First Republic Bank (FRC) 2005 Q3 法說會逐字稿

Good day and welcome to the First Republic Bank third 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 Ms. Diane Snedeker (ph).

Please go ahead, ma'am.

Thank you and welcome to First Republic Bank's third quarter 2005 conference call.

Speaking today will be President and CEO, Jim Herbert, Chief Operating Officer, Katherine August-deWilde, and Chief Financial Officer, Willis Newton.

A webcast replay of this call will be available at www.firstrepublic.com for 30 days.

An audio replay is available for two weeks.

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

The reservation number is 564-01-39.

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 Form 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're very pleased with the third quarter results.

Net income for the quarter was $14.3 million, an increase of 30%, compared with $11 million for the third quarter of last year.

Diluted EPS of the third quarter is $0.54 per share, up 26% over last year.

Importantly, net income for the nine months grew to 39.6 million, up 30%, or $1.54 per share, up 25% versus last year.

We're also very pleased to have declared a quarterly cash dividend of $12.50 per share.

The dividend reflects our continued satisfaction with the bank's results.

I want to highlight a few things for the quarter and then talk about a couple of important trusts of the company.

The following are some of the highlights: balance sheets grew very nicely.

Our margins dropped only slightly, and actually have held up very well as interest rates have continued to rise and as the yield curve has continued to flatten.

While fed funds (ph) have risen 275 basis points over the last five quarters, our net interest margin has remained very stable, ranging quite narrowly between 320 to 335.

This quarter's margin was 331.

Our lending volume set a record.

It was the largest single quarter loan originations in our history.

Total wealth management assets grew by 3% in the quarter, and have grown now 13% year-over-year.

Core deposits were up very nicely and total deposits have increased 26% in the past year.

I will speak more about this in a moment.

Additionally, we raised $24 million in new common stock by selling 660,000 shares.

We are quite pleased with this transaction and it was quite timely.

From a strategic perspective point of view, third quarter results reflect the continuing success in growing our franchise and in managing two particularly critical areas of our business-- continued deposit growth and maintenance of loan quality.

Let me focus for a moment on deposit growth.

It might provide some insight into the strength of our franchise.

And it underscores a fundamental difference between First Republic and many others.

At a very basic level, deposit growth is the core of our business.

In this regard, we continue to be quite successful across all segments.

We approach deposit gathering somewhat differently than others and in a three distinct ways-- we gather deposits through preferred personal banking, we gather deposits through preferred business banking, often related to preferred personal banking clients, and we deposit gather through our 30 preferred banking offices.

Rising interest rates are making deposit gathering more challenging.

In fact, our organic deposit growth rate continues to run at a rate at least twice the industry average.

There are good reasons for this.

Our growth in deposits is the direct and planned results of the extraordinary service levels delivered to our clients by top-flight bankers and a vast array of other current client service personnel.

Exceptional, differentiated client service remains the very foundation of our First Republic brand and it has become a competitive advantage in the marketplace.

To understand the importance of integrated service quality, please consider that a meaningful share, for instance, of our preferred banking transactions actually take place at our preferred banking offices.

Each of our offices is a fully integrated service center, prepared to meet the needs of our largest clients, as well as walk-in clients.

That's very unusual in today's world of private banking, which is increasingly siloed and structured in ways that promote a service layering from one piece of an organization to another.

Superior service quality supports our deposit growth in three key ways.

First, satisfied clients are the best generators of new clients and additional new deposits.

We live and have lived for years on word-of-mouth marketing.

It is the single most potent force to build an enterprise.

Clients have been bringing their friends to us with increasing regularity and often take great pleasure in sharing this secret with their friends.

Second, client satisfaction translates into a higher customer retention rate.

We have a very low customer turnover.

Third, our service quality has enabled us to create deep and very broad relationships.

On average, our loan clients, for instance, purchase more than seven products from us.

The stickiness of our relationships that this reflects helps attract and keep deposits, and importantly, gather related deposits such as businesses or non-profits with which the satisfied preferred banking customers are often involved.

In short, clients love the service they're getting and they bring their friends.

To further underscore how these factors manifest themselves to strong deposit growth, it's useful to review a few metrics.

The preferred banking deposits represented by our direct preferred banking function total $3.3 billion today.

This function hardly existed six years ago.

It is now 52% of our total deposits.

This source grew 30% in the last 12 months.

Our preferred banking offices represent 46% of total deposits and grew 25% over the last 12 months.

Currently, only one office which is opened just five quarters ago is not breakeven, but it's rapidly approaching profitability.

Importantly, more than 20 preferred offices open more than four years deposit growth in even these offices, which one can consider to be fairly mature, was 19% year-over-year in the last 12 months.

Total deposit growth in the 10 offices open less than four years was 68% in the last 12 months.

So, some very unusual results and we're quite pleased.

Well we may not-- we've not open the new offices in '05, although we may open one, we currently expect to open between five and eight locations in '06.

In addition to deposit growth, we are also pleased with the continued strong performance of our loan portfolio as interest rates continue to rise.

There is only one delinquent borrower in our single-family portfolio.

The key reasons for this strength are our traditionally conservative credit culture and a high quality of customer.

Quite importantly for our long-term safety, at the time of loan origination, the average loan to value ratio of our entire single-family loan portfolio is 57%.

Many of our single family loans are interest-only mortgages, which have now been originating quite successfully for over 12 years.

These loans meet the needs of our high network client.

We have never had a loan loss in any such loan in our history.

In short, it was a very solid quarter and a strong nine months.

We continue to execute our business plan, while continuing to maintain very high-quality assets.

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

Indeed, First Republic's brand is its extraordinary service.

Now let me turn it over to Katherine August, our Chief Operating Officer.

Thank you, Jim.

The third quarter was a very good one.

Growth in both assets and deposits were strong.

Loan originations were the highest in the bank's history.

Asset quality remained excellent.

Total fee income in the third quarter increased compared to the second quarter.

Our efficiency ratio of 67.3% for the quarter is consistent with our efficiency ratio over the past year.

Deposits were up nicely, increasing at a 70% rate for the quarter and 26% compared to a year ago.

In our last call, we mentioned that checking account balances were relatively flat for the first six months of the year.

Checking balances have begun growing again, rising 8% for the quarter and they are up 27% compared to a year ago.

Checking account balances are now over $1.8 billion.

Total non-interest income increased 34% compared to a year ago and was up 5% in the second quarter.

Wealth management fees, deposit fees and loan fees were all up for the quarter.

Our non-performing loans decreased due to the pay-off of one $4.5 million loan that had been in foreclosure.

In addition to receiving all of our principles, we collected past due interest, late charges and other expenses.

I would like to take a moment to talk about our loan portfolio and conditions in the housing market.

As it has been reported in the media, inventory of homes for sale are up and prices have softened somewhat in our market.

This is something we have been expecting for a while, and our loan portfolio is well-positioned as interest rates continue to rise.

Importantly, the average loan-to-value of our single family loans at time of origination is 57%.

Our home equity portfolio reflects similar strengths.

That's because our home equity lines are made up of loans primarily to the same borrowers.

Our home equity lines are carefully underwritten to qualified buyers one at a time with the same exacting standards and the same discipline and the same types of loan-to-value ratios with which we originate first mortgages.

As we have said before, we will never compromise and have never compromised our underwriting standards to compete in our markets.

Our current balance sheet, interest only loans represent 79% of single family home loans.

We have been making these loans to high net worth clients for about 12 years.

We both retain and sell these loans.

And importantly, we have never had a loss on any interest-only home loan.

The reasons are partly in our underwriting.

At time of origination, the average single family home loan client at First Republic has a net worth in excess of $10 million and liquidity which is sufficient to repay our loan almost four times.

The average FICO scores of our borrowers are about 740.

Finally, we underwrite all of our adjustable rate mortgages for the qualification interest rate that is substantially above our fully-adjusted start rate.

For example, we currently underwrite adjustable rate mortgages at 8%, which is fully 3% higher than today's actual starting rate.

The quality of our clients and the focus on discipline in our underwriting process is the reason we have experienced over 20 years only 1.5 basis points of cumulative loan loss on home loans, including home equity lines originated.

With respect to wealth management, our platform is now fully complete and is being well received by clients.

For this quarter, investment advisory fees and assets are up 3%.

Compared to a year ago, these are up 13%, and we're pleased with these increases.

We have had significant growth in our trust and brokerage activities.

Trust assets are up 57% year-over-year and brokerage assets are up 78% year-over-year.

Overall, we are pleased with the continuing volume of business, acquisition of new clients and our asset quality.

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

Thank you, Katherine.

During the first and second quarters of this year, the bank's net interest margin was 3.35%.

For the third quarter, we reported a margin of 3.31%, a relatively small decline given the current continued rise in short-term rates and the flattening of the yield curve.

The bank's average yield on loans and investments increased 23 basis points for the quarter.

Our loans and investments are responding to the move up in short-term rates.

Looking at liabilities, the cost of borrowings from the Federal Home Loan Bank moved up with short-term rates and were up 42 basis points in the quarter.

On average, the cost of our liquid deposits has increased 30 to 40 basis points in the third quarter compared with the prior quarter.

But the costs of our CDs were only up 21 basis points.

Our checking accounts earned very little interest and have an average of almost-- and having an average of almost 1.8 billion and these accounts limited the increase in our overall cost of liabilities to 29 basis points.

Although our margin was down four basis points, the increase in our average balance sheet moved our net interest income up $3.8 million or 6.2% on a linked quarter basis.

As noted in our last 10Q, a continued measured increase in interest rates should result in slightly higher net interest income and a relatively stable net interest margin over the next year.

A continued flattening of the yield curve or a temporary inversion would put more pressure on our margins in the near term.

During the quarter, we issued 660,000 shares of common stock.

This was our fifth transaction to raise capital in the past two years, including three small stock sales and two preferred common stock offerings.

In these transactions, we have raised about $165 million of tier 1 capital.

As a result, our capital ratios remain strong.

At September 30, our leverage ratio was 7.49% and our total risk-based capital ratio was 13.35%.

Loan servicing fees, net of amortization, declined in the third quarter of 2005, compared to the prior quarter and last year's third quarter.

This is in spite of the growth in our servicing portfolio to an all-time high of over $4.1 billion.

Because of the increase in the prepayment of certain adjustable rate loans in our servicing portfolio, we have increased our amortization rates on mortgage servicing rights this year and recorded a small impairment charge of $140,000 in the third quarter.

However, as we have noted before, we are collecting a high level of prepayment penalties as these loans pay off.

The loan and related fee line includes approximately $1.5 million of prepaid fees in both the second and third quarters of this year.

Now, I will turn the call back to Jim Herbert.

Thank you, Willis.

In closing, I would like to leave you with a thought.

We remain totally focused on providing outstanding client service and hiring the very best bankers we can find.

This strategy is the key reason we continue to grow organically at double-digit rates or more than twice the industry average.

Thank you.

We'd be happy to take questions.

Thank you. (OPERATOR INSTRUCTIONS)

And we'll take our first question from Mike McMahon from Sandler O'Neill.

Good afternoon.

A couple of questions.

You had record loan originations in the quarter in a post-refinance market.

And I am not surprised, given that rates are still attractive in housing activity here.

But can you give us a little more color on the $1.3 billion?

Approximately how much were single family and what you believe is driving the record loan originations?

I don't have the exact number on the amount of single family, but a quite high percentage is.

This quarter was a very active purchase quarter for home loans.

In addition, as we've continued to hire bankers who bring clients, that's helped us grow our origination.

And our commercial real estate business banking, as well as secured loans are growing, but it's still heavily single family business.

Okay.

And then I heard you or Jim say that, or somebody say that you qualify the borrowers at the 8% rate when the start rate is closer to 5.

And I'm hearing stories out there, and I never know if the stories are true, how prevalent they are.

But start rates of 1% or 1.5%.

Are you not doing those teaser rates?

We are not doing those teaser rates.

Our loans are fully accrued at start.

And we have, for many years, originated loans where we qualified the borrowers at well above the start rate, if the loan is an adjustable rate loan.

Right.

And I'm -- for the record I don't think anyone is concerned about Ios (ph) at First Republic.

Willis, a question for you.

On the collection of the delinquent loan, did that have any material impact on the interest on the margin in the third quarter?

Mike, there was-- we probably collected several hundred thousand dollars worth of back interest on that.

But we-- the increase in the loan and related fee line from last quarter to this quarter is related to late charges and other foreclosure fees and penalties that we collected in connection with that borrowing.

Okay.

I was just concerned or curious, if the margin perhaps was up a basis point or two, where it would have been, had you not collected that previous uncollected interest?

I am not sure it would make a full basis point difference.

Very good.

Thank you.

(OPERATOR INSTRUCTIONS)

We'll take our next question from Kevin Reevey with Ryan Beck.

Good afternoon.

Congratulations on nice quarter.

Thanks, Kevin.

I was wondering if you could tell me.

I noticed that the assets under management Froley Revy were down about 4%.

If you could give us some color there?

Yes I can, Kevin.

Unfortunately, Froley Revy lost one large-- or pretty good-sized, anyway-- state account in the quarter.

They shifted out of what they consider to be any alternative income product into straight agencies and governments, as I understand it.

And that was about a $200,000, $250,000 loss.

They also -- converts did not have a very good quarter.

And it has not been a good time for the converted market.

It is getting a little better.

But as you know, it has been a hard year for converts.

Let me just follow-up on that.

The total assets lost from that client were about $300 million, which results in about a $200,000 a quarter change.

This happened sort of at the end of the quarter.

So we had those assets for most of the quarter this quarter.

But offsetting that was some appreciation this quarter that was approximately 200 million of market appreciation on their base, which is the first time we've seen that this year.

And that was good news for Froley.

And then I notice that your short-term borrowings were up about 24% on a quarter.

Can you talk about how you are thinking about your funding strategy going forward, and how do you think that would impact your margin?

We have used short-term borrowings, as you know, from time-to-time to respond to loan growth blip-ups, which this quarter certainly represented.

We also carry our- in our minds, an allocation- we carry loans held for sale with FHLB borrowings.

That's a warehouse facility, almost.

It doesn't function that way, but that's how we line up the funding.

The other thing is that to some extent-- and we're cautious about this because, of course, deals might not close.

But to some extent, as you know, the pending merger that we have with First Signature is mostly a cash asset acquisition.

And that would be utilized if we close the transaction to reduce short-term borrowings.

So in other words you would use the cash on their balance sheet to reduce the short-term borrowings that were outstanding?

Yes.

Exactly.

We need a place to go with the cash.

Great.

And the final question is early, Jim, you mentioned you're going to open about six to eight new offices in '06.

Should we be thinking about our expense assumptions differently going forward?

Well, I think-- the answer is yes to some extent.

The good news is that by the time that those open we will have no offices that are unprofitable that are currently open.

As I mentioned, we have one that's a little short of profitability, but very little.

That's an unusual condition for us.

So we have been functioning with three to five, three to six offices below breakeven for quite a while.

The fact that we have five to seven, five to eight brand new ones next year, probably will negatively impact us a bit.

They are not, with one possible exception, out of area.

Their in-fill offices and markets were already in.

Great.

Thank you.

Thank you.

(OPERATOR INSTRUCTIONS)

And we'll take our next question from Don Worthington with Hoefer & Arnett.

Good morning.

Couple of questions.

One, on the-- you mentioned two non-accrual loans, commercial real-estate loans.

Can you provide any additional information there without being too specific ?

Just kind of in general, the nature of the loans and what your expectations are there for resolution?

Hi, Don.

This is Willis.

Hi.

The bulk of our non-accrual loan balance continues to relate to the one loan here in San Francisco that, at this point, is now fully occupied and has been paying for-- currently for more than a year and has been on cash-basis interest recognition.

We will be looking at that in the fourth quarter to determine its status.

And then, there is one other smaller loan that we think we are reasonably well-secured.

Okay.

Thanks.

And then, in terms of-- in the deposit generation, you were talking about all the reasons why deposits are up so substantially.

And it looks like, in fact, you're doing such a good job that the ability to fund loans isn't necessarily keeping pace.

So you're getting an increase in securities.

Is that something you would expect to continue or would you work down the securities portfolio and put it into loans, over time?

It's a good question, Don.

The increase in securities is, to some extent, related to the utilization of the capital, which we acquired as well as related-- I referred to in the last 12 to 18 months.

We have gone after capital opportunistically, aggressively, as we saw the markets being well priced from our point of view.

And we wanted to employ that-- those funds, but employ them in a very liquid and AAA level way.

And that's the increase driver.

It's unlikely that the investments would experience a same percentage increase.

Okay.

Great.

Thank you very much.

And we will take our next question from Manuel Ramirez with KBW.

Hi.

Good morning.

I have a few questions.

I'll only ask a couple, and then get back into the queue.

First, on that last comment from Jim.

Willis, would it be possible to quantify the impact on the margins from adding securities to offset some of the dilutive impacts on the capital raises?

I know it's hard to get a precise number.

But generally speaking, what the core margin would have looked like ex that additional $500 million or so securities?

Manny, quarter-over-quarter, the yield on our securities portfolio was down about 14 basis points.

And so that was a bit of a drag on our margin.

Okay.

Most of our investments are in SBA adjustable rate, prime-based paper.

And we would expect them to keep pace with the move up in rates.

But we did sort of add a big slug at the end of last quarter and the beginning of this quarter.

And now we would just be maintaining our portfolio due to runoff.

So what you have been adding incrementally was the floating rate securities?

That is correct.

Similar to what you had earlier in the year, if I remember correctly.

You had some munis (ph) as well.

We are gradually building our muni portfolio at a fairly steady pace.

Okay.

Thank you for that.

The second question is really on your expansion plans for next year and how that relates to the efficiency ratio.

Given the comment that virtually all your branches are at breakeven at this point, or will be very shortly, should we read into that that we probably saw a trough efficiency ratio sometime earlier this year and you should see an increase from here?

Let me just give you-- let me take a quick overview comment, and then ask Willis to detail that a little bit.

The primary variables in our efficiency ratios have a lot to do with the pace at which we hire new bankers and the pace at which we open new offices and the volume of business we are doing.

A large part of our costs in the enterprise are variable.

They are driven directly off of volume, both of deposit gathering, of assets under management gathering, and importantly, off of lending.

To the extent should you have the growth rate that we are experiencing, you have an intrinsic early inefficiency, particularly in the deposit gathering piece and the loan gathering piece, because both loans and deposits have very long lives, as do AUMs (ph).

And the cost-- the variable compensation cost-- is impactful in the first about eight quarters.

So that's the main driver, Manny.

In there, however, is the cost of an office.

The actual cost of an office, the rent, the people, are component of expense that is often climbed past in about 18 months, unless it's a Time Warner office or a big location.

Most of what we expect to be opening are going to be more modest in size in the next 12 months than anything of the order of magnitude of a Rockefeller Center or a Time Warner with one exception, and that is we are looking downtown Manhattan.

But even that will be a little more modest.

Okay.

That's helpful.

And then the other side of that is, given that your core deposit growth continues to be healthy, I think, by any measure in this environment and you are opening these new branches, what impact do-- is it possible to quantify the impact of adding these new branches over the next 12 to 18 months on your deposit growth rates sometime next year?

In other words, you go from 15 to 20% core deposit growth to 20 to 25% core deposit growth, given what you are doing on same store sales in your very old branches?

I think that I would like to be optimistic enough to think that our same store sales will keep up at this level.

And quite frankly, they have for a number of years.

But we are pushing the limits probably here on how good this can be.

Now, we think that way every quarter, to be honest with you.

And every quarter, we are pleasantly surprised for a long time now.

But I just want to put out that note of caution.

Having said that, mostly we are filling in service points and/or we are filling in outreach points for preferred bankers to operate in and be able to handle the immediate territory.

That's a particularly important concept when you remember that mostly we are an urban bank, and urban markets operate in sort of concentric circles of influence geographically.

And thus, the upper east side of Manhattan, for instance, is a very important service point for us.

The lower end of Manhattan is an important service point to add.

We are going into the desert in California, which services both Northern and Southern California clients, as well as local.

So I would say that they-- I would hope that they would be additive.

But the percentages are off of small bases, of course, for new offices.

Right.

So your point is that since you are filling in service areas, that you are really supporting your existing customers rather than gathering a lot of new deposits?

No, we will be gathering a lot of new clients because of proximity and the ability to get to them more quickly and service them better, too.

So it will be about-- it will be a lot of both.

That has been our experience anyway.

Okay.

Great.

Let me make one extra comment ...

Sure.

...about occupancy costs.

Over the last year, year and a half, while we haven't opened extra branches, we have done some things in our locations to expand, adding floors (ph) in San Francisco, expanding in New York and in Los Angeles and our major hubs.

We have growth room now in these locations, and so I would characterize that part of our occupancy cost to be sort of at a run rate, and that the growth coming going forward will be added as a result of the satellite offices that we will be opening in the various locations.

Okay.

That is helpful.

Adding coin counting machines, I'm sure?

All right.

Thanks.

And we'll take our next question from Jed Gore with Sinova Capital.

Hi.

Thanks for taking my question.

Good morning.

Good morning.

Great quarter.

I just was hoping, since I got you on the call, to ask about-because a couple of my questions have already been answered-just ask about this bank you bought from John Hancock.

And sort of, what the strategic rationale is, what you get for it and what did you pay?

We paid a bit above buck, which is what we have announced, a modest amount above buck.

The strategic initiative mostly is driven by further expansion into New England, in terms of their ability to operate in several states.

And we expect to close it towards the end of the year or first quarter of next.

It is a limited expense acquisition in the sense that it's mostly an asset and liability acquisition.

It's subject to regulatory approval, at several levels.

And we're in that process now.

So this gives you a banking license basically in New Hampshire, Massachusetts, Maine, Connecticut?

Well, it could.

Okay.

And book value was 40 million?

The book value is in the high 20s.

Am I right Willis?

Okay.

The book value does not include some preferred stock that is owned by the parent company.

Okay.

Thanks.

And I appreciate your time.

And we'll take our next question from Dave Henley with DLH Capital.

Hi.

Actually you just answered both of my questions.

They were about first signature and then the plans for where the offices will go.

Maybe you could spend a second and tell the extent you know if you've got one more Manhattan office, where would the other four or five or six go approximately?

Sure.

We are entering Napa, and we are going into, as I said, the desert in California, the Palm Springs area.

We are going down to Los Altos, which is an outreach from the Palo Alto market we're already in.

We're going into the Manhattan locations, as I indicated.

And that's all the East Bay.

I'm sorry-- we're headed into-tentatively, subject to a final location, the East Bay here in San Francisco.

Thank you.

Thanks.

And it appears there are no further questions at this time.

I'd like to turn the conference back to our speakers for any additional or closing remarks.

Thank you very much for your time.

We appreciate it.

Thank you.

And that does conclude today's conference.

We do thank you for your participation.

And have a great day.