First Republic Bank (FRC) 2005 Q4 法說會逐字稿

Good day and welcome to the First Republic Bank fourth quarter and year-end 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. Dianne Snedaker.

Ms. Snedaker, please go ahead.

Thank you, and welcome to First Republic Bank's fourth quarter and year-end 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 3345616.

Before we begin, I'm required to inform you that some of the statements made on this call may be forward-looking, which involve inherent risks and uncertainties.

A number of important factors could cause actual results to differ materially from those in the forward-looking statements.

You should rely only on our forms 10-Q, 10-K and other regulatory filings.

And now I'd like to introduce Mr. Jim Herbert.

Thank you, Dianne.

Let me start by saying that 2005 was a very good year.

Our best yet.

This was in spite of a very challenging interest rate environment.

Deposit growth was exceptional.

Loan originations were the highest we've ever had.

Assets under management increased.

And our net interest margin for the entire year increased even though the margin dipped in the fourth quarter.

Net income for the year was $54 million, a 27% increase year-over-year.

Diluted earnings were $2.08 per share, a 21% increase year-over-year.

We're also very pleased to declare another quarterly cash dividend of $0.125 per share.

What I'd like to do is review the year's accomplishments and outline some of the challenges for 2006.

Then Katherine and Willis will discuss the fourth quarter in more detail.

During 2005, the balance sheet grew very significantly, 26%.

Our loan portfolio increased about 15%.

Investments grew an unusually large amount due to purchases which we made as we quickly employed new capital raised opportunistically during the year.

Importantly, deposits were up 25%.

A key reason for this is that client momentum is very strong.

Even in a rising rate environment, we still added $314 million, or 18%, to our checking balances.

And we also added $561 million, or 20%, to our other liquid accounts.

For the first time in five years, our CDs did grow as a percent of deposits as clients saw higher yields.

CDs at the end of the quarter were 22% of total deposits, up from 18% at the end of last year.

Our net interest margins for the full year increased to 3.33% compared to 3.24% during '04.

This nine basis point year-over-year improvement came despite continuing increases in the fed funds rate.

Our fourth quarter net interest margin did decline to 3.20, giving back some of this increase during the year, and we're now coming under some margin pressure.

Willis will comment on this further.

Loan volume exceeded the 2004 record level.

Our mix of loan originations was quite stable with single family volume and slightly higher business lending.

Total Wealth Management assets grew 7% and Wealth Management fees grew 10%.

Our asset quality remains stellar.

Nonaccrual loans at the end of the year were 8 basis points of total assets.

From a strategic perspective for a moment, 2005 was the year in which we further strengthened our Wealth Management platform.

Our brokerage and trust activities had a very successful year.

Brokerage assets grew 60% and trust assets increased 46%.

Our investment managers had generally positive operating results, although there is opportunity for improvement.

Overall, we were happy with our Wealth Management activities in 2005.

Katherine will discuss these in greater detail in a moment.

Separate from performance metrics, there are a number of other achievements in 2005 we'd like to highlight.

We increased the quarterly dividend of First Republic common stock by 25%.

We completed a three-for-two stock split in March.

We raised $74 million in new capital.

First from a $50 million issue of preferred at an attractive price and then from a $24 million sale of common stock also at attractive price.

Both of these were opportunistic.

Fitch Ratings upgraded The Bank's long-term deposit ratings to single-A-minus.

We've made progress in expanding our franchise on the East Coast.

The previously announced acquisition of a New England bank will soon give First Republic the opportunity to open branches in Boston, Massachusetts and Greenwich, Connecticut.

Clearly it was a very good year.

2006 will be more challenging for everyone in banking, including ourselves.

We expect a difficult operating environment due to the flat yield curve, potential for further rate hikes, and a probable lower loan volume.

Noninterest expense is also likely to increase somewhat as we open approximately six new preferred banking offices this coming year.

In spite of the likely challenges in '06, we intend to continue building our core franchise with new locations extending our New York franchise into Greenwich, making our Boston office full service, and steadily optimizing the investments we've made.

We will never compromise the quality of service to our clients, which is our franchise and continues to attract new clients at a very rapid rate.

Now I'd like to turn it over to our Chief Operating Officer, Katherine August-Dewilde.

Thank you, Jim.

Fourth quarter was very solid and we're pleased with the performance.

Growth in both assets and deposits was quite strong.

Loan originations were robust, and only slightly below the third quarter's record.

Asset quality was excellent.

Our efficiency ratio was 67.7% in the fourth quarter and was stable throughout 2005.

Our noninterest expenses were up 15% fourth quarter-to-fourth quarter and up 25% for the year.

Historically, the first quarter is always our most challenging.

This is primarily due to lower loan volumes, higher payroll costs, and in 2006 the opening of new offices, beginning in the first quarter.

In the fourth quarter, deposits increased 535 million, which is an annualized rate of 33% compared to the third quarter.

Checking account growth was particularly strong with balances over $2 billion at the end of the year, up $217 million in the fourth quarter.

Fourth quarter is typically a very strong quarter for checking account growth, and this last quarter was no exception.

Wealth Management fees were up slightly for the fourth quarter compared to the third quarter, due to our success in growing our client base.

Our momentum among Wealth Management the clients seems to be building nicely.

Asset quality continues to be excellent.

There were no foreclosed loans at the end of the fourth quarter.

Nonaccruing assets consisted of two real estate loans totaling $7.6 million, or only 8 basis points on total assets.

Our portfolio of single family home loans remains very strong.

Our average loan-to-value is 58%.

As we've mentioned in the past, approximately 80% of our single family home loans are interest only.

We have never had a loss in an interest-only loan in the 12 years we've been originating them.

Looking at the housing market, we are seeing rising inventory and fewer multiple offers that exceed asking price.

Nonetheless, our markets remain strong, and we are still seeing active interest in home purchase.

Home purchases represented 44% of single family loan originations for the fourth quarter and 50% for the year.

Let me also talk about some additional areas of performance that were noteworthy in 2005.

In the fourth quarter, we solidified our Wealth Management services to provide clients with a comprehensive range of investment options.

To that end, we integrated wealth advisors into each of our markets in conjunction with the launch of Portico, our open architecture investment model .

Wealth advisors consult with clients to help them decide how their assets should be managed to meet their goals and objectives.

Portico provides clients with financial planning asset allocation, ongoing quarterly reporting, and a wide selection of investment management options for broad diversification.

Wealth advisors help clients choose from among a wide selection of investment solutions.

The program is being well received.

In addition, in 2005, our preferred banking offices had strong growth.

Offices open more than two years grew deposit balances 24%.

We're delighted with the continued growth of these more established offices.

Business banking also grew nicely.

There was strong demand for our Eagle One product, which is our small business loan.

We're also very pleased that we continue to acquire marquee private business banking clients.

At the end of 2005, nearly 50% of our checking deposits were attributable to business banking.

Further, we're quite pleased with our cross-sales success.

Preliminary numbers indicate that our 2005 loan clients were using an average of 8.25 products or services. 22% of them were Wealth Management clients, either through our wealth advisory subsidiaries, trust, or brokerage.

We continue to focus on service quality.

Our clients remain satisfied, and they are increasingly referring their colleagues and friends to us at what seems to be an accelerating rate.

Our high client satisfaction is due in part to improved teamwork between our relationship managers, business bankers, and wealth advisors.

Our bankers are increasingly comfortable referring their clients to wealth advisors and business bankers.

We're pleased with the stability of our employee base.

Turnover has always been relatively low at First Republic.

However, it declined in 2005 as a result of focused improvements in recruiting and training.

Overall, we're happy with our business model, new client acquisition is strong, and the high level of client services leading to many new referrals.

These fundamentals are at the core of our franchise, and they're working very well at First Republic.

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

Thanks, Katherine.

I'd like to elaborate on a few points that impacted our earnings this morning.

During the fourth quarter, our net interest margin declined 11 basis points from 3.31% to 3.20%.

For most of 2005, we have had a stable margin and have been able to lag increases on our deposits.

In the fourth quarter, we finally had to respond to competitive pressures by increasing rates on our passbook and money market accounts, the cost of which rose by 50 basis points on average.

This increase drove up the cost of our deposits fairly quickly due to the average size of the balances in these accounts.

Looking at our assets, some of our investments reprice quarterly and do not yet reflect the prime rate increases that occurred in the fourth quarter.

Also, those adjustable rate loans which reprice on a lag basis do not yet fully reflect previous rate increases.

Nonetheless, on the liability side, our net interest margin will face continued pressure as long as the yield curve remains flat, and more so if it inverts.

Additionally, if our competitors significantly raise their deposit rates, we will be required to follow suit.

I'd like to comment on a few trends in our nonaccrual loans.

This past quarter, we moved one large commercial real estate loan, totaling $16.3 million, from nonaccrual status to performing restructured because of continued payments and positive operating results.

This loan had been on nonaccrual since June, 2002, but it has been making all its payments for the past 16 months.

Included in our nonaccrual loans at year-end is one renovation home loan and another small property which has now become an REO.

Also, there are $5.9 million of single family loans which are more than 90 days past due.

These loans are well secured and in the normal process of collection.

The net gain on sale loans was $843,000 for the fourth quarter, a lower amount than in the prior two quarters.

This lower level of gains is due to the sale of $153 million pool of intermediate fixed rate loans which occurred in the fourth quarter.

Such sale resulted in a loss of approximately $850,000, or 55 basis points.

After retaining hybrid loans of this type for most of the year, we decided to slightly adjust our balance sheet, as we do from time to time, to make room for additional hybrid loans in 2006.

Our professional expenses for the fourth quarter of 2005 were higher than normal run rate.

During the quarter we reached a final agreement with our insurance company on proceeds to be paid on the litigation settled in the spring, and we receive all payments under our policy.

This left an additional one-time cost of $580,000 for legal fees which were not reimbursed to the bank.

Total costs related to this litigation, including deductibles and the amount expensed in the second quarter, was 2.5 million.

This concludes this litigation and there is currently no material litigation against the bank.

Finally, a major element of our EPS calculation is the number of shares outstanding.

For the fourth quarter, the bank's diluted shares increased 387,000 compared to the prior quarter.

As you may recall, we issued 660,000 new shares in an equity offering in the middle of the third quarter.

Due to the timing of that offering, only half of those new shares were outstanding in the third quarter EPS calculation.

The higher level of shares outstanding in the fourth quarter of 2005 was responsible for a $0.01 per share lower earnings on a quarter-to-quarter comparison.

Now I'll turn the call back to Jim Herbert.

Thank you, Willis.

In closing, we'd like to say that we're quite pleased with the year and are prepared for the challenges of '06.

We remain totally focused on providing outstanding client service and driving towards client acquisition.

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]

Our first question comes from Mike McMahon, Sandler O'Neill & Partners.

Good morning.

A couple questions.

First, I noticed that the assets under management at Trainer Wortham declined in the fourth quarter.

Can you give us some color on that?

Mike, I think we need to mention that the AUMs are now being presented net of the assets that Trainer and Starbuck manage on behalf of the bank.

So that is a reflection of the different method of presentation.

I believe the Trainer assets actually increased a little bit this quarter.

Okay.

Prepays are slowing, and I think you indicated they were about 14% annualized in the fourth quarter down from 18 in the third quarter.

So you may have lower loan originations in '06 due to the O curve or higher rates or some combination of that, but wouldn't a general offset to that be lower prepayments and therefore not necessarily significantly lower balance sheet growth?

Yes.

That's exactly right.

We would expect our prepays to be lower if our refinances are slowed.

We're not sure of the impact, but that's a correct statement, Mike.

Alright.

Thank you for now.

Thanks, Mike.

We'll hear next from Jordan Hymowitz with Philadelphia Financial.

Hi, guys, good quote on the loan and deposit growth again.

My question is that, if we stay in the current environment where we are today, the current yield term environment, where would the margin settle out at, at this point?

That's hard.

Jordan, it's hard to call.

Remember one thing I'd like to remind people of.

We have some control over that, because we can choose to grow deposits at a lower rate.

And if the balance sheet growth slows down, we probably will do so.

The point at which we would do that would be the point at which we felt that the growth of deposits was not attracting a very substantial number of new clients at the same time.

We have been responding in the last year with growth in the deposit side because, in addition to growing the funds, we were in fact bringing in tremendous number of new clients through new trial.

It's very hard to-- if you look at-- you can look back historically for about eight quarters.

Willis, correct me if I am wrong here, we have operated pretty much between sort of 315 and 335.

Okay, and maybe I can ask the question this way.

Was the end of the quarter margin substantially different from the average?

Yes.

Because we raised rates on our deposit pools of two type -- passbooks and money market accounts -- in the month of December, the answer is yes.

Okay, and can you say what that number was, or that's proprietary?

We don't really break it out.

It's a little too tight to be accurate.

But the other thing that's happening is we are hopeful that the rates that we now have are set and will sustain us in a competitive environment that we foresee for the quarter.

Okay.

Thank you very much.

Thanks.

[OPERATOR INSTRUCTIONS]

Our next question comes from Kevin Reevey with Ryan Beck.

Good morning.

Good morning, Kevin.

Willis, I was wondering if you could tell us what percentage of your loans that are on your books are variable in nature and then what percentage are at or near caps?

Is that something you track?

About -- at the present time, between two-thirds and three-quarters of our loans would be adjustable rate in nature.

Adjustable within one year.

We don't really track the loans that would hit an interim cap, and I'm unaware of any loans that have hit their maximum life cap.

Okay, and then as far as deposit pricing, where do your rates stand vis-a-vis your most, I would say, aggressive competitors in the marketplace?

Are they at, above, or below kind of the median rate?

We're still running a little below.

The service quality delivered can still attract our clients without rate -- head to head rate competition.

Our bigger challenge has been a migration within our customer base moving out of checking and into rate paying instruments as rates have become back on the radar over the last year.

We've been-- we have managed to keep a little ahead of that in the checking side, as you can see, by having a growth in checking.

But that growth has come through a tremendous number of new relationships opening up while the average balance in our checking accounts probably has diminished a bit.

The other migration that's occurred is that -- and that's why we mentioned the CDs -- for the first time we have money market and passbook money moving back towards CDs.

That's not so much a rate advantage at this moment as it is a bet on turn by the clients.

Got it.

And then, Katherine, you mentioned that at the end of 2005 that your loan client used about 8.25 products.

How does that compare to the prior year?

The prior year, it was about 7.5.

The 8.25 was for the whole year?

It's for anybody who did a loan with us in 2005.

And it's up quite significantly from the prior year.

Great.

Got it.

Thank you very much.

And next we'll hear from Manuel Ramirez with KBW.

Hi.

Good morning, everyone.

Good morning, Manny.

A couple questions for you.

First, kind of a nitpicky question on your loan and related fee line.

If I look at the decline in the prepayment rate on your loan portfolio versus the decline in your loan and related fees, it seems like the decline in fees was a little more substantial.

I'm just kind of wondering, for modeling purposes, how should I think about driving that number, off of which factors.

And then I have a follow-up.

We did continue to receive some significant prepayment penalties during the quarter on loans that repaid.

Earlier in the year, we had a special situation where a loan that had been delinquent paid a lot of late charges and foreclosure interest, that was not a recurring item.

And I don't remember if that was in the third quarter or the fourth quarter.

Okay, so it ran through the fee line, not net interest income.

That's correct.

Okay, alright, so that explains it.

In Q3.

I'm sorry?

That was in -- that special income was in Q3.

Okay, that makes sense looking at the trend over the course of the year.

And the second thing was, I was following up on the question on the margin.

Jim, I was kind of curious about your deposit pricing strategy.

What I could read in your comment based on not being able to lag deposit rates too significantly is that you feel like you have to pay up in order to track new clients, and I know that that is not really your value proposition, but I'm just trying to understand the logic a little bit better about why you need to move up rates if the primary motivation is to track new customers as opposed to just defend those interest-paying balances of existing customers.

Well, actually the strategy, you said it properly, Manuel.

The strategy is mostly a defensive strategy with current clients.

We have a philosophical base here which says it's a lot more expensive to get a new client than to keep one you already have.

And that I think is true of all businesses, some forget it.

And we do not run our deposit pricing based on what it takes to get new clients.

We run it based on what it takes to keep the clients we have.

And what has happened is that the awareness of rates of course has spread widely in the last year.

We were able to lag behind that for quite a while and then some competitors got so aggressive out here, in California in particular, that we had to be more defensive.

We held out as long as we could.

I think generally speaking, because of the service quality, we can lag behind.

But we decided to take a-- what I would call a slightly bold step for us and move up the rates in the two biggest account sections we have in December, and one of the thoughts was to try to mitigate the migration to CDs.

Okay.

And then the early returns on that strategy have been positive?

Working very well.

Very positive.

It was exactly what we needed to do, but it was a bold stroke at one time.

And of course there's nothing comparable in the asset side that moves in bulk like that.

Sure.

And then, one last question on deposit pricing.

We'll get past that subject.

If we're looking at your rates vis-a-vis competitors, I have a tough time thinking about precisely who the competitors would be in your niche, like-- if whether or not I could actually see those specific rates.

Obviously, in one of your markets, City National is the logical one, but kind of, who should we be looking at when looking at rates across companies?

Well, there's two types-- there's two steps of competitors.

One are the bank-like, the bank competitors, and then in our offices you have to at least take into account the-- still the savings and loan, savings bank competitors, although we're able to price way under them now.

We still feel that pressure.

Not so much head-to-head on service, but we do feel it in advertising.

And so we have to be-- we responded-- for instance, we introduced a liquid CD in response to others who had it.

It's actually an attractive product because you can down price it-- you can trade for the liquidity of being able to pull it out, and it doesn't act like a liquid account, it stays.

So we have really two levels of competitors.

Then we have, I would say, effectively three markets truly.

Northern California, southern California, and New York.

And so we respond individually in those markets.

In New York, where we don't have a large base of certain types of accounts, we're actually prepared to be a little more aggressive in order to build the relationships, and the newness of the market gives us more flexibility, and we don't worry too much about sort of short-term pricing on a quarterly basis.

We pay a lot of attention, but we don't worry about it if we don't have a large base.

I think the other thing that's going on -- as you know, relative to indexes, our positive pricing is in fact continuing to decline, but the lag time on our mortgage products on the 11th, for instance, and some on the prime quarterly adjust have lagged a little bit.

Okay, that's extremely helpful.

Thank you.

Our next question comes from Don Worthington with Hoefer Arnett.

Good morning.

Hi, Don.

Couple things.

One, you mentioned the increase in the securities portfolio to leverage the capital.

Can you comment a little bit about where you'd see the securities portfolio going over time, in terms of percentage of your balance sheet.

From the current level, as a percentages, it's likely to stay steady or decline.

It's not likely to go up.

That was a pretty large runup.

I should add it's almost 100% triple-A-rated munis or SBA adjustable rate securities, more of the latter.

Okay, and then secondly the branches you mentioned, six branches, did that include the two that you're acquiring in the northeast or is that in addition to?

No, it includes those two.

Okay, great.

And then finally, any outlook on loan sale volumes and whether you'd do another restructuring type transaction, similar to what Willis outlined for this quarter?

We can't really comment at this point, Don, just because we don't know actually.

We're kind of watching the balance sheet growth issue.

Okay.

Thank you.

[OPERATOR INSTRUCTIONS]

We'll hear next from David Henley with DLH Capital.

Hey Jim, could you just spend a second on the Wealth Management business where you've made some changes in the platform?

Do you have some goals that you could share with us for what you hope will be the growth in AUM going forward, X market appreciation and some sense for that 22% penetration rate, where you think that can go and what share wallet you think you have?

Is there any kind of quantitative or qualitative comments you can make about your expectations for that business this year?

I'm going to make some qualitative comments.

We're really at the introductory stages of this broader platform.

We're very pleased with it, but we don't have enough information to project off of.

Our goal, as always, is to continue to better penetrate our client base and to grow that number, which we have continued year-over-year.

Obviously we're focused on growth.

One of the things that's in the numbers here, as we need to remind ourselves is, Trainer Wortham in the last year had a $500 million CBO mature successfully.

So that was an asset downtick, and the convert market of course has been under a lot of pressure, so Froley Revy's had a challenging year.

That's actually improving recently.

But our -- we think '06 is the year that tells us how well this new platform works, and so we're watching it, working very hard at it.

We have the people in place.

Importantly, in '05 we've carried, in the second half of '05 at least, we've carried pretty much a full cost structure in the new methodology.

And now we have to watch it begin to deliver.

Thank you.

Thanks.

And we'll take a follow-up question from Mike McMahon, Sandler O'Neill & Partners.

Yeah.

I wanted to ask when did you actually implement the increase in the deposit pricing?

The first round of increases was December 1 pretty much.

Okay.

And then the second round was towards the end of December or just recently in January.

We are now at rates that are higher by about 50 basis points on our passbook and our money market savings than they were prior to the increase.

We did two one quarter increases, Mike.

Okay, and then --

And by the way, we, to some extent, although we're very much a private bank, even private banks function at the retail level, and we crossed a point, which was 4%, and so we decided that it was worth the extra 10 or 15 to get to that point.

Okay.

As a depositor, I appreciate that.

[ LAUGHTER ]

I'm one of those guys that moved money out of a NOW into a CD last quarter, but it wasn't material, unfortunately.

[ LAUGHTER ]

Salaries were down link quarter.

That was a little surprising.

Can I have some color on that?

I think, as we got to the end of the year, we realized that we had inadequate provision for incentive comp.

Okay.

And finally, could I expect, or could we expect mortgage servicing fees to move up a little bit?

Presumably you're going to set the amortization rate for the quarter at a lower rate than it had been.

The servicing portfolio consists of both fixed late loans which are prepaying at a more slow level and adjustable rate loans, some of which have picked up recently with the flat yield curve.

So it'll be a mix of pluses and minuses going forward, Mike.

Alright, then probably no material change to the run rate?

Hard to call.

Hard to call.

We'll keep following the market.

The market would seem to say there are pluses and minuses.

Very good.

Thank you.

And seeing no further questions, I'd like to turn the conference back over to our speakers for any additional or closing remarks.

Great, thank you all very much.

We appreciate it.

And thanks for listening in.

Bye-bye.

That does conclude today's teleconference.

We would like to thank everyone again for their participation, and have a wonderful day.