First Republic Bank (FRC) 2005 Q2 法說會逐字稿

Good day everyone and welcome to the First Republic Bank Second Quarter 2005 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 Mr. Greg Berardi.

Please go ahead, sir.

Thank you and welcome to First Republic Bank Second Quarter 2005 Conference Call.

Speaking today will be President - CEO Jim Herbert;

Chief Operating Officer, Catherine August-deWilde; and Chief Financial Officer, Willis Newton.

A webcast replay of this call will be available at www.firstrepublic.com for thirty days.

An audio replay is available for two weeks.

Domestic and international participants can dial 719-457-0820.

The reservation number is 7946654.

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 forward-looking statements.

You should rely only on the Bank -- Bank's form 10Q, 10K and other regulatory filings.

And now I would like to introduce Mr. Jim Herbert.

Thank you, Greg.

Let me start by saying we're very pleased with the second quarter results.

Net income for the quarter was 12.7 million compared with 10.3 million for the second quarter of '04, or up 24%.

Diluted earnings per share for the second quarter was $0.50 per share, up over 22% over last year.

We're also very pleased to have increased our quarterly cash dividend by 25% to $0.12.5 per share up from $0.10 a share.

This dividend increase reflects our continued satisfaction with the Bank's overall results.

I would like to review some of the highlights of the quarter briefly.

Our margins held up well in the face of rising short term rates and a flattening yield curve.

Net revenue and deposit growth were solid.

Lending volume was a second best in the Bank's history.

Our credit quality remains very strong.

Asset growth was very good both in loans and investments.

Except for increased assets managed for the Bank, wealth management assets were relatively unchanged for the quarter.

Our efficiency ratio remains steady keeping in line with the [inaudible] trust bank peer group and at a level we're satisfied with for now.

Year-over-year asset growth was 24% and year-over-year deposit growth was 27%.

During the quarter we also absorbed two costs that had an impact on our results.

First, following the issuance of 50 million of new series B preferred perpetual stock in mid-march we incurred the first full quarterly payment of preferred dividends which impacted net income by 670,000 after tax for the quarter, or almost $0.03 a share.

Or asset growth in the second quarter generated sufficient net interest income to fully offset the cost of this new capital.

We're pleased with this result.

Second, during the quarter we settled certain litigation that had been pending.

This led to a pre-tax charge above our insurance coverage of about 1.2 million or $0.03 a share.

That was slightly higher than we had previously expected.

I would like to take a moment to talk about the initiatives that were undertaken to further optimize[inaudible] franchise.

As we mentioned in our last call leveraging our wealth management is a major focus for this year and next.

Specifi -- specifically we've done the following over recent quarters: we've introduced a new open architecture model for our wealth management clients and we've nearly completed the hiring of our wealth advisory team to implement this model.

We've hired additional reps also in our broker dealer group.

In addition to wealth management, our [trust] in the private banking continues to be quite successful.

Private banking for businesses continues to be quite successful and we're very pleased with it.

Kathy will discuss some of the additional specifics of the wealth management activities in a few moments.

As you may recall, our plan is to open two to three new branches or offices per year on the average.

We're currently working on five or six additional preferred banking offices, none of which may be quite open by the end of '05 however.

Although we would expect them all to be operational throughout '06.

All of the currently contemplated locations are in existing markets or are natural extensions of markets where we're already operating.

As we continue the study optimization of the franchise, we're keeping a close eye on market conditions particularly housing prices and interest rates.

In the second quarter we took further steps to modestly tighten our already very tight lending criteria in response to the rise in-housing prices.

Over all we're actually quite satisfied with the composition of our loan portfolio and the strength of our credit quality.

With respect to interest rates, our balance sheet continues to perform well as the yield curve flattens.

We do expect short term rates to continue to rise.

In short it was another very solid quarter.

We continue to execute the business plan while remaining attuned to new opportunities.

Our franchise is performing quite well and our extraordinary service levels are being maintained.

Now I would like to turn over to our Chief Operating Officer, Katherine August-deWilde.

Thank you.

As Jim mentioned the second quarter was a good one.

Asset growth was very strong in both loans and investments.

Asset quality remained excellent.

As we expected, total fee income in the second quarter was comparable to that in the first quarter.

Our efficiency ratio was 67.8%.

Without the settlement related charge that Jim mentioned, the efficiency ratio would have been 66.2% or consistent with where it has been for the last twelve months.

We are currently satisfied with this efficiency ratio given the stage of development of the enterprise.

Deposits grew at a 19% annual rate for the quarter and 27% year-over-year.

The growth was due to new client acquisition, effective cross selling, and a steady increase in client referrals.

Our checking account balances have been approximately 1.7 billion for most of the year.

While the June 30th balance is up 27% year-over-year, it has been challenging to grow checking account balances in 2005 at least thus far.

We are however pleased with our core deposit growth rates.

With higher interest rates our clients are moving funds to money market accounts and other higher yielding accounts.

As a result the average balance per checking account has declined somewhat from year end.

Offsetting this trend, however, is that we're bringing in many new accounts from the many new clients we're doing business with.

Although non-interest income was up 30% compared to a year ago, it was essentially flat quarter to quarter.

This was due to three factors.

A decrease in the gain on loan sales, we sold fewer loans, a modest decline in wealth management fees, and on the other hand all other non-interest income net was higher.

With respect to wealth management activities, these were $11.6 million, an increase of 16% compared to a year ago but a slight decrease compared to the first quarter of 2005.

The modest quarterly decline in investment management fees was due to the full quarterly impact of two items we discussed in last quarter's call.

These were the successful plan maturity of a large CBO and the loss of one large account by Froley Revy both of which occurred in the latter part of the first quarter.

Those declines were partially offset by the growth in new wealth management assets.

We're making significant progress in developing our wealth management franchise.

For example, our Brokerage Services and Trust Company have performed very well over the past quarter and the past year.

Assets for each group has grown more than 75% in the past twelve months.

We're also seeing early results from our open architecture investment models that we have been building for awhile.

This approach provides access to [inaudible] investment advisors or from a large number of alternatives.

The model is comprehensive and seamless and delivers financial planning, asset allocation, manager selection and consolidated reporting to our clients.

Also during the quarter we effectively completed the hiring of additional wealth advisors.

The full cost of which we'll show initially in the third quarter.

These experienced professionals help our clients choose and implement the Wealth Management solutions that best meet their needs.

Results thus far indicate the clients are clearly appreciating the quality of the presentations and the choices being offered to them.

Turning to loan origination, volume was 1.25 billion in the sec -- second quarter, up 40% from the first quarter and nearly equal to the record set in last year's second quarter. 55% of home loan originations for both the quarter and the year were purchases.

The strong lending volume was due to the active real estate markets in which we operate, favorable interest rate environment, and continued new client acquisition.

Given the discussion in the press about home prices and real estate lending, we thought some metrics about our current loan portfo -- folio would be helpful.

Specifically, our home loans originated in the last year have on average the following characteristics.

Average loan to value for purchases was 63%, for refinancings was 53%.

Our clients have liquidity on average which equals several times their loan amount.

Clients have significant net worth and average FICO scores well over industry standards in excess of 740.

As a matter of information, the Bank has not and does not intend to offer low dock or no dock loan programs.

It is also worth noting that First Republic successfully offered clients interest only loans for more than a decade.

These are generally tax driven with a high quality of our portfolio and our clients low loan to values.

The credit worthiness of our interest only loans remains strong.

As a matter of history, the Banks total loan losses on $19 billion of single family home loans over the past twenty years including interest only loans is only 1.5 basis points.

That's a cumulative number.

The [inaudible] adjustable rate mortgages First Republic has for many years had a policy of underwriting a borrowers [inaudible] service capability at a rate meaningfully above the actual loan start rate.

Recently we further increased this qualifying rate to reflect the increase in short term rates.

Another indicator of our credit discipline is our under writing standards for home equity lines.

They are exactly the same as that for first mortgages, and the vast majority of our home equity lines are behind mortgages we have originated.

We've never had a loss on a home equity line since we started making these loans more than 15 years ago.

As a result of these of careful credit analysis and strong borrower profile, we're comfortable with our loan portfolio and our single family lending.

We continue to compete successfully on pricing but we have not and we will not compete on credit standards.

I would now would like to turn this over to Willis Newton, our Chief Financial Officer.

Thank you, Katherine.

During the second quarter the bank's net interest margin was 3.35% or equal to the prior quarter and up 17 basis points over last year.

We are pleased with this result.

Compared to the first quarter of this year, the bank's average loans increased $300 million in the second quarter and the average loan yield was up 28 basis points.

For investments the average portfolio increased $250 million and the average tax equivalent yield was up 8 basis points.

Collectively, the average yield earned on loans and investments increased 27 basis points for the quarter.

Our loans and investments continue to re-price upwards during the period based on higher short term market rates.

Our deposits grew at an annualized rate of 19% for total deposits.

And our core deposits grew at an annualized rate of 10% for the quarter.

Total deposits were up $283 million.

We have begun to see the impact of higher rates on our deposit costs.

On average, our liquid accounts paid 30 to 40 basis points more in the second quarter of '05 than in the first quarter.

And cost of our CD's on average was up 26 basis points.

However, our checking accounts earned modest interest and having an average of 1.7 billion in these accounts limited the growth in our overall cost to deposits to 25 basis points.

We increased the amount of borrowings from the federal home loan bank, the cost of which moved up 22 basis points.

So for the average of all liabilities this quarter, was 2.05% or up 27 basis points, the same amount of increase is -- as our average asset yield.

Thus our net interest margin was unchanged.

As a result of the bank's larger average balance sheet, our net interest income creased -- increased $4.7 million for the quarter, a quarterly growth rate of 7.8%.

Our capital ratios remain high.

And they were enhanced by the $50 million of series B preferred stock that we issued in March.

At June 30 our leverage ratio was 7.56% and our total risk base capital ratio was 13.28%.

These levels of capital allow further balance sheet growth.

At June 30 the bank had only three non-accrual loans for a total of $20.6 million or 2.4% of total assets.

Or .24% of total assets.

The largest loan in this group continues to perform well and has been making full payments for nearly a year.

These were very good results for the first quarter.

I will now turn the call back to Jim Herbert.

Thank you Willis.

In closing let me say we're -- we're very pleased with the results for the second quarter and year-to-date.

We're very focused on optimizing the franchise.

We continue to be fixated on delivering the highest quality service in the marketplace and pursuing other growth opportunities as they might present themselves.

Now we would be happy to take questions.

[OPERATOR INSTRUCTIONS] Mike McMahon, Sandler O'Neill & Partners.

Good morning everyone and nice quarter.

A couple -- or afternoon I guess at this point.

A couple questions.

The increase in the securities portfolio, can you give us some color on what types of securities were purchased.

I assume there was probably more municipal securities purchased in the quarter and if that's true I would imagine the tax rate might be go -- be going down a little bit?

Mike, the -- the [inaudible] portfolio did grow up in the quarter but more of a -- more of an ongoing investment rate.

Biggest increase was government adjustable rate paper.

And we billed up -- it's a bit of a tactical move to cover the costs of the preferred and get it employed properly.

The -- the rate of increase in the quarter should not be projected forward.

Okay.

And would that have any change on the -- on the -- on the tax rate?

At this point we believe that we have anticipated sort of a mix of our income for the year with the year-to-date effective tax rate so I think we're pretty good for the rest of this year, Mike.

Okay, and were the securities purchased throughout the quarter or towards the beginning or the end or can you sort of generally characterize that?

Relatively evenly throughout.

A little more skewed towards the end maybe.

Okay.

Very good.

And I'll tell you what, I will get back in line.

Thank you.

Okay.

Thanks, Mike.

Kevin Reevey, Ryan Beck Brokerage.

Good afternoon.

Willis, can you talk a little bit about the service charge item, what the key driver there was in the quarter was it price?

Was it volume?

Was it both?

Yes, I think you're probably referring to the loan and related fee item, 1.7 million for the quarter up from 949,000 last quarter.

This primarily relates to prepayment penalties that we collected on loans that paid off during the quarter.

This is -- we didn't see a huge increase in loan repayments but the particular loans that -- that -- that paid off during this quarter carried a sizable number of prepayment penalties which we do a good job of collecting on.

And those customers that prepaid, did they refinance though you or was it through another institution?

I would say by and large they -- they refinanced with us, Kevin, they may have gone from a adjustable rate loan to a 5 or 7 year fixed rate loan.

Or they may have had a five or six -- five year loan that was several years old that they wanted to extend on.

And then the growth in your -- it looks like you have excellent growth in your loan categories, particularly in -- in the C&I loan category, were you seeing the growth particularly what kind of loans are you booking?

That is Jim, Kevin.

That's mostly the growth as I referred in my comments only brief -- briefly in our private business banking activity.

And in the -- and in a decent growth in commercial real estate, smaller commercial real estate and multi-family deals.

It's our -- our perception of is it's -- it's good growth, it's steady and it's diversified.

And then on the deposit side, who are you stealing share from because your deposit growth actually was very impressive when compared to other institutions.

Pretty much everybody in every market.

I mean it's not any one particular target.

We're just taking more share.

The real driver, though, for us that's different than others, and it's really a key part of our franchise is the private banking driver.

Our deposits are now more than half from what we consider to be private banking direct sources as opposed to office deposits.

Also a big driver is the private banking business relationships we're establishing who are meaningful sources of deposit growth.

Great.

Thank you.

Thank you.

Manuel Ramirez, Keefe Bruyette and Woods.

Hi, good afternoon.

Congratulations on the quarter.

I have a couple of questions I think directed at Catherine.

Could you talk about whether or not there were any significant expenses associated with the ramp up in the new wealth management model which is in place but maybe there were some significant up front costs that were run through the P&L the last two to three quarters?.

If you -- kind of give us a ballpark sense of how much that may have been?

And secondly a related question is what would be the ongoing expense associated with that business?

We have been working to build our Wealth Management business over the last year, and we've had a bit of a steady increase in the last several quarters including a few hires throughout the beginning of this year and a sig -- and the majority of them were hired at the end of this quarter.

So we had some expenses for this quarter.

I don't have the exact dollar amount, the full brunt of which will for the first time will be felt in the first quarter.

We are also however bringing in revenues along with them at this point.

We have initially offered some of our products only as a pilot, they're now fully out there.

Okay.

And as far as the revenue model, I guess what kind of fees would you collect on every dollar of assets that you bring in that are managed by an outside manager?

And how do those fees stack up relative to what other institutions you're competing against offer?

We are competitive with other institutions offering the same product and I think it is a bit of probably too much information to say on this call exactly what that's going to be, but they're competitive with other people.

We're very pleased -- we're very pleased with it so far.

Okay.

But presumably when the reven -- revenues are significant enough you will break it out on -- on the call.

Yes, yes, definitely.

Okay.

Terrific.

Thank you very much.

Don Worthington, Hoefer & Arnett.

Good afternoon.

A cup -- couple of things.

One, I just want to clarify in terms of the numbers you're showing for the total Wealth Management assets at about 14.5 billion, that now includes the securities portfolio; is that correct?

Willis -- Willis that 14.5 includes the three managers?

Yes, [inaudible] always included those on a segment basis and we're now just highlighting that we've disclosed it in the past in the Qs, but now -- now we'll probably make sure that -- that's aware.

Those entities do ac -- actively manage these investments earned fees which are included in their segment revenues but are of course eliminated when we put our consolidated books together.

Okay.

Thanks.

And then in terms of the [inaudible] 90 day past due moved up a little bit, 6.8 million.

Is that anything in particular or just some smaller items there?

We have one single family home loan I think that is 90 days past due and in the process of collection, and that -- that loan is in bankruptcy and we would expect to have resolution of that in the next six months.

And we would expect to collect all of our money.

Relative to the loans that are on non-accrual, we dispersed a few extra funds to complete the -- the build out of the tenant improvements on -- on the largest property.

And there was one small loan that was added this quarter.

Okay.

Thank you very much.

Thank you.

David Henley, DLH Capital.

Hey, Jim, could you spend a second and just talk about how much your growth in deposits and loans is dependent upon your new branch activities so maybe you treat everything that's been open for 24 months or more as kind of a comp and then you look at what's happening in your comps with deposits and loans versus the new branches?

Sure.

I will do it any general way because I don't have those the numbers exactly in front of me.

But our -- our definition of new, as many of you know, is two years or older open or a relationship manager with us or what have you.

We've used that for a number of years.

The -- the growth of the old -- older branches over two years or more is running quite satisfactory.

It is about 8 to 10%.

We can have that in more detail for the next call.

The new -- the new locations tend to grow faster but of course they're coming off small basis.

But in theory, if we've chosen our location right they meet an unmet need from a convenience point of view and have an early deposit growth gathering spurt, so to speak.

For instance our Time Warner branch in New York is one of our fastest growing branches ever.

In fact, it may be the fastest ever and is doing very well.

And so the -- the newer locations are -- are -- pick up -- pick up with good early 40, 50, $60 million and then they begin to slow down a bit percentage wise.

The piece you can't measure quite as accurately is the money brought in by relationship managers in the private banking piece.

Most of them actually continue to gather deposits at a very, very strong, steady growth rate because they have the compounding effect of new clients and referrals.

The -- again, though, a new relationship manager with us always has a spurt of new activity as they bring clients over and so on.

Then they establish a base.

Then they grow at a more normal but -- but by market standards high rate, more normal for us.

Thank you.

So it is 8 to 10 on both deposits and loans for the more -- for the more mature branches and then the balance really is coming from -- from the newer branch activity?

That's correct, David, except that the loans are not as tied to branch locations.

They're more the centralized people.

And the deposits are the ones that are kind of same store measurable.

Thank you.

Jed Gore, Sunova Capital.

Hi.

Thanks for taking my question.

Great quarter.

Just a sort of theoretical question.

Is there a size either in terms of the assets in the loan book or that [inaudible] Froley Revy where you start to scale a little bit in terms of your expense base?

Well, the answer -- the answer in the loan book side is yes because then you're seeing that in the -- in the profitability of the offices and of the balances in terms of loans.

And the -- and the management -- the asset management side there is definitely economy of scale, but they're still climbing over.

We did not cut back when the markets declined.

We kept our overhead, we kept the people.

And we're now coming back through that basically over the last twelve months.

And so the economy of scale is improving slightly and should improve more [inaudible] into the growth.

There is specific -- there is definitely economy of scale in the broker dealer and the Trust Company which we're just beginning to achieve.

Okay.

So you're mentioned comfortable with your efficiency ratio here so I guess we can assume that the efficiency ratio will stay about this level, but at some point begin to creep a little bit lower or is that a fair statement?

It -- it probably is fair.

It's probably fair.

We are comfortable, as Katherine said, for the current state of the development of the franchise. [Inaudible] We're not trying to be cute.

What we mean by that is that we have a number of things still being developed, as I think we've talked about extensively.

And those need to -- those need to -- those need to break through to exactly your point, Jed, which is the economy of scale.

And second question on the margin.

This quarter you were able to offset the rise price of your funding with -- with repricing your loans.

Is that trend -- do you expect that trend to continue?

Which is to say are you going to continue to be able to fight off margin pressure?

It is honestly hard to say.

Our models would indicate we're in pretty good shape.

It really depends on two things, how fast the rates go up and so forth and quite measured as we all know.

And number two, if the yield curve at some point ultimately averts, the pressure will be more extreme for everybody including us.

Right, and prepays, I guess, spiked up to about 19% in the quarter.

Any sense of where prepays are month-to-date?

We don't have that number.

Okay.

Qualitatively do you -- do you see prepays continuing to run at this level.

Yes.

I think so probably, maybe a little lower or higher.

I mean it depends on the -- depends on the -- the -- the five-year, seven-year treasury report.

Okay.

Thank you very much.

Thanks.

Mike McMahon, Sandler O'Neill & Partners.

I tried to delete that.

My question has been answered.

Thank you.

Manuel Ramirez, Keefe Bruyette and Woods.

Hi, a couple quick questions.

First on deposit growth, Katherine noted that it's been tough to grow checking deposits on surprisingly in the current interest rate environment.

But as far as overall non-timed deposit -- deposit growth going forward over the next year or so, how would you set your expectations if -- if you were an analyst in thinking about deposit growth?

I think you spoiled the market with pretty phenomenal-- growth the last couple years but clearly it's getting more challenging particularly as the Bank gets larger.

I'm just trying to wonder what you think is a realistic expectation?

And then secondly on the securities portfolio since part of the -- the thought process was to leverage capital in order to neutralize the impact of the coupon you had to pay on the preferred stock.

Should we assume that you're going to bleed off some of those securities as the balance sheet continues to grow?

And do you chew up the capital with loans?

Thanks.

In terms of deposit growth for the year while it's a bit tougher to grow deposits right now, we expect to have good steady deposit growth.

And in terms of the securities portfolio we built that up to a level and that level well covers the preferred dividend and we would expect it to stay at about there and growth steadily and particularly including our municipal bond strategy which is a quarter-by-quarter month-by-month strategy.

Okay.

But let's say that deposit growth is slower than it has been historically and as a result it is not as easy to fund the balance sheet going forward, would you just assume start to shrink the securities book a little bit rather than replace instead of trying to fund your -- your balance sheet wholesale?

It probably won't shrink the book any, Manny, I think it'll stay the same and grow very modestly.

The deposit, but don't miss read Katherine's comments.

The deposit growth so far is quite satisfactory.

We're pleased.

The piece that's causing us a little -- a little concern is the shift towards interest paying components as opposed to checking growth.

On the other hand we've [inaudible] checking very steady and the amount of -- the amount of new accounts that we've opened in checking is -- is almost exactly the same as the -- as the decline in average balances so it is holding quite well.

We are up 19% at an annual rate for the quarter.

Right.

Like I said you spoiled the market.

And the final question is since you did mention that there was a little more [inaudible] pressure on the deposit rates in the second quarter, can you give us an update what you're seeing early on in the third quarter.

A little bit of more of the same.

You know rates -- as rates move up, the money market funds are the source of the primary pressure of course and money market funds have a duration of about 60 days or so in them and so they catch up about every 50 or 60 days.

And so the last increase will ripple through over the next thirty days.

Okay.

Thank you very much for your input.

Thanks.

[OPERATOR INSTRUCTIONS] It appears there are no further questions today.

Mr. Berardi I will turn the conference back over to you for additional or closing remarks.

Okay.

Thank you.

Thank you all very much for taking the time.

We appreciate it.

Bye bye.

And that does conclude our conference call today.

Thank you all for your participation.