First Republic Bank debt downgraded to ‘junk’ status by S&P Global Ratings

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First Republic Bank absorbed debt rating downgrades from two bond rating firms Wednesday, as concerns mounted it will suffer further deposit flight that will hurt its already modest profitability.

S&P Global Ratings downgraded its issuer credit rating on First Republic Bank by four notches to BB-plus from A-minus, placing it in speculative grade, or ‘junk,’ status, in a move that came just hours after it put the bank’s debt on review.

Fitch Ratings cut the bank’s long-term issuer default rating to ‘BB’ from ‘A-minus, while Moody’s on Monday placed the company on review for a potential downgrade.

First Republic FRC, -21.37% stock fell 21.4% to end trading at $31.16, a new 11-year low. The stock price dropped below the $31.21 hit during the big bank selloff on Monday. The bank did not respond to a request for a comment on the ratings actions.

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“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,” S&P said in a statement.

Banking analyst Richard Bove of Odeon Capital said the First Republic downgrades are “pretty shocking” to the company because they’ll raise borrowing costs and raise questions about the health of the business.

But Bove said the company’s line of credit with JPMorgan Chase & Co. JPM, -4.72% and a watchful eye from federal banking regulators will keep the bank healthy.

“Is the company in deep trouble? No,” Bove said. “I don’t think the U.S. government will let it go.”

However, the bank does have some weaknesses such as a large number of investments in mortgage-backed securities with a fixed yield, while its cost of holding deposits is increasing, he said.

The Federal Reserve’s liquidity measures announced Sunday, including the creation of the Bank Term Funding Program and an easing of terms offered through the discount window, are a positive, said S&P. The program offers loans of up to one year to banks that pledge eligible securities.

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“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,” said S&P.

First Republic’s deposit base is more concentrated than most large U.S. regional banks, said the agency, and that presents heightened funding risks in the current environment. As of Dec. 31, the bank had about $176.4 billion in deposits, 63% of which were commercial.

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“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,” said the agency. “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.”

First Republic said over the weekend it has more than $70 billion in contingent borrowing availability to meet liquidity needs, consisting of borrowing capacity from the Fed, and the financing from JP Morgan. But S&P expects it will use wholesale funding to address near-term liquidity pressures, encumbering its balance sheet.

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“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%,” said the S&P statement.

And that’s not all. Earnings pressure will likely intensify, as reliance on wholesale borrowings are more expensive than deposits. The bank makes more of its profit from net interest income than fee income and its net interest margin already shrank in the fourth quarter by 26 basis points from the prior quarter. Fourth-quarter return on average assets was just 0.74% and return on equity was just 10.1%.

“Lastly, we think First Republic’s business position is weaker following the events of the past week,” said the S&P statement. ‘”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.”

Typically a downgrade of one notch equates to roughly 25 basis points of additional borrowing costs for a company.

However, a four-notch downgrade signals greater potential problems for a company and could result in more stringent loan requirements such as giving up equity in the business to a lender, according to one debt analyst who asked to be unnamed.

In a research note published Monday, Bove said Canada’s RBC may re-approach First Republic about a merger deal. In the past, RBC has been rejected by First Republic.

“RBC will pursue its desire to buy First Republic, once again,” Bove said in the research note. “It is not unrealistic to assume that First Republic may now listen. “

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This article was originally published by Marketwatch.com. Read the original article here.

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