First Republic Bank (FRC) 2011 Q1 法說會逐字稿

Good day, ladies and gentlemen.

Thank you for standing by.

Welcome to the First Republic Bank's First Quarter 2011 Earnings Conference Call.

During today's presentation, all parties will be in a listen-only mode.

Following the presentation, the conference will be open for questions.

(Operator Instructions)

I would now like to turn the conference over to Dianne Snedaker, Chief Marketing Officer of First Republic Bank.

Please go ahead, ma'am.

Thank you, and welcome to First Republic Bank's First Quarter 2011 Conference Call.

Speaking today will be the Bank's Chairman and Chief Executive Officer, Jim Herbert, President and Chief Operating Officer, Katherine August-deWilde, and Chief Financial Officer, Willis Newton.

Before I hand the call over to Jim, please note that on this call, certain information presented contains forward-looking statements.

These statements are based on Management's current expectations, and are subject to risks, uncertainties, and assumptions.

Potential risks and uncertainties that could cause the Bank's business and financial results to differ materially from these forward-looking statements are described in the Bank's periodic reports filed with the FDIC from time to time.

All information discussed on this call is as of today, April 20, 2011, and First Republic Bank undertakes no duty to update future events or circumstances.

In addition, certain of the financial information discussed on this call or presented in our press release represents non-GAAP financial measures.

The Bank's earning release, which was issued this morning and is available on the Bank's website, presents reconciliations to the appropriate GAAP measures and an explanation of why the Bank believes such non-GAAP financial measures are useful to investors.

And now I would like to turn the call over to Jim Herbert, Chairman and Chief Executive Officer.

Thank you, Dianne, and thanks to everybody for joining our call.

We are pleased with our strong first quarter results, which reflect continued organic growth of our entire franchise, particularly in Deposits and Assets Under Management.

And we're quite pleased with the clean, straightforward quality of our earnings.

Our net income was $89 million for the first quarter, up 17% from the prior quarter.

Diluted earnings per share, as reported under GAAP, were $0.67, compared to $0.60 for the prior quarter.

Excluding the impacts of purchase accounting and IPO-related costs, our net income was approximately $54 million for the first quarter, a solid 20% increase from the prior quarter.

Our diluted earnings per share on this basis was $0.41, a 17% increase.

We are pleased with this growth.

Let me just summarize the trends for the last nine months of operations since we became an independent bank again.

Total assets have increased at an annualized rate of 22%.

Deposits are up an annualized rate of 16%.

Private Wealth Management assets have increased at an annualized rate of 38%.

And total loan originations are strong for the first nine months, at $6 billion.

Loan growth was positive over this last quarter, and total loan growth for the nine months has annualized at approximately 11%.

Our credit quality, importantly, remains very strong, with total non-performing assets accounting for only 0.001% of total assets.

Since becoming independent, we have also moved our balance sheet toward a neutral asset liability position, which should protect us in the event of rising rates.

While we continue to establish our Investment Portfolio, which is now 5% of total assets, our cash position is still over $2 billion at the end of March.

At the end of the quarter, our Tier-1 leverage capital ratio was 9.24%, and we continue to be well capitalized by all measures.

All this puts us in good position for continued growth.

During the quarter, our overall deposit growth was strong throughout the bank, and our planned expansion of deposit offices remains on track.

We opened 1 new office on Sand Hill Road in Menlo Park and have 5 more locations underway, on which we have signed leases.

Loan volume was $1.9 billion for the quarter, up 85% over the first quarter of last year, and represents the second strongest first quarter in our history.

We're also quite pleased with the increase in our Wealth Management assets for the quarter, which rose $2 billion, or 12%, to a total of $18.9 billion.

As Katherine will describe in further detail, our franchise continues to benefit from the relative economic strength of our urban coastal markets, as well as the improving economic outlook among our higher net worth client base.

Now I would like to turn the call over to our President and Chief Operating Officer, Katherine August-deWilde.

Katherine?

Thank you, Jim.

We are very pleased with our first quarter operating results, and we continue to experience strong organic growth across all areas of our business.

Bank assets at March 31, 2011 were $23.6 billion, an annualized increase of 22% since July 1st.

This increase was primarily driven by deposit growth, new Federal Home Loan Bank advances, earnings, and the proceeds from the bank's IPO.

Since we became independent last July, deposits have increased $2.1 billion to $20 billion at March 31st.

Checking and other liquid deposits accounted for this growth, which allowed us to let some of our CDs roll off.

Our checking deposits were $6.2 billion at March 31st, and were 31% of our deposits.

Liquid deposits are now 72% of deposits, up from 66% on July 1st.

We are quite pleased with this continued improvement in our deposit mix.

As a result of the improved mix and market rate, the contractual rate paid on our average deposits has decreased to 79 basis points, down 17 basis points from third quarter of 2010.

Deposit growth is strong across all three of our deposit channels.

Since July 1st, Preferred Banking deposits have grown $1.1 billion, Wealth Management deposits, including [sleep] accounts, have grown $730 million, and Preferred Banking Office deposits have grown $315 million, for total growth of $2.1 billion.

Total loan volume during the nine months since July 1st was $6 billion.

Loan originations were $1.9 billion in the first quarter, a strong performance.

There was seasonality in our loan originations, and generally the first quarter of the year is our lowest origination quarter.

Loans outstanding, including loans held for sale, increased at an annualized rate of 11% since July 1st, and now total $19.5 billion.

We were pleased to have net loan growth of 1% for the quarter, in spite of high levels of repayment.

Commitments for both personal and business lines of credit increased approximately 4% during the quarter, while usage declined slightly due to seasonality.

We're pleased that the commitments, which represent new and growing clients, continue to increase.

The economic conditions and home prices in our urban coastal markets are stable to improving.

We are seeing a modest increase of home purchase activity in most of our markets.

Approximately 63% of all loan originations during the quarter were home loan originations, of which 32% were for purchases.

Assets managed or administered by First Republic Private Wealth Management totaled $18.9 billion at March 31st.

This was an increase of 12% during the first quarter, and a 38% annualized increase since July 1st.

We are experiencing substantial increases in all areas, Investment Management, Brokerage, and Trust.

As we discussed last quarter, we have made significant investments in Private Wealth Management during the last two years.

These investments are part of a strategic focus on Private Wealth Management and are paying off.

Since July 1st, we have increased by 35% our team of seasoned Wealth Management professionals.

Strong growth of Wealth Management assets exhibited during the first quarter and in the nine months since our independence, is a result of the combination of new assets from these new [buyers], existing clients, and improved market conditions.

We are pleased that some activity in liquidity is returning to the secondary market for jumbo home loans [and] well executed transactions.

During the quarter, we have agreed to sell two packages of longer-term fixed rate home loans, totaling approximately $260 million, to two different buyers, and we will retain servicing, as we always do.

We are continuing to invest in all areas of our business, and at the same time, our efficiency ratio is to remain stable for the past three quarters, at approximately 59%.

This excludes purchase accounting and one-time items.

First Republic is delivering solid performance.

Our Lending, Deposit, Wealth Management businesses are all very strong, with high client satisfaction.

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

Thank you, Katherine.

As usual, I have a few numbers to review.

The income components related to our purchase accounting are presented in several tables in our press release.

The largest amount, loan discount accretion, was $43 million this quarter, down from $48 million last quarter.

This income item will vary from period to period, depending on the amount and type of loans which repay.

The amortization of deposit premiums added $17 million to net interest income this quarter.

This income item will decline steadily, due to the maturity of the underlying CDs.

During the quarter, we sold some home loans that were marked last July and recognized $3.8 million of discount income, specifically attributed to those loans.

As an offset to these purchase accounting income items, we must amortize the intangible assets that were created last July.

This resulted in an expense of $5.9 million for the quarter.

In total, the impact of purchase accounting added $59.7 million to our pre-tax earnings, a 4% decrease from the prior quarter.

Importantly, net income without purchase accounting and one-time items increased 20%, to $54.5 million for the quarter.

Earnings per share on this measure rose to $0.41, a 17% increase from the prior quarter.

We focused on our contractual net interest margin, or the difference between what we receive on our loans and investments compared with the rates that we pay on our deposits and borrowings.

Our contractual NIM was 3.55% for the quarter, up 5 basis points from the prior quarter, because of our lower deposit costs.

Due to our improved deposit mix, we were able to drive contractual deposit costs down to 79 basis points for the quarter, as Katherine mentioned.

This was a 7 basis point improvement in the quarter.

On the asset side, our higher investment balances offset a modest decline in our average loan yield, and as a result, the average rate earned on all interest earning assets, on a contractual basis, was unchanged.

During the quarter, we agreed to sell approximately $260 million of longer term fixed rate home loans.

On a net basis, purchase accounting discounts on these loans sold added about $0.02 per share to the quarter's results.

In addition to the sale of these loans, we also added $300 million of 4 to 6-year fixed rate FHLB advances as part of our continuing efforts to position the Bank in a relatively neutral interest rate risk position.

Finally, earnings from our tax advantaged investments have reduced our effective tax rate to 37% for the first quarter.

We expect approximately the same tax rate for the next several quarters.

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

Thank you, Willis.

The first quarter represented a very strong start to 2011.

We're experiencing consistent organic growth in all areas of our business, as we maintain very high credit quality.

We're happy with the results of the first quarter, and are pleased with [all of you that] have recognized the success of our banking model.

In fact, during the quarter, Private Asset Management Magazine named us Best Private Bank in North America, and recognized us for the Best Private Client Service, which we appreciate very much.

Thank you for your continued support of First Republic Bank, and now we'll open the call up for questions.

Thank you.

Ladies and gentlemen, at this time we will begin the question-and-answer session.

(Operator Instructions)

One moment please, for our first question.

And our first question comes from the line of Steven Alexopoulos with JPMorgan.

Please go ahead.

Hi, everyone.

Hello, Steve.

Hi.

Maybe I'll start on the margin.

The first thing, for Willis, I guess, the yield on securities, which was up quite a bit, 624, is that sustainable, do you think, here?

Well, Steve, that reflects the tax equivalent yield on the munis that we bought, including the ones that we bought in the fourth quarter of last year.

Going forward, we would expect to invest more heavily in alternatives to the munis.

Okay.

Which would, I guess, be beneficial to the securities deals overall?

Willis?

Yes, I'm here.

Beneficial.

The investment of incremental investments would probably not be higher than the average muni yield, so we would expect the average yield to reflect a mix of different types of investments, and likely be lower.

Okay.

So with that said, how do you think about the sustainability of the core margin here at around 355.

Well, we believe our margin is relatively stable in this range, because we do have the cash to put to work, and we've extended our liabilities quite a bit, and have absorbed the cost of that here in the quarter.

Okay.

And Willis, just following up on that, did you guys take any other actions besides -- I saw the home loan bank advances get added in terms of actions to stabilizing them with swaps, or anything like that, in the quarter?

There were no additional actions other than the sale of some longer-term fixed rate loans, and the addition of Federal Home Loan Bank advances by $300 million.

Okay, and then just a question on the loan side.

Do you guys talk about the pipeline for originations -- what it's looking like here, and how we should be thinking about how much of that gets sold versus retained in the portfolio?

The pipeline, as we see it right now, is up a bit.

We have seasonality, as you know, in our loan originations.

The first quarter is usually the lowest quarter, and we're pleased with the pipeline going forward.

We sell loans from time to time, and generally sell all of our 30-year fixed rate loans.

So, Katherine, any help for us in terms of thinking about what you might retain for the year in the Loan Portfolio?

Most of the loans we make we will retain -- the lion's share of them.

So, going forward, we would expect good growth in loans, and we're not planning on loan sales.

From time to time they do happen, and we sell loans on a flow basis to deal with the 30-year fixed rate.

But seasonality is in our favor going forward.

We are looking to a good second quarter based on the pipeline, and loan sales will be a very modest part of that.

Okay, and maybe a final one for Willis.

How should we think about the tax rate here?

Well, what we do every year is, we try to project what the effective tax rate will be for the year as a whole; and so we believe that, based on our current level and expectations for earnings, and the amount and quantity of tax advantage investments that we are making and have on the books at the present time, that we'll be at 37% or so for the next several quarters.

Okay, thank you.

Appreciate it.

Thank you.

And our next question comes from the line of Ken Zerbe with Morgan Stanley.

Thanks.

Just going back to the NIM for a second -- I guess when you guys were doing a road show, and, obviously, you went public -- I think there's an expectation perhaps for a 330, maybe 335 NIM.

Obviously we're at 355 on a core basis.

What has changed versus where you were 4 or 6 months ago in terms of your expectations?

Is it more cash on hand?

Is it better muni yields?

Because it seems something must have changed since then.

Well Ken, it's Jim.

The primary change has been on the Iiability side, in fact.

We've had very considerable success on bringing down the cost of funds, and that's been reflective, to some extent, in the migration in the account mix.

We are steadily taking down our CD percentage and taking up the more liquid account, particularly checking.

The other thing that's happened, as you indicated, is that the yields we've been able to achieve in the Investment Portfolio have exceeded our expectation a bit.

It's worth noting we're still sitting on $2 billion of cash, which is not yet invested in any meaningful way, really.

And the level is reflective, to some extent, of the term draws we've done from the FHLB, which are, as Willis indicated, relatively fully absorbed as to cost in the margin in the first quarter.

We're currently a bit optimistic about the margin.

It is higher than we have historically experienced, and we were probably cautious in our projections.

I see.

And of that $2 billion, how much of that do you view as available to be re-deployed into longer-duration securities, and how long is it going to take to get there?

Either longer-duration securities or loan growth -- I would say, probably 3/4 of it, roughly.

Okay, perfect.

Second question for Willis.

The purchase accounting adjustments -- it seemed that they were slightly elevated, given the loan sales that you did during the quarter.

Going forward, should we expect it to be -- I don't want to say a cliff drop from here -- but to be down a little more materially next quarter, barring no further loan sales?

I think that's correct.

What we've experienced in the last couple quarters has been a relatively high repayment rate on our whole Loan Portfolio.

In fact, in the fourth quarter of 2010 and the first quarter of 2011, our CPR was 40% higher than in the third quarter 2010.

And we don't know what loans we'll repay in the future, but I think this is around the average that we've now done for 3 quarters.

Okay.

All right, thank you.

Thank you.

And our next question comes from the line of Unidentified Participant.

Please go ahead.

Good morning.

Good morning, Erica.

I just wanted to dive a little bit more deeply on your statement that you're now at balance asset neutral.

What are you assuming in a rising rate environment on the liability side, in terms of your ability to maintain the sort of mix and prevent attrition; and also how much of the increase in short-term rates you will be passing through to your depositors?

Well, we've run an extensive analysis that you would expect, and have done a lot of historical analysis.

The nice thing about our funding is that we are very high core deposit funded, 80% to 90% range, and that the history has been well tested historically; so we have actually quite a good experience base from which to project.

And we run our models, as everybody does I'm sure, from up 100 to up 400 of shock and term movements.

So we've spent a lot of time on this, and we've done 3 things, as you know, to extend liabilities or shorten assets.

We've sold long-term loans, as we just did; we've taken FHLB term draws; and we've put in a swap against some adjustable-rate liabilities.

I think that our general assumption is somewhere around 70% rate move relationship to actual moves; and that has stood up historically for quite a long time, over a 10-year period, 15-year period.

And we assume some migration to CDs, but not all that much, because of our client base.

Remember the mix in the client base is quite different than other banks.

We have a lot of people that are operating with their minimum cash operating needs with us, and those minimums are much higher for the profile of client that we have, both individual and corporate.

Got it.

And my second question relates - - I guess just taking a step back, and it's really regarding some of the wholesale changes that's being proposed today in Washington -- with regard to the Residential Mortgage market.

Have you thought about how to quantify the potential opportunity, if any, for First Republic, seeing that the proposal to lower the GSE conforming limits and keep more capital on non-QRM mortgages?

Let me comment on the limits, and I'll have Katherine talk about the qualified mortgages.

But the roll-back of limits is only positive for us, as we've indicated.

Some people recently -- if you think about any other industry where 90% of it is government, and the government begins to pull back, one would presume the private sector might have an opportunity.

The region of pull-back also is, of course, right at our level.

Our average loan is about $900,000, and they're pulling back in our markets from $720,000, $729,000, down to $625,000.

That should be incrementally disproportionately helpful to us.

Katherine, you want to talk about the QRM?

In terms of the qualifying residential mortgages -- I think most of you probably know this -- we make mortgages that generally have very low loan to values; far lower, on average, than the proposals we've seen.

And we also do tier our loan to values for a purchase versus refi or cash-out refi.

And that seems to be the driving test for the QRMs at the moment.

So we think we should benefit significantly.

That being said, we're not, on average, a very large seller of mortgages, and we will focus more on growing our balance sheet.

I guess just to translate your comments into rough numbers -- is the potential benefit from the decline in conforming loan size limits, could that accelerate your loan growth as it's tracking today?

Or is it enough to keep your loan growth where it is, and it can mitigate the headwind from rates rising, or just simply the law of large numbers?

I actually would say it's likely to accelerate it a bit.

We're operating at our current levels, of course, without that benefit, so it should only be a net advantage.

The truth is, of course, we don't have any percentage idea.

But it is clearly in the right direction.

Okay.

Thanks for taking my call.

Thank you.

(Operator Instructions)

And our next question comes from the line of Aaron Deer with Sandler O'Neill & Partners.

Please go

Good

morning, everyone.

Good morning.

If we can go back to the margin line of questions -- all else equal, if rates stay kind of low here for an extended period, and given the excess liquidity on the balance sheet and your ability to deploy that into higher yielding assets, why wouldn't we expect to see the margin go up meaningfully from here?

You sounded optimistic on that, but it seems like there could be quite a bit there.

Plus your deposit rates, obviously, it seems like those could come down quite a bit.

Hi, it's Jim.

The deposit rates may or may not be able to come down further.

Actually, I might have said the same thing last quarter, too, in the interest of conservatism, but we don't know how far we can press it, and there's a client relationship issue here at some point, obviously.

But if you take your assumption that rates stay about where they are, what's really happening here, of course is the manifestation of a steep yield curve.

And we are benefiting from it, and I don't see why, in fact, we wouldn't continue to benefit.

Your theoretical question of, if we keep in that same environment and we do deploy the additional cash, it is possible the margin would go up further.

We just are hesitant to project it, because we're a little ahead of our normal margin anyway.

Okay.

And then a question on the expense side.

Is it your expectation that deposit insurance assessments will come down here in the second quarter?

I'm sorry, could you repeat that?

Do you expect your deposit insurance costs to drop in the second quarter?

Yes, we do.

We're working through those calculations, but with our posture, we would expect a decrease.

Okay, great, thanks for answering my questions.

Let me go back to your prior question for one second, not to overlook something.

Willis alluded earlier to the CPR rates, which are quite high.

Of course, one of the reasons that's happening is that we have a refinancing down of loans that are at somewhat higher rates going on.

That's part of the reason the margin may experience a capping.

Okay, that's helpful.

I appreciate it.

Thanks.

Thank you.

And our next question comes from the line of Brian Zabora with Stifel Nicolaus.

Thanks.

Good morning.

Just a question on the deposit growth.

Can you give us a sense on how much are new customers or existing customers, and how sustainable the first quarter growth rates are?

Well, we've been very pleased with the growth.

There are a fair number of new customers in there, and it's a mix.

And, of course, at the very end of March, you see the beginning of the run-up to tax time; which, for our particular clients, is quite large.

And so there is seasonality on the deposit move towards the end of March as well.

Katherine, do you want to take that?

The other thing that's going on is, we introduced, just over a year ago, a suite product for our Trust, Brokerage, and Investment Management clients, and that is increasingly very successful.

So that instead of sweeping most of the assets to third-party money market mutual funds, most of them are swept onto our balance sheet, and we expect that to continue to grow.

And those are at relatively low yields.

Great.

And just a question on expenses.

Usually first quarter, there's some seasonality, yet efficiency ratio came down a little bit.

Could we see further improvement, or maybe should we expect this ratio to stay around current levels?

We expect it to stay around current levels, and we are investing in all elements of our franchise.

Thanks for taking our questions.

Thank you.

Thank you.

And I'm showing our final audio question comes from the line of Chris McGratty with KBW.

Good morning, guys.

Just a question on CPR rates.

I think you said in the fourth quarter it was around 21%.

Maybe I missed it earlier, but what was the CPR rate in the first quarter?

Hi, Chris.

The CPR rate was still at around 21% for the total portfolio.

Okay, so if I'm looking forward to the second quarter, with loan growth a little bit lower than I think what we were expecting this quarter, should we assume Q2 loan growth is more similar to the fourth quarter?

Or how are you guys thinking the about just consolidated loan growth?

I think in the next quarter, we're hopeful that the volume will pick up and a few more of the loans will stick.

Katherine?

There's another piece of CPR that may be helpful going forward.

Back to the question asked about the changes in government regulation -- some of our competitors, mortgage brokers, will not be as effective with some of the loans they've been making that also result in CPR payoffs.

So higher loan to value loans will be harder to make and harder to find a home for, and so, therefore, we will have many fewer outside refinances.

Obviously, we keep a good percentage of any loans that get refinanced, but at the margins that will help us.

And in addition, the fact that some of our competitors will not find a home for their loans should help our loan growth going forward.

Okay, go ahead.

If I might, it's Jim.

This CPR issue, we've been through this a lot over the years, and whenever you get a turning in activity level coupled with lower rates -- which obviously generally happen together; one stimulates the other -- you get a period of time when CPR runs up on you, and it's more challenging to have net growth.

We're in that period.

We're delighted, actually, to have net growth in the face of CPR this strong.

We're not very worried about it.

It changes after a quarter or two, and so it's just a matter of time.

What we focus on mostly is the volume and the growth in new client base, both of which are doing extremely well.

Okay.

And Willis, did you guys provide the dollar amount of pay-downs this quarter, or could you?

The dollar amount of pay-downs on the portfolio that we bought on July 1 was about $700 million.

And that does include, I think -- we did sell about $120 million of those loans.

And this is my last question.

On your 5/1 product, where are yields?

What are you guys putting new stuff on to work at today?

I think it was in the low 4s last time we talked.

The base rate would be in the low 4s, but when we have an exceptional client from whom we get a lot of deposits and investment management opportunities, it could be lower than that.

All right.

Thanks a lot.

Thank you.

And our final question comes from the line of Casey Haire with Jefferies & Company.

Good morning, thank you.

Could you provide some color on the C&I Loan Portfolio, which actually held up pretty well, given that the 4Q growth was a lot of short-term capital call volumes?

Was that just back-filled with plain vanilla C&I, or was the short-term capital call volume strong again?

Well, a couple of things.

First of all, we are pleased it held up as well as this, because, seasonally speaking, it would normally be, the outstandings would be down more.

We've had, as Katherine commented earlier, a substantial increase in commitments in that area.

We've also been quite active in the tax exempt nonprofit direct 501(c)(3) lending area, very successfully so.

Great clients, great relationships, good loans.

And so we're very pleased.

The business loan demand has been for us quite strong, actually.

We have also increased our staff of business lenders, and that has helped us grow, and we look forward in the future to increase business from those people who have joined us in the last six months.

Okay, great.

And then just circling back to the comments on the efficiency ratio -- you guys are tracking pretty well relative to your 60% target long-term.

So your point is that you can stay at the current level, even with the coming branch openings and continued hires?

I think we're in a range that we're comfortable in.

As we've indicated previously, we're in the high 50%, low 60% range, and we're comfortable in that range at this point.

The amount of growth that we're taking on in terms of new people and new locations is well within our ability to manage it inside those ranges.

Okay, thanks very much.

Thank you.

Thank you.

I will now turn the call back over to Mr.

Jim Herbert for any closing remarks you may have.

Thank you very much, everyone.

We appreciate it, and we're pleased with the quarter, and we look forward to speaking with you all at the end of another quarter.

Thank you.

Ladies and gentlemen, that does conclude our conference call for today.

We'd like to thank all of you for your participation.