Overview
- We believe the risk of deposit outflows is elevated at First Republic Bank despite the actions of federal banking regulators and the bank actively increasing its borrowing availability to mitigate risk associated with the bank failures over the last week.
- We expect increased wholesale borrowings to further weigh on its net interest margin.
- We lowered our long-term issuer credit rating on First Republic Bank to 'BB+' from 'A-' and placed our ratings on CreditWatch with negative implications.
- The CreditWatch negative reflects the lack of visibility on the level and pace of deposit volatility and the potential for higher usage of more costly wholesale funding.
Rating Action
On March 15, 2023, S&P Global Ratings lowered its long-term issuer credit rating on First Republic Bank to 'BB+' from 'A-'. We also lowered our senior unsecured issue rating to 'BB+' and the subordinated and preferred stock issue ratings to 'BB-', and 'B', respectively. We placed all of our ratings on First Republic on CreditWatch with negative implications.
Rationale
We believe the risk of deposit outflows is elevated at First Republic--despite actions by federal regulators. In the wake of recent bank failures due to 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. The BTFP offers loans of up to one year in length to banks pledging eligible securities. Still, 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.
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. As of Dec. 31, 2022, First Republic had approximately $176.4 billion in total deposits, of which 63% were commercial. We believe 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. According to 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. 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.
First Republic recently reported over $70 billion in contingent borrowing availability to meet liquidity needs. On March 12, 2023, First Republic announced that 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. This does not include capacity through the Federal Reserve's BTFP. We expect the bank to use wholesale funding to alleviate liquidity pressures in the near term, thereby encumbering its balance sheet. Funding metrics could weaken relative to peers, and we expect the ratio of loans to deposits--already high at 95% as of year-end 2022--may rise above 100%.
We expect 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. The bank's reported net interest margin in fourth-quarter 2022 contracted by 26 basis points from the prior quarter to 2.45%. Its fourth-quarter 2022 return on average assets and equity were modest at 0.74% and 10.1%, respectively.
We think 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. The bank's common equity Tier 1 risk-based capital ratio was 9.2% as of Dec. 31, 2022. Its ratio of tangible common equity to tangible assets--another solvency measure--was 6.4% (or 4.2% after factoring in losses on held-to-maturity securities). In February 2023, First Republic added $397 million of common equity, which we expect to bolster capital levels. 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, we think First Republic's business position is weaker following the events of the past week. 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.
CreditWatch
The CreditWatch negative reflects the potential for further funding and liquidity deterioration in the wake of the recent bank failures.
We could lower our ratings on First Republic further, potentially by several notches, if:
- Sustained deposit outflows erode liquidity, perhaps because of further market instability;
- Borrowings encumber its balance sheet;
- The bank is forced to rely heavily on the BTFP or other government funding support;
- Diminished earnings power hurts capital; or
- Other financial or operational issues arise because of elevated market risk.
We could resolve the CreditWatch with no rating changes if:
- Deposit levels stabilize and wholesale funding needs are significantly less than we anticipate.
Ratings Score Snapshot
| To | From | |||||
|---|---|---|---|---|---|---|
| Issuer Credit Rating | BB+/Watch Neg/-- | A-/Watch Neg/-- | ||||
| SACP | bb+ | a- | ||||
| Anchor | bbb+ | bbb+ | ||||
| Business position | Moderate (-1) | Adequate (0) | ||||
| Capital and earnings | Strong (+1) | Strong (+1) | ||||
| Risk position | Adequate (0) | Adequate (0) | ||||
| Funding and liquidity | Weak and Moderate (-3) | Adequate and Adequate (0) | ||||
| Comparable ratings analysis | 0 | 0 | ||||
| Support | 0 | 0 | ||||
| ALAC support | 0 | 0 | ||||
| GRE support | 0 | 0 | ||||
| Group support | 0 | 0 | ||||
| Sovereign support | 0 | 0 | ||||
| Additional factors | 0 | 0 | ||||
| SACP--Stand-alone credit profile. | ||||||
ESG credit indicators: To E-2, S-2, G-3; From E-2, S-2, G-2
We see governance factors as a moderately negative consideration in our analysis of First Republic. The high level of market risk in the wake of recent bank failures over the last week has significantly intensified vulnerabilities within First Republic's operating model. The bank grew loans more rapidly than deposits in 2022, which we believe contributed to funding and liquidity pressure in the current higher market rate environment.
Environmental, social, and governance (ESG) credit factors for this change in credit rating/outlook and/or CreditWatch status:
- Risk management, culture, and oversight
Related Criteria
- General Criteria: Hybrid Capital: Methodology And Assumptions, March 2, 2022
- Criteria | Financial Institutions | Banks: Banking Industry Country Risk Assessment Methodology And Assumptions, Dec. 9, 2021
- Criteria | Financial Institutions | General: Financial Institutions Rating Methodology, Dec. 9, 2021
- General Criteria: Environmental, Social, And Governance Principles In Credit Ratings, Oct. 10, 2021
- General Criteria: Group Rating Methodology, July 1, 2019
- Criteria | Financial Institutions | General: Risk-Adjusted Capital Framework Methodology, July 20, 2017
- General Criteria: Principles Of Credit Ratings, Feb. 16, 2011
Related Research
- First Republic Bank 'A-' Rating Placed On CreditWatch Negative On Funding Profile Risk, March 14, 2023
Ratings List
| Downgraded; CreditWatch Action | ||
|---|---|---|
| To | From | |
|
First Republic Bank |
||
| Issuer Credit Rating | BB+/Watch Neg/-- | A-/Watch Neg/-- |
| Senior Unsecured | BB+/Watch Neg | A-/Watch Neg |
| Subordinated | BB-/Watch Neg | BBB+/Watch Neg |
| Preferred Stock | B/Watch Neg | BBB-/Watch Neg |
Certain terms used in this report, particularly certain adjectives used to express our view on rating relevant factors, have specific meanings ascribed to them in our criteria, and should therefore be read in conjunction with such criteria. Please see Ratings Criteria at www.standardandpoors.com for further information. Complete ratings information is available to subscribers of RatingsDirect at www.capitaliq.com. All ratings affected by this rating action can be found on S&P Global Ratings' public website at www.standardandpoors.com. Use the Ratings search box located in the left column.
| Primary Credit Analyst: | Nicholas J Wetzel, CFA, Englewood + 303-721-4448; nicholas.wetzel@spglobal.com |
| Secondary Contact: | Rian M Pressman, CFA, New York + 1 (212) 438 2574; rian.pressman@spglobal.com |
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