First Republic Bank (FRC) 2006 Q3 法說會逐字稿

Good day everyone, and welcome to the First Republic Bank third quarter 2006 earnings results conference call. [OPERATOR INSTRUCTIONS] At this time, I would like to turn the conference over to Mr.Greg Berardi, please go ahead, sir

Thank you and welcome to First Republic Bank's third 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 14 days.

An audio replay is available for 2 weeks.

Domestic and international participants can dial 888-203-1112.

The reservation number is 2370574.

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 very much, Greg.

Let me cover the quarter briefly, but it was -- it's important to understand that we had a pretty challenging quarter.

The inverted yield curve and expenses related to our expansion and one-time charges all impacted the bank's earnings in the quarter.

These challenges will persist into '07 as we fully absorb the Bank of Walnut Creek acquisition and the costs of some of our expansions in the northeast and northwest, both of which are preceding very well.

Katherine and Willis will talk to these subjects in a moment.

Despite these challenges, it's important to view the quarter results in larger context of extraordinary period of franchise development for the bank in '06.

We had a unique opportunity to enter Portland, Oregon, Seattle, Washington, Greenwich, Connecticut, and Boston, Massachusetts, all of which are consistent with our strategy to target coastal high-wealth metropolitan areas that are contiguous to our existing markets.

An unexpected opportunity also presented itself in our home market in the form of the acquisition of the Bank of Walnut Creek, which is a perfect fit for us.

These opportunities, by one measure only for instance, contributed a full 37% increase this year, in the number of our banking and wealth management offices.

Over the past year there's also been a 21% increase in total assets, not including the Bank of Walnut Creek.

We have added 10,000 new customers from this acquisition.

All of these franchise investments are strategic and we continue to take a long view of our business.

We realize that paying for the opportunities would be more difficult in the current operating environment.

However, we deliberately decided not to forego them.

During 2007, we currently expect no new expansions in our geographic footprint and anticipate that investments made during 2006 will be drivers of growth for the next several years.

Before I cover the highlights of the quarter, I think it's important to recognize that the current price shown on our earnings is coming almost entirely from revenue.

Increases -- interest rates have risen but interestingly enough if we have the same interest margin in the last quarter, not a particularly strong 3.19%, our efficiency ratio would have been the same, in spite of our cost increases.

In essence, we primarily have a revenue issue brought on in the form of the inverted yield curve.

This will continue in the fourth quarter and we will also be impacted in the fourth quarter by some additional expenses from the Bank of Walnut Creek acquisition, which we will also go into in a moment.

Let me cover briefly the highlights of the quarter.

A diluted earnings per share of $0.57 per share, up about $0.06, 6%, I'm sorry, compared to a year ago.

Earnings were impacted by a number of small, unusual items.

For instance, we had $0.01 per diluted share in pre-acquisition costs for the Bank of Walnut Creek, another $0.01 in occupancy expense related to the first and second quarters as we revised our lease accounting, and approximately $0.01 in temporarily high occupancy costs for additional space in Rockefeller Center, which we expect to sublease out.

We also had a modest adjustment in our FHLB stock dividend income methodology, about $0.005.

Our tax provision was also adjusted -- impacted favorably as a result of the first two quarter lower tax rate moving into the third quarter.

Overall, the loan volume of the business was good.

Our asset quality remains very high, our wealth management assets continue to grow and are up 21% compared to a year ago.

The policy gathering, which is one of our biggest challenges, as it is for many other banks, is running at a decent 12% annualized rate.

However, this is lower than our historic rate.

Generating new deposits does remain very challenging although we're generating a lot of new customers.

Margins were squeezed due to three trends primarily, slower deposit growth was shifted as more to wholesale borrowings, a somewhat unfavorable shift in our deposit mix, although we're not particularly worried about this, and the inverted yield curve.

Bank of Walnut Creek does operate with higher margins and we should benefit positively from this going forward.

Overall, we remain pleased with the progress we've made under our business plan.

But we fully realize that we have a near-term challenge to manage through the current interest rate environment, while absorbing the expenses that relate to our buildout.

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

Thank you, Jim.

I'd like to comment on our expansion activities, first the Bank of Walnut Creek and then our new offices in the northwest and Boston.

The Bank of Walnut Creek is a terrific fit for First Republic.

From a cultural perspective, both banks are similar.

The Bank of Walnut Creek shares the same committment to excellent client service that we've always had at First Republic and has a very strong commercial banking business which complements our own.

The merger also gives First Republic many new clients, a team of outstanding bankers, a fuller complement of business banking products, and seven offices in affluent and growing communities.

The Bank of Walnut Creek's offices in the East Bay and San Jose, which complements our San Francisco peninsula offices, have enabled First Republic to now circle the entire San Francisco Bay area.

The integration of both bank systems should be completed by year-end.

Our teams have been working together closely since the transaction was announced in May.

In Portland and Seattle, where we opened wealth management and trust offices in April, we expect operations to breakeven in 2007.

As of September 30, 2006, assets under management in the northwest were already approximately $300 million.

We have a terrific team in place.

Eventually we would like to have a banking license in the northwest.

In Boston, we're also making terrific progress.

Our new full-service office, which we opened in January, has been well received.

We've hired very experienced bankers and there is tremendous synergy with our venture capital and private equity business in San Francisco, Palo Alto and New York.

Total deposits in Boston have already reached $100 million.

Business banking continues to grow nicely.

Business checking accounts are up 24% from a year ago and up nearly 60% over the past two years.

Total business deposits are up 31% in the past year and now represent one-third of total deposits.

The addition of the Bank of Walnut Creek will further strengthen and expand our business banking capabilities.

When we began offering business banking seven years ago, our strategy was to focus on the businesses that our private banking clients own or ran.

Today, we've established ourselves in a number of sectors and now business clients actively seek out First Republic, even if there is no private banking relationship.

Often the private banking follows the business banking.

Another strength of the quarter was wealth management.

Assets under management were up 21% compared to a year ago.

We experienced very strong growth in brokerage assets, which are up 51% year-over-year.

Custody and trust assets are up 48%.

Our wealth management business benefited from new client acquisition, strong marketing, improving conditions in the equity markets, and the increasing effectiveness of First Republic wealth adviser.

At September 30th, our total wealth management assets were $16 billion.

Of this, $10 billion were invested in equities or convertible securities, which are benefiting from stronger equity markets.

We're pleased with the quarter's loan volume of $1.2 billion.

Total loan sale gains in third quarter were $3.4 million, compared to an average of $1.2 million in the prior 12 quarters.

As a result of strong loan volume and improved market conditions in the third quarter, we sold more loans than we have recently.

Of the loans sold in the quarter, approximately one-third were adjustable and the remainder were fixed.

Similar loan sales gains may be difficult to achieve in the fourth and subsequent quarters.

There has been considerable media attention, there continues to be media attention, about home prices slowing.

We have noted some softening and believe this trend will continue in the near-term.

Inventories are rising and houses are staying in the market longer.

However, home purchasing activity in our markets remain strong.

We continue to ply our historically rigorous underwriting standards to all loans we originate.

Asset quality remains strong, total amount of accruing assets were $10 million or just 10 basis points of total assets.

Due to recoveries, we have not made a loan provision this year.

Future provisions will depend on loan quality and the level of loan growth.

We continue to deepen relationships with existing clients.

We are now selling almost nine products or services to 2006 loan clients.

Each loan client has an average of 2.33 checking accounts, 71% have a money market account and 25% now have some type of investment account with First Republic.

We clearly face challenges through the end of the year and into 2007 in executing our expansion strategy in this difficult interest rate environment.

We've begun to analyze our expenses, we believe we can reduce non-critical costs without hindering our plans for growth.

As our new investments in the northeast, the northwest, and the East Bay of San Francisco mature, they should add measurably to the bottom-line and should prove to be very successful additions to our franchise.

The level in quality of our service to clients remains excellent.

Now I would like to turn the call over to Willis Newton, our Chief Financial Officer.

Thank you, Katherine.

This morning I'd like to spend a moment giving you some specifics on the cost of our market expansions.

In the northwest, our offices are fully staffed and we are now incurring most of the costs.

Our revenues will increase as assets under management increase.

During the third quarter, our pretax loss was a little above $600,000 and we expect this loss to decrease somewhat in the fourth quarter.

As Katherine noted, we already have $300 million in assets under management in the northwest.

Our full service Boston banking office has expanded rapidly since it opened in January.

Loan volume has been good there and deposit growth has been very strong.

As Katherine noted, we are over $100 million in total deposits.

Currently, the cost of our newer Boston and Greenwich offices exceed revenues by approximately $600,000 per quarter.

We expect the Bank of Walnut Creek acquisition to be neutral to marginally accretive on our diluted EPS in 2007.

However, we currently estimate that in the fourth quarter of 2006, we will incur one-time charges related to the acquisition of approximately $4.5 million.

As Jim noted, our efficiency ratio increased from 70% in the second quarter to 74.3% for the third quarter.

This increase is primarily due to a reduction in net revenue.

If our net interest margin had stayed at the same level of 3.19% in the third quarter, as in the prior quarter, our efficiency ratio would have remained stable at about 70%.

The primary challenge to net revenues has been the decline in net interest income due to the inverted yield curve.

For the third quarter of 2006, the bank's average assets that earn interest grew $600 million and the yield on those assets increased 13 basis points.

This growth was funded by $200 million of deposits and $400 million in FHLB borrowings.

However, the average cost of our liabilities increased 37 basis points in the third quarter, driving down our margin and reducing our net interest income.

We expect to face continued pressure on our net interest margin so long as the yield curve remains inverted.

Now, I'd like to turn the call back to Jim Herbert.

Thank you, Willis.

In closing, I'd like to say we're making good progress on executing overall plan.

We continue to build a very strong franchise and foundation for future growth.

We do recognize we have several challenging quarters ahead of us.

We've been here before and we're comfortable with the path we're on.

But we remain very committed to our strategic plan and to developing exceptional service delivery in our new markets as we have in our home markets.

Thank you, we'd be happy to take questions.

[OPERATOR INSTRUCTIONS] And we'll take our first question from Mike McMahon with Sandler O'Neill & Partners.

Good morning.

Jim, did you say that you currently have no new expansion initiatives planned for 2007 beyond what you've announced?

That is correct, Mike.

What I said was no new geographic plans.

But other than a couple of offices that we're committed to already, we don't have any other plans.

Okay.

And I'm curious if something was presented to you that made sense, would you consider it?

Or is your focus now on building out what you have?

I think, we're definitely focused on building out what we have.

This has been a tremendous growth year for us.

It's easy to forget the pieces as they kind of add up one at a time.

When you sum them up, it's a lot.

And obviously, we took it on right into the face of the curve problem.

So we've got our plate full and we intend to digest.

Right.

And I'm wondering, Willis, if you can share with us from an asset liability standpoint, out over the next six to 12 months, how you've positioned the balance sheet in terms of asset sensitivity.

And in relation to that also and add a additional question, I'm under the impression the Fed is done raising rates for a while.

And I guess we'll know or maybe we already know as of ten minutes ago.

But probably no more increases this year and potentially declines next year.

And I'm wondering if you're thinking about a potential for a rate decline next year and how that might impact your balance sheet in how you've got it positioned.

Well, our balance sheet today is a product of the environment that we've been in.

And we have a higher percentage of intermediate fixed rate loans on our balance sheet than we have had in the past.

The Bank of Walnut Creek provides a -- some relief from the impact of higher rates.

We are doing some things at the margin, selling some fixed-rate loans and locking in some borrowings to address what we think is the -- what's going to happen in 2007.

We don't think that there's going to be further increases in the rates, but the timing of any decreases is also unknown.

It's a difficult environment, we think we're taking some step that will help us.

Okay.

And I'm curious, as the final question, you have a fair amount in your money market accounts as depositors have shifted funds to higher rate paying accounts.

In the event that rates start dropping, how responsive to declining rates could we expect those to be?

They were slow to move up.

Will they be slow to move down, in general?

They'll be slower to move down in general, Mike.

But the headwind that we've been facing, more than anything else, has been the decline in the average checking account balance, not so much our -- we have a lot of new accounts, we're bringing in new clients at a very rapid pace.

One of the biggest challenges we've had was the decline in the average account.

That appears to be abating a bit.

I do think that the money market decline would be probably about equally slow coming down as it was going up.

All right, thank you.

Our next question comes from Manuel Ramirez with Keefe Bruyette & Woods.

Good morning.

Could you be a little bit more specific on where you think the margin is going in the fourth quarter?

The Bank of Walnut Creek adds 12 to 15 basis points to your margin.

Are you -- it sounds like you're implying that the margin at the current First Republic, before the deal, I guess the deal closed recently, would be down.

So net/net what does that do to the margin?

Is it flat, is it up, is it down?

Or let me ask the question differently.

Do you think excluding the deal net interest income would grow in the fourth quarter?

Our assets are continuing to grow, excluding the deal.

And there continues to be pressure on the margin.

We've worked very hard with our investment advisers in order for them to find good investments.

And we are finding things but it's not really that easier, that easy, to generate net interest income.

We're disinclined particularly, Manny, to take risk, as you know.

And so what we have not done is go out the risk curve.

And so it's pretty tough call.

The hardest part for us is trying to factor in the Bank of Walnut Creek.

Bank of Walnut Creek is a positive, as you said.

Whether it will overcome the negatives intrinsic in the structure we have or not, I don't know.

So we're concerned about the fourth quarter net interest income but we can't, we're just not comforting projecting it

Okay.

As far as your expansion efforts, how should we ultimately measure the results over the next year to two years?

I mean, it seems to me like the primary rate of measure of the Company's success over the last few years has been deposit growth.

So that I assume once rates kind of level out, you'd expect a re-acceleration of deposit growth, given how aggressive you have been investing this year.

Is that a fair assumption or how do you think about it?

Well, I think that is a fair driver assumption, yes.

And I think one of the things that we would point out is that the fourth quarter's often been a particularly good gathering quarter for deposit growth for us, in part because a lot of our clients are bonus-based.

But this year might be a little different.

We would say measure it by deposit growth, measure it by assets under management on the wealth side and then in third position probably would be loan growth.

And I say that because as you know, we choose to keep ourself dependent upon market conditions.

So loan growth has a exogenous sort of driver in it called secondary market conditions.

But the real franchise is the deposit franchise.

And we're pleased with it.

We're disappointed this year, but this happens.

These moments happen.

They've happened two or three times since we've been running the bank.

They come and go.

And finally, are you worried at all about your capital position?

Just looking at your total risk-based capital it seems like you're at a lower level than you've been anytime in the last several years.

I don't think the Bank of Walnut Creek materially changes that metric.

And given that asset growth is still strong, your capital generation is not that strong and it seems to me like you're probably looking at a capital raise at some point in 2007.

We're not worried about it, no.

We watch it all the time, of course, and our business planning pays a lot of attention to capital positions, as you can imagine.

But we're not particularly worried about it.

And we do have room for more preferred if we needed it.

Okay.

Thank you.

Thanks.

Our next question comes from Don Worthington with Howe Barnes & Hoefer.

Good morning.

Good morning, Don.

A couple things.

One, can you discuss a little bit the strategy behind increasing the securities portfolio over the last year in terms of what was behind that.

Is it just trying to get some more earnings or a liquidity issue?

It's been a combination of earnings and liquidity, Don.

And also for the last six months, at least, quite unusually, well traded agency securities have actually been almost on top of loan yields, single-family loan yields.

And, as a result, if we have a choice, we'd prefer to be in the securities rather than loans as an asset class.

The loan demand also that we've been willing to keep has been down a bit for balance sheet growth purposes.

The flow has been pretty good.

But more and more, of course, people have shifted to fixed so we've been inclined to sell.

Okay.

And then Willis, I didn't catch the number, the merger cost in the fourth quarter.

Our best estimate today is right around $4.5 million.

Okay.

And I guess lastly, I just noticed within the wealth management portfolios, it looks like the Froley, Revy assets were down and then the internal trust company and the securities company were up.

And just more curious about the Froley, Revy balances in terms of what's going on there.

Froley, Revy, as you probably know, is a convertible manager and that asset class has been under some pressure and they have had a couple of large institutional investors who have made asset allocation charges.

Okay, terrific.

Thank you.

[OPERATOR INSTRUCTIONS] We will now take a question from Lana Chan with BMO Capital Markets.

Hi, there.

Hi, Lana.

I had a couple of follow-up questions.

One is on, I think Willis or Jimmy said that you expect the pacific northwest to breakeven in 2007, was that right?

Correct.

And how about Boston?

When is that expected to breakeven?

We're not certain, but probably 2008.

Okay.

It's going very well there.

Okay.

And Willis, can you give us an idea if you don't have any more expansion in 2007, other than what you've previously announced, what kind of expense growth should we be looking at in '07 versus, I guess, 20% plus growth that we're seeing this year?

We are looking at our expenses right now to deal with some of the revenue challenges of the yield curve.

And we'll be studying that over the next several months.

Okay.

And then, just my last question was on the tax rate, again, related to '07, I guess '06 is going to be about 25% according to your press release.

What should we be using for '07?

I think the '07 could be slightly higher than that if our tax preference items maintain where they are.

But it will be down from last year rates.

It will be a little closer to this year's rate.

Okay.

Thank you.

Our next question comes from Mike McMahon with Sandler O'Neil and Partners.

Just a little item.

Did you have a net recovery in the quarter of about $500,000?

Yes, we did.

We had about $600,000 of recoveries.

Okay.

Thank you.

[OPERATOR INSTRUCTIONS] And we have a follow-up question from Manuel Ramirez with Keefe Bruyette & Woods.

Hi.

This question is for either Jim or Katherine.

Do you pay your private bankers based on the cost of deposits that they bring in, in addition to the volume, or do you just pay them based on deposit volumes?

We reward very strongly for very low cost deposits.

Okay.

So, I mean, I would imagine as deposit volume growth here has slowed that your incentive-based compensation for the deposits has presumably moderated?

It has, Manny, although the compensation has stretch-out a period of time.

So the moderation doesn't show very early.

But to your point, we don't pay by rate, but we pay by type and that intrinsically thereby by rate.

You pay by type.

So if I just look at your money market rates, they're pretty high relative to market rates right now.

I think your all in money market costs around 4% or so.

At least that's my estimate for this quarter.

So, you don't differentiate for that fact.

We compensate most strongly for checking accounts, NOW accounts and DDA accounts.

And we post the money market rate and as long as that rate is taken, we pay a modest amount of bonus for it.

It's much different than the checking account.

So can you give me a sense if I bring in $1.00 of checking account balances versus$1.00 of money market balances, what's the difference in incentive comp over whatever period of time?

Manny, we're not prepared to discuss that level of detail.

We would consider it proprietary.

But suffice it to say it's many multiples.

Okay, I appreciate that.

Thanks.

At this time, there are no further questions, I would like to turn the conference back over to our presenters for any additional or closing remarks.

Thank you all very much for taking the time.

We appreciate it.

This concludes today's presentation.

Thank you for your participation and have a wonderful day.