Fitch Ratings has downgraded First Republic Bank's (FRC) Long-Term Issuer Default Rating (IDR) to 'B' from 'BB'. The Rating Watch Negative is maintained on FRC's ratings. The Viability Rating (VR) was downgraded to 'b' from 'bb'. This follows Fitch's recent action "Fitch Downgrades First Republic to 'BB'; Places Ratings on Negative Watch" published on fitchratings.com on March 14.

Key Rating Drivers

The downgrade reflects the current financial profile and challenges FRC faces from both a funding and earnings perspective. The bank's funding mix has materially altered over the last two weeks as withdrawn deposits have been replaced with costly wholesale borrowings, primarily from the Fed Discount Window. On March 16 the bank announced that it had received $30 billion in deposits from a consortium of 11 of the largest U.S. banks. Those deposits carry an initial term of 120 days at market rates. While this injection created necessary headroom from a liquidity perspective, the bank's new funding profile is relatively costly and is viewed as the primary ratings constraint.

Fitch estimates that, due to the higher cost of funds, FRC is currently operating at a net loss that is not sustainable over the longer term absent a balance sheet restructuring. Furthermore, to the extent that FRC is required to repay the $30 billion at the end of its term, it will have to raise liquidity by selling assets. This is complicated by the fact that, similar to other U.S. banks, the fair market value of securities and loans are below their book value and a sale of assets would likely require a significant recapitalization. FRC's balance sheet is concentrated in relatively long duration municipal securities as well as residential mortgage loans. As of 4Q22, FRC's securities and loans carried unrealized losses totaling 16.3% and 13.3%, respectively, relative to amortized cost.

FRC successfully completed a common equity raise in 1Q23, before the funding and liquidity pressures mounted. This resulted in a pro-forma CET 1 ratio of 9.43% using 4Q22 risk-weighted assets. This capital position provides the bank with some buffer to withstand losses over the near-to-medium term absent any significant losses from asset liquidations.

Since the rating action last week, Fitch believes FRC's liquidity position has improved. Specifically, deposit flows have shown improvement for FRC in recent days and following receipt of the deposit package, the bank currently has adequate liquidity to provide good coverage of remaining uninsured deposits (not counting the recent $30 billion package).

From a credit risk standpoint, Fitch still views FRC's asset quality as pristine. The majority of FRC's loans are super-prime residential mortgages that have to-date benefitted from FRC's conservative underwriting standards that have driven some of the lowest credit loss track records in the industry.

The Viability Rating has been assigned below the implied Viability Rating of 'bb-' due to the following adjustment reason:

Funding and liquidity are viewed as the 'Weakest link', reflecting FRC's structurally weaker funding profile and heavy reliance on wholesale funding following recent deposit attrition.

Rating Sensitivities

Factors that could, individually or collectively, lead to negative rating action/downgrade:

The Rating Watch Negative indicates that there is a heightened probability of further ratings downgrades for FRC.

Fitch will use the Watch period to gather further information on FRC's deposit flows, funding plans and the resulting impact on the Outlook for earnings and capital. Further downgrades are possible to the extent that FRC's capital position is eroded such that the CET 1 ratio falls below 7%. FRC's ratings will also be downgraded if it experiences further meaningful funding pressures in the form of deposit outflows.

Factors that could, individually or collectively, lead to positive rating action/upgrade:

Fitch could remove FRC's ratings from Rating Watch Negative if it believes the earnings, funding and liquidity profiles are supportive of the current rating.

Over the longer term, Fitch could upgrade the ratings if FRC manages to reorganize its balance sheet by paying down wholesale funding to more manageable levels such that the outlook for earnings and capital supports a higher rating.

Other Debt and Issuer Ratings: Key Rating Drivers

FRC's 'B' Short-Term IDR is in line with the 'B' Long-term IDR under the mapping in the Rating Correspondence Table within Fitch's criteria.

FRC's Long-Term deposits of 'BB' are rated three notches higher than its Long-Term IDR and senior unsecured debt of 'B', which is a departure from our baseline notching of one given the low level of the IDR. U.S. uninsured deposits benefit from depositor preference in the event of resolution, providing superior recovery prospects. Fitch also believes the recovery prospects for uninsured deposits have improved following recent failures of other U.S. banks that have been designated as systemic risks.

FRC's short-term deposits are rated 'B' in accordance with the Rating Correspondence Table in Fitch's criteria and based on FRC's Long-Term Deposit Rating.

FRC's senior unsecured debt rating is equalized with its Long-Term IDR in accordance with Fitch's criteria.

The subordinated debt rating of 'CCC+' is notched two levels below the VR of 'b' for loss severity. These ratings are in accordance with Fitch's criteria and assessment of the instruments' non-performance and loss severity risk profiles.

FRC's 'CCC' preferred stock rating is notched three levels below its 'b' VR, two times for loss severity and once for non-performance.

FRC has a Government Support Rating (GSR) of 'ns'. In Fitch's view, the probability of government support is very low. Accordingly, the IDRs do not incorporate any support.

Other Debt and Issuer Ratings: Rating Sensitivities

All debt level ratings have also been placed on Negative Watch.

FRC's Long and Short-Term deposit ratings are sensitive to changes in FRC's Long-Term IDR.

The senior unsecured debt rating is sensitive to changes in FRC's Long-Term IDR.

FRC's subordinated debt and preferred stock ratings are sensitive to changes in FRC's VR.

FRC's GSR is 'ns' and there is limited likelihood that these ratings will change over the foreseeable future.

VR Adjustments

The Business Profile has been assigned below the implied score due to the following reason:

Historical and Future Developments

The Asset Quality score has been assigned below the implied score due to the following reason:

Concentrations

The Earnings and Profitability score has been assigned below the implied score due to the following reason(s):

Historical and Future Developments

The Capitalization & Leverage score has been assigned below the implied score due to the following reason:

Historical and Future Developments

Funding & Liquidity score has been assigned below the implied score due to the following reason:

Non-Deposit Funding

Best/Worst Case Rating Scenario

International scale credit ratings of Financial Institutions and Covered Bond issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. 

ESG Considerations

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity.