First Republic Bank (FRC) 2004 Q1 法說會逐字稿

Welcome to the First Republic Bank first quarter of 2004 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 Snedeker (ph), Chief Marketing Officer.

Thank you and welcome to First Republic Bank's first-quarter 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 888-213-1112. The reservation number is 521-615.

Before we begin I'm required to inform you that some of the statements made on this call could 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'd like to introduce Mr. Jim Herbert.

Let me start by saying that we're very pleased with the results of the quarter. Asset growth was good due to strong loan originations and our fee income from wealth management groups showed meaningful growth. At the same time, our costs stayed in line. The trend towards improved fee revenue and net interest spreads is very positive overall. As a result, net income for the first-quarter was 9.1 million when compared with 6.9 million for the first-quarter of 2003 after excluding gain on sale of deposits in '03. Diluted EPS for the first-quarter of 2004 was 56 cents per share compared to 45 cents per share for the first-quarter of '03, up 24 percent. We're also pleased to have declared another common stock dividend of 12.5 cents per share for the quarter.

I'd like you briefly expand on the points I've mentioned and then talk about rising rates and their potential affect on our business. First, loan volume was strong, originating 880 million, the highest first-quarter that we've ever had. we've seen a shift from refinancing to purchases, which play very much to our strong client service capabilities. Historically we capture increased market share in strong purchase markets.

Next, our asset growth remained high, in part because we didn't complete a significant loan sale or REMIC, and also because loan payoffs slowed. Our net interest margin improved by 11 basis points and we've lowered our deposit cost while rates on earning assets remained relatively constant. Fee income in all three of our money management firms also grew significantly. Trainer Wortham, Froly Revy and Starbuck Tisdale all benefited from new client acquisition as well as a rising market.

Our brokerage and trust service groups both made positive contribution to earnings after being launched just a few years ago. Total wealth managements rose to almost $12 billion, a 39 percent gain over the past year, while related fees were up 28 percent in the same year. Our operating costs stayed in line and our efficiency ratio at 68.3 percent has improved over the last two quarters. Importantly for future growth we took advantage of lower interest rates and a strong stock market over the last year to increase our total capital by more than 37 percent in the last 12 months.

Our results are strong. We do have some additional expenses that have yet to be absorbed from the buildout of our franchise. Most of these additional expenses will be realized throughout this year. Managing this anticipated cost increase and balancing it with revenue growth is really our key challenge for 2004. Let me take a moment to talk about interest rates and their potential impact on our business.

Over the past month longer-term rates have increased, and we expect short-term rates will rise as the economy continues to accelerate. First Republic is well-positioned to handle a rate increase, from a risk management, credit quality, and loan volume point of view. We have historically operated as an asset-sensitive entity. The management team remembers quite well the 1994 experience, in which rates rose very rapidly and many were caught off guard. That experience has shaped our thinking as we've positioned our balance sheet for the past few years.

Today more than 75 percent of all of our assets adjust within one year with many of them adjusting monthly. We use minimal risk -- a minimal amount of derivative instruments, we rely instead on naturally matched funding of sources and uses and a very conservative secondary market practice to manage interest rate. Because of our strong capital position, the balance sheet composition, and additional loan production capabilities, we feel we're in pretty good shape going forward.

In closing let me say again that we're well -- that we're very pleased with the results of the first-quarter. The trends are positive and are consistent with the careful planning that's gone into our business strategy. Now I'd like to turn it over to our Chief Operating Officer, Katherine August-deWilde.

Thanks, Jim. As Jim mentioned, the first quarter of 2004 was strong. Deposit and checking account growth was very good. Fee income from our investment advisers increased substantially. A rise in home purchase activity plays to our strengths of high service as well as a broad range of product offerings. And the average number of products for loan clients climbed above seven.

In the first quarter total deposits grew to $4.7 billion, up from 3.7 billion a year ago representing an increase of 27 percent. Checking accounts increased at the end of 2003 and we are pleased to maintain those balances throughout the quarter. Average checking account balances were 1.2 billion in the first-quarter of 2004, up 15 percent from the prior quarter's average checking account balance. In addition to good deposit growth this quarter, we carefully managed the cost of our liabilities to increase our net interest margin.

In the wealth management area, we are very encouraged by the results of all of our operating units. Fee income from our three investment advisers, our trust company and our brokerage company rose 2.2 million or 28 percent compared to the same quarter a year ago. During this quarter assets under management increased $950 million as a result of both improved market conditions and new wealth management clients. $420 million of that increase was due to market appreciation and $530 million was due to net new asset growth.

Turning to loan growth, we experienced record first-quarter loan volume. We are anticipating a continued high level of loan originations in the second quarter for several reasons. First, we've added a number of bankers and while our newest bankers have yet to become fully productive, they are beginning to add to loan volume. Second, home purchase activity is very strong in all of our markets. In strong purchase markets clients who are buying homes tend to gravitate towards the higher level of service that First Republic provides. We get a larger share of the purchase business because of our Realtor referrals and our reputation for service. Purchases represented about 50 percent of our home loan production in the first quarter of 2004. This is up from just 25 percent for most of 2003. Third, we now offer a full range of personal as well as business loans to our clients. These segments of our business are growing very rapidly.

While we have continued to experience loan growth we've remained focused on asset quality. Disciplined underwriting remains central to our corporate culture and has been critical to our success. As a result we have just one non-accruing loan which represents .22 percent of total assets. This loan continues to show an improving trend. We have no foreclosed loans.

In recent speeches, said officials have suggested that borrowers with high debt loads may pose a particular risk to banks during a period of rising interest rates. By contrast the typical First Republic client is better able to withstand risk due to several factors. First, they have higher than average incomes. Second, they have higher than average liquidity positions. Third, their credit scores are strong, and they generally have higher lower than average -- or lower than average loan to value ratios. That leads to, we believe, a safer client profile as rates rise.

Our cross sell success has continued to grow. In the first-quarter of 2004 the average number of products used by our loan client exceeded seven for the first time. Once we have established a relationship with a client and have won their trust they generally choose us for a wide range of products and services. Deepening client relationships and increasing productivity are key themes for First Republic. We are intensifying our training programs to leverage the investments in new technology, new products and new employees that we have made over the past several years. Our focus will be on ensuring that our existing resources are as productive as they can possibly be in the delivery of client service.

2004 will be a period of growing into the opportunities we have created as we reap the investment in people, products and locations. The largest remaining component of our expansion is the new Time Warner location in New York the branch is well located and has already generated increased visibility in Manhattan. In short, we are pleased with our progress our increasing roster of clients is validating our approach which is to provide world-class private banking and wealth management delivered with exceptional client service. Now I'd like to turn the conference over to our CFO, Willis Newton.

As you well know by now, we had a good quarter. I would like to focus on a few topics -- capital position, our net interest margin and prepayments, and then we'll take questions. On February 3rd the Bank issued 65 million of new non-cumulative perpetual preferred stock. This issue qualifies as tier 1 regulatory capital and the dividend rate of 6.7 percent represents excellent execution on an historical basis. This brings our Tier 1 leverage ratio to over 7 percent at the present time.

In our financial statement the preferred stock dividend is a reduction of the net income used in determining net income available for our common stock holders. Also, the preferred dividend amounts are deducted for purposes of our EPS calculations. We intend to use this capital to support future balance sheet growth. At a normal leverage ratio the preferred stock issue will support almost 1 billion of new assets. We will cover the cost of this issue with about 100 million of new muni securities.

Next, as has been noted, our net interest income increased. For the quarter the Bank's net interest margin was 3.22 percent, an increase of 11 basis points compared to the prior quarter. We actively managed our deposit products to achieve lower cost and we benefited from the repayment of 118 million of higher cost advances in the fourth quarter of '03. Also there continues to be a significant increase in our lowest cost deposits, our checking account balances. These balances averaged 1.2 billion for the quarter and on average were 15 percent higher than last quarter and 60 percent higher than the first quarter last year.

Another factor affecting our net interest margin is the purchase of tax advantaged Bank qualified municipal securities. These munis have a good tax adjusted yield. As Jim said, the Bank is asset sensitive and over 75 percent of our assets adjust in one year. As more fully described on page 109 of our 2003 annual report, in a 200 basis point gradual rising rate scenario, the bank's interest rate risk model indicates that our net interest income would increase approximately 3 percent in the first year and increase approximately 8 percent in the second year.

Finally, for the last two quarters our loan volume has included a lower percentage of refinances. The lower level of refinances is directly beneficial because, one, our balance sheet loans pay off slower; and two, the value our mortgage servicing rights remain firm or increase. The repayment speeds on our servicing portfolio, for instance, was only 17 percent in the first quarter of the year and was 19 percent in the fourth quarter of last year. These are more normal levels after experiencing prepayments as high as 40 percent at times over the last three years. Now let me turn it back to Jim for closing comments before questions.

In closing, let me say that we're very pleased with the results for the first quarter of '04 and for recent trends in general. We've indicated our business fundamentals remain sound, our capital has improved substantially, and our growth investments are paying off. We are well-positioned we think for the challenges of rising interest rates. With that, let us open up for questions, please.

(OPERATOR INSTRUCTIONS) Kevin Reevey, Ryan Beck.

Congratulations on an excellent quarter. I missed most of the call, so I apologize if this question has already been asked, but I noticed that there was a significant increase in your 90-day past due account. Any reason why there is a trend here that we should be aware of?

There is not really. We had one single-family that's 90 days past due, but still accruing, it'll work out. And the other one is the growth -- the construction loan still has new tenants coming in and we're building out TI's on it, that's why it's grown a little bit, but actually that's the good news. The building is well over 60 percent occupied now, and it looks like it's going to be 80 percent in the next month or two.

Excellent, thank you.

Manual Ramirez, KBW.

Just a couple of things, if you don't mind. First, could you talk about what your plans are for loan sales and securitizations over -- at least the next quarter but I guess for the rest of the year? You kept a little bit more on balance sheet than I expected this quarter. Second, Katherine, you mentioned that it's going to be a balancing act between expenses and revenues this year -- it has been for the last couple years. Maybe you could quantify what you see for expense growth going forward particularly with the new branch opening in New York City? And then I have a follow-up question if you have a chance.

Let me respond to the first half first. The balance sheet and loan sale growth is going to be probably a little more balance sheet initially because we, as well as alluded to, we are growing into the preferred. And so we're utilizing that to cover the cost of preferred and get positive leverage on it. The loan sales will be timed as they always are to respond to market opportunity to some extent. In due course we expect that we will be looking at REMIC some time this year but we're not perfectly sure, it'll depend on the mix of loans that we originate as well.

The other thing I want to mention about that is we are opportunistic about whether to sell loans at securities or whether to sell them as home loan packages. In terms of cost, as we have said many times before, this is the year when the brunt of the cost will impact us. We're working hard to both increase fee income and to increase spread and margin as well as our balance sheet to be able to accommodate that growth in expense which we expected. We are on track no different than we had plan before. I don't know if we get into detail of exactly the increase in expenses, however.

Maybe you can talk about how much your headcount has changed sequentially and year-over-year?

The assets per person -- let me come at it slightly differently which is a relationship. The banking assets per person have actually gone up about $1 million in the last year or so. And they were going down for about two years in a row many of them, and then they've come off bottom and they're now climbing again. And so what we're comfortable with really is that we appear to have either at bottom or gone past bottom on the efficiency issues. In terms of total assets, that's true of bank assets and of total assets.

So our headcount increase is slowing down. The only remaining thing to open yet is the Time Warner in New York. We actually -- although it wasn't in the first-quarter, we opened the Orange County expanded location in the last week or two and we have a Las Vegas branch move still happening but that's more a lateral move than it is anything else, although it's a big improvement. But it will bring with it one or two new people at the most. And so the majority of this is really now being shown in the P&L, or will show in the next quarter or two. Then it's mostly behind us and we'll have to see how our run rate is. But we're right -- at this moment, we're pretty comfortable with how it's looking.

Let me also answer that in terms of headcount. As you know, our headcount probably peaked at about June of 2002, and from that point we've reduced it significantly. From that point we're up less than 5 percent and are very pleased with that level that includes much of this buildout, as well as some contractors we have on staff right now working on several IT improvements, much of which will disappear over the next four or five months. So we think we will wind up in a very modest increase over a two-year period, particularly offset or if you contrast it to our asset growth.

That's very helpful, thank you. One last question. I apologize if I missed this at the beginning. Willis, what was your loan sale margin in the quarter? I came up with I think 28 basis points or so, which I know was below the average number that you've talked about in prior quarters and just curious if I was calculating that right; and if so if it was below the average, why that was 7.25 when interest rates were declining overall?

We had gains of about 600,000 on 264 million, but 80 million of those loans that we delivered and sold this quarter were longer-term fixed-rate loans that we sold at a loss and took the mark-to-market value in the fourth quarter. So 80 million of those loans had no gain to them, another 100 million of those loans had a modest 20 basis point gain in them, and the flow loans that we sold during the quarter, about 85 million, had a more typical 45 to 50 basis point gain on them. Net-net around 22.

And the fixed-rate came out of your held for investment portfolio or they were sitting -- they were there in the held for sale portfolio at the end of the fourth-quarter.

They were transferred in at the end of the year and they were priced and delivered in January.

Okay. Thank you very much for your time.

Mike McMahon, Sandler O'Neill.

Let me extend my congratulations to Katherine since Jim and Willis have already been congratulated. And same to you, gentlemen. Two questions. The loan sale issue is always an issue that comes up every quarter. Am I correct that in general you sell your fixed-rate and retain your arms?

Yes, you are correct in general, but we also sell arms, usually LIBOR pools into REMIC and manage our deposit growth and our capital requirements. So, in general, that's correct on a flow basis. You see us selling 30 and 15 year fixed-rate loans, but we do opportunistically sell LIBOR floaters from time to time.

And if I can follow up on that, when you opportunistically sell the LIBOR floaters from time to time, is that primarily a function of managing your deposit growth or market opportunities?

It's primarily a function of managing our deposit growth because actually in those loans, generally the price is relatively stable.

So we should look at deposit growth --.

Let me interrupt for a second. She's saying deposit growth, but what we're really focused on is asset growth because we can fund with FHOB (ph) borrowings as well. What we do is maintain our asset growth carefully based upon capital available, Mike.

Okay. And I see the increase in the assets under management which is a very positive sign in this environment, congratulations there. You did hire some folks or move some folks around if I recall a quarter or so ago to increase your marketing efforts and I'm wondering if you can give us some general color on those activities?

Well, we did hire two people from another investment adviser that had been purchased by another bank, and they joined us and the assets we expected to come with them did come. But that's probably about 15 percent of our new assets under management.

Very good, thank you.

(OPERATOR INSTRUCTIONS) Don Worthington, Hoefer & Arnett.

Congratulations on the quarter. Just had a couple of other questions. One, in light of the reduction in prepayment speeds, do you anticipate that there would be any recapture to the MSR at any point?

We had not considered that in the past and we don't plan to do so in the future. We will adjust our amortization as rates rise.

Okay. And then in terms of the lending, you mentioned that in a purchase market you tend to pick up market share. Where do you usually pick that up -- from larger banks? And then secondarily, do you expect any change in the loan mix in terms of your portfolio?

We tend to pick up market share from -- in a purchase market primarily from mortgage brokers, very large banks, and -- because people who are refinancing their houses are really just looking for the lowest possible rate and they're not necessarily looking for the degree of service that they are looking for when they want to make sure that they win the home they've just purchased. So, we also pick it up from large banks because people are sometimes concerned that they may not have the ability to close quickly or to commit clearly.

In terms of our loan makeup, our balance sheet is likely to stay relatively similar in terms of the percentage of home loans, but we are slightly increasing quarter-by-quarter the percent that is commercial real estate, business loans as well as other secured loans.

Okay, great. Thank you.

Mike McMahon, Sandler O'Neill.

Willis, I'm wondering if the company has made a decision on the tax -- the California retax issue yet?

Mike, we have had -- no, there have been no new developments in that area in the past three months. And we are not taking any benefit in 2004.

Okay. Thank you.

And there are no further questions at this time. I would like to turn the call back over to our speakers for any additional or closing remarks.

Okay, great. Well, thank you all very much for taking the time. We appreciate it and we appreciate all the questions. Thank you very much.

And that does conclude today's conference all. Thank you all for joining us. You may now disconnect.