First Republic Bank (FRC) 2011 Q3 法說會逐字稿

Welcome to the First Republic Bank's third-quarter 2011 earnings conference call.

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

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

(Operator Instructions)

Today's conference is being recorded, October 20, 2011.

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

Please go ahead.

Thank you, and welcome to First Republic Bank's third-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 stepping in for Willis Newton today, our Deputy Chief Financial Officer, Mike Roffler.

Before I hand the call over to Jim, please note that any forward-looking statements made during this call are made as of today, are based on Management's current expectations, and are subject to risks, uncertainties, and assumptions.

Potential risks and uncertainties that can 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 would like to turn the call over to Jim Herbert.

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

First Republic had a very successful third quarter.

We continue to build our franchise and attract new households, even in these rather uncertain times.

We are at or ahead of our expectations in most aspects of our business.

It was, for instance, an extremely strong loan origination quarter; in fact, our second best that we've ever had.

And our deposits continued to grow quite strongly from all sources.

The credit quality of the loan portfolio remains very good.

Non-performing assets were less than 0.125 of 1%.

We also took advantage of the low rates during the quarter and drew some FHLB fixed-rate term advances.

We will speak more about this in a moment.

For earnings, the key measure that we pay attention to -- this is excluding all purchase accounting and other one-time items -- was $0.42, up 20% year over year.

Let me take a second to summarize the last 12 months very briefly.

Our loans have increased by 16%.

Deposits have increased by 15%.

On the private wealth management side, total assets have increased by 14%.

Quite importantly, the book value of the enterprise has grown by 20%.

So far this year, our loan originations have totaled $6.9 billion.

We are particularly pleased with the progress we are making in business banking, which Katherine will speak more to in a moment.

The model for First Republic remains quite simple and quite differentiated.

We offer very customized personal service, private banking, private business banking, private wealth management.

We have a single point of contact for all banking and wealth management.

We are focused on a limited number of urban, coastal, supply-constrained markets.

Our earnings come from the extremely well-established balance sheet and ongoing business, representing a strong client base.

We have always and we continue to run a very matched book, assets and liabilities.

Importantly, we are quite pleased with our consistent core efficiency ratio, which this quarter ran 58.8%.

Importantly on the deposit side, for instance, checking and savings increased $2 billion during this last quarter, while we continue to shrink our CDs.

CDs now represent just 22% of total deposits.

This is down from 32% a year ago.

This overall mix change is lowering our cost of funds.

In a more macro sense, we have a very unusual opportunity at this time to attract both individual and business clients, as of the result of some of the dislocations happening in the banking market in general.

In short, First Republic represents a unique, almost one-of-a-kind private bank, operating bi-coastally.

Now, let me turn this call over to Katherine August-deWilde, our President and Chief Operating Officer.

Thank you, Jim.

We are quite pleased with our third quarter.

Loans are now $21.5 billion, up 16% in the last 12 months.

Loans outstanding increased 6% this quarter or $1.1 billion.

Significantly, loan originations year to date were $6.9 billion.

And for this quarter, they were $2.6 billion, which was our second-best quarter ever.

The origination volume reflects the strong pipeline that I mentioned on last quarter's earnings call.

Currently, our loan pipeline is at its highest level ever.

Deposit trends are positive across all three of our deposit-gathering channels.

Preferred banking deposits have grown 26% year over year.

Wealth management deposits, including our sweep accounts, have increased more than 70% year over year to $2 billion.

Checking and savings deposits in our preferred banking offices are up 27% year over year, and total deposits in those offices are up in spite of the intentional reduction of CDs.

Our markets are doing relatively well economically.

There is considerable strength, in particular, in San Francisco and the Silicon Valley, which represent about 35% of our business.

As always, we continue to underwrite loans to our high credit standards.

This quarter, more than 62% of our loan originations were home loans.

And interestingly, 37% of these loans were for home purchases.

During the quarter, we were particularly pleased with our continued growth in business banking.

Our strategy continues to be following our clients to their businesses and nonprofits.

Business loans and lines outstanding were up 12% for the quarter, and we should note that business-related deposits are now $8.1 billion, and they represent 37% of total deposits.

For First Republic private wealth management, assets managed or administered were $18.5 billion at September 30, up 14% year over year.

In addition to the growth in assets, sweep accounts are now up 70% year over year.

As a result, third quarter revenues increased 52% year over year.

We continue to hire experienced relationship managers, business bankers, and wealth management professionals.

They are attracted to our highly desirable private banking platform.

Our lending deposit and wealth management businesses are strong, and they continue to benefit from our single point-of-contact model.

Client satisfaction remains high.

And now, I would like to turn the call over to Mike Roffler.

Thank you, Katherine.

I'm pleased to report the third quarter generated strong quarter earnings, reflecting growth in our loans, investments, and deposits.

Third quarter core revenue growth of 5% represents another consecutive quarter of core revenue growth.

These revenues totaled $236.7 million for the quarter, up 20% year over year.

Coordinate interest income is up 16% year over year, and 4% compared to the prior quarter.

This has been driven by our average balance of earning assets increasing 19% year over year, and 9% compared to the prior quarter.

We continue to have significant liquidity in these uncertain times, as cash balances were 8% of total assets at September 30.

As Jim mentioned earlier, we added $1 billion of longer-term, fixed-rate FHLB advances during the quarter, as part of our continued asset liability matching.

This additional liquidity, which was the result of strong deposit growth and new FHLB advances, has an impact to our net interest margin, as our average cash balances increased $600 million during the quarter.

This cash earns only 25 basis points, and the additional liquidity in the third quarter reduced our net interest margin by 9 basis points from the prior quarter.

As a result, our contractual net interest margin was 3.41%, down 13 basis points, compared to the prior quarter.

This quarter, our expenses grew in line with the growth in our revenues.

As a result, our core efficiency ratio remains stable at 58.8%.

We have maintained this efficiency ratio within a tight range of 58.7% to 59.4% during the past 5 quarters.

Over the past year, our salary and benefits expense has grown, as we have hired producers, client service and support team members to support our ongoing growth.

In addition, in the last year, our technology costs have increased as a result of initiatives to expand and enhance the customer experience and our ongoing investment to improve efficiency.

The current rate of growth for these technology costs should moderate in the future.

Finally, to follow on Jim's initial comments about our business model, it's helpful to remember that, as a straightforward private bank, we are not involved -- nor have we ever been involved -- in the business of investment banking, proprietary trading, or subprime lending, and we do not have any exposure to sovereign debt or outstanding repurchase demands on the mortgage servicing portfolio.

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

Thank you very much, Mike and Katherine.

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

We have had very good loan growth this quarter and year to date.

We have improved our deposit mix substantially throughout the year.

Our credit continues to be quite strong and clean, and our capital levels are very strong.

We would like to note that this quarter represents 26 years of continually profitable operations.

With that quick summary of the progress for the quarter, we thank you very much, and we would like to turn this over for questions.

Operator?

Thank you, sir.

Ladies and gentlemen, we will now begin the question-and-answer session.

(Operator Instructions).

Our first question comes from the line of Steven Alexopoulos with JP Morgan.

Please go ahead.

Good afternoon, everyone.

Hi, Steve.

Jim, maybe I will start, given the rate environment, do you think you have enough offsets to keep the margin --I'm talking about the core margin, 340-ish -- relatively flat over the next few quarters?

We think so, Steve.

We think we can out run the compression that came, as you saw, about 70% from excess cash.

The real issue is, can we control the flow of deposits coming in and contain the excess cash number?

It's a nice problem, as you can imagine, on the deposit side, but it looks like we should be able to maintain it more or less in the range that we are operating in.

I would take you to net interest income, obviously.

The growth and the earning assets of the enterprise have driven net interest income very strongly, and that's an offset as well.

And then, Jim, on the loan growth, given the very strong refi activity during the third quarter, can you give us some color on why loan growth picked up?

Because I would have thought the higher re-fis would have hurt growth.

I'm talking about loans held in portfolio.

There are a number of reasons for that, Steve.

First, we have a number of purchases.

Loans are growing through all of our business line, multi-family and small commercial real estate, as well as business banking.

In spite of refinances of our own balance sheet, we capture most of them with new loans, and we also win business that is at other banks.

And we have been successful in that area, as clients recommend us and as new producers bring in their existing book of business.

Katherine, just one follow-up, and then I will turn the call over.

Any early signs of a pick up in the pipeline from the conforming limits coming down?

I know it's early, but just curious.

We would expect that to be a benefit to us, because as the 30-year fixed is not available through the agencies, we would expect more people to choose our balance sheet loans, and we are pleased about that.

It's too early to tell, but I will tell you that our pipeline is at the highest level it's ever been.

Okay.

Great.

Thanks.

Thank you.

Our next question comes from the line of Erika Penala with Bank of America Merrill Lynch.

Please go ahead.

Good morning.

Good morning, Erika.

My first question is a follow-up to Steve's question.

It sounds like, from a cyclical perspective and assuming you are going to continue to deepen your market share in the East Coast, that the deposit flows will continue to be generous.

I guess, with that premise in mind, is there sort of a level of deposit growth that would cause you to be more aggressive in terms of deploying your cash into your securities portfolio?

Generally speaking, we invest and loan only at a pace that we are very comfortable with.

We have historically refused to be driven by excess cash into action that was different than we felt was extremely conservative.

And we are probably going to maintain that stance.

Okay.

This is a very technical question, but in terms of the prepayment penalty, as some of your current customers refi, how much does that typically support the core NIM, and does that number fluctuate materially depending on the flows -- the refi flows?

Erika, this is Mike.

It's been consistent at about 5 to 6 basis points of the NIM for the last 2 to 3 quarters.

So, it hasn't fluctuated a lot.

Okay.

And my last question before turning the call over is, Katherine, you mentioned that you have both purchase and refi origination volume and -- as well as growth in other loan categories.

From a geographic standpoint, is most of this coming from your relatively newer marketplace?

Or is this mostly still sort of in California?

The business is coming from the same geographies that our balance sheet that -- as the loans on our balance sheet, with one exception.

Because of the very strong economy in the Bay area, we are slightly up a few percentage points in loan originations in that market.

But aside from that, it's across the board.

Okay.

Thank you for taking my questions.

Thank you.

Thank you.

Our next question comes from the line of Joe Morford with RBC Capital Markets.

Please go ahead.

Thanks so much.

Good morning, everyone.

Hi, Joe.

I guess following up a little bit on the questions that have been asked, the deposit growth is impressive, no matter how you look at it.

I wondered if you could talk about some of the drivers behind that, that may have caused it to accelerate as much as it did just the past 3 months?

And in looking at some of the deployment you did do, the types of investments that you were making this quarter.

The deposit growth comes from several places.

First, with the volatility in the market, clients and prospects who become clients are going more to cash.

Second, we have new relationship management portfolio managers who are bringing their clients to us.

And third, our business banking, where we have increased our focus over the last several years, is doing very well.

Business banking deposits are more than 5 times the loan is outstanding.

And so, the more focus we have on business banking, particularly with highly qualified clients who don't use their lines as much, the more our deposits grow.

Okay.

And then I guess just one follow-up would be, given that the volumes are so strongly on the positive side, what other opportunities do you see to further lower deposit rates and/or improve the mix that can in the sense help control this flow?

It's not so much control the flow, although that is part of it.

But we still carry a book of well over $4 billion of CDs.

They roll, they tend to have a kind of a 1-year average life, roughly.

So, they roll quite regularly.

We also have buried in there several hundred million dollars of a money desk component, which we used to extend our term when we came out of BofA.

Those are rolling off; we are not renewing them.

They don't carry any relationship with them, and they are higher priced at this point.

We have about -- the CDs rolling in this quarter are in the 1.8% range, roughly.

And so that's our biggest opportunity.

The rollover is in excess of $1 billion in the quarter.

So, we will continue to focus on that.

We are also focusing on the CDs in another way.

Some of the CDs are single-product CDs.

We don't have the normal cross-sell that we achieve in our business, and we are dropping those rates even further and thus capturing either a particularly attractive rate or moving the client out of the bank.

So, we are working it fairly aggressively, but very methodically.

Okay.

That's helpful.

Thanks, Jim.

Thank you.

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

Please go ahead.

Good morning, everyone.

Good morning.

I guess kind of following up in that same line of questioning.

You gave some color on the pricing on the liability side.

I'm wondering if you can also give us a sense of, with all of the new loan growth that's [gone] on in the past quarter, what kind of pricing have you been getting in each of the major product areas?

Well, our loan rates are about the same as they were last quarter, up just ever so slightly.

And that's for the entire mix.

We have not seen a significant change in the rates on home loans, other kinds of real estate loans, or business line.

Okay.

And then maybe a couple of questions on the expense side.

Comp expenses has been coming up.

I think you, obviously, have been hiring a lot of folks.

I am curious, of the increase that we saw this quarter, how much of that is the result of additional hiring, versus maybe increased accruals for bonuses and just general compensation, given the strong performance that we've had?

I would say that most of it is really due to new hiring.

There is a little bit of increase this quarter in our bonuses as a result of production volumes and growth in assets.

Okay.

And was there anything unusual in the other line item?

That seemed to have been up a little bit.

Other expense?

Yes.

No.

I would say it's largely driven as a result of a couple of factors.

Adding of people, you add some administrative costs and recruiting costs.

And also, as we have higher loan volumes and deposit volumes, there's other operating costs that go along with that.

Okay.

Great.

Thanks for taking my questions.

Thank you.

Thank you.

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

Please go ahead.

Thanks.

A question on deposit growth.

Can you give us a sense how much of this is coming from new clients that you are attracting, or how much is coming just from existing clients?

It's more coming from existing clients, because in 1 quarter, you don't bring in that many new clients.

But we do have deposits coming from new clients, and also, as we season a relationship, from people doing more with us.

They may have been a new client in the first quarter who are over several quarters bringing the rest of their deposits to us.

And then, sorry if I missed this.

Did you give line utilization on the commercial side, as far as -- has that changed this quarter versus last?

One moment, please.

Is it commercial real estate you are referring to or the commercial lending?

No.

Commercial line, the C&I.

The Commercial line -- business line.

Yes.

Those -- the change in that outstanding is mostly draws on the just in time lines under funds.

Lines of credit.

I would say the utilization rate is up just slightly.

Yes, but it's still pretty modest.

Great.

Thank you for taking my questions.

Thank you.

Our next question comes from the line of Christopher McGratty with KBW.

Please go ahead.

Good afternoon.

Good afternoon, Chris.

Mike, in the securities portfolio, what are you guys buying?

I would say couple of things.

We have continued to buy municipal securities as part of our continued tax and investment strategy.

We bought just under $280 million during the quarter.

It's a very diversified portfolio, and we look very closely when we invest.

The other thing is we did buy in the available for sale portfolio some highly rated commercial (technical difficulty) securities that have a relatively short life, around 5 years or so.

And the average size of our bond portfolio is about $5 million per issue.

Okay.

So should we be expecting continued growth in this portfolio going forward, as you kind of recontinue to rebuild it?

You know there was a little over $2 billion.

We are continuing to rebuild the portfolio, and as we continue to have excess liquidity, we will look strategically at our investment portfolio.

Okay.

And then Jim, maybe a comment on capital.

I assume -- you are at the year anniversary.

How are you guys thinking about the dividend or potentially implementing one?

Well, as you know, we paid a dividend previously, but we really have been working closely with the regulators on re-establishing the entity in every respect prior to discussing a dividend.

The earnings would clearly support it, but we are very cautious about that at this stage.

Great.

Thanks a lot.

Thank you.

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

Please go ahead.

Great.

Thanks.

In terms of the NIM, how much of the stability in NIM that you are thinking about actually comes from excess liquidity coming down, versus other items?

Well, some of it comes from that, Ken, for sure.

But the main driver is that our liability and asset pricing at the incremental level appears to have stabilized.

Now, it might change.

But as of now, it's stable.

As Katherine commented, the new loan book this quarter was approximately the same price, slightly higher, in fact, as last quarter.

On the deposit side, we are gaining a bit, but of course we are also getting down to a level where it's going to be harder to gain.

So, it's kind of a -- it's a combination.

Any upside at this point, as you properly imply, probably lies in the proper utilization of cash in earning assets, as opposed to just federal reserve deposits.

Understood.

And then, can you just give an update on wealth management?

I know we haven't discussed that too much right now.

But is this -- obviously, you are growing earnings there.

It still remains very small percentage of your total portfolio -- or your total revenues.

What needs to happen for that to materially increase as a percentage of revenues over time?

Well, there are two different issues.

One is, we were focused on growing the revenues and then in time increasing the profitability as well.

But the bank grows its assets and liabilities very quickly, and we don't plan to stop that.

We do have a plan to continue the new hires and the referral programs we have within the bank, and we expect revenues to continue nicely.

And we would love to see it outgrow the bank, and we are working towards that.

It also depends on market.

And would you consider an acquisition of teams or a bigger acquisition of wealth?

We tend to hire people, and sometimes people come in twos and threes.

We are less likely to do an acquisition.

Okay.

Thank you.

Thank you.

Our next question comes from the line of Christopher Nolan with CRT Capital.

Please go ahead.

Hi.

Thanks for taking my call.

Another angle on the capital question.

Your tier one leverage ratios came down from 938 to 895.

My understanding is because you're technically a De Novo Bank, you have a floor of 8% leverage?

That's correct, Chris.

So given -- everything I'm hearing sounds like the business is just going very well.

Continued growth seems strong.

Should we start factoring in a capital raise sometime in the next couple quarters or so?

No.

Part of the decline has to do with cash, which if we have to we can control it, and we will.

We don't see a capital need in the enterprise for actually indeed several years.

Remember that we have the GAAP driver.

We have the purchase accounting driver.

So, our return on equity from a GAAP point of view is approximately 14% to 15%.

And the growth rate of the balance sheets -- the total assets are a little above that, but the earning assets are running at 14% to 15%, as are deposits.

So, the only imbalance at all is the excess cash.

Okay.

So, as you put that more to work, your margins -- excuse me, your returns show increase and be able to support the growth better?

Exactly.

Either we slow it down or we put it to work, one or the other.

But the intention is to avoid doing a capital raise?

We don't foresee a capital raise in the future.

Okay.

Thank you very much for the clarification.

Thank you.

(Operator Instructions).

Our next question comes from the line of Casey Haire with Jefferies & Company.

Please go ahead.

Good morning.

My question is on the FHLB draws.

I think you said it was up $1 billion this quarter and -- $600 million of which was in the run rate.

So, obviously that bleeds through to the next quarter.

What rate are these FLB draws coming on?

And then secondly, doesn't the strong deposit flow sort of mitigate the need for more draws going forward?

To answer the first part of your question, these are long-term draws, close to a 5-year life, and it's part of our continued asset liability matching to maintain a relatively neutral balance sheet.

The cost is about 163, and we continue to match and look weekly at our position to make sure that we are neutral going forward.

Okay.

And you mentioned that the CD roll off at 1 -- it's -- what is the new rate on new CDs?

Probably in the 40 basis point range.

Okay.

Then just lastly on the tax rate, that ticked up a little bit this quarter.

Is that because of less muni placements in the securities book?

Is that a good run rate going forward?

It is a little higher than last quarter.

In the second quarter, we had to get our annual tax rate to 36%, so it's a little lower in the second than the first.

We continue to expect a 36% tax rate for the rest of this year, which is why we are at that level this quarter.

Okay, great.

Thank you.

Thank you.

I show no further questions in the queue.

At this time, I would like to turn the conference back to Mr.

Herbert for closing remarks.

Thank you very much, and thanks, everyone, for being with us today.

I guess I would just like to sum up very quickly.

We have, for more than a quarter of a century, run a very long-term focused enterprise.

We focus on client growth and acquisition and good service.

This is one of the best quarters in our history for client acquisition.

The backlog would indicate the coming quarter will be the same.

I would focus everyone on the growth of average earning assets, which have been 23% over the last year, 7% in the last quarter.

And the deposit trends are very strong, and importantly, the mix is at an inflection point for us, particularly the business banking piece that Katherine referred to.

Credit remains extremely strong.

We have less than 0.125 of 1% delinquency.

So, we see the current macro environment of dislocation as an extraordinary opportunity to acquire good new clients, and we intend to take advantage of it.

Thank you all very much for listening in on the call.

Ladies and gentlemen, this concludes the First Republic Bank third quarter 2011 earnings conference call.

Thank you for your participation.

You may now disconnect.