First Republic Bank Absorbs Debt Downgrades Amidst Deposit Flight

First Republic Bank is facing new challenges as it absorbs debt rating downgrades from three major bond research firms related to deposit flights that are likely to hurt its profitability. On Wednesday, S&P Global Ratings downgraded its issuer credit rating for the bank by four notches to BB-plus from A-minus, placing it in speculative grade or “junk” status. The move came just hours after S&P put the bank on review for a downgrade late Tuesday. Following the announcement, the bank’s stock fell 18% to $32.38, bringing it close to the 11-year low of $31.21 hit during the big bank selloff on Monday.

Elevated Risk of Deposit Outflows Affecting First Republic Bank

S&P stated that it believes the risk of deposit outflows is elevated at First Republic Bank despite the actions of federal banking regulators and the bank actively increasing borrowing availability to mitigate risk associated with the bank failures over the last week. The Federal Reserve’s liquidity measures announced on Sunday, including the creation of the Bank Term Funding Program and an easing of terms offered through the discount window, offer some relief. Still, if deposit outflows continue, the bank would need to rely on its more costly wholesale borrowings, encumbering its balance sheet and hurting its modest profitability.

Deposit Base Concentration Poses Heightened Funding Risks

First Republic’s deposit base is more concentrated than most large US regional banks, which the agency says presents heightened funding risks in the current environment. As of December 31, 2021, the bank had approximately $176.4 billion in deposits, 63% of which were commercial. S&P expects that the portion of deposits above the Federal Deposit Insurance Corp. insurance limit of $250,000 is most susceptible to withdrawal, despite the bank’s historically excellent depositor loyalty. According to the bank’s data, its number of deposit accounts is around 20% of the average US bank with $100 billion to $250 billion in assets, highlighting its higher-than-average account sizes.

Challenges in Addressing Near-Term Liquidity Pressures

Although First Republic Bank has more than $70 billion in contingent borrowing availability to meet liquidity needs (consisting of borrowing capacity from the Fed and financing from JP Morgan), S&P expects it will need to use wholesale funding to address near-term liquidity pressures. This will encumber its balance sheet, weakening funding metrics relative to peers. The ratio of loans to deposits, which was already high at 95% as of year-end 2022, may rise above 100%. Moreover, earnings pressure will likely intensify as reliance on wholesale borrowings costs more than deposits.

Business Position Weaker Following Recent Events

As a result of the volatile swings in its stock price and heightened media attention surrounding deposit volatility, S&P believes the bank’s business position will suffer. Market perceptions of its creditworthiness have declined, and its business stability has weakened as a result.

Conclusion

First Republic Bank is facing significant challenges amidst debt rating downgrades and deposit flight concerns. The bank’s profitability and funding metrics are at risk, and a four-notch downgrade only adds to the difficulties. While the Federal Reserve’s liquidity measures offer some support, the bank is still exposed to potential problems, and its business position has weakened following recent events. It remains to be seen how the bank will address these challenges in the coming weeks and months.