First Republic Bank (FRC) 2011 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

And welcome to the First Republic Bank second-quarter 2011 earnings conference call.

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

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

(Operator Instructions).

This conference is being recorded today, Wednesday, July 20 of 2011.

And I would now like to turn the conference over to Dianne Snedaker, Executive Vice President and Chief Marketing Officer.

Please go ahead, ma'am.

Thank you, and welcome to First Republic Bank's second-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 any forward-looking statements made during this call are made as of today, and 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, including the Bank's current report on Form 8-K filed today.

In addition, some of the financial information discussed on this call includes non-GAAP financial measures.

The Bank's earnings release, which was issued this morning and is available on the Bank's website presents reconciliations to the appropriate GAAP measures, and explains why the Bank believes such measures are useful to investors.

And now, I'd like to turn the call over to Jim Herbert.

Thank you, Dianne.

And thanks to everyone for joining our call today.

Overall, the Bank had a very successful and consistent second quarter.

We're at or ahead of our expectations in many respects.

In particular, we had a very strong loan origination quarter.

This first year of our independence has been very successful, and we are quite pleased.

Very importantly, the credit quality of our loan portfolio remains quite strong.

Our particular client segment in our urban coastal markets continue to perform relatively well, economically.

In summary, for the quarter, diluted earnings per share as reported under GAAP were $0.64, compared with $0.67 for the prior quarter.

If you remove the 1-time items from each quarter, diluted EPS was $0.66 during the second quarter, versus $0.65 for the prior quarter.

Let me summarize the results of this first year of independence.

For the year, assets have increased by 17%.

Loans have increased by 13%.

Deposits have increased by 11%.

We also have improved the deposit mix.

I'll speak more about this in a moment.

Private wealth management assets have increased by 34%, and total loan originations for the year were strong at $8.4 billion.

Quite importantly, book value per share increased 21% for the year to $18.03.

On another important front, we also continue to maintain a very closely matched book, from an asset and liability perspective.

We continue to reestablish our investment portfolio, which is now 8% of total assets.

And our efficiency performance was very satisfactory, and remains quite consistent.

Our deposit franchise is growing very nicely.

In the last 12 months, deposits have increased $2 billion to $19.9 billion.

Liquid deposits, which include lower cost checking and savings accounts, have increased by 27% over this 1-year period.

The growth in liquid deposits has allowed us to pursue a strategy of reducing some of our single product certificate of deposit clients.

As a result, CDs have decreased intentionally, causing our overall deposit mix to improve significantly.

CDs now represent just 25% of total deposits, down from 34%, only 1 year ago.

Generally, deposit trends are positive across all 3 of our primary deposit-gathering channels.

In the past 12 months, preferred banking deposits have grown by 19%.

Wealth management deposits, quite importantly including sweep accounts, have more than doubled.

Total deposits in our preferred banking offices, which include most of our certificates of deposit, are up in spite of the intentional outflow of CDs.

Liquid deposits in these preferred banking offices have increased by 20% in the past 12 months, a very strong performance.

Our planned expansion of new preferred banking offices remains on track.

In the last year, we've opened 1 new office, but much more significantly we have signed leases, and have under way 7 additional locations.

We have successfully reestablished our new office pipeline.

We expect to open 5 to 7 offices annually in our existing markets, with several of these new locations well under way.

Now I'd like to turn the call over to Katherine August-deWilde.

Thank you.

As Jim indicated, we are very pleased with our second quarter.

Total assets are now at $23.8 billion, up 6% thus far in 2011.

Loan outstandings increased 4% for the quarter, or by $827 million.

Loan originations during the past 12 months were $8.4 billion.

Originations were very strong for the second quarter at $2.4 billion, which is our third best quarter ever, and our loan pipeline remains strong.

Our 4 primary markets -- San Francisco Bay area, the coastal areas of greater Los Angeles, New York, and Boston continue to perform relatively well economically, with particular strength in San Francisco and the Silicon Valley.

35% of our business is located in the 3 counties of San Francisco, San Mateo, and Santa Clara.

Home purchase activity is showing signs of improvement in our markets.

Approximately 56% of all loan originations for the quarter were home loan originations.

I'd like to point out that over half of these home loan originations were for home purchase.

Importantly, business loans and lines outstanding are up 7% in the quarter.

Commitments for business lines of credit increased approximately 14% for the quarter.

We are very pleased with this result, which reflects our increased emphasis in this area.

Assets managed or administered by First Republic private wealth management grew substantially over the past year, increasing by 34% to $19.6 billion.

Revenue for wealth management for the quarter increased to $24.7 million, which is up from $16.9 million for the same quarter, 1 year ago.

Over the last year, the growth in assets under management by First Republic Investment Management was particularly strong, growing 48% to $7.9 billion.

These are our highest fee-earning assets.

Wealth management deposits, including sweep accounts, have more than doubled during the past 12 months, and they are now $1.6 billion.

This newer source of funding, which is diversified, inexpensive, and stable, is a very positive result of our expanding wealth management business.

Now I'd like to turn to some comments on efficiency.

This quarter, our efficiency ratio, excluding purchase accounting, was 59.1%.

We are happy to note that we've maintained our efficiency ratio within the range of 58.7% to 59.4% for the past 4 quarters, while continuing to invest in the expansion of the enterprise.

We are continuing to invest in all aspects of our business.

It continues to be an attractive time to hire relationship managers and wealth management professionals.

First Republic continues to deliver solid performance, meeting or exceeding our expectations.

We have extraordinary client acquisition opportunities for both individual and business clients.

Our lending, deposit, and wealth management businesses are very strong, and client satisfaction remains high.

Now I'd like to turn the call over to Willis Newton.

Thank you, Katherine.

Our diluted EPS for the quarter was reduced by $0.02, to $0.64, due to a 1-time accelerated stock option expense.

Last quarter's diluted EPS of $0.67, included a $0.02 gain from purchase accounting discounts on loans sold.

Adjusted for these 2 items, our diluted earnings per share from recurring operations were $0.66 this quarter versus $0.65 last quarter.

As shown in the table at the back of the release, our core EPS, excluding purchase accounting, was $0.41 for each of the last 2 quarters.

However, without the non-recurring stock option expense, core EPS for this quarter would have been $0.43.

By the way, I would note that there are no more stock options with the potential for early vesting.

Our contractual net interest margin remains stable at 3.54% versus 3.55% last quarter.

As the quarter progressed, we put cash to work in both loans and investments, which would benefit the Bank's net interest income going forward.

Under the new rules implemented this quarter, our FDIC insurance costs declined by $4.2 million, as we are now assessed at a lower rate.

We achieved this lower calculated assessment rate primarily due to the high level of our core deposits, the low level of our non-performing assets, and the solid level of our earnings.

Additionally, under the new method, we benefit from having strong capital ratios and liquidity.

We expect our calculated assessment rate to remain at this new lower level.

Also, we expect to have a tax rate of 36% for all of 2011.

This rate results from our continued addition to our tax-advantaged investments.

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

Thank you, Willis.

To summarize, we're quite happy with the Bank's performance this quarter.

Loan growth remains very solid, and actually accelerated as we moved through the quarter.

The improvement in our deposit mix by reducing CDs will be better for the franchise long term.

We continue to have very clean credit, and very strong capital levels.

Earnings are as expected, and we're delighted with our overall progress, both in this quarter and for the first full year of independence.

The quarter also produced several other achievements for the Bank, including our stock's inclusion in the Russell 1,000, 3,000, and Global indices, and the relative weighting of the Bank's stock within 6 Dow Jones indices increased substantially.

Quite importantly, the credit ratings of the Bank were reaffirmed by Fitch and S&P, with S&P raising our outlook to positive.

Moody's also issued a mortgage origination report, separate from its credit rating, in which it awarded First Republic its highest rating level.

That's a quick summary of the quarter.

We thank you very much for your continued support of First Republic.

And now we would like to open the call for questions.

Operator?

Thank you, sir.

(Operator Instructions).

Steven Alexopoulos, JPMorgan.

Maybe I'll start -- looking at the pressure on loan yields, I guess they're down around 16 bps in the quarter.

If mortgage rates stay where they are today, is there enough pick up in moving cash to securities to keep the NIM above 350 in the second half of the year?

We think there probably is -- primarily, as you point out, by investing additional cash, but also the mix of the loans -- if as you heard Katherine, of only about 56% were single family this last quarter.

And our mix is shifting a little bit more towards business lending, which has some slightly higher rates on it.

But the pressure on NIM from loan rates is real, and we stay competitive as you know.

Jim, the jump-in period on loans implies that you had good volumes in June.

Can you talk about the pipeline of business heading into 3Q?

The pipeline is quite strong, and we're pleased.

It's been strong for the last six or eight weeks, and it continues to date, across all of our businesses, and all of our geographies.

The provisions seemed very high relative to book loan growth.

Can you maybe give some color on why the need for such a high provision, and how we should be thinking about this for the rest of the year?

The provision as you know, is related to the net new loans that grow that we originate during the quarter.

We have record loan volume and -- excuse me -- that line grew at a $1.9 billion, and we provided about 55 to 57 basis points on those loans.

Joe Morford, RBC Capital Markets.

You saw some pretty significant improvement in your deposit mix again, with CDs running off and being replaced by more liquid accounts.

But the cost to customer deposits was actually unchanged again, at 44 bps.

Now has that pretty much reached the floor now, and do you see much further opportunity to run down CD balances?

The answer to the first question, whether it's at a floor, I think it's pretty close to floor.

We might do a little better, as some of the CDs run off with older higher rates, but as they diminish as a percentage of total, the impact of that likewise diminishes.

What we did, was not just sort of let CDs run out, but it was more selective than that might imply.

What we have been doing, as we do around the business from time to time, is we looked at the makeup of CDs and focused on those households that had only CDs with us, and attempted to convert them into multi-product clients.

We were actually fairly successful in many cases.

Those cases where we were not successful, we down-priced CD-only pricing, and that has worked to selectively pull out various single-product clients, which we find particularly attractive as a process.

The end of period loan-to-deposit ratio is now up to about 99%.

And I was just curious if that was much of a concern for you or the regulators at this point?

And I also saw you added a couple $100 million more in FHLB advances.

Should we expect more of that in the coming quarters?

Well, the ratio is not a particular concern.

We've operated at those levels historically, and I -- we don't have any reason to believe it's a concern for the regulators either.

The -- you should expect to see ongoing use of term fixed rate FHLB draws, as we use them to continue our asset liability matching.

And that's as you know, we take a very incremental approach to that.

We do it all the time.

We think about it regularly, and just inch our way into a position, rather than any big startling moves.

Aaron Deer, Sandler O'Neill Partners.

Katherine, I was wondering if you could talk a little bit about your -- the success, in terms of recruiting efforts?

It sounds like there's going to be quite a bit of branch additions throughout the year.

I'm wondering how that process is moving along, and what we should expect, in terms of compensation cost?

It looks like they were fairly flat sequentially, when we back out the options expense.

I'm just wondering what we should look for in that line?

We have been very successful, and continue to be very successful, hiring top producers.

In terms of our relationship manager hiring, that is ramping up very nicely in all of our markets.

And in the third quarter, we would expect the compensation cost to be about where it will be, in terms of new hires who are not yet fully productive, because they have so recently joined us.

In terms of the wealth management professionals, we did quite a lot of hiring in the first two quarters of our independence.

And so now, we will be at a more normalized run rate, with fewer professionals who are not yet fully engaged and fully productive.

In terms of the offices, Aaron, we would expect to open in the next 12 months, 4 or 5 that are under way.

And we have, as I think we indicated, about 7 leases, new leases signed and in process.

Our backlog for opening for the next 2, 12-month periods, looks to be about 4 or 5 per period, in all markets.

We're strictly inside our markets.

We are not going into any new territories.

Willis, there were a couple items, sub lines, that were a little curious.

One was on information systems was up a bit.

I'm wondering if that's at now a new run rate?

And then the same for the other expense line?

We would expect the IT cost to continue to ramp up as we play a little bit of -- of not so much catch up, but we are -- we're working on technology to guide our efficiency in our productivity.

In terms of the other expenses, the contributors to other expenses included the hiring of new people.

It included some higher loan-related costs on the higher volume.

And we also had some costs, higher costs from the liquid deposit growth, and our client activity.

We would -- we also incurred last quarter a $500,000 one-time income item from Banc of America.

So it's reasonable to expect that number to then drop back down to some degree?

I think it will vary with business activity, but it might have been a little high this quarter.

Christopher McGratty, KBW.

I wondered if you can talk about the rate on new production, of 5/1 ARMs.

What's the loan yields being put on the books at?

The loan yield is depending on the client's relationship with the Bank, and how much they have with us, is in the mid-3s.

And I recall, it was -- 4 last quarter?

No, its been mid-3s for a couple of quarters.

And then on the loan pay offs, I think there was about $700 million or so in the first quarter.

What was that number this quarter?

Maybe you can speak in pre-payment rates?

The pre-payment fees declined a little bit this quarter, from about 18% down to 16%.

That translated into a little over $100 million less of balance sheet repayments.

On the expense and the efficiency guidance, you talked about the stability in your efficiency ratio, but balancing that with the investment in the franchise.

Should we assume -- I think you've been guiding to high 50s, low 60s.

Is that still fair?

Or is that -- can we see a little bit of improvement, kind of as the year kind of comes to an end?

We're actually very comfortable in the range we've been operating.

And in fact, without the incremental $0.02 a share from the accelerated option exercise, we would have been 53 -- 57.3% this quarter.

We expect though, the 58%, 59% to be very well within what we can achieve.

Christopher Nolan, CRT Capital.

The investment into the held-to-maturity portfolio, is -- should we expect that to continue to grow?

I thought the focus is going to be more on available for sale, in the second quarter and going forward?

The investment portfolio primarily, in held for sale, is where we place the longer-dated muni securities.

And we have continued to add a bit to that.

We will not add as much going forward, as we did in the first 12 months of our existence.

All right.

But you will still keep -- incrementally adding to it?

Yes.

Our available sale is up in the quarter.

That's where most of the growth was in a variety of securities.

Looking ahead to the third quarter, given that balance sheet growth was fairly flat, given the drawdown of CDs, should we expect a catch up, in terms of accelerating balance sheet growth in the third quarter?

Or should we expect further drawdowns in the CD balances?

The balance sheet is likely to grow a bit more in the third quarter than it did in the second.

The majority, the biggest hit on the CD drawdown is probably behind us.

What will be the impact to the diluted share count, following the secondary offering for the third quarter?

The secondary offering will not have a significant impact on the diluted EPS denominator at all.

But if you look at the trend of the first quarter to second quarter, our EPS share count grew about $500,000.

As long as the share price remains relatively in a narrow range, that we would expect the denominator to increase $400,000 or $500,000 per quarter.

Great.

Any visibility you can provide in terms of further share sales by your insiders?

I mean -- I don't want to say insiders, I mean the private equity holders and so forth?

We can't really comment on that at this point, because we don't know.

It's really their call.

Erika Penala, Banc of America Merrill Lynch.

Please go ahead.

I just wanted to follow up on the question with regards to balance sheet growth going forward.

You mentioned on the CD side, that the level of attrition will taper off.

Would you also consider accelerating your pace of draw, in terms of the FHLB advances?

We probably wouldn't accelerate it, Erika, but we certainly will be drawing in an orderly fashion to maintain a matched book, which we -- which, if you look at the last couple quarters have been kind of a $200 million to $300 million per quarter draw rate.

I go through and bake in -- into our average balance sheet model, some of the end of period movements, with regards to your cash deployment, and I assume the same level of down draft, in terms of loan yields, and of course, the reinvestment rate on when the cash is lower, I'm getting to a core margin in the mid 3.6's.

Is that reasonable to assume for the third quarter?

Erika, that is the result of your modeling.

Some of the investments that we have put out, have been in Treasuries and agencies, and have had slightly lower yields.

But we would expect it to have a margin.

We would hope the net interest income will be higher, regardless of where the margin comes out.

So the bottom line is that the reinvestment rate paired with potential -- more downdraft in the loan yields makes that scenario fairly unlikely in terms of significant core margin expansion, based on the cash deployment?

The shift that continues into lending is the driver really.

And although the rates in lending are low as we all know, they are certainly an improvement over cash, or even the short-term Treasury ladders, and other things that we have done in the shorter term investments.

The real question is the magnitude of the deposit-driven growth, net from where we are now, and/or any draws from FHLB giving us new cash to deploy.

We're cautiously optimistic about the deposit growth.

(Operator Instructions).

Brian Zabora, Stifel Nicolaus.

My question is, following up on Erika, on the cash.

What is the level that you'd like to keep that cash balance at, on an end of period basis?

Or maybe asked differently, how low -- how much more declines can we see in that cash balance?

The cash position that we need to sort of operate on a regular basis is in the $400 million to $500 million range.

And then just a question on other income.

It was down -- about -- in half in the quarter.

Was anything meaningful or anything lumpy in that number?

The line item and other income is normally about $2.4 million.

But in the last 3 quarters, hedge accounting has caused some variances with that.

We had about $500,000 of income in the fourth quarter of 2010, and then last quarter as well, which turned around this quarter.

However, despite this volatility, we believe that the $500 million worth of interest rate swaps provide valuable protection against the rise in interest rates.

And we don't -- we can't forecast where that will go, going forward, but net-net, to date, we're even on hedge accounting.

Okay.

And then just lastly, obviously very strong loan growth, can you just talk about how competition, how pricing is holding up in some of the C&I, and maybe multi-family where you saw good growth?

It's a very competitive market, particularly competitive in single-family, but multi-family is also very competitive.

Business lending, there's competition certainly for the client.

But it has not really impacted price very much, so we're still getting the prices, and the quality we have always expected.

We're doing a bit more of it, with more focus on it.

Commercial Real Estate lending, surprisingly to us recently, particularly in smaller buildings, which we tend to lend on, has also become increasingly competitive.

I would now like to turn the conference back over to Mr.

Herbert for closing comments.

Please go ahead.

Okay, thank you, operator.

And thank you everyone, for taking the time.

Just a quick summary if I could.

Obviously, our credit risk continues to be quite low.

The markets that we're operating in, and the segments that we're operating in, continue to perform quite well, particularly relatively, but in an absolute sense as well.

And they seem to be picking up steam.

We spend every day, every week, every month taking share away from others, successfully so far.

The momentum that we have on all fronts is pretty strong.

Loan growth is strong.

Liquid deposit growth is strong.

Wealth management assets are growing very well.

Our loan delinquencies not an issue, as I said.

Margins are holding pretty firm, particularly given the pricing pressure on lending, and the efficiency ratio is very much in line, and we're pleased.

So with that, we thank you very much for listening in on our call today.

Ladies and gentlemen, this does conclude our conference for today.

We thank you for your participation, and you may now disconnect.