KBRA Affirms Ratings for Bridgewater Bancshares, Inc.

KBRA affirms the senior unsecured debt rating of BBB, the subordinated debt rating of BBB-, the preferred shares rating of BB+, and the short-term debt rating of K3 for St. Louis Park, Minnesota-based Bridgewater Bancshares, Inc. (NASDAQ: BWB) (“Bridgewater” or “the company”). KBRA also affirms the deposit and senior unsecured debt ratings of BBB+, the subordinated debt rating BBB, and the short-term deposit and debt ratings of K2 for Bridgewater Bank, the main subsidiary. The Outlook for all long-term ratings has been revised to Negative from Stable.

Key Credit Considerations

The Negative Outlook for BWB's long-term ratings is primarily attribuatble to the company's sustained below-peer capital profile, with the CET1 ratio tracking over 200 bps below the peer average. The strong loan growth in recent years (22% CAGR since 2019), primarily within multifamily, was the main driver of the deterioration from 10.3% at YE20 to 8.7% at end-2Q23. While KBRA positively views management’s intent to rebuild capital ratios given the uncertain operating environment, we believe that the ability to generate internal capital in a timely manner will be difficult given the recent decline in earnings capacity, as well as the projected loan growth, which is certainly a considerable decline from recent year levels, though still meaningful in the mid-single digits range. Additionally, BWB has historically relied on a higher level of noncore funding to support loan growth, with core deposits to total funding averaging 75% from 2018-2022. However, the funding profile has remained under pressure, with the ratio falling to 63% as of 2Q23. Moreover, the company’s ability to enhance the core deposit franchise over the medium term will be challenging given the highly competitive deposit market and loan growth targets. Given this, the cost of deposits have substantially increased to 2.66% at 2Q23 (compared to 1.69% for the median among KBRA's publicly traded banks), which have undoubtedly pressured earnings. While current profitability remains suitable for the rating category, with ROA just under 0.90% for 1H23, NIM compression is expected to persist in 3Q23 and should continue to impact bottom line returns. KBRA favorably views Bridgewater's lengthy track record of pristine asset quality driven by a credit-focused management team with prudent and disciplined underwriting standards as well as broad-based knowledge of local operating markets. Although also supported by a relatively benign credit environment, BWB’s five-year NCO average of 0.01% is well below the majority of its peers, which has continued in 1H23. The company adopted CECL in 1Q23, and despite the negligible historical loan losses, BWB has conservatively built loan loss reserves to 1.4% of loans. While BWB’s investor CRE concentration is elevated compared to peers at 510% of total risk-based capital, we acknowledge that when excluding multifamily, the concentration is comfortably below 300%. We also recognize that the multifamily portfolio represents the largest concentration in the loan portfolio and has historically performed very well with virtually no losses since the company’s inception. Additionally, multifamily properties are generally located in desirable locations throughout the Twin Cities metro area.

Rating Sensitivities

A return to a Stable Outlook could occur from a material improvement in risk-based capital metrics, notably a CET1 ratio tracking between 9%-10% by mid-year 2024, less dependence on noncore funding, while maintaining strong credit quality and sound profitability. Given the Negative Outlook, a downgrade is possible over the medium term, which would transpire from a continued decline in capital causing CET1 to fall further below the rated peer group average, or further pressure on the funding profile, or any unexpected earnings/credit issues.

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