First Republic Bank (FRC) 2002 Q1 法說會逐字稿

Good day and welcome to the First Republic Bank First Quarter 2002 Earnings Results. Today's call is being recorded. At this time, I would like to introduce to you today's speakers, Mr. Jim Herbert, President and Chief Executive Officer; Ms. Katherine August-deWilde, Chief Operating Officer; and Mr. Willis Newton, Chief Financial Officer. Now I would like to turn the call over to Mr. Jim Herbert. Please go ahead, sir.

Thank you very much and good morning. Welcome to our First Quarter 2002 conference call. We appreciate your taking time to join us. A Webcast replay will be available at www.firstrepublic.com for about 90 days; an audio replay is available for a week. Domestic and International participants should dial 719-457-0820 for the replay. The reservation number is 586352.

Today we're going to spend about ten minutes - 10 to 15 minutes describing the quarter, then take questions. On the call with me today are Katherine August-deWilde, our Chief Operating Officer and Willis Newton, our CFO. Each of us will deal with separate areas of the business. We hope you've seen our earnings release that was issued earlier this morning. It's available on the major new services and on our Website.

Before we begin, I'm required to inform you that some of the statements made on this call may be forward-looking which involve inherent risks and uncertainties. A number of important factors could cause actual results to differ materially from those in the forward-looking statements. You should rely on our Forms 10-Q and 10-K and Other Regulatory filings, all of which are available on our Website.

First Republic's business, fundamentals, and results remain strong. We continue to be very committed to managing a safe, solid, and strong institution with controlled growth. Let me make an overriding comment in the sense that the quarter-to-quarter, year-to-year comparisons are quite meaningful in terms of their up percentages.

We would be inclined to guide people to focus on the earnings for the quarter and the prior quarter ranging around 57 cents per share. This feels like a reasonably sustainable level, under current conditions at least.

The Bank continued to make good progress in its most important strategic goals. Our capital ratios are excellent and we're increased a bit by the perpetual non-cumulative preferred stock offering, which we completed during the quarter. The asset quality remains high. Our core deposit growth continues. And importantly, our cost of funds continues to improve.

As noted in our prior calls, we continue to maintain rigorous credit standards, yet we are originating a fairly high level of new loans through our expanded credit approval and marketing groups and the addition of new loan officers.

These origination levels drive the most important driver of our business long-term, particularly in terms of franchise bio and that is the acquisition very steadily of more private banking clients -- day in, day out, quarter in, quarter out. And that's where our expenses and are focus are entirely driven.

Our balance sheet management strategy, which is to manage the growth to a contained level, has resulted in the slower growth, which we actually desire. Loan sales during the first quarter were meaningful; we sold 284 million of individual loans on a flow basis. Also, we funded $90 million which are the held-for-sale category and will be, in due course, sold into the (REMIC) in the next several quarters.

We completed the sale of $50 million of commercial real estate loans and we currently hold $240 million of loans held-for-sale for our next single family running.

As a result of the loan sales and strong repayments of the loans, the Bank's permanent loan portfolio actually has decreased about $100 million in the last year about 3%. When interest rates rise which we expect to occur later in this year, we expect to originate more loans which will stay on our balance sheet at the same time as loan repayments slow down. This will result in a bit more rapid loan growth and is one of the reasons that we decided to tap the capital markets in the first quarter.

Over the past 12 months, our checking account balances have increased about $250 million or 88%. Because we had excess liquidity in the first quarter as a result of deposit growth, the raising of new preferred and loan sales, we have slowed our deposit growth even more in the first quarter of this year by dropping our interest rates and reducing our advertising a bit.

On-going stock repurchases for the quarter totaled 54,000 shares, costing about $1.5 million. And our trust and brokerage activities continue to gain customers and add new assets, helped in part by improving market conditions or certainly going through neutral at least.

Our New York investment advisor subsidiary, Trainer Wortham, had a second consecutive quarter-to-quarter increase in assets under management; modest, but are growing in the right direction. After the markets are improving, we have picked up some new customers.

Trainer Wortham also sponsored a $350 million CBO, which closed in February and - on which they expect to earn a management fee for seven to ten years. Their advisory fees for the second quarter will be based on a somewhat higher asset value base at the end of March.

Starbuck, Tisdale, which is known as an investment advisory firm that we've closed the purchase of on March 15th. The principles are continuing on with the firm and have very strong incentives for future growth. We're delighted to be associated with the firm. It's a terrific firm in Santa Barbara. They manage equity investments and the - they're managing a bit over $900 million at this point.

They will be very good for our wealth management segment and availability in general and also specifically for southern California and our own trading in Santa Barbara. We will be opening Santa Barbara, a full-service bank, in this coming week or two.

Froley, Revy is a convertible manager which we've had a minority position in for a while. We have announced that we expect to purchase the remainder of Froley, Revy and we would hope that that closes in this quarter. The Froley, Revy is a convertible (spacelist). It manages about $2.2-$2.3 billion. We've owned 18% of the firm for a couple of years and we're looking forward very much to continuing what has already been quite a successful relationship.

We did sell 42 million of non-cumulative (RAIG) preferred as I mentioned previously. This is Tier I and Tier II qualified capital. It was a retail transaction managed by Wells Fargo Securities. It did a very good job and (Ryan Vack) was also assisting on the deal and as was (Keith Rod-Woods).

And we - this is - the proceeds from this offering are a modest drag on earnings right now. The cost of the funds was 8.875% deductible because of RE - REIT status. And so we're reinvesting those funds. That's trading on NASDAQ as FRCCP (as in computer).

Our strong client acquisition and deposit growth focus continue to be a source of meaningful transformation for our balance sheet and income statement. We're dedicated to creating significant customer base franchise value for the bank. One of the biggest opportunities in this area is our growing entrée in the New York City market, which is proving to be quite successful. And we will be opening a second location in New York City sometime in the fall of this year.

Now let me ask Katherine August-deWilde to further discuss our asset quality, deposit growth, and some of the business trends. Katherine?

Thank you, Jim. This quarter we reported non-performing assets of only four basis on total assets making this the ninth quarter-end that non-performing assets have been below ten basis points. As we've said before, this is an extraordinarily low level of non-performing assets and future quarters' delinquencies are likely to be higher.

This quarter we had a net recovery of almost $200,000 for the quarter. We have no real estate-owned REO. We had at the end of the quarter three non-accrual loans. At March 31st, 2000, we also had one 90 plus day past-due single family home loans which was very well secured and has been brought current in early April.

We continue to actively resolve any collection issues. We're very proactive in the evaluation of our loan profiles - portfolios and will continue to be diligent. Due to the uncertainty of the economy, we have added $750,000 to our loan loss provision in the first quarter of 2002. While we believe we are well reserved, we think it's prudent to continue to strengthen our reserves.

We continue to do business with very credit-worthy clients. Our loan originations were very strong in the first quarter. Usually the first quarter is the lowest quarter of the year. At $596 million for the first quarter of 2002, our loan volume exceeded all quarters except for several quarters in 2001 where we had an extraordinary level of rate and return lease finances because of the very low interest rates.

Our refinance business has declined from about 80% of our originations in the fourth quarter to 70% of our originations in the fourth - in the first quarter. Loan to the refinances are rate in term, which improved client cash flow.

Home purchase activities were quite strong in our market. Thirty percent of our originations were in-home purchases. Home prices remain at below their mid-2000 peak, which has allowed buyers who are comfortable with their economic situation make attractive purchase deals. This is true in all of our markets in New York, southern California, and the Bay area.

Our high origination volume has not occurred at the expense of underwriting standards or credit quality. As always, we continue to be an A-quality lender.

We're quite pleased with the overall development of our deposit franchise. Florida deposits are now 67% of total deposits. Checking account balances continue to build and at the end of the quarter, were $536 million. That's 88% higher than a year ago. Checking account deposits are now over 16% of total deposits. We're very pleased with that growth.

Banks deposit growth is a result of both adding new relationship managers and acquiring new clients and successfully cross-selling additional products and services to current clients. So far in 2002, new loan clients have purchased an average 5.7 bank products which compares favorably to where we were over the last two years.

Our products per client continue to build throughout the year. A client may come to us for one or two products and over time, as they get to know us better and we understand their needs, we sell more products as the year goes on.

On average, each new loan client for 2002 has 1.2 checking accounts with us or that's five checking - four checking - sorry, five checking accounts for every four clients and most have a money market account.

We've had increasingly successful cross-selling to loan clients, wealth management services, including investment advisory, brokerage, and trust. Our success in acquiring new clients is based on providing the full range of services and products that our clients want; complete with a very high level of personalized service.

We continue to interview and hire truly outstanding bankers at all of our markets. This has been a rare opportunity to find excellent bankers who are skilled at delivering products and dedicated to our brand of very high quality personal service.

Clients continue to move their investments and their banking to First Republic both due to the high level of the client service compared with some of the larger institutions and keep up the strong relationships they build with our bankers at First Republic.

We are meeting our wealth management objectives, the private banking objectives, which are to reduce our cost of funds and to increase our non-interest income.

Start in early 2000, just over two years ago, First Republic Trust Company has grown trust and custody assets with just under $900 million at the end of March, up 45% from a year ago. New business continues to come from our cross-sell efforts and from client referrals. First Republic Trust Company operates offices in California, Nevada, and New York.

Our Investment Division, which includes an NAFC broker dealer, also continues to grow. The Division has total assets of $482 million at the end of the quarter, an increase of 93% over last year.

We showed in the press release client assets and our investment advisory firms, Trainer Wortham, Starbuck, Tisdale, First Republic Trust, and our Investment Division were $6.3 billion at the end of March 2002, compared with $4.4 billion just a year earlier. Terms of values (are) (seen) income has risen to 21% of net revenue. This percentage should continue to rise as we complete the acquisition of Froley, Revy and own Starbuck, Tisdale for a full quarter.

I'd like to introduce Willis Newton who will talk about the financial results for the quarter.

Katherine, thank you. First, on capital, with the Series B preferred stock issue, we have increased our already strong capital ratios. At March 31, 2002, our leverage ratio was 6.4% and our total risk-based capital ratio was 14.3%. The dividends paid on this new issue will be tax deductible. We are well capitalized as apparent for future growth opportunities.

Our net interest margin has increased due to our increased amount of core deposits and our lower cost of deposits. We do not take more risk in our assets to increase our margin.

For the first quarter of 2002, our net interest spread was 3.30%, up six basis points from the prior quarter and up 19 basis points from the first quarter of last year.

Our net interest income for the quarter was 1% higher, compared to the prior quarter. These lead core increases are a result of active reductions in the deposit rates paid to customers as well as the change in our deposit mix. The average rates paid to our deposit customers declined more than the average loan yield, which varies with market rates.

While we have benefited from some of our real estate loans, which began to hit floors in the last half of 2001, we have also experienced an increase in cash on a short-term basis from loan sales and deposit flows. As these funds are invested in short-term rates, it puts downward pressure on margin.

Mortgage servicing rights - mostly good news here. During the first quarter, prepayments on loan service decreased to 33% from their peak of over 40% in the prior quarter. This drop is due to the slight increase in mortgage rates and the burnout effect of having mortgage rates so low for nearly a year. On our balance sheet, our mortgage servicing rates are now an aggregate of $14.5 million for about 60 basis points on the average on servicing portfolio.

Another way of looking at this as mortgage servicing rates - rights average about two times the annual service fee on the loans in a service portfolio. Going forward, we would expect a gradual decline in the rate of prepayments from the current level for the rest of the year 2002.

Goodwill. Approximately $25 million of the Bank's goodwill relates to its acquisition in 1999 of Trainer Wortham. We have been advertising this goodwill at about $1.2 million a year for a reduction in our diluted EPS of about 9% per share for the last two years or two cents per quarter.

Under the new accounting rules for 2002 called, Statement of Financial Accounting Standards No. 142, our type of goodwill no longer requires amortization. In connection with the adoption of this new pronouncement, we did not have to take an impairment charge on the goodwill that we have on our books. And in connection with the purchase of Starbuck, Tisdale in March, we added $14 million to our goodwill.

Jim, would you like to take - have a few closing comments?

Well, let me just say that I think 2002 is a year of execution and enhancement of what we've been doing and the first quarter is somewhat reflective of that.

The one thing that's bothering us the most is our - keeping our costs under control, matched up to our growth rates and our improvements and that, quite frankly, is quite a challenge, as people can see our efficiency ratio slipped slightly further yet to 71%. That's a little bit of a surprise to us. The earnings overcame it but it's not where we want to be and we're working hard on that.

But it's a balancing act and the opportunities presented us by hiring new relationship managers and expanding our business are so considerable that we're working very hard to just keeping them all balanced; so far I think successfully, but it's a challenge.

I think with that, operator, why don't we open it up for questions.

Thank you. The question and answer session will be conducted electronically. If you would like to ask a question, please press the star key followed by the digit one on your telephone. We will proceed in the order that you signal us and we'll take as many questions as time permits. Once again, please press star one to ask a question. And we'll pause for just a moment.

Our first question comes from Charles Gunther of Wells Fargo Securities.

Yeah. A simple question that I noticed quite a difference in the tax rate between this quarter and the year ago and I suppose the year ago rate was unusually high. But could you fill me in on that please?

Yes. Hi, Chuck. The lower tax rate in the first quarter resulted from some overall tax planning that we've done. And it - one thing on a historical basis, our effective tax rate has been inflated by 1% to 1.5% due to the non-deductible rate nature of goodwill. Goodwill was something that wasn't expensed and was not tax deductible. Going forward for the rest of 2002, we would expect our tax rate to range between 36% and 38%.

Okay. Thank you very much.

Once again, if you would like to ask a question, please press star one now. Our next question comes from (Nancy Bush) of (Brian Beck) & Company.

(Nancy), thank you for that question. We are still originating more loans in northern California followed by originations in southern California and then New York. New York is where we are growing the number of relationship managers the most and over time, we would see the balance shift so that they'd come more into line. But that will take us a while as we get people in place. The goal is to be more even.

Are there any significant differences, Katherine, in, you know, the characteristics if a mortgage loan originated into various regions or do they tend to be pretty much the same as to, you know, size and term, etc.?

Well, there are a couple of differences. The obvious one is in Manhattan; there are more - considerably not a co-op.

Right.

You know, a little bit of that lending in San Francisco but, you know, a good percentage of our loans in Manhattan are co-ops and that's not standard in other places. Also, it's a little more expensive for clients to do a mortgage loan because of all the costs involved that we do not have for that in-client in California through lawyers and title company expense. So there's not so much rush to refinance as quickly.

In northern California, at the very high end of the market, at least half of the homes tend to be sold for call cash. I think in LA and New York, it's slightly less than that but that tends to be typical in all of our markets.

But Katherine, our LTVs and loan sizes are about the same really, aren't they?

They're about the same. And our percentages of purchases versus refinances are about the same. It is a very similar client base in terms of both liquidity and what they're doing with their homes.

Right. And...

Let me see if I can add, one of the key aspects is very viable. There's a diversification value obviously to our balance sheet. But what's quite importantly and not quite as obvious is there's a very considerable value to the diversification in terms of getting (REMIC's) done...

Okay.

...because we can - with this origination - and remember that the New York origination actually tends to be New York plus some New England business. And so it's very - it's - so it's diversified nicely. And when you go into our (REMICs) with that kind of diversification, it's really quite helpful.

May I also ask looking out of the New York City office opening in the fall, are we going to get sort of a notable bulge in expenses as a result of this? Or are there accruals on-going now so that we won't see, you know, such a, you know, such an expansion of expenses at one time?

Well, as a practical matter, I mean I was literally thinking about that this morning. As a practical matter, you're going to get a pick-up in expenses. They're mostly relating to space because the advertising level will be about the same and people will be added as we add them. And the day we move in, so to speak, we will add people that day, do you know what I mean?

Uh-huh.

But we will add space. So there are two steps also. We're going to be opening a branch at 48th and 6th about September. And we're going to be opening the office space above it about December - late December. So we'll probably impact the - it slides in a little bit. There's a little spreading. Trainer is going to be moving also from their current office space over to our new office space so there's some consolidation value there.

Do you think, Jim, that you'll be able to make any considerable headway in this 71% overhead ratio? Or where should we think about it, you know, as we go further in the year here?

You know, I wish I could be more optimistic than I'm inclined to be and the reason is - I mean this sounds shall I say less controlled than it actually is. But the truth is we're faced with such surprisingly good opportunities. And the opportunity manifests itself almost entirely in the acquisition of good people and to a lesser extent, in the opening of filling in branches that we're doing.

So we don't - I wish I could give you intelligent guidance. I would be inclined to guide you but it's soft guidance in the 67% to 72% range. But I just don't think we're going to pull this back into the mid-60s for a while. And the reason - you put your finger on the reason; it's the New York issue. Whether it can go up higher than that, I don't know.

During - please remember that investment management companies and trust companies operate - and Froley, Revy for instance, is going to be acquired here shortly and Starbuck, Tisdale, they tend to operate with a different efficiency ratio than the Bank does.

Right.

And so actually, as we shift throughout management, the efficiency ratio - if you look at trust banks, the efficiency ratios tend to hang in the mid-60s, more or less. They do not operate in the low - in the 50s. And that's a function of the wealth management cost of delivery structure a little bit.

(Nancy), the other thing we're doing in terms of people in New York is we've taken a bit of space in our current location to begin hiring the people who will be in the 48th and 6th Avenue space. So there will not be a people bulk-up but we are building those people as we find them now.

Right. Thanks very much.

And as a final reminder, if you would like to ask a question, please press star one. We have a follow-up from Charles Gunther of Wells Fargo Securities.

Jim, bringing back to almost the first thing you said, as I understood it, one can expect earnings in the 50-cent range for the next three quarters. Is that what you were trying to say or were saying?

I wasn't being that specific, (Charles), and I'm not trying to hedge. I'm just saying that I didn't want people to start to look at 39% increases; do you know what I mean? I really wanted to - I don't want - that's what was making me nervous...

I see.

...is about our own release, quite frankly. We had - the comparison of the early quarters of last year to this year, we're meaningfully a different bank.

Yeah.

And so - but - and we're also, pursuant to the discussion we just had with Nancy, we're at a level now of expense and operating costs and challenges such that a breakout on the order of this kind of a move one quarter to the next is simply not in the offering.

Okay. Well...

And we're - and we feel reasonably comfortable where we're operating.

So then again, Jim...

I'd say on the other hand, we feel reasonably comfortable where we're operating now. That's what I was trying to say around the 57 number.

When you get this - whether you've just raised of the work, that will make quite a different, won't it?

It will help a lot honestly. And also climbing over the initial quarter or two of acquisitions of Starbuck and of Froley will help. And in the upward move in assets under management is - has considerable leverage in it...

Right.

...as well.

Well, (separate) Froley moves don't cost much except legal expense, do they?

You mean to get them done?

Yeah.

Well, there's always some integration costs and there's some early stage plus you don't see full effect of course for a quarter or two.

Right.

And it's really more of the latter I was referring to. You'll see all of these acquisitions full bore in the - let's see, the third quarter.

All right. Thank you.

Thank you very much.

Our next question comes from Theleil Metta of (Second Kurt Capital).

You made two statements about slowing down deposit growth. And I'm curious what exactly you meant by that, if you can just give me some color on what that implies to the next couple of quarters?

Sure, Theleil. It's nice to hear from you.

It's nice to hear from you as well.

The - well, basically we had as you know at Gangbusters last year, I mean beyond our projections to put it mildly. And between that and the new capital we've raised, we find ourselves with that excess liquidity. And the reason it's excess is that we have a Federal home loan bank borrowing still outstanding but they have prepayment penalty zone and that are prohibitive. So we can't (rights) the payoff of them.

And so we are - we're - instead of growing the deposits quite as rapidly as we probably could be, what we're doing is in fact trying to push down our costs of funds a little bit and shift the mix even more away from CDs. And I think that that effort is - it's kind of a - we think of it as a little bit of a back and pruning kind of effort.

Okay.

It's not a long-term thing at all. It's a little bit of a reaction. We're doing it very, very carefully because the last thing we need to do is disenchant any of our new clients but on the other hand, we have - once again, we're going to go through our CDs and find out who's not in the, you know, sort of CD debt - bank CD market.

Right.

And so it's just - and I just wanted to point it out. Also, honestly, as the market gets better, I think you're going to find that many banks are not growing their deposits quite as rapidly as they did last year. That was a major shift to bank deposits.

Have you been pushing some of the deposits that you have been getting as part of new relationships into the money market?

We go actually - we go wherever the client wants to go.

Right.

We don't try to judge for them, we just listen and try to guide them as best we can. But we're finding that the mix is about the same as it has been. There's not a big change going on. It's a matter of how much we advertise for any rate-sensitive product at all and we basically have stopped that advertising.

Okay. If the environment stays reasonably close to where we are today, meaning prepayment (fees) continue to improve, the percentage of purchase activity continues to rise, and the percentage of arm production continues to rise, how long do you think it will take you to sop up some of the excess liquidity that you've got on your balance sheet?

It's a good quarter.

Okay. You can do it that quickly.

Yeah. It's not a long-term deal.

Okay.

A quarter, maybe two at the most. The bigger challenge is to get the new preferred leverage maybe one to one. That's about where it breaks even.

Okay.

You got it out once and then you've got a leverage once and you're about there, maybe one and a half to one.

Okay. Great. Thank you very much.

Okay.

I think it's fair to say that we have not discontinued our effort to raise checking accounts.

Oh yeah.

You know, those are, you know, that has been a continuation of that every day, every branch, every relationship manager has continued to work on that.

Oh yeah.

And it appears there are no further questions at this time. I'll turn the conference back over to you, Mr. Herbert.

Okay. Well, thank you. Thank you, everybody, very much for taking time to be on the conference call today. We appreciate it. Thank you.

That concludes today's conference. We thank you for your participation.

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