First Republic Bank (FRC) 2006 Q2 法說會逐字稿

Good day and welcome to the First Republic Bank second quarter 2006 earnings results conference call. [OPERATOR INSTRUCTIONS]

At this time I would like to turn the conference over to Ms. Dianne Snedaker.

Please go ahead, ma'am.

Thank you and welcome to First Republic Bank's second 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 888-203-1112.

The reservation number is 2298654.

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 Forms 10-Q, 10-K and other regulatory filings.

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

Thank you Dianne.

Let me start by saying the second quarter was satisfactory, but very challenging.

Year-over-year results are strong.

Net income for second quarter was $15.4 million, a 21% increase compared to our second quarter of last year.

Diluted earnings per share were $0.57, which is up 14% from the same quarter last year.

The six months, overall, was also strong.

Net income is 21% ahead of last year, and diluted earnings per share are up 16%, overall a good half year.

Some of the highlights of the quarter include loan volume, which was our best ever, at $1.5 billion.

Our assets grew in the bank's balance sheet 8% for the quarter and 23% year-over-year.

Very importantly, asset quality remains very strong.

Our estimated '06 tax rate is lower, which had a positive impact on earnings in the second quarter and the first six months of the year.

Very importantly, as we announced previously, we signed a definitive agreement in the quarter to acquire Bank of Walnut Creek.

This represents a very good growth opportunity in the attractive East Bay market here in the San Francisco Bay area.

We're also very pleased to announce an increase in our quarterly cash dividend to $0.15 a share, a 20% increase.

We've now paid dividends for 13 consecutive quarters and have increased the rate each year.

Let me spend a few minutes on deposit growth, loan sale gains and net interest margin, to put the quarter in perspective.

Then I'd like to talk about the progress we're continuing to make to build our franchise.

Average checking balances were flat compared to the first quarter, while loan growth was funded by FHLB borrowings.

This raised our cost of funds.

As a result, our net interest margin declined a bit from 3.31% to 3.19% for the quarter.

This isn't unexpected, given the fact that we have an inverted curve, but it's disappointing, nonetheless.

Deposit growth overall, although it was up 9% for the first six months of the year, proved to be very difficult during the second quarter.

Deposit gathering in this quarter was among the most challenging the bank has ever faced.

So far, this is only a one quarter experience, but it certainly has our undivided attention.

We're working very hard to overcome the flatness of growth without overpaying for deposits.

Contributing to a lower noninterest income was the fact that our loan sale gains were lower than the prior quarter.

Our volume was down and our gain on loans sold was also down, pretty much again a function of the yield curve environment.

Results were also impacted by increased expenses, due to new locations and hires, primarily in Portland, Oregon, and Seattle, Washington.

Katherine will speak more to these in a moment.

These new expenses were fully felt for the first time in this last quarter.

We're very excited about the expansion, but needless to say, the up-front costs are now hitting us.

While new assets under management in balance sheet growth are adding to the top line rather nicely, our revenue growth did not outstrip expenses in the quarter.

Moreover, we may or may not be able to overcome the increased expenses during the remainder of '06, due to the cost of of bringing several new offices on line, blended with continued margin pressure, and one-time cost related to the Bank of Walnut Creek acquisition.

As long as we have an inverted yield curve, net interest margin will continue to be under pressure and secondary market mortgage sales may be as well.

Our wealth management segment encountered difficult conditions in the equity late in the second quarter, but performed quite satisfactorily, nonetheless.

Total assets under management rose 5% during the quarter and 19% year-over-year.

We expect additional growth coming from Portland and Seattle, where we have added 13 professionals in the past quarter.

New accounts, however, are just now starting to open.

Currently, we do not expect loan volume to be quite as robust in the second half of the year, although it is still relatively strong.

The overall economy continues to be relatively strong in our urban bi-coastal markets, but real estate markets are clearly slowing down.

Despite the numerous short-term challenges typical over rising rate, flat yield curve environment, the bank is executing its strategic business plan well.

We continue to build a franchise by being opportunistic.

In particular, we're very pleased to be proceeding with the acquisition of Bank of Walnut Creek.

This transaction is expected to close by the end of the year, and is a very good compliment to our culture of exceptional service and strong credit quality.

From a strategic perspective it's important to note that the first half of '06 is an extraordinary period of opportunity for the bank.

First Republic significantly expanded into important markets on both coasts, while further developing inside of our existing markets.

We face real challenges the next couple quarters.

We're working aggressively to offset the impact of rising rates, flat yield curve into expenses, which we've incurred for strategic reasons.

At the same time, we continue to stay focused on our long-term goals of creating an unparallel wealth management franchise based upon exceptional products and client service.

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

Thank you Jim.

I'd like to take some time to review the specifics of the quarters.

Loan originations were robust, assets were up nicely, wealth management assets increased for the quarter and for the year, and total deposits were up more than 23% over the past 12 months.

Let me talk first about deposits.

As we noted in last quarter's call, deposit growth was unusually strong in the first quarter of the year for several reasons.

We acquired $300 million -- $390 million in CDs in this first quarter, as part of a first signature acquisition.

As we noted on that call, we sold them in April as we had planned to.

In addition, several large investment fund clients had large capital calls deposit in the bank during part of the first quarter, and deposits earmarked for tax payments began funding at the end of the first quarter.

These funds were consistent with the unusually high tax payments collected from wealthy individuals this year.

Early in the second quarter we experienced deposit outflows from these three categories.

In looking at our deposit gathering, it's also helpful to provide some perspective on seasonality.

Generally, the bank has grown checking account deposits more rapidly in the second half of the year than in the first half.

For example, for the first half of 2005, checking balances were actually down 2%.

However, for the first year of 2005 they were up 21% for the full year.

By comparison, this June 30, checking balances were actually up 2% compared to the end of 2005, so a slightly better first half.

Total deposits followed a similar pattern.

For example, during the first half of 2005, total deposits were up 11%, and by year-end, total deposits were up 25%.

For the first half of 2006, our deposit growth is a bit lower than last year, up 9% versus 11% last year.

The second quarter of this year was very challenging for deposit gathering.

We have taken steps to increase our deposit growth, but it is uncertain whether we'll be able to do it in a cost-effective manner.

In the second quarter, the bank's wealth management business faced similar conditions in the equity market.

Total assets in wealth management were up 5% from last quarter.

Much of this, however, came from lower revenue, custody and brokerage assets.

First Republic wealth advisors, our recently formed group that coordinates wealth management marketing activity, had continued to generate wealth management assets for both our investment advisors and our new open ach -- open architectural platform, and we're pleased with the progress it's making.

Asset quality remains quite strong.

Total nonaccruing assets were only $9.5 million or just 10% of total assets.

Very significantly, we're continuing to deepen relationships with our existing customers and new clients.

Our cross sale success on new loans continues to improve, and is now 8.8 products or services with each loan.

This is an all time high.

By comparison, this ratio of products and services to loans -- to new loans was 7.5 at the end of 2004.

Our efficiency ratio was 70.1% in the second quarter compared with 68.3% in the proceeding four quarters.

As we've noted on previous calls, we have been expecting higher expenses due to strategic investments.

In the Pacific Northwest, our Portland and Seattle offices have now been open for most of the quarter.

Expenses exceeded modest startup revenues by approximately $600,000 in the second quarter.

We expect these offices will generate additional assets under management and move toward profitability in 2007.

In addition, we continue to add offices in our existing market.

In July we opened an office on the San Francisco peninsula in Los Altos, California.

In the fourth quarter we plan to open offices on the upper eastside of Manhattan and in Palm Desert, California.

Loan volume set a record in the second quarter, although we expect that trend to soften somewhat in the second half of the year.

The bank originated $588 million of new home loans for the quarter, up from $540 million in the first quarter.

Purchased loans increased to 58% of the total for the second quarter, compared to 50% for both the prior quarter and in 2005.

In the second quarter we originated record volume loans in five other loan categories outside of single family.

They were home equity lines, commercial real estate loans, construction loans, business loans and lines, and personal loans.

Our success in originating high-quality loan volumes reflects the fact that relationship managers have shown great flexibility in identifying and meeting all of the credit needs of our clients.

With respect to conditions in the housing markets, rising interest rates and significant price increases in houses in our markets over the last few years are having an impact.

Inventories are rising somewhat, houses are staying in the market longer, and prices are generally softening a bit.

Home purchasing in our markets does remain active, and we are continuing to apply our historically, very rigorous underwriting standards to loan originations of of all types.

Rising interest rates have negatively impacted loan sales in the secondary market.

During this quarter, market conditions resulted in lower pricing for both adjustable rate loans and intermediate fixed.

Loan sales gains in the second quarter were only $222,000, down about $1 million from the average of the eight prior quarters.

Given market conditions, we chose to sell just under $200 million in loans, or roughly half of the sales for the average of the eight prior quarters.

As Jim noted earlier, we continue to make good progress in building the franchise.

In particular, our business banking continues to grow, as we cross sell our private banking clients.

Business checking accounts are $1.1 billion and represent 54% of total checking deposits.

Business loans commitments are increasing nicely, and actual loan outstandings rose 11% in the past six months.

Overall, our business is performing quite well, despite challenges.

We remain focused on building the franchise by taking advantage of strategic opportunities and through planned investments in our existing market.

Our service level and quality remain excellent.

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

Thank you, Katherine, and good morning.

I'd like to spend a moment talking about our planned acquisition of the Bank of Walnut Creek, and then comment on our noninterest income and our net interest margin.

On Tuesday the parent company of the Bank of Walnut Creek reported very solid financial results for the second quarter.

In general, higher interest rates are beneficial to the Bank of Walnut Creek, because they have a largely adjustable loan rate portfolio and they have a high percentage of checking deposits.

The Bank of Walnut Creek's recurring net income for the quarter was $2.3 million.

To get this number, we are excluding one-time expenses related to our pending transaction of $350,000, and eliminating results of their discontinued mortgage operations.

With our exchange ratio of .97, we currently expect to issue approximately 4.1 million shares to complete this acquisition.

On these new shares, the Bank of Walnut Creek's adjusted recurring net income for their second quarter would have been $0.57 per share.

There were a number of positive trends in our noninterest income.

Brokerage fees from trading in mutual funds were $1.257 million, a 57% increase year-over-year and a 14% increase over the first quarter.

Fees on customer deposits continue to climb steadily, and we're up 29% year-over-year and up 9% for the quarter.

Our loan and related fees were $1.7 million and have been at a relatively high level for the past four quarters, due primarily to the continued collection of prepayment penalties when loans pay off.

And finally, our loan servicing fees, net of amortization of mortgage servicing rights, were a little over $1 million this quarter.

That was much higher than the prior three quarters, because as rates have risen, the prepayment speeds on fixed rate loans in our servicing portfolio have slowed down.

Our net interest margin declined 12 basis points from the first quarter to 3.19% in the second quarter.

Looking behind these numbers, the decrease was primarily due to an increase in the proportion of FHLB borrowings used to fund our asset growth and the rapid run up in the cost of these funds.

Specifically, our average FHLB advances increased from $837 million in the first quarter to almost $1.4 billion in the second quarter.

The average rate paid on such borrowings increased 74 basis points quarter-over-quarter.

As a result of both increased volume and increased rates, the interest expense for the federal home loan bank borrowings double over the prior quarter.

By comparison, the average cost of our deposits rose only 17 basis points in the same period of time, and the average yield on our loans and investments adjusted upwards by 22 basis points.

As Katherine has indicated, we are working hard to stimulate deposit growth to pay down these more costly borrowings.

Now I would like to turn the call back to Jim Herbert.

Thank you, Willis.

In closing, we would like to say we're satisfied with the quarter, but we recognize the challenges ahead and for the remainder of the year.

We are very focused on shoring up deposit growth and net interest margin in the short-term, but we are actually very confident that our long-term business strategy is quite on track.

Thank you.

We'd be happy to take any questions.

Thank you. [OPERATOR INSTRUCTIONS] And we will take our first question from Kevin Reevey with Ryan Beck.

Good morning, everyone.

Willis, can you talk about if you have any FHLB borrowings coming due in the latter half of this year and kind of what your thoughts are there, if you do?

Good morning Kevin.

The prior -- the primary nature of the increase in our federal home loan bank borrowings have been short-term -- shorter term overnight borrowings.

And we have a very modest amount of advances that are fixed for greater than a year, and about $250 million that are fixed for less than a year, so I would project the borrowings that would mature -- and some of them are at rates above the overnight rates because they were done a few years back.

Some of them are slightly above -- below the current rate.

So the primary impact on our borrowings this quarter was -- was the volume and the increase in overnight rates, as opposed to any -- any maturation of borrowings from prior periods.

I see.

So the $250 million that you said was fixed for less than one year, is any of of that coming due in the latter half of this year?

About half of it.

And what's the weighted average rate on that?

I'd say right around five.

And then, your commercial real estate growth, what markets are you seeing that growth come from?

We're seeing that growth come from primarily the San Francisco Bay area, but a little bit of it throughout all of our markets.

And then my last question is on are you going to be doing anything, or have you started to do anything differently in order to grow core deposits, primarily checking accounts?

Katherine, do you want to answer that.

Yes, we're doing a couple of things.

We have raised our rates a bit.

We lagged a little bit from the competition and we have caught up in the last couple of of weeks in rates, and we'll continue to watch that very closely and remain competitive.

We've also really refocused all of our bankers and relationship managers on deposit growth as the most important goal for the rest of the year.

And when you say you lagged the deposit rates, is that for money market and savings or does that include [NOW], as well?

It includes money market, savings and CDs.

Our NOW rates are very low.

We haven't raised those in a long time.

Great, thank you.

We'll now hear from Manuel Ramirez with KBW.

Hi, good morning.

Given Katherine's comments on the inherent seasonality in your deposit base -- and I know it's hard to get a handle on since the growth has been fairly rapid -- but given that this seems to be a recurring pattern, do you think that maybe the balance sheet should have been managed a little bit differently first quarter to the second quarter, particularly given the increase in the securities portfolio?

And secondly, kind of on the same issue, seems like there's a fair amount of volatility in the margin from quarter to quarter, which may not be unavoidable, but it does seem like there's a little bit more volatility in the margin than there is in comparably-sized companies that I would consider your peers.

Just see if you have any thoughts on that.

Thanks.

I think, Manny, the answer is in retrospect.

We probably -- although time will still tell, we might have kept the $390 million of CDs rather than selling it, because it had -- but it had a three-plus year duration on it, so time will tell.

At this point, right this moment, those CDs are a little cheaper than our overnight FHLB borrowings, but if we get a down-tick in earnings income and rates in the next couple of years, we will be glad we sold them.

The other thing that happened is that we had a pretty unusual build-up in the first quarter and first half of the second quarter from tax receipts being paid, as Katherine alluded to, which, quite frankly, caught as a little unaware.

We were not as focused on the flow of taxes overall and we probably counted on that a little too much.

But I don't think we'd do much differently.

What has happened is that the balance sheet has grown by probably about $100 million more than what we would have expected because the loan sale volume is lower by that $100 million.

I think the margins, I would be -- I could be wrong.

I mean, I don't know where the margins are going, but we have been between -- I think the fourth quarter of last year was 320 and we're 319.

So I think we've been 315 and 335, which is a reasonably narrow band, for probably eight or ten quarters, at least, maybe more.

Willis, does that seem right to you?

That does seem right.

I would just also say that we raised this capital last year with the idea of growing into it, and our leverage ratio at the end of the quarter is still right at seven, slightly below.

So we feel good about the balance sheet growth that has occurred over the first half of the year.

It was a little front loaded with investments and a little more loans in the second quarter.

I think the only thing really going on here is that our deposit gathering in the second quarter -- and I emphasize only that quarter -- has slipped behind and we're working hard to pick it back up.

And we're focusing on it and, you know, we don't want to be [PollyAnn'ish] about it, but we have not had this problem exist over the past years for any extended period.

Occasionally it does happen.

Okay.

Given that it sounds like the deposit run off happened earlier in the quarter and now you're raising rates, it sounds, like based on Katherine's comment, here early in the third quarter, is there a risk that you kind of overcompensate on pricing and is some of that natural uptake in deposits, perhaps you're overpaying for it in the second half of the year?

It's always possible, Manny, but you know, actually, if the fed is about to pause and go into a stable period, our delay in raising deposits will prove, in fact, to have been the right thing to do.

But time will tell.

The -- we're going to go about it aggressively, but very systematically.

We don't feel any sense of, you know, panic over this at all.

We just need to get at it more aggressively than we have been.

Okay, great.

Thank you very much.

Thanks.

[OPERATOR INSTRUCTIONS] Moving on to Lana Chan with BMO Capital Markets.

Hi, good morning.

I want just to follow up with that last question.

If the deposit growth does come back like it usually does with the seasonality affect in the second half, do you think that that will help to stabilize the margin from the second quarter level?

It will depend on how fast it comes back, Lana.

The answer should be yes.

But it really will depend on whether -- how fast it comes back and also whether the fed continues to raise.

Our margins will stay under pressure probably, no matter how well we do in deposit gathering, until the fed stops racing, which we would hope will be either this next move, if there is one, or after it.

But it feels that way to us, certainly.

But the second quarter -- our experience in the second half of most years is that it's a better deposit gathering time than the first half, and that's been true for many, many years for us.

Okay.

And could you remind me, are there any title and escrow deposits in your volumes?

We have a few, but they're not very meaningful.

Katherine, do you have any estimate of that?

It's under a $100 million.

Okay. it's And then the second part of my question, I guess more for Willis.

In terms of the expense growth with the new branches and the build-up of the business in the wealth management area, could you give us an estimate of how much more expense growth we should expect for the second half of the year, maybe relative to the efficiency ratio?

Lana, I would note that if we had not had the northwest expansion, our efficiency ratio for the second quarter would've been right around 69.5, 69.4, something along in that lines.

The additional offices that we -- that we have planned are more traditional deposit offices.

They will add incrementally to our expenses, but probably not any more than what we have experienced through the first half of the year, the first quar -- the second quarter with Pacific Northwest.

Okay.

Thanks, Willis.

[OPERATOR INSTRUCTIONS] And it appears there are no further questions at this time.

Mr. Herbert, I would like to turn the conference back over to you for any additional or closing remarks.

Great.

Thank you all very much for taking the time.

We appreciate it.

Thank you.

Good-bye.

And if I could add one thing -- forgive me for adding this last comment, but we understand there were some technical difficulties accessing the beginning of the bank's live earning call webcast, so please be aware that a complete playback of this call will be available via our website at www,firstrepublic.com, or by dialing 888-203-1112, or 719-457-0820 and using the passcode 2298654.

Let me just repeat those numbers one more time.

That's either 888-203-1112 or 719-457-0820, passcode 2298654.

Thank you very much.

And that does conclude today's conference.

Thank you for your participation.