchise erosion following the high-profile failures of SVB Financial and Signature Bank, despite the deposit base being more diversified from a sector/industry standpoint.”
A credit ratings downgrade can make it more expensive for First Republic to borrow, and both credit ratings agencies said they may downgrade it further.
Community Banks Receive a Government Lifeline
Meanwhile, FRB took steps in the past week to shore up its liquidity after announcing over the weekend new additional financing from the Fed and JPMorgan Chase to buttress its balance sheet.
The financial lifeline has boosted the bank’s cash reserves to a total of $70 billion in unused liquidity, which it could use to respond to potential customer withdrawals. This does not include the additional liquidity that it is eligible to receive under the Fed’s BTFP program.
“First Republic’s capital and liquidity positions are very strong, and its capital remains well above the regulatory threshold for well-capitalized banks,” said Jim Herbert, FRB’s executive chairman, and CEO Mike Roffler on March 12.
However, S&P is still not convinced that these new measures will be enough to keep the bank’s credit rating at investment grade if clients continue to pull out cash.
Herbert told CNBC that the bank was operating normally and was not seeing any massive deposit outflows, but he declined to say specifically how much had been withdrawn so far.
The credit review firm expects that FRB will have to acquire more costly wholesale funding, which could include borrowing from public debt markets.
“If deposit outflows continue, we expect First Republic would need to rely on its more costly wholesale borrowings. This would encumber its balance sheet and hurt its modest profitability,” wrote S&P analysts Nicholas Wetzel and Rian Pressman.
“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,” they concluded.
The S&P analysts said although FRB had a strong history, they warned that continuous interest-rate hikes by the Fed were weakening the lender’s financial flexibility.