First Republic Bank (FRC) 2003 Q3 法說會逐字稿

Good day and welcome to the First Republic Bank third-quarter 2003 earnings results conference call. As a reminder, today's call is being recorded. At this time, I would like to turn the conference over to Miss Diane Kenneteker (ph), Chief Marketing Officer. Please go ahead.

Welcome to the first Republic's Bank third quarter earnings conference call. Speaking today will be President and CEO Jim Herbert, Chief Operating Officer Katherine August-deWilde and Chief Financial Officer, Willis Newton. A webcast replay of this call will be available at www.FirstRepublic.com for 30 days. An audio replay is available for two weeks. Domestic and international participants can dial 719-457-0820. The reservation number is 600322.

Before we begin, I am required to inform you some of the statements made on this call should be forward-looking which involve risks and uncertainty. A number of important factors could cause actual results to differ materially from those in the forward-looking statements. You should rely only on our forms 10-Q, 10-K, and other regulatory filings. And now I would like to introduce Mr. Jim Herbert.

I would like to do a quick overview of the bank's third-quarter results. And I will focus on primarily our continued progress under our strategic business plans. The third-quarter was a good one for First Republic including all of our wealth management units. We are pleased with the results and we're also pleased that the Board of Directors has announced a cash dividend of 12 1/2 cents per outstanding share to be paid on Nov. 25th.

As outlined in our news release today that income for the third-quarter was 7.9 million, which is a 26 percent increase compared to the third-quarter of '02. Total diluted EPS was 51 cents from third-quarter of '03 compared to 40 cents for the same quarter last year.

For the first nine months of '03, net income was 30.4 million or $1.99 which was up 57 percent from the same period of time last year. The nine-month income for '03 includes higher than normal gains on the sale of loans which we will discuss more in a moment as well as a onetime gain in the first quarter on branch deposit sales.

Loan gains did help our results considerably and it's also clear that -- however -- it is also clear that our underlying wealth management franchise is kicking into a higher gear. The franchise that we have been building to offer the highest quality private banking and wealth management services is really beginning to work out for several years of investment spending on products, branches, and new people.

To this point, deposit growth was stronger than expected and is now ahead of our plan. Over the past year total deposits grew 28 percent and checking account balances increased 41 percent. Froley Reedy (ph) - our convertible securities investment adviser - brought in additional assets through its relation [indiscernible] evening investments both in the quarter and in the nine-months. Importantly our business bankers are succeeding in following our private client bank clients to their businesses and banking those businesses.

In fact, business bank checking balances have out paced personal checking deposits. Marginally, because we have a tremendous combination of competitive products and very high-quality services. Deposit growth was truly one of the highlights of the quarter. Another highlight for the quarter was our record loan volume, due to the recent wave of refinancings bank originated more than 1.1 billion in loans during the third-quarter. Asset quality remains strong and we will speak more to that in a moment.

We took advantage of the demand for our high quality assets and favorable conditions in the secondary markets and achieved good execution on several small loan sales during the quarter.

These sales resulted in about a $4 million gain, lower than the prior quarter but still quite strong historically.

Finally, First Republic Trust which was started only 3 and 1/2 years ago broke even in this quarter for the first time and has joined in our brokerage operations as a possible entity. The profitability of these of our investment groups and the strong deposits growth indicate that the franchise is beginning to reach critical mass in all of the areas of our business. We now have the proper balance of products, branches, and relationship managers.

Going forward, we anticipate net investments and new personnel offices and products will proceed at a somewhat more normalized paced.

Assets managed by all three of our advisors and our trusted investment division (indiscernible) 10.3 billion - a 36 percent increase from a year ago.

Looking ahead, we believe the economy is gaining strength and that interest rates may continue to rise. The recent rise in rates has begun to reduce refinance volume a bit and will lower loan production, the volume of loans sold and the amount of related gains in future quarters.

However, a further increase in rates should eventually lead to higher margins. And increased earnings on our lower-cost checking account deposits. Also, an improved economy should result in continued growth in our wealth management assets. These results and our positive outlook would not be possible without the ongoing development of products building the branches and hiring of the personnel which we have been pursuing for quite a while.

The cost of these initiatives are still being absorbed and, indeed, will continue to be absorbed for several more quarters.

In summary, we believe we're well positioned to take advantage of the merging economic recovery. We stay very focused in managing our business according to plan and we are pleased with the strategic investment made over the past couple of years are beginning to be quite productive. We are confident in our gross strategy and business model and we like the results.

We believe there is considerable value in consistency which the bank has shown over the last few years.

Now I'd like to turn it over to Katherine August-deWilde, our Chief Operating Officer, to speak more specifically about our operations.

Thank you, Jim. Our continuing strategic objective is to be the premier private bank in our market. This is a long-term commitment which we are executing one client, one branch, one relationship manager and one product at a time. We're making excellent progress towards that objective. We continue to emphasize growth in our checking account balances which are a key driver of future profitability and a good measure of our relationship based deposit franchise.

We're very pleased with increases in both business and personal checking deposits. At the end of September '03, checking balances were $976 million a 41 percent growth rate in a year. They now represent 23 percent of total deposits.

These represent 21 percent of total deposits - down from 31 percent a year ago. Favorable trends in our deposit mix continue as a result of a focus cross selling effort and an increasing number of highly skilled relationship managers. We now offer competitive products to businesses including a compelling online cash management system.

As a result, combining these products with our high level of service the banks' total deposits reached almost $4.2 billion - which is a growth rate of 28 percent in the past year.

Let me step back a minute and talk about the expansion and evolution of our business model. We know that our people, branches, and products take about 18 to 24 months to reach full productivity.

Additionally, because of our compensation mechanism, new accounts have reduced profitability in their first two years. The relationship of new to old (indiscernible) reference in prior calls continues to evolve. Based on relationship managers hired as branches opened, about one-half of our relationship managers have been with us for less than two years.

We hire very experienced relationship managers but it still takes them a while to come to fruition in our institution. One-third of our branches have been opened for less than two years. We expect the relationship of new to old should peak during the next year.

Our checking balances are approximately $1 billion in less than six years. With each year that passes, the profitability of that business grows. Loan originations for the third quarter were over $1.1 billion which represents record volume. A large part of that volume in the past two quarters is related to low interest rates.

Since June, however, mortgage rates have increased 100 basis points from a 45-year low. Increases in intermediate treasury in particular have low refinance volume.

Purchase activity continued through the quarter driven by low interest rate with 28 percent of our originations being purchased transactions. On average, our single-family loans to value ratios on purchases were 70 percent and on refinances they were less than 50 percent. These are historically conservative levels.

Asset quality remains strong as it has through this economic downturn as a result of our underwriting discipline. Nonaccruing loans were .22 percent of assets and we have no REO property.

Selling loans is a forepart of our business. Level of gains, however, are subject to secondary market conditions and the volume of loans sold. In the third-quarter we sold $329 million of loans, recording pre-tax gains of $4 million or 121 basis points on the principal of the balance of loans sold.

In the second quarter, we sold $490 million of loans - generating $8.2 million in gains or 1.6 percent of the principal sold.

By comparison, activity and gain for these two quarters was significantly higher than in periods of more normal originations and sales. We expect a meaningful decline in mortgage banking activity and earnings beginning in the fourth quarter of 2003.

Our investment advisers are benefiting from the improvement in the equity market. Asset managed by our three advisers our trust company and our investment division have reached $10.3 billion. This is up 2.7 billion over the last year or 36 percent.

Fee income from these wealth management assets was $8.4 million - up 12 percent from a year ago. In addition to the new funds managed by Froley Nevy, wealth management asset and revenues have come from [indiscernible] of relationship managers, new locations and products as well as a growing stream of client referrals. Importantly, in accordance with our plan we continue to add new clients at historically rapid rates. This is reflected in our loan volume through [indiscernible] and our deposit growth.

And now I'd like to turn the call over to Willis Newton, our Chief Financial Officer.

Thank you, Katherine. This morning I would like to discuss trends in our margins, our costs and our allowance. Compared to the second quarter of this year, our average earning assets were up 7 percent and our net interest income increased 1.4 million. This occurred despite a 10 basis points decline in our net interest margin on a linked (ph) quarter basis. Our average loan yield held up fairly well dropping only 12 basis points. Our investment portfolio on average fell more - 66 basis points - due to three factors.

First there was a 25 basis point cut in the primary at the beginning of the quarter. We also had a high level of premium amortizations, caused by prepayments on some of our securities. And, finally, we had a higher balance of short-term investments earning the overnight [indiscernible] rate of 1 percent.

On the positive side the continued growth in our average checking balances as a percentage of total deposits has pushed the average cost of our liabilities down 10 basis points.

Turning to our efficiency ratio, our efficiency ratio is generally comparable to last quarter because the increases in our net interest income and our recurring fee revenues offset our expense increases. Several of our expense categories have begun to level out or grow more slowly. Occupancy cost in particular have been in the same range for the last four quarters.

Compared to the prior quarter advertising and professional costs showed slight decreases while technology cost were up slightly. Also, like everybody else, we are incurring higher costs to require new regulations - most notably, Sarbanes Oxley.

Spurred by the 45 year low rate and the apparent turn, mortgage repayments in the last quarter were higher. We wrote down our mortgage servicing rights by $392,000 during the quarter. The increase in interest rates that has occurred - particularly in [indiscernible] treasuries - is expected to result in lower future prepayments.

During the quarter, we added $3 million to our allowance for loan losses in light of the strong loan growth we have experienced and including a growth in our non real estate secured loans. We're comfortable with the level of allowance for loan officers. We have nearly two-thirds of our loan portfolio secured by single-family home loans and our accumulative losses on this product has been only 2 basis points on all originations since the inception of the bank 18 years ago. This is an unusually low loss experience.

If, for example, we set aside 10 times this actual loss experience, the remaining allowance represents over 1 and 1/2 percent on all other loan types - most of which are secured by real estate or other collateral. I would now like to turn the call back over to Jim.

Thank you, Willis. In closing, let me say that we continue to be very encouraged by the results. Our business fundamentals remain sound and the growth in many of our investments that we made over the last couple of years are paying off. The deposit franchise in particular is growing very nicely as is our business banking franchise.

We are encouraged by the positive developments in all the wealth management entities as well. We would now be happy to take questions as they come up. Thank you.

[Operator Instructions]

Manuel Ramirez with KBW.

Couple of questions for you. First, looks like the compensation line was somewhat elevated this quarter. I was wondering if that was anything special in that number? If you had added a lot of people in the quarter and whether or not that's a fair level off of which to model going forward? And then, second, Katherine, maybe you could talk about what you are expecting on the [indiscernible] sales margin to be in a slower mortgage market?

Okay. I can address both of them. On the compensation side, the tremendous record loan volume as well as our deposit growth resulted in us making sure we had our bonus calculations correct. Normalized gains are hard to say. When they are coming down, as they had in this last year, gains are very high. When rates move up they can go the other way. And our normalized gains can run between 35 basis points to 75 basis points.

Back to the compensation. Really quickly. About how much of the increase would you say is related to the elevated origination volumes? Do you expect maybe a $1 to $2 million decline, just based on the slow mortgage market?

[indiscernible]

I think that we would expect to have slightly lower accruals for incentive compensation in the fourth quarter. We've achieved some of our objectives already this year. And I think that's about all I can say.

Okay, great and then one other question, obviously, you've had a tremendous improvement in the right hand side of the balance sheet over the last couple of years. And you continued to have a lot of momentum based on the positive [indiscernible] quarter. On the other hand on the asset side, clearly, all the growth has been primarily single-family and home equities which, intuitively, would be lower spread loan products. So maybe you can talk about the interplay between those two forces and how we should think about the margin and a better

We have -- you are correct on both sides of the balance sheets. We don't envision a meaningful shift in the asset mix profile, although it will tilt a bit as a single-family refinance volume slows, down, remember it wasn't just refinancing of our business, it was refinancing to us from somebody else, in many cases. And so, I think the single-family growth probably slows a bit. The one that is growing rather steadily although off a small basis business loan outstanding. The equity lines will also grow a bit if rates stay up and the people stop refinancing the core home, they'll shift to the equity line a little bit.

Commercial real estate we have - for obvious reasons - shied -- have been very cautious about. Last couple of years. We're gaining confidence recently. The multifamily piece we shied away from because it got too competitive in our opinion, pricewise. That has abated a bit, somewhat, very recently. So -- so I think the mix the growth forward probably shifts a little way from single-family but not dramatically because we're not inclined to be in very many other businesses as a core business. Katherine, you want to add anything to that?

No I think that's exactly what's happening. Our focus has been to originate the cleanest quality loans we can and that will continue to be our focus - we're an A quality originator of everything we do.

Let me just add one thought to Willis's suggestion. I think he is right. It's important to think about the balance sheet in terms of how much the balance sheet is now predicated on LIBOR and prime rates rates and there's been a very large shift in the balance sheet over the last two or three years away from the 11th District, away from intermediate fixed and towards prime and LIBOR floating. Business products, commercial lending products, and the home equity lines all help that. And one of the things we have been doing for several quarters at least is anticipating the rise of rates.

Actually that brings up another question if you can update us on what the part of the portfolio [indiscernible].

The numbers I don't have -- I don't have let's see, let me come back to that, give Willis a minute or two here. I think we think can give you a rough number. Maybe we can go on next question and we will answer that one, Manny, in the process.

Kevin Reevey with Ryan Beck.

I had a couple of questions related to some of the line items in your income statements. First of all, noticed (indiscernible) charges declined on a link quarter basis but your balance sheet grew. Can you give us some color on that?

Well the service charges are net and, Kevin, and they're subject to the mortgage servicing rights adjustments. And so you see a decline because of the increase of prepayment rates somewhat above our estimated numbers. And so what you're seeing is a net number -- net of charge-offs. Sorry -- yes, reductions. And one would hope that if rates stay where they are or rise, the repayment rates on the mortgages begin to decline and we pick up, we go back into a positive servicing income mode.

Great and then I also noticed the occupancy expense has declined even though you opened a new branch during the quarter in LaJolla. Can you explain why that happened?

Kevin, there were a couple of adjustments on some subleases and a renovatement (ph) that were fairly minor and onetime items. We would expect our occupancy costs to run around 6 million 9 as a base going forward.

And then on the assets from the management. How much of the growth was due to new client additions vs. market appreciation.

Well, a meaningful share was new client additions particularly taking into account Froley Nevy's new money from the Nuveen funds. But if you take that out the new client additions are moderate but positive, overall, and the market appreciation is helping. I hasten to add that we -- it's a mixed blessing to have fixed income management because fixed income assets under management declined in the quarter as a result of the move up in rates.

Great. So basically going forward, how much would you say are we going to see in the fourth quarter related to market appreciation in the fourth quarter?

We can't call that. If the market stays the way it is, we would hope - based on discussions going on and so on, that we'd have some net new client additions but very importantly the -- we are done taking into new money from the Nuveen fund so there will be no more new flow from them.

No, I mean as far as any carryover for market appreciation from -- during the third quarter to fourth quarter? How much -- in other words what percentage did you get in terms of credit for market appreciation in the third quarter?

I think it is important to note that the revenues we will earn in the fourth quarter will be driven primarily off of the balances at September 30th. So that should be helpful in looking at that issue. Higher assets will lead to revenues going forward.

Once again [Operator Instructions]. Mike McMahon with Sandler O'Neill & Partners.

Willis, you very clearly laid out the seller credit results of the Company and I am just wondering you have an ample provision each quarter and are you trying to get to a certain percentage of the portfolio for the allowance or...? How are you looking at that? How should we model that?

Mike, this is Jim. We want, as you know, like everybody does - I presume - an internal adequacy analysis. Every quarter - in fact, sometimes we run it more frequently than quarterly. And we basically have -- we're driven by that and that model takes into account the mix of loans as well and for obvious reasons requires higher loan provisions on say, unsecured lines or business lending than it does on single-family home loans for instance. And as the portfolio shifts, albeit fairly slightly, it requires some additional reserves. We also have always been -- I have been particularly focused on the adequacy test that that is only that (ph) of the system than a test. I'd like to be -- get beyond that just so we're not completely dependent upon the sort of mechanics of that. And I also try, if we can, to see where trends are going in terms of shift and stay ahead of them. I would say if you look back though, and Willis, correct me if I'm wrong here, but if you look back over several years we have been in the kind of 65, 75 basis point range for quite a while. On total loans.

That added some good color. Thank you.

Once again [Operator Instructions] [Operator Instructions]. It appears there are no further questions at this time. Mr. Herbert, I'd like to turn the conference back over to you for any additional or closing remarks.

Quick, Manny, we can't put our fingers on that (indiscernible) number for you - we will try to get it -- try to get to you. But suffice it to say it is somewhere in the 5 to $700 million range that (indiscernible) right now. Thank you very much. We appreciate your time and support of the Company. Bye-bye.

That concludes today's conference. Thank you for your participation.