First Republic Bank (FRC) 2006 Q1 法說會逐字稿

Good day and welcome to the First Republic Bank first quarter 2006 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 Snedaker.

Please go ahead, ma'am.

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

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

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

An audio replay is available for two weeks.

Domestic and international participants can dial 719-457-0820. the reservation number is 2164928.

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 would like to introduce Mr. Jim Herbert.

Thank you, Diane.

Let me start by saying the first quarter of 2006 was the best earnings quarter ever.

Net income for the first quarter was 13.3 million, a 22% increase compared to the first quarter of last year.

Diluted earnings per share were $0.57, which was up 16% over the first quarter of last year.

We were pleased to have exceeded by about $0.02 the consensus earnings estimate of $0.55 a share for the quarter.

Let me review for a moment a couple of the highlights of the quarter.

Loan volume held up better than it was expected.

It was 21% ahead of the same quarter last year.

Deposit growth was very strong.

Katherine will talk more about that in a moment.

Our net interest margin increased 11 basis points compared to the fourth quarter.

The first quarter of this year did, however, prove to be a bit challenging for loan growth on our balance sheet.

We experienced rapid loan payoffs and, because of the flat yield curve, we continued to originate a large number of longer term fixed rate loans.

We did not keep these on the balance sheet.

We did continue the purchase of additional investments.

Our efficiency ratio was up a bit, mostly as a result of taking advantage of growth opportunities that could enhance our franchise.

As always, some of these new investments take time to mature.

A few of our recent investments include the opening of offices in Boston, Greenwich and Portland, Oregon.

As we previously reported, we recorded a $3.8 million recovery to our loan loss reserves from the payoff of a large commercial real estate loan that had been restructured.

As a result, we did not need to make a loan-off provision during this most recent quarter.

We are also very pleased to declare another cash dividend of $0.125 per share for the quarter.

Strong deposit growth at a reasonable cost was a key reason that our interest margin increased from the fourth quarter.

The adjustable assets on our balance sheet, particularly our prime based loans and investments, also helped as rates continued to rise.

So far, SLI bill restructuring is working out relatively well.

The first quarter was also notable because it highlighted two very positive trends for the bank.

Our continued strong success in attracting terrific new clients and our ability to capitalize on opportunities that fit strategically into our business plan.

With respect to new clients, our relationship managers and wealth advisors are doing a world class job.

We continue to land significant new clients in our markets at an accelerating rate.

This is primarily due to our very high service levels, coupled with the growing dissatisfaction of clients coming from institutions where service is being reduced, our business models are in a state of flux.

Our commitment to exceptional client service is also being validated by the success in penetrating the higher network segments within our markets.

First Republic recently completed a biannual review of its market strategy in conjunction with a very respected international consulting firm.

We found some very interesting things, including the following: higher net worth households are disproportionately concentrated in the metropolitan coastal markets on which we focus.

Within these markets, the number of high net worth households is growing more rapidly than in other areas of the country and the household -- the high net worth household share of wealth is increasing.

Finally and most importantly, First Republic's overall penetration rate of high net worth households in our markets has increased over the past two years, rather nicely in several cases.

We are in some operating a very strong rapidly growing markets among a rapidly growing segment.

And we continue to take market share.

Because we understand our target markets and their potential, we have been comfortable in pursuing opportunities that present themselves.

This is exactly what we have done in each of the past few quarter, including early in the second quarter of '06.

We are pleased with our recent expansion into the northeast.

In Boston we are building on the past five years of a very successful loan production office and are seeing good initial response to our new full service private banking office there.

In Greenwich, Connecticut, we are off to an equally good start and have a terrific team in place.

Early this month we entered the Pacific northwest with an initial wealth management office in Portland, Oregon.

The office is staffed with highly experienced investment management and trust professionals.

The Pacific northwest fits quite nicely with our strategy of serving markets with a concentration of high net worth individuals, particularly if the markets are reasonably approximate to our existing locales.

In short, we remain very pleased with our overall progress.

Despite the challenges of balancing growth on a flat yield curve, the entire franchise is performing well.

We are particularly pleased with the ever improving coordination among our relationship managers, our wealth advisors and our preferred banking offices.

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

Thank you, Jim.

We are very pleased with our results for the first quarter.

Growth and deposits was quite strong.

Loan originations were robust.

Asset quality continues to be excellent and assets under management were up nicely.

In the first quarter deposits grow by more than $1 billion, which is clearly very strong.

But this growth included some unusual items.

I want to take a moment to discuss the reasons for this growth and to properly normalize it. $390 million of deposit growth came from CDs acquired in connection with our expansion in New England.

These deposits have been sold and will move off of our balance sheet at the end of the second quarter.

Of the remaining $600 million in deposit growth, about one-third came from our preferred banking offices, another third came from normal deposit gathering activities from our relationship managers and the approximately remaining one-third was due primarily to meaningful implosive funds from several of our larger fund management clients.

While this last component is an important part of our business, it does ebb and flow and was particularly strong during the first quarter.

We're very pleased that our average checking account balances rose to $2.1 billion, an increase of 9% over the prior quarter's average.

This is somewhat higher than our trend line expectations, and also contributed positively to our margin.

Assets under management were up approximately $1 billion, or 8% compared to the fourth quarter.

Wealth management fees were up slightly in the fourth quarter and they should improve next quarter due to the increased assets under management at March 31, 2006.

Most wealth management fees are calculated on assets at the end of each prior quarter.

Asset quality continued to be excellent.

We had one foreclosed property carried at $500,000 at the end of the first quarter.

Now accruing assets consist of $9.4 million, or just 10 basis points of total assets.

Looking at the key segments within our housing market, we see rising inventories and fewer multiple offers that exceed the asking price.

However, home purchase activity remains active.

Our portfolio of single family home loans remains very strong.

Our average loan to value is 58% at the time of origination.

For all of last year, 67% of our originations were single family home loans.

For this first quarter, this was 63% of originations.

Single family home originations were split evenly between purchases and refinances for the first quarter.

By dollar amount, we originated 16% more single family home loans in the first quarter of 2006 than the first quarter of 2005.

We are also quite pleased with our cross sales success on new loans, which was over 8.5 products and services and is at an all-time high.

I would like to take a moment to address three initiatives that we're focusing on in 2006, increasing checking accounts, expanding business banking and growing wealth management assets.

As I mentioned earlier, we are quite pleased with the growth in average checking balances and will continue to focus on checking growth this year.

In the past year, business loans were up nicely and business checking now represents more than half of our checking deposits.

Our private business banking has been successful as we follow our clients through the businesses and organizations they own or run.

In mid 2005 we started to hire wealth advisors to work with our relationship managers in each of our markets to generate assets under management, primarily from the relationship manager's clients.

We are pleased with the results thus far, as these wealth advisors are increasing referrals from our relationship managers.

In the first quarter of 2006, our wealth advisors brought in $266 million of assets under management.

By comparison, they brought in $392 million for the last two quarters of 2005.

Overall, our franchise is performing very well.

We believe that our high client satisfaction demonstrates continued strong team work between our bankers and our wealth advisors.

Client acquisition is -- no -- no audio ]

Katherine, it appears that we have lost your sound.

Can you hear me?

Let me conclude Katherine's remarks.

She indicated that client acquisition is strong and our high service quality is leading to many new referrals.

These fundamentals are at the core of our business strategy and reflect First Republic's evolution to a fully integrated wealth management franchise.

Good morning, everybody, this is Willis and I would like to comment quickly on five topics, net interest margin, stock option expense, loan repayments, our efficiency ratio, and the tax rate.

Our net interest margin was 3.31% in the first quarter, up 11 basis points compared to the prior quarter.

In the last call we discussed our concerns about pressures on our net interest margin from the flat yield curve.

There were several positive influences in the first quarter.

First, many of our investments adjust quarterly and they earn higher rates beginning January 1, due to the two increases in the prime rate that occurred in the fourth quarter.

Also, the adjustable rate loans in our portfolio based on prime and even the ones based on lagging indexes, such as coffee, earned higher rates and continued to move up throughout the quarter.

Importantly, as Katherine mentioned, our average checking balances were 9% higher.

These additional low-cost funds had a positive impact on our margin.

Also, as a result of deposit inflows and strong deposit growth, we were able to lag rate increases on our money market accounts.

We expect that our net interest margin will continue to be at risk as long as the yield curve remains flat or inverted.

But would note that it has ranged between 3.18% and 3.35% since the first quarter of 2004.

Over these last nine quarters, the period that includes the beginning of the fed rate increases.

There's been a lot of discussion about stock option accounting this quarter.

Since 2003, the bank has been expensing options as they were granted.

In adopting the new accounting standard, FAS 123R this quarter, we have only added the expense of a few unvested options.

For the first quarter, the bank's after-tax option expense was $54,000 in total.

For the full year of 2006, we expect only $174,000 worth of after-tax stock option costs, or less than $0.01 per share for the full year.

The bank no longer uses options as part of its regular incentive compensation.

In this year's proxy, the bank has submitted a proposal to stockholders that would cancel all remaining ungranted options in a further move toward reliance on respected stock.

During the quarter the bank experienced a relatively high level of repayments of ARM loans in both the servicing portfolio and on its balance sheet.

The repayment of loans resulted in higher amortization of mortgage servicing rights, which explains the decrease in net service fees.

Offsetting these lower fees was the collection of $1.4 million of prepayment penalties upon the payoff of loans in the first quarter.

The bank's efficiency ratio increased to 69.1% for the first quarter, compared to 67.8% last quarter.

The first quarter of each year is always a challenge due to annual salary increases and higher payroll taxes.

In fact, our highest efficiency ratio in both 2005 and 2004 was in the first quarter.

I'm pleased with the decline in our effective tax rate to 31.0% in the first quarter, compared to 34.5% for last year.

This lower rate is due primarily to the increased level of our muni securities and our investment in [Boley] and tax credit investments.

In conclusion, it was a good quarter and we're pleased with the results.

Now I would like to turn over the call to Jim.

Thank you, Willis, very much.

Let me just correct for the record, I evidently said the wrong quarterly earnings in my first opening remarks.

We earned 15.3 million for the first quarter.

We are very pleased with the quarter and are looking forward to the rest of '06.

We are very focused on providing client service in an outstanding manner.

This strategy is the key reason we continue to grow organically at the double digit rates that we are.

Thank you very much.

We would be happy to take questions.

Thank you. [OPERATOR INSTRUCTIONS] We'll take our first question from Mike McMahon with Sandler O'Neill.

Good afternoon.

And very, very nice quarter.

Thanks, Mike.

Can you share -- I didn't quite follow.

The last third of the deposit increase came from inflows from who, once again?

And you said that it fluctuates?

Katherine actually said it.

Katherine said it but I think her mike is out so let me try to respond.

Basically we have fairly sizeable business dealing with various funds, Private Equity, VC Funds, et cetera, quite a large number, several, meaning probably between 10 and 20.

And there were a fair amount of capital inflows in the first quarter, coming primarily from capital calls.

It's a good business.

It's a rather steady business for us but it does go up and down a bit and that's what she was getting at.

Okay.

And then I had evidently missed this, but First Republic wealth advisors is, I think, new to this press release.

And it had $146 million in assets under management or administration.

Can you talk about that, please?

The First Republic Wealth Advisors is a title we have given to a new group that have actually been functioning, Mike.

We have been talking about them as wealth advisors.

We just put First Republic on the title.

It's not an official -- it's not a corporate unit at all.

It's a designation for the wealth advisors that are operating between our relationship managers and the clients that want to use our open Portico platform.

The wealth advisors have been in operation since the middle of '05.

And they are generating assets for all segments of the wealth management segment, all entities.

We will be disclosing separately the amounts that are retained on the open architecture platform, and that's what you see, and that's grown to $146 million in about three quarters.

The total amount brought in, as indicated, is much higher.

And for the quarter was over $265 million.

Okay.

Very good.

And apparently you bought some more Boley in the quarter and is that run rate of 1.5 million a quarter a decent run rate?

The Boley was acquired the first of December.

So this is the first full quarter.

Okay.

So it is a -- yes, do you have the right run rate numbers.

Okay.

Thank you very much.

And a fantastic quarter on all measures.

We'll take our next question from Lana Chan with Harris Nesbitt Investments.

Hi, good afternoon.

I had a question about the prepayment penalties this quarter of 1.4 million.

Could you give us the amount that was in the fourth quarter of last year, as well as the first quarter of last year?

Yes, Lana.

We have been experiencing a relatively high level of prepayment fees.

I'm going to check that right now.

Is there another question while I'm looking.

Also on the other side of that, the higher amortization of MSRs.

Am I correct to assume that that increased by a like amount, of $1.4 million or was it a different amount this quarter?

Or how much did it increase?

The amortization of service fees was up about $300,000 this quarter compared to last quarter.

And compared to a year ago, it was about $1 million higher.

As long as the yield curve remains inverted, we would expect to continue to have the same sort of experience that we have been experiencing the last several quarters.

The prepayment penalties have been fairly consistent for the last three quarters.

Our loan-related fees was 1.6 million in total for the quarter versus 1.349 in the fourth quarter.

About 85% of that is prepayment penalties.

Okay.

I would say about 1.2 million in the fourth quarter.

I can firm that up for you.

Okay.

Prepayment fees that we have on our loans acts as a relatively natural hedge against more rapid payoff in either balance sheet or service to loans.

Right.

Right.

Okay.

And then could you remind us about your extension plan for the rest of the year?

What markets should we expect further branch openings?

We have planned in the markets that we already operate in somewhere between four and six additional offices.

And springing off of Portland, of course, Seattle and the northwest look like a natural expansion for us, if we can find something that's attractive.

So is that the four to six more offices, although it's likely to be this year?

Yes, they will be.

We have offices under construction in New York, down the peninsula in San Francisco, in the desert in California, and we are close to a deal on a location in the far west side of L.A.

Okay, great.

Thank you.

Thank you.

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

Good morning.

A couple of things.

One, was there any gain on the sale of the deposits out of the northeast?

The short answer is under purchase accounting we will sell them for what they were marked to, and there's no gain or loss.

Okay.

Thanks.

And then in terms of the securities portfolio, what would be your plan over the next, say, couple of quarters either maintaining that or running it down?

We would expect to maintain it or grow it a bit over the coming quarters, Don, depending on opportunities.

Okay.

And I guess lastly, in terms of the wealth management asset growth, do you have a breakdown as to how much was new business versus just increases in the market valuation?

That will take a minute to get.

We did have strong market growth this year, this quarter, and the growth was about a little over 1 billion, about 60% of that was market increases.

We had good net deposit and new account openings as well.

Okay, great.

About 40/60.

Perfect.

Thank you very much.

[OPERATOR INSTRUCTIONS] We'll go next to Manuel Ramirez, KBW.

Good afternoon, gentlemen.

I have got a lot of questions so give me the hook whatever you want to cut me off.

The expenses in the first quarter versus the fourth quarter, can you give us a little bit more of a breakdown on what the moving parts are aside from the normal seasonality?

It seems like the bump up is a little bit more than you would expect from seasonal issues.

And I guess specifically, since you were fairly active making investments in some markets outside of California, how much of that showed up in the first quarter?

Manny, we had the cost of Boston and Greenwich in the quarter for the entire quarter since those offices were open, but the merger had not closed.

We had most of the people on board during the quarter.

We -- everything else, I think is fairly normal in terms of the increase in people, the increase in all the marketing personnel, personnel related professional fees, and maybe there was a little bit of extra Sarbanes-Oxley costs this quarter, as we got to the end of the year and saw where that came out.

But not anything too unusual.

Have you pre-hired any people who are going to be in the locations that Jim referenced in the second through the fourth quarters?

We have about four or five savings or office people already working with us in that regard, Manny.

Okay.

And I know your locations are staffed pretty leanly, maybe two or three people per location.

Four or five would be two locations where you already have staffing costs then?

Yeah, although just to clarify, we're now running at about five people per office.

Okay.

Got you.

The second question is on your comment about, obviously, adjustable rates mortgage retainments have been accelerated, not a surprise.

We also know that you don't retain fixed rate mortgages.

I guess the question really -- still it begs the question, what does that do for growth in your mortgage portfolio going forward?

Should we assume that there is going to be less growth but more gain on sale income?

It's going to be challenging.

This first quarter was pleasantly surprising in most respects, obviously relative to overall volume.

But the growth in the balance sheet at the loan line is going to be challenging, until we get a reestablishment of a bit of a yield curve.

The good news is that adjustable rate mortgages are more desired by our customer base than the mortgage sort of borrowing public as a whole.

And number two, the purchasers of homes tend to go to adjustables a little more than fixed at the higher end also and we tend to be a relatively significant purchase finance shop, rather than a refinance shop.

Okay.

So we shouldn't assume a 30% plus prepayment rate persists necessarily indefinitely?

It's hard to call.

We're just watching.

It won't be indefinite, obviously, but it could go on for a while.

I mean, it's hard to call.

Okay.

And one last thing and then I will jump back in the queue.

This is a question for Jim.

You said that you have a proposal for shareholders to cancel existing options and just buy unrestricted stock.

What does that mean for restricted stock grants in the near term?

Well, we have out for our proxy we have a request for 875,000 additional restricted stock.

That's meant to be at least a couple year requirement.

And we are cancelling, I believe, Willis, correct me here, about 120,000 options that were unused?

So you are going to replace some of those presumably?

We would, but we have gone and we are proposing to go entirely to restricted stock, which, in fact is what we have been doing pretty much for the last couple of years anyway.

I guess I was just wondering if you are cancelling 100 some thousand options would you immediately replace them with restricted stock in sort of a one to two or one to three ratio or something like that?

Well sort of in a soft way, yes But the answer is not immediately, no.

We're just offering -- we're asking for a grant to continue, obviously, as we need to hire people and so on.

Okay.

That's very helpful.

Thank you.

And Manny I would just add that the vesting period for our shares of restricted stock are five to seven years.

[OPERATOR INSTRUCTIONS] We have no further questions in the queue.

Actually we just now had one.

Lana Chan with Harris Nesbitt Investments.

Hi, sorry, just a quick follow-up on the tax rate.

Should we use 31% effective tax rate going forward?

Lana, we estimate our tax rate at the beginning of every year and that's what our current best estimate is for 2006.

Okay.

Thanks, Willis.

And we also had a follow-up from Manuel Ramirez, KBW.

Jim, can you give us a sense of how big you think ultimately the buildout in Connecticut and Boston will be?

Are we looking at two or three branches in each market?

Are we looking at something substantially more?

Obviously the market opportunity is not that huge in either one of those markets as it is in Manhattan.

If you could give us a sense of how big it gets and how quickly it gets that big?

Well to some extent, we are watching ourselves to see.

Greenwich is an obvious -- that north -- sorry the southwest corner of Connecticut is clearly a target for us.

But we're going to wait and see whether we need more offices there or not to establish a presence, which we clearly needed to do.

Boston is a little bit of reaction to the very strong team we have up there and have had for a number of years.

And we will also be watching that to see what our physical presence does for the flow of business.

We don't yet have an indicator.

We're very happy to be in both places but I actually can't give you a very good answer yet nor do we have anything in our planning that is very clear cut yet.

Okay.

So just let me know if I got this right.

New York, when you went in New York that was a very clear, obvious, big opportunity and obviously the early returns were good, so you've added people aggressively there.

Boston and Connecticut a little bit more opportunistic, you had the people in place.

You are going to watch how it pans out.

Maybe longer term you get a little more aggressive.

Near-term, you will watch how it goes?

That's very accurate.

We're waiting to see.

We have no doubt they will be successful.

The question is degree and, more importantly particularly in Boston, will more offices bring more business proportionately or not and we actually don't know yet.

And one last thing, and I promise I will shut up.

Could you give us a sense of, competitively, what you are seeing in Southern California?

Is the market where you said that you are adding a couple of additional branches?

Obviously growth has been good there over the years.

Who is coming?

Who is going in the market and what you are staffing -- how your staffing is changing down there?

Well, as you will appreciate and I'm sure you know, we generally don't comment on competitors per se, but the marketplace continues to remain very competitive.

Southern California is a tough market.

On the other hand we are getting our share of business.

We do intend to expand pretty much in all the areas that we're in in Southern California very steadily over this year and next and so on.

We're very pleased with it, with our position down there.

It is subject to the same consolidation that is going on elsewhere, but to a somewhat lesser extent, actually than some other markets.

So I think it's a stable marketplace.

The economies are strong.

L.A. is particularly strong.

And we continue to expand and expect to continue to do so.

Terrific.

Thanks, gentlemen.

And that is the last question we have for today.

I will turn the call back over to our speakers for any closing comments.

Thank you all very much.

We appreciate your time and support and thanks for listening into the call.

This does conclude today's conference call.

We appreciate your participation.

You may disconnect at this time.