First Republic Bank (FRC) 2004 Q2 法說會逐字稿

Good day everyone and welcome to the First Republic Bank second quarter 2004 earnings results conference call. As a reminder today’s conference is being recorded. At this time I would like to turn the conference over to Diane Snedeker, Chief Marketing Officer. Please go ahead.

Thank you and welcome to First Republic Bank second quarter conference call speaking today will be President and C.E.O Jim Herbert , Chief Operating Officer Katherine August-deWilde and Chief Financial Officer Willis Newton. A web cast replay of this call will be available at www.firstrepublic.com in thirty days. An audio replay is available for two weeks. Domestic and international participants can dial 719-457-0820, the reservation number is 699177.

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

Thank you Diane. Let me start by saying we are very pleased with the results of the quarter. Our results are slightly ahead of the plan for the year. In the second quarter, asset growth was good due to record loan originations, purchases of investments and an accumulation of loans for future securitizations.

Fee income from our wealth management groups also continued to grow. Significantly increased net interest income and improved fee revenue are replacing last years’ high level of mortgage banking income. At the same time our costs have stayed in line. The trends of asset growth, that is just income growth, improved fee revenue and expense control are all adding up very positively.

Net income for second quarter was $10,300,000 compared with $10,800,000 for the second quarter of 03. Diluted EPS for the second quarter was 62 cents per share compared to 71 cents per share for the second quarter of 03. Importantly by comparison , I would like to note that the second quarter of ‘03 had loan sales gains of $8.2 million pre-tax versus loan sale losses in the second quarter of this year of a $0.5m .

We were pleased to declare another common stock cash dividend of 12.5 cents per share. Let me briefly expand on the points I have mentioned and then discuss the impact of rising rates on our business.

Second quarter loan volume was the strongest we have ever had. We originated $1.3 billion, 12 % higher than our next best quarter. Operating costs are stabilized. Importantly are efficiency ratio of 65.1% for the first 6 months of 04 is improving due to good cost control and higher level net interest income. We are in short growing into our investments that we have made over the past few years and as we indicated we thought would occur.

Fees from our three money management firms increased 4% in the last quarter and we’re continuing to attract new clients at Trainer Wortham, Froley Revy and Starbuck Tisdale and our brokerage and trust service groups. As these number suggest we are comfortable that our strategy is currently successful and the company is doing well.

We are in a home stretch of a build out of our franchise which began nearly six years ago. We have some additional expenses yet to be absorbed from these efforts. Managing these additional anticipated costs in the context of rising interest rate and a probable slow down of mortgage lending are our key challenges in the second half of 04 and into 05. Overall we are very pleased with the success of the build out. Over the past six years First Republic has transformed itself into a highly successful bicoastal private bank that is profitable in all of its four competencies -- private banking, business banking (an increasing part of our business I might add), investment management and trust

As we continue to achieve our long term business objectives we think it is appropriate to note another basis for comparison of our resolve is our long term stock performance. Over the past ten years, First Republic stock has had a compounded annual growth rate of 16.3% through June 30 ‘04 according to Bloomberg. I am pleased to report also that during that period we have had a stable base of highly respected institutional investors who have been with the company for an extended period of time, and we appreciate very much that support and patience.

Now I would like to take the moment to talk about interest rates and their potential impact on the business. I will turn it over to Katherine August-deWilde with more details on the operating side.

Over the past several months interest rates have increased and we expect short term rates will continue to rise. First Republic is positioned to handle a rate increase, but we are cautious about the adjustment lag as inherent in mortgage assets and the adverse effect of a flattening yield curve. We are also aware that the mortgage lending could slow down.

First Republic has historically operated as an asset sensitive entity. We remember quite well the 94 experience in which rate rose very rapidly. We have strived to position our balance sheet during the declining rate environment for inevitable increase in rates that would be coming. Today more than 70% of our assets adjust within one year, with many of them adjusting monthly. First Republic makes minimal use of derivative instruments, relying instead on a naturally matched source and use, and a conservative secondary market practice to manage our interest rate risks.

Overall we are pleased with the results for the second quarter and for the first half of the year. The trends are positive and the underlying fundamentals of business appear to be strong. We are also well positioned to meet the inevitable challenges ahead. Our franchise is gaining momentum in each of the markets and we are comfortable about the health and direction of the bank. I would like to turn it over to our chief operating officer Katherine August-deWilde.

Thank you, as Jim mentioned the second quarter of 2004 was a strong one. Checking account growth was good and contributed considerably to our very good deposit growth. The income from our wealth management activities increased. Loan volume was the highest on record, the average number of product per client remained above 7 and or expenses appear to have stabilized.

In the second quarter total deposits grew to $4.9 billion, up from $3.8 billion a year ago, an increase of 28%. Checking account balances climbed to $1.2 billion at the end of 2003. We were pleased to maintain those balances throughout the first quarter. Then in the second quarter of 2004 average checking account balances increased 6% to $1.3 billion. This is 55% higher than the same period a year ago. Business checking deposits grew 64% over the past year and now accounts are almost half of checking deposits.

In the wealth management area key income from our three investment advisors, our trust company and our brokerage company grossed 34% and $10m compared to $7.5m for the same quarter a year ago. However, assets under management we relatively flat during the second quarter due to difficult market conditions.

Turning to lending, we experienced record loan production in the second quarter for several reasons. First, low interest rates at the end of the first quarter stimulated refinances during the second quarter. In addition, in all of our markets purchase activity continues to strengthen, representing 58% of production this year compared to only 26% in 2003.

Purchases played to our new client service focus and we continually capture additional market share and purchase markets. Next as we have said over the past several years we have added a number of bankers, they are now beginning to add to loan volume. And finally our full range of personal and business loans contributed meaningfully to our lending activity. These segments of our business are growing rapidly.

During the quarter assets grew 8.5% $6.8 billion, up from $6.3 billion. Importantly this growth included a meaningful ramp up certain of adjustable rate loans held for sale. We would expect to issue a Renex (ph) in the last half of this year. Our high loan quality continues to be central to our corporate culture and it has been critical to our success. As a result our non-accruing loan, which consists primarily of one construction loan represents only .21% of total assets and again we have no foreclosed loan.

We are also quite pleased with our cross sales success the average number of products sold to 2004 loan client was almost 7.5. Once we have established a relationship with a client and have won their trust, they generally choose us for and increasingly wide range of products and services.

Our costs have stayed in line, our efficiency ratio is 65%. We have yet to absorb the full impact of the Time Warner build out. However, the percentage of seasoned offices and sales people have begun to shift. As you will recall, we have been tracking the percentage of offices and sales people who have been with us less than two years, versus those who have been with us more than two years. The number of offices opened less than two years, have declined 29% in the second quarter of 2003, 23% today. In the second quarter of 2003, more than half of our salespeople have been with us less than two years, compared to less than 40% of them today.

Part of the stability in our costs is due to these improving ratios. This year we are also focusing on improving overall productivity. We are emphasizing enhanced training, and also improved business systems. Overall we are making strong progress in all aspects of our franchise. The increasing roster of clients is validating this strategy, which is to provide world class private banking and wealth management, delivered with exceptional client services. And now I would like to turn this over to Willis Newton, or Chief Financial Officer.

Thank you Kim (Technical Difficulties) Morning everyone. This is Willis, after that technical difficulty, I would like to focus on a few topics -- our capital, our margin and our repayments and then we will take questions.

In February the bank issued 65 million of non-cumulative perpetual preferred stock. This new tier one regulatory capital increased our leverage ratio above 7.5% at issue, and set the stage for future asset growth. To offset the payment of $1.1 million per quarter in dividends on the new preferred, the bank has now increased its total assets.

As Jim noted, our net interest margin decreased as expected given market conditions. The banks’ net interest margin for the quarter was 3.18%, a decrease of 4 basis points, compared to the prior quarter. On average, our asset yields dropped more than our liability costs. However, with the June 30 increases in short term rates. Many of our arm loans begin to rise early in the third quarter.

On average for the second quarter liability costs benefited from a continued increase in the volume of our lowest cost deposits. As Katherine mentioned, our checking account balances averaged $100m above the prior quarter. Also, we had an additional $200m in overnight advances to fund some of the increases in our loans held for sale. These FHOB borrowings are priced at or near the FED bonds rate.

Our net interest margin is also affected by the purchase of bank qualified annuities. Which have good tax adjusted deals. Overall we are satisfied with the second quarter’s margin, as short term rates rise more rapidly, we expect to experience a short margin squeeze followed by upward adjustment of our assets. The bank is asset sensitive and over 70% of all of our assets adjust in one year. Also, over 15% of our interests bearing liabilities are fixed for more than one year. In a rising rate scenario, the bank’s interest rate model indicates that our net interest income would increase 3% in the first year and 8% in the second. However, we would expect an additional lag of three to six months in many of the bank’s mortgage loans. Our primary defense against this lag is to continue to steadily grow our average balance sheet.

For the quarter, our record loan volume included slightly higher refinances by dollar amount. Yet, the higher short term and longer term interest rates should lead of a lower level of future re-finances. This lower level of payoffs will benefit our balance sheet and our mortgage servicing income. Just comparing the second quarter and the first six months of 2004 to those of last year, we can see that there has been a very positive swing in our net loan servicing fees this is because we haven’t had any write-downs and our loans are now expected to have longer lives. I would like to turn it back to Jim for closing comments.

Thank you. In closing, let me say that we are pleased with results for the second quarter of 2004 and for the first six months of the year. As we have indicated, the business fundamentals remain sound and the growth in all of our investments are paying off --the growth that we have been spending. Each day we are attracting new clients and building new relationships. Personnel are very focused on client service, and we continue to add extremely talented people to the bank, as well as improving our training systems at all times. We will be now happy to take questions.

If anyone in the phone audience has a question, please signal by pressing Star one (1) on your touch-tone telephone at this time. If you are using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Once again, press star one if you do have a question. We will take pour first question from Kevin Reevey with Ryan Beck.

Good afternoon. Congratulations on an excellent quarter.

Thank you

I have a couple of questions related to some line items on the income statement. First it looks like, and I apologize if this is already been addressed, but I just joined the call about five minutes ago. But it looks like your brokerage income declined by about 53% on a quarterly basis. Can you give us some color as to why that happened?

In the first quarter of the year Kevin, we had a one time income item from the brokerage participation in the sale of a CBR that was done, and that was not recurring in the second quarter so it is primarily a difference of that in the first quarter.

That is about a $700,000 loan Kevin, without that I think there was continued borrowed progress.

Great and then I noticed that you advertising expense line item was up 22%, is that just a one time event for the quarter or is that a level we should expect to see loan for?

Diane do you have an opinion on the run-rate?

Um…I would have to look for that, I am sorry.

Diane -- the run-rate on the advertising rate Kevin is -- probably you ought to look at this quarter as the appropriate run rate. Because as we open new branches and new locations, we are picking up the advertising. We have had actually a number of good opportunities presented to us which we have taken, and in the fourth quarter there will be an increase coming from our sponsorship arrangement with Time Warner Center in New York.

Yeah it - - that kicks in October and we will be at slightly higher levels proportionately representing a proportion to the growth of the bank. We’re staying very constant, we’re not expanding this as a proportion - -

Great. Thank you.

Next, we’ll hear from Mike McMahon of Sandler O’Neill.

Let me add my congratulations also. Let me start by saying that I am not concerned about credit quality with First Republic.

I note that from inception, I think you’ve reported you’ve had cumulative losses in your single county portfolio, 2 or 3 basis points over many, many, many years. Having said that, housing prices are on fire in California in general and I know that you have a wealth yield average borrower with low LCDs, but can you shed some of your own feelings on the housing market in California and how you are going to continue to maintain your - - hopefully your stellar asset quality?

Katherine would you like to respond?

Yes. We’re very aware of that. Actually in California as well as in Manhattan, prices have been on fire and the purchase market continues to be very, very strong. We monitor this on a very regular basis. We are looking at whether or not there is a point when we will, and we do from time-to-time tighten up some of our purchase loan values.

But significantly, what we are doing client-by-client is being absolutely focused on making sure they have the right kind of income capacity, the right kind of historical credit and most significantly, the right kind of liquidity.

Mike is it - -

We also do qualify our borrowers when they take out adjustable rate loans at a much higher than the start rate for their payment ability.

That latter point was the one I was going to make Mike. We – we’re doing – we’re using; I think 7% now are we not Katherine.

7 ½

7 ½. So we’ve always had an artificial underwriting guideline internally to the bank, which is above…when rates are we stay above it. And the other thing that’s happening is that, if you look at the - the housing prices are moving up of course, the ability to service the obligation sort of reflected by debt service coverage ratios, has actually not changed in our portfolio, if anything the coverage ratios are probably slightly better than they have been. So, so far the clientele seems to be staying appropriately in proportion veering upstream.

Great, thank you very much.

Thank you.

Once again if you do have a question for our presenters today please press star one at this time. We’ll move on Manuel Ramirez of KBW.

Good morning everyone, a couple of questions for you. First just looking at the long growth this quarter, it’s a lot less concentrating in single family (inaudible) a little in the quarter, a lot more home equity, commercial real estates. Can you talk about what’s driving that, particularly on the home equity side, just you know, thinking about it intuitively one would think that there would be a huge demand for home equity from your customer base but obviously wrong there.

And secondly, can you talk about what would happen to the margin if the source of interest rate increase has at a measured pace as seems to be likely here in the near future and you mentioned that there could be a margin squeeze with rising rates – that you have the same sort of squeeze when our rates are moving up only 25 basis points every six weeks. Thanks.

Why don’t I respond to the question on the loans and turn the margin to Jim or Willis. We did grow single family, what’s happened is a lot more of our single family loans have been in the category of loans held for sale as we are preparing for rimming, so in terms of originations in this quarter, single family was actually quite heavy. In terms of helot [ph], we have had a focus quite a long time on encouraging our clients at – take out a helot [ph] whenever they are under the accessible loans value on a combined basis. And because we have clients who put fixed rate or immediate fixed rate loans on, over the last two or three years, it’s a very, very low rate, rather than refinance they are increasingly using their helots as well as we are increasing the number of helots we used to address this promotion to our clients. Our helots [ph] are underwritten the same way our first mortgages are, with the same tight underwriting guidelines and they’re primarily behind our own firsts.

And what is that combined with the value that you use Katherine?

Well it depends on the loan amount but as a $500,000 closed loan, we put 80 and at a $1.5m we’re more likely to be at 60.

We bring you down with size, Manuel, but we also – Katherine what’s the draw level on our home equity at this point, about 40%?

Yes, 40% and extends between 38% and 42% for about ten years.

We’ve not yet experienced such (inaudible) and we’ve not yet experienced any loss on home equity lines in over a decade.

In terms of the other areas we are focusing energy and attention on the other areas of our balance sheet, this is the time when a construction lending tends to be a little bit more active because it the summer months and we are well staffed now – fully staffed in business lending as well as construction lending in our markets.

If I can have one comment on business lending, one of the thing that is becoming quite successful for the bank, in moderate amounts but a growing amount is that we have decided to take the model to the next level, which is the obvious one, which is to follow those customers who are business leaders in their enterprise, be it a law firm or accounting firm or a - - the professional service firm of many kinds – as well as other businesses and we are beginning to go upstream through the client that is very happy with the bank often who started just with a mortgage loan to their business. So most of the business banking growth and the enterprises comes from existing clients of one sort or another and that’s a very powerful cross marketing piece that’s beginning to really work.

Willis, you want to take the second half of Manuel’s question?

Sure, the question had to do with what do we see happening to our margin if there is a, the favorite word is measured increase in interest rate. Well I think the margin pressure would be less in a measured environment than if there is a, say 75 or 100 basis point move by the end of the year more rapid rate. We believe that the margin pressure is some where in the neighborhood of 10 to 20 basis points although we believe that our balance sheet and the composition of our deposits should allow us to sort of hold the line, in even the worst cases around 30%.

Great thank you very much.

And another reminder if you do have a question please press star one now, we’ll pause for just a moment. And we have another question from Manuel Ramirez.

Thanks I’m back on again. If I was to (indiscernible) a transaction deposit growth, there was decent growth for usual, a bit slower than we’ve become accustom to seeing, 2.4% not annualized by my calculation. Does that have anything to do with the current quarter decline and compensation at all or could you Katherine just generally could you talk about the dynamics the surprising decline in expenses? Thanks.

In view of the second part of that question could we talk about what was client expenses?

Generally what was driving the decline in expenses in most of the compensation line.

Okay well first let me respond on the deposit growth. We had a tremendous amount of deposit growth, particularly 10% growth in the fourth quarter of the year. Usually we have a bit of seasonality where our checking account decline in the first quarter, in fact we held that level and then in this quarter began to increase it. I’m going to turn to Willis to answer the question on the declines in compensation.

Actually if I could just let me add one thing to that. We are experiencing more head winds as is everybody I think on deposit gathering as interest rates rise and there are alternatives particularly in the CD and money market area. And importantly as the stock market has improved you’ve got some money moving out into that market. I think last year we were along with many others, the beneficiary of parking money. And so we do not think that it’s likely, it’s possible, but we don’t think it’s likely that our checking account deposit numbers will be percentage wise, quite the same level they were last year. The exception to that might be business checking.

And do you think that it’s really the checking balances there most impacted by alternatives like the stock market or money mark mutual funds or which ones should we really be watching?

Well the checking balances are impacted in large part by the velocity of new clients and how active those clients are. If they are making investments for their stock markets or real estate or venture capital funds drawing down or what have you, you can get a movement out or reduction. But the other – the longer lines to watch are the past book in the money market accounts because those are subject to rate competition. As you know for instant the Dreisis [ph] and Swab money market accounts have been down round 1/2 %. And they will start to move up relatively quickly as the short end of the curve goes up and we’ll have to compete.

The issue will be is that will it squeeze our margins or is it going to simply be slow down in growth, and it’s a trade off at all times. We have recently increased our rates of debt in response obviously to the quarter point move. And we like though for a couple of weeks we’re able to hold back for a couple weeks then we started to have a very considerable slow down in growth so we’d move back up. And so we work very hard never to lose clients that we have but sometimes we chose not to play when it comes to getting new clients if we think rates are – have lift up suddenly orders of particular comparative market which is not going to change.

And Manuel as to your question it’s always kind of difficult to project what a whole year is going to be like in the first quarter. So I think we’re pretty comfortable with the compensation cost that we have recorded the first half of the year. And that’s really kind of what we always try to do is to get it right for the whole year and we have considerably – we’re now half way through the year.

So should we look at the average of the first half rate as what we should grow our compensation expense off of.

Yes I think so we will have – we complete the transaction that we’ve announced (indiscernible) we’ll have some additional people related to us, so that will affect several line items but that would be the starting point.

Great thank you very much.

And we have no further questions in the queue at this time, I’ll turn the conference back over to our speakers for additional or closing remarks.

Thank you very much we delighted that everybody take the time to be on the call and we appreciate the questions. Thank you very much.

That does conclude today’s conference. Thank you for your participation you may now disconnect.