KBRA Downgrades Ratings for Bankwell Financial Group, Inc.; Outlook Stable

KBRA downgrades the ratings for Bankwell Financial Group, Inc. (NASDAQ: BWFG) ("Bankwell" or "the company"), including the senior unsecured debt rating to BBB- from BBB and the subordinated debt rating to BB+ from BBB-, while affirming the short-term debt rating of K3. KBRA also downgrades the ratings for the company’s subsidiary, Bankwell Bank ("the bank"), including the deposit and senior unsecured debt ratings to BBB from BBB+, the subordinated debt rating to BBB- from BBB, and the short-term deposit and debt ratings to K3 from K2. The Outlook for all long-term ratings is Stable.

Key Credit Considerations

The downgrade of Bankwell’s ratings was driven by its diminished core capital profile – including a nearly 170 bp decline in the CET1 ratio (to 8.2%) from 2Q22 to 1Q23. The bank’s significant 1Q23 LTM loan growth of 39%, primarily via its healthcare / senior housing lending vertical, is the primary driver of the regulatory capital depletion. Coinciding with this capital depletion was a further weakening of the company’s funding base, which weighed heavily on brokered deposits to fund the balance sheet growth (~67% core deposits / total funding at 2Q23). KBRA views the company’s ability to “backfill” the liability side of the balance sheet with low-cost core deposits to be limited over the intermediate term due to a loan-to-deposit ratio that has tracked just below 100% in recent quarters in combination with the strong deposit market competition in the greater-NYC area.

While the company’s well above-peer loan growth strategy served to add high-yielding assets to the balance sheet and boost recent period ROA and NIM, the margin has been pressured in 1H23 (3.07% in 2Q23, down >60 bps from 4Q22) due to the combination of the company’s liability-sensitive balance sheet, the Fed’s contractionary monetary policy initiatives, and a deposit market that has become increasingly more competitive, even more so following the bank failures in March. With NIM expected to contract further over the near term, along with a revenue profile that remains largely spread-reliant (with noninterest income generally comprising <10% of total revenue), profitability measures are likely to decline prospectively from previously strong levels. Positively, counterbalancing margin headwinds is the company’s well-contained noninterest expense base, which is supported by the company’s branch-lite strategy.

Bankwell’s loan portfolio has yet to show meaningful signs of credit deterioration, as the bank’s problem asset levels remain modest and primarily idiosyncratic in nature. Conservative underwriting standards have supported minimal loss content over time, evidenced by an average annual NCO ratio of <10 bps since 2014.

The company’s double leverage at 2Q23 of approximately 125% is among the highest in KBRA’s rated universe, which reduces the company’s capital optionality going forward.

Rating Sensitivities

A rating upgrade is unlikely over the intermediate term. Rebuilding core capital measures closer to peer averages for the next rating category higher, along with an improved funding profile, are necessary factors for positive rating momentum to occur. Maintaining solid profitability and credit metrics over time would also be viewed favorably. Continued aggressive financial management, along with significant credit deterioration, or a meaningful reduction in profitability, could pressure the ratings.

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