First Republic Bank (FRC) 2003 Q4 法說會逐字稿

Good day and welcome to the First Republic Bank fourth quarter of 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 Ms. Diane Schnedeker (ph), Chief Marketing Officer. Please go ahead.

Thank you and welcome to the First Republic Bank fourth quarter and year end earnings conference call. Speaking today will be President and CEO, Jim Herbert; Chief Operating Officer, Katherine Augusta-deWilde; and Chief Financial Officer, Willis Newton. A web cast 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 888-203-1112.

The reservation number is 521615. Before we begin I am 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 only on our Forms 10-Q, 10-K and other regulatory filings. And now I would like to introduce Mr. Jim Herbert.

Thank you, Diane. We are very pleased with the results for the fourth quarter and for the full year of 2003. As outlined in our news release earlier today, net income for the year increased 40 percent to $37 million. Diluted EPS was 2.41 per share for the year, a 42 percent increase compared with $1.70 for '02. Year-end results included a $4.4 million gain from the sale of branch deposits which took place in the first quarter of '03 and accounted for 29 cents per share.

For the fourth quarter net income was 6.7 million compared with 7.1 in '02. Diluted EPS for the fourth quarter was 41 cents per share compared to 46 cents per share for the fourth quarter of '02. As previously announced the fourth-quarter earnings were lowered by 2.3 million or 14 cents per share due to a state income tax adjustment. In many respects 2003 was truly a transformational year for the bank. The investments in our businesses are beginning to show positive results across the board.

Every major business unit is now profitable, including our investment management, trust and brokerage groups. The numbers really tell the story. Loan originations grew 16 percent, total deposits grew 26 percent. Our checking account, which have been a particular focus of the enterprise, grew 58 percent. Total bank assets increased by 24 percent. Our total wealth management assets grew by 41 percent, and overall assets managed including the bank, wealth management and loan serviced grew by 28 percent.

Our asset quality also remains very high. The balance sheet is strong. We raised 80 million in common and preferred capital during '03, and we increased our total capital by 22 percent during the year. We are also very pleased to have adopted in July our initial quarterly cash dividend. The performance is the result of consistent execution of our business plan as well as the impact of three very distinct factors. First, the economic and market conditions improved meaningfully in '03.

We benefited considerably from the boom in mortgage refinancing and the rebound in the stock market. Second, we completed the introduction of new products and services, which were very well received by our clients. Some of these new services include everything from tech imaging and online cash management to trust account reporting. Third, our cross-selling efforts worked extremely well. As our franchise matures our banking teams are getting much better at leveraging our investment management trust and brokerage products as well as using our new banking products.

All of these factors helped us generate a record number of new clients in 2003. In short it was a very good year. We look forward to building on our momentum but want to be clear that 2004 is not without its challenges. Gains from loan sales will likely be lower as interest rates stay the same or rise, and we will likely have difficulty matching the extraordinary growth in assets under management which was achieved in 2003. One of our key challenges will be to replace unusually good mortgage banking income of the past two years with stronger net interest and key income.

Reflecting on 2003, it was a very good year that had essentially two unusual items in it. First, the more obvious is the gain on the sale of the branches which accounted for 29 cents per share. Second, our loan sales were unusually successful, as we have said, both in terms of quality and execution and if loan sale gains have been at the five-year average of 62 basis points per dollar of loans sold, the 2003 earnings would have been lower by 20 cents per share. Together the onetime branch sale gain and the unusually high loan sale gains accounted for 49 cents per share in 2003. Now I would like to turn it over to our Chief Operating Officer, Katherine August-deWilde.

Thanks, Jim. We are now approaching critical mass in most of our markets, and we are benefiting from our ever growing reputation in quality and exceptional (technical difficulty). The results have been continued strong performance in every aspect of our core business. In 2003 deposit growth exceeded expectation. This is particularly true in our checking account balances. Checking accounts now total over $1.2 billion and represent 27 percent of our deposits, up from 22 percent last year.

This growth took place across the board in preferred banking, our branches and business banking. In wealth management we achieved strong client growth and increasing fee income. This was a result of successful marketing efforts, the hiring of seasoned portfolio managers, Froley Revy’s success in attracting new assets, especially assets from two new Nuveen funds, and the completion of our third CBO with Trainer Wortham. Fee income accounts for 26 percent of net revenue.

In 2003 our cross-sell ratio also increased. We achieved a record of seven products per loan client. Our expanded mix of products and services was also a big factor in our success in 2003. We were especially well positioned to take advantage of the strong demand for mortgages and we were able to achieve high cross-sell success. Coordination among our business units continues to improve, particularly in business banking, cash management and wealth management.

In 2003 we were increasingly successful in expanding the relationships of our private banking client to include the businesses they run or influence. One measure of this success is that business checking accounts grew 72 percent this year to $570 million. We will continue to focus on banking the businesses of our clients in 2004. While we focus on growth, we did not sacrifice asset quality. Disciplined underwriting remains at the core of our corporate culture and it has been critical to our success.

We have just one nonaccruing loan which is 0.22 percent of total assets at the end of 2003. The property securing this loan has an improving trend. Additionally, products such as CDO (ph) is continued to be well received by our clients. We are pleased to have closed our fourth CDO last week and we have sold preference shares to our qualified private banking client. With a strategic perspective the investments in our franchise are enabling us to acquire new clients at a faster rate than we ever had before.

These clients are increasingly attractive, and they represent excellent cross-sell opportunity. You may well see additional clients because of the continuing consolidation in the banking industry. Historically large bank mergers have resulted in many high net worth clients and bankers joining us. Our expanded footprint and product mix will only make us more attractive. Our goal is to build on our market momentum in 2004. As we have mentioned on previous calls, the delayed productivity of our growth initiative will be an ongoing challenge in 2004.

The cost impact of all of our investments should peak during this year. We believe 2004 will be another positive year for First Republic. Our strategy is being validated in the marketplace every day, and we are making progress on our objective to be the premier private bank and wealth management franchise in our market. I would like to turn the call over to our CFO, Willis Newton.

Thank you, Katherine. The rate of loan repayments slowed in the fourth quarter of 2003. On average our balance sheet and our servicing portfolio experienced repayment at an annual rate of 19 percent. This is considerably slower than in the prior two quarters. When our loans have a longer average life they are more profitable for us. As Jim commented earlier our mortgage banking as been strong for two years now with a high level of loans sold or securitized and an above-average gain on sale of those loans.

As we pointed out in the release, our gains on the sale of loans were 1 percent of principal sold in 2003, and 80 basis points in the prior year. Our average gain for the last five years has been 62 basis points. If we had sold the 2003 volume at 62 basis points, our EPS for the year would have been 20 cents lower. As an offset to lower mortgage banking income, if our mortgage loans repay at a slower level our mortgage servicing rights will have an increased value, and our net service fees will increase.

For the year our net interest margin in 2003 was 3.21 percent. In the last quarter our margin was 3.11 percent, a drop of 6 basis points from the prior quarter. This occurred because our average loan yield declined to 4.7 percent as our loans repriced downwards faster than we could cut our cost of liabilities. A few comments on the interest rate environment. We believe that we are well positioned for an increase in rates. Our rise in rates would be beneficial for the bank. After a period of initial adjustment by our mortgages we would earn a higher spread on our checking accounts.

On the other hand, if rates stay at their existing level or drop no more than a few basis points, we would expect continued moderate repayment of loans and a net interest margin that is near the range of our recent experience. On the efficiency ratio, excluding the deposit sale, our net interest income and our non-interest income improved more rapidly than our expenses in 2003. This is a good trend and it led to a decline in our efficiency ratio from 71.8 percent to 70.5 percent. We are pleased with this improvement, but we are committed to bringing this ratio down further.

They should occur gradually as our gross initiatives continue to mature. The lower level of our efficiency ratio in the fourth quarter was due to the timing of reaching incentive goals and a lower loan volume. We note that the efficiency ratio for the full year of 70 percent is more representative of what we should expect for next year. I would like to turn it back to Jim.

In closing let me say that we are pleased with the results for '03. As we have indicated, our business fundamentals remain sound and our gross investments are paying off. Each day we are attracting new client relationships. Our personnel are very focused on client service and we continue to add extremely talented people to the bank. We are now happy to take questions on our results. Thank you.

(OPERATOR INSTRUCTIONS). Manuel Ramirez from Keefe, Bruyette & Woods.

Congratulations on a good quarter. A few questions for you. I won't ask them all right now, but let me start off. First, could you try to quantify for us what the effect of lower mortgage volumes and I think the press release (indiscernible) bonus accruals was on the operating expenses in the fourth quarter and what we should expect going forward? Secondly, could you give us a sense of what sort of mortgage origination volumes you are implicitly building into your forecast for 2004?

And thirdly, whether or not you have any room to maneuver on your liability costs. I know your deposit rates are still a little bit higher than average. I might be wrong there, but it looks like it, and whether or not that will be supportive of the margin going forward for the first half of 2004. Thanks.

Let me answer that question. If you look at the expense ratios for the year, that is more representative of what we would expect. There were some changes in it quarter by quarter but the year is a normalized level. In terms of mortgage loan volume, it is very hard to predict that. It really depends on what happens with rates. We are seeing good purchase activity in our markets, but unless rates fall again we wouldn't expect the extreme volume that we saw in the second and third quarter.

What was your third question, Manny?

It was on deposit cost.

We watch deposit costs very closely and it depends on rates, and we are both attracting deposits and matching their costs as well as we can do both.

Okay, thank you.

(OPERATOR INSTRUCTIONS). Kevin Reevey with Ryan Beck.

Good morning. I joined the conference call a little bit late. I had basically three questions. The first one, and I apologize if this has already been answered, going forward what do you expect the kind of more of a normalized provision because it dropped substantially in the quarter, and I know that is because you had improving credit quality.

And then my second question would be, I noticed that your salary expense came down about 19 percent on a lean quarter basis and I wanted to know why that was. Was there something extraordinary in the third quarter that I didn't see? And my other question had to do with your branch development and kind of if you can give us an update as to how your branches are coming along.

Let me start with the branches and then we will work to the other two. The branch development for the '04 year was pretty well clearly announced. We have an opening taking place in May or June, roughly at the Time Warner Center in New York. That is fully committed. We are under construction. And we have an opening in Orange County near the airport that is under construction.

It we will be technically a branch but it is actually more an office for our relationship managers who are out of space in Newport Beach basically. And at this point, unless I'm missing something, that's it for the '04 and given where we are in the year right now that is likely to be pretty much what we do in '04.

And how are those branches you have already opened? You opened Santa Rosa and La Jolla. How are those branches doing? Are meeting expectation?

They are. They're pretty much on target. I was reviewing actually just last night the branch system in general at year-end, and it's pretty well on target. We have a couple that are a little lower than we would like. We have a couple that are exceeding expectations, but generally they are fine. Willis, you want -- salary expenses and provision?

I would comment that on our compensation costs that we try to match the compensation to achieve with a certain goal. We had record deposit inflows, and we achieved some of our goals for the year through the first nine months. And then we had lower loan volume in the fourth quarter.

We think that on a go forward basis, as we said, our efficiency ratio for the year is reflective of where we should start out 2004. The provisioning is subject to review on a quarter by quarter basis. We have had some strong loan growth, but we also had excellent asset quality. And I'm afraid we just aren't able to provide any guidance as to where that's going to go Kevin.

Okay. And then as far as the compensation goes, if I understand you correctly, basically what you are saying is because you had lower loan volume in the fourth quarter that was the primary reason why your salary and benefits expense were lower in the fourth quarter versus the third quarter? Did I say that correctly?

That plus we had achieved some deposit goals that we had set for the year. We have reached those goals through the first nine months.

Got it.

(OPERATOR INSTRUCTIONS). Manuel Ramirez.

Kind of a more general question about how incentive comps for your relationship managers is divided between meeting loan origination goals and meeting deposit goals. You probably can't get to specific numbers but just give us a general sense of how that is divided up or how we should think about it. And then secondarily, if Willis you can talk about whether or not you did anything with their borrowings as far as extending them out to take advantage of low rates. Thank you.

We pay our relationship managers for the full relationship loans deposits, asset growth and the success they have in selling their clients' the wide range of the product and services they need. Less than half of our compensation is directly attributable to loan growth, a little bit less. the rest is assets, deposits and other (technical difficulty).

And the question you had, Manny, regarding borrowings -- we actually during the quarter, we sold some of our longer-term loans, and we try -- we are trying not to be stuck with the lowest cost loans at any point in the cycle. And we repaid some advances that were at a slightly higher rate that were matching those borrowings. We think we are well-positioned on a go forward basis. So we did not add more longer-term advances in the quarter.

Did you prepare those advances or were they just rolling off?

We prepaid some and some roll off, Manny. The other thing that kind of driving this interestingly enough, is that our deposit growth has been so very strong that we have not needed advances nearly as much as we have in the past. You can see they are up for the year but they are not up percentage-wise in line with the rest of the enterprise.

As a percentage of the balance sheet, they have gone down significantly.

That's correct and that is of course -- long-term we would rather fund the franchise primarily on deposit franchise, if you will, and it has been quite successful. So we've had an interesting kind of balancing in quandary on our hands that is a good one.

One other question. The held for sale portfolio was up to I think close to $400 million at the end of the quarter. Is that an indication that you're thinking about doing a REMIC (ph) in the first quarter?

It is an indication of two things. It is an indication of some loans that are already committed and that either will be sold or have been sold early this year and sometime in the first half of the year we would expect to do a REMIC.

Willis, do you book the gain when you have a commitment or when you actually sell the loan?

Well we follow GAAP, Manny, and GAAP would say that if you have a gain you recognize the gain when the loan is actually closed. If you sell something or you commit to sell something and you have a loss, then you have to book the loss at the time that you commit to sell it and we did that a little bit in the third quarter, and we also did that a little bit in the fourth quarter.

Okay, thank you very much.

Kevin Reevey.

I just was looking more closely at your expense line item. I noticed that you're advertising and marketing is up tremendously. Is that a number that in the fourth quarter we should expect to see going forward, or was there something unusual in the quarter?

Kevin, what we did in this quarter was we added the marketing into the advertising and so there may not be a comparable number in the third quarter. We were trying to break out the other expenses down into a smaller component. So maybe I need to provide a quarterly revision to you and I will try to do that.

That would be helpful. Thank you.

If you compare year to year you will see in the press release format that they are comparable.

(OPERATOR INSTRUCTIONS). We have no further questions at this time.

Thank you very much for your time. We appreciate your coming on the call.

That does conclude today's conference. We thank you for your participation. You may now disconnect.