First Republic Bank (FRC) 2012 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to the First Republic Bank first-quarter 2012 earnings conference call.

During today's presentation, the lines 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 call over to Dianne Snedaker, Executive Vice President and Chief Marketing Officer.

Please go ahead.

Thank you, and welcome to First Republic Bank's first-quarter 2012 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 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 could cause the Bank's business and financial results to differ materially from these forward-looking statements are described in the Bank's periodic report 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 of 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.

We are very pleased with our first-quarter results.

Loans, deposits, bank, and wealth management asset growth were all very strong, and credit quality remains excellent.

First Republic is experiencing considerable success in attracting clients across all of its businesses and markets, particularly in the San Francisco Bay Area, where economic activity is very robust.

Our first-quarter results point to the underlying strength of the franchise, even as we continue to make considerable investments in new personnel and offices.

Katherine will speak more about this in a moment.

I'd like to briefly summarize the numbers for the quarter.

Core earnings per share, excluding all purchase accounting adjustments, were up 20% year-over-year to $0.49 a share.

Core net income was up 25% to $68 million.

Loan volume for the quarter totaled $3.2 billion.

This is our largest first quarter ever, and was 70% higher than the first quarter a year ago.

Loans outstanding increased by 3% during the quarter.

Deposits rose by 4% during the quarter.

Total wealth management assets grew by 8% during the quarter, this was the result of both a strong market as well as significant new client additions.

Quite importantly, our asset quality remains strong.

Non-performing assets remained at a very low 11 basis points of total assets, less than 0.125%.

At quarter-end the Bank continues to exceed all the current regulatory guidelines to be well-capitalized.

Our Tier 1 leverage ratio was 9.48%.

This includes our newly-issued non-cumulative perpetual preferred stock, which added a net $164 million of Tier 1 capital in the quarter.

First Republic's performance is primarily the result of its concentrated focus on exceptional client service, coupled with a very disciplined asset underwriting.

It is also the result of meaningful improvement in economic conditions in our six very carefully chosen coastal geographic markets.

In short, the Bank continued to perform very well.

On that note, I'm particularly pleased to announce that in light of our continuing strong performance, we would expect, subject to Board's declaration, to begin paying a quarterly cash dividend of $0.10 per share following the second quarter of this year.

All dividend payments beyond 2012 will be subject to ongoing regulatory oversight.

Now, let me turn the call over to Katherine.

Thank you, Jim.

Results in the quarter were strong across all our businesses, deposits, loans and wealth management.

We're pleased with the success of our deposit-taking initiatives in the first quarter.

Total deposits grew to $23.3 billion.

Importantly, liquid deposits continued to grow and were up 7% in the quarter.

Checking balances are more than $10 billion and represent 43% of total deposits.

We saw growth across all of our deposit-taking channels during the quarter.

Deposits in our banking offices were up 2%, preferred banking deposits, those sourced by relationship managers and business bankers were up 6%, and deposits from wealth management clients were up 4%.

Looking at real estate markets in our carefully selected geographies, home values are relatively strong.

Los Angeles is improving, and Boston and New York are doing well.

The San Francisco Bay Area, with its healthy economy and robust technology sector was very strong.

Home purchase activity in the Bay Area is accelerating.

Inventory is limited, and multiple offers are becoming common.

We are very well-positioned in San Francisco and Silicon Valley, and stand to gain from the increased economic activity in the region.

Our average loan balances grew 6% in the first quarter of 2012.

Home loans were 59% of total originations in the quarter, and of those, 29% were from home purchases.

For the past seven quarters, purchases have been about one-third of home loan originations, and our pipeline remains very strong.

Business banking, a key strategic focus, also performed well.

Business deposits, which were up 6% in the quarter, are over 40% of total deposits.

Importantly, business loans outstanding grew 9% for the quarter.

Deposit wealth management had a very good quarter.

Assets grew $1.7 million or 8% to $22.1 billion.

Net new client money was approximately $600 million, or 36% of the total growth.

As Jim mentioned, we are continuing to make important significant investments in our franchise.

In this regard, I'd like to comment on two specific aspects of our client acquisition strategy, new offices and new personnel.

During the next four quarters, we anticipate opening approximately 10 new full-service banking offices.

In March, we opened a Delaware Trust Company location, which will be particularly important for our wealth management business.

We continue to have opportunities to hire new relationship managers, business bankers and portfolio managers.

The portfolio managers are particularly attracted to our private banking model.

These investments in people and offices have up front costs, and we continue to remain comfortable with an efficiency ratio of 58% to 62%, given the current economic climate.

We're quite pleased with the high quality of our new hires and the desirable locations of our planned offices.

These initiatives position us well for future growth, and we are off to a terrific start in 2012.

And now I'd like to turn the call over to Willis.

Thank you, Katherine.

Today, I have a detailed comment in four areas of the financials, the higher volume of loan sales, asset liability matching, the effect of loan repayments, and our lower tax rate.

During the quarter, the Bank sold $552 million of longer term fixed-rate loans, a higher than usual volume.

The secondary market for home loans is improving, which gives us more flexibility in managing our balance sheet.

We recorded a $3.8 million gain on these loan sales, or approximately 70 basis points.

By comparison, in the prior six quarters, the average amount of loans sold was $220 million and the average gain was 56 basis points, excluding purchase accounting discounts.

During the quarter, we added $950 million of intermediate term fixed rate federal home loan bank advances with an average term of 5.5 years and an average rate of 1.4%.

Coupled with the loan sales and the new preferred stock, we believe we remain appropriately matched in the event of a rise in interest rates.

Since we sold most of the loans and borrowed most of the advances late in the quarter, the impact of these conservative balance sheet management actions have not yet been fully reflected in our net interest margin.

With the dip in interest rates, prepayments were adding high 25% annualized rate for the fixed rate loans, and our loans service portfolio for investors.

As a result, we recorded impairment charges of $2.5 million on our mortgage servicing rights during this quarter.

By comparison, such an impairment charges were about $1 million in both the prior quarter and the same quarter a year ago.

The rate of repayment of our balance sheet loans slowed down a bit.

Also, due to the continuing decline in the balances of purchase loans and their associated loan discounts, we recorded lower income from accretion of a purchase accounting discount.

This quarter's loan discount accretion was $38 million versus an average of the $46 million per quarter in 2011.

Since our independence, the Bank has been implementing a strategy to reduce its income tax rate.

We have rebuilt our portfolio of municipal bonds, purchased bank-owned life insurance and tax credit investments and originated tax-advantaged loans.

As a result of the step we've already taken and our projections for additional investments this year, we currently expect that we will have an effective tax rate for calendar year 2012 of approximately 31%.

This rate is 4.7 percentage points below our effective tax rate for calendar year 2011.

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

Thank you very much Katherine and Willis.

In closing I wanted to summarize by saying, we're very pleased with the quarter and the opportunities in front of us.

Let me highlight a few noteworthy activities from within the quarter as well.

We received regulatory approval to begin a dividend program, which reflects the continuing strength of First Republic.

We completed a successful secondary offering of common stock.

This increased the float in our stock while also reducing our private equity ownership to less than 40%.

Also, during the quarter, we expanded the strength of our management team, particularly including the hiring of Senior Executive Vice President Mike Selfridge.

Finally, we're pleased to have again been honored by Private Asset Management Magazine as the best private bank for client service.

Thanks to all our shareholders for your continued support.

We very much appreciate it.

Now, we're happy to take your questions.

(Operator Instructions).

Our first question comes from the line of Dave Rochester with Deutsche Bank.

Please go ahead.

On the expense side, maybe if you could just talk about that trajectory going forward?

I know you're making a lot of new investments.

Can you talk generally about a good run rate for 2Q, and then when do you think that growth will slow?

Sounds like that might be in maybe the second quarter next year after the build-out of all of the branches and the new hires?

Hi, it's Katherine.

We would expect the expense ratio to be between 58% and 52% on a run rate basis.

The brunt of the new investments are going to be hitting throughout the rest of this year, then we will be able to reap the benefits of them.

While we don't project forward, this will be an important year for investment spending.

It's particularly important as we have the purchase accounting adjustment that will run-off in the future to make the investments now.

And Dave, this is Willis.

A couple of comments.

The salary and related benefits line includes some seasonal factors.

We have higher payroll taxes this quarter, about $7 million in the first quarter of this year compared to $5 million last year in the first quarter and $2.5 million or so on average during the other three quarters in last year.

So about half of the increases in salary and expenses in the first quarter are related to seasonal factors.

Our occupancy line includes much of the rent cost for our new offices, but we're not yet bearing the cost of the depreciation, because the offices are not yet open nor are we bearing the cost of all of the people, as we have hired some but not all of those folk.

And then the tax credit investment line is up about $1.5 million over the last quarter and that's where we write off the low income housing tax credit investments that we make on our balance sheet, but we get a greater benefit in the tax provision than you see that increase in expense.

Okay, thanks for that extra color there.

Appreciate that.

And then just switching to loan pricing real quick, if you can update us on some of the yields on the C&I and CRE that's in your current pipeline, to get a sense where the market is today or where you guys are today?

We are putting loans on -- single family loans at about 3.25%, and that includes both adjustable loans as well as five and seven-year hybrid loans.

The income property loans are a bit higher than that, and most of the C&I loans are at approximately prime.

All right, great.

It sounds like you're saying the pipeline is still strong.

Would you characterize that as being stronger than last quarter, sort of leading to maybe an acceleration in growth into Q2?

The pipeline is very strong.

It has picked up a little bit from last quarter but we went into the first quarter with a very strong pipeline as well.

We are pleased about the strength in our markets and the business that we're seeing.

Great.

All right, thanks guys.

Thank you.

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

Please go ahead.

Thanks, first a question for Willis.

I was hoping you could just give a little more information on the underlying drivers of the higher core NIM this quarter, so excluding all of the purchase accounting adjustments.

It seems like it was driven by security yields, but I wanted to make sure that was the case, and is it sustainable going forward, and obviously layer in what negative impact this might have from the advances in loan sales you had mentioned.

Thanks.

Yes, Ken.

The NIM in this quarter increased, primarily as a result of us having lower average cash balances.

The average cash balances declined from $1.8 billion in the fourth quarter last year to $900 million this quarter, which is about as low as it is likely to get in the near future.

You can just see that our ending cash was $1.4 billion, and that's as a result of the additional advances, as well as deposits coming in, in anticipation of tax payments.

So the NIM benefited from putting that cash to work, and also from the investments in loans that we booked in the fourth quarter last year, and we had outstanding for the entire quarter.

I would comment on our contractual loan yields, which has declined steadily over the past five quarters from 4.68% a year ago, to 4.14% this past quarter.

That's a decline of 54 basis points.

By comparison, our contractual deposit costs, which we do mention in the release, have declined 39 basis points to 40 basis points or 4.4%, so and as Katherine mentioned, our new loans are going on at lower rates, and we are doing things to match up and draw down these advances so those are the elements that we see playing the role in next quarter's NIM.

Okay, I think I got all that.

So it sounds like it should be sustainable, but you have the loan repricing going forward, which will bring that down over time so there's nothing necessarily unusual this quarter other than the cash?

That's correct.

Okay, and then the other question I had just goes over to Silicon Valley.

Are you able to quantify how much your loan growth came from Silicon Valley or is there any way that we can measure the impact of the technology boom there is having on your overall business?

It's Jim.

It's really not that identifiable, Ken.

We could look at the growth in loans in that area, and our home lending activity is particularly robust in that area, as you might expect, but it's not physically quite frankly that large relative to the entire base of the Bank.

On the other hand, the venture capital fund business that we do down there is quite active, but those loans don't tend to be outstanding for any length of time.

We are picking up some business lending, and that's improving, but it isn't all there.

So it's really holding its own as a share of the enterprise, but it is not particularly standing out, except in the home lending area, and in the strength of the housing market, just in terms of safety.

Got it, okay.

Thanks a lot, Jim.

Thank you.

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

Please go ahead.

My first question is a follow-up to David.

Katherine, I appreciate the color that you gave with regards to the 58% to 62% efficiency ratio, but looking further ahead to 2013 and 2014, in your opinion, what is the more inherent efficiency ratio of a bank when you model once, some of the investments are behind you?

Or is it hard to say that this goes lower because, unlike some of banks, your life stage in terms of growth seems to be longer than everybody else's?

Erika let me just start with one comment that's kind of overriding, and I'll shift to Katherine.

One of the components of our efficiency ratio has quite a lot to do with the growth rate of the enterprise.

It isn't just about the service delivery.

A fair part of it is, but it's also about the growth rate, which Katherine was kind of alluding to before.

And our growth rate, as you know from our conversations and we've tried to pretty well lay out for everybody, is not necessarily a target that we have.

It is almost in response to the flow of business we see.

But some of it is quite planned and to the extent that growth rate and the investment going forward does not slow down, we're probably operating about in the range we need to operate in.

Katherine, do you want to talk about the service component of it?

Yes.

One of the things we do differently, as I know you know, Erika, is we have a higher level of service that brings us a lot of clients.

It also costs us some expenses.

In addition, we're having good success growing private wealth management, and that's at an inherently higher expense ratio than banking does.

It doesn't take capital, but the better we do there, the more pressure, if you'd call it that, that puts our expense ratio, it's very good because it's very valuable to us.

But that business never operates at the same expense ratio as the commercial bank.

And as we continue to grow, we will continue to offer and deliver the kinds of service.

This is probably very high 12-month for the new offices and the percentage of new producers, but we will continue to grow throughout 2013 and 2014.

Just to emphasize that last point that Katherine made, the percentage of new offices that we intend to open and the percentage of new producers, portfolio managers, et cetera that we have, as a percentage in each case of the existing base, is at an all-time high.

Got it.

Okay, and I appreciate that.

Separately, and this is may be a question more appropriate for Willis.

I appreciate walking us through some of the puts and takes in the margin.

I guess I'm wondering, you mentioned that there's some seasonality to the deposits that you've gotten in this quarter, based on tax payments, and of course, you're going to likely have stronger long growth the next quarter.

I'm wondering if on an average basis, your cash doesn't really move next quarter, even though the end of period did.

Are you going to continue to draw down the cash levels, or is cash going up?

Erika, we believe that we will continue to have strong loan originations, coupled with some repayment, but we will continue to attract new depositors.

I think the cash balances this quarter are likely to be on average somewhere between the average of last quarter and where they were at the end of the quarter.

And that's going to impact our NIM a little bit.

Got it, so I guess is the cash level in terms of the average balance in the first quarter could have represented the trough?

Yes.

Okay, got it.

I appreciate it.

Thank you.

Thank you.

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

Please go ahead.

I guess just a question on the securities portfolio, just curious in the past quarter, what types of securities you have purchased including the rates and duration.

And also, as you look forward, kind of whether you have in terms of expected maturities in the upcoming quarter.

The purchases have been primarily munis, Joe, consistent with our portfolio.

A little slower than previously, because the market has been a little tired and slightly less attractive, and we see that as a continuing activity.

The yields are holding up pretty well, actually.

They are a little tighter than they were, but not a meaningful move of any kind.

And as to your question about whether we have maturity and rolling off, when we came out of Bank of America we didn't have any securities, and everything that we've been buying is of a longer term, so we may have some calls but we don't expect to have a lot of repayments.

Okay, and then also just Willis, can you comment on your plans for additional loan sales?

From your comments about the improvement secondary market and the volume this quarter, it sounds like we may be kind of settling in at a new higher level going forward, or what would your thoughts be there?

Well, we tend to sell the longer term fixed rate loans, and to keep hybrids in the adjustables.

And from time to time, we build up enough to sell, and we will look to sell them, but $550 million last quarter was about 2.5 times normal.

Right.

Okay, thanks so much.

Thank you.

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

Please go ahead.

A quick follow-up on Joe's question with respect to the loan sales.

I'm just curious, I'm guessing these are anywhere between 10 year and 30 year product that's being sold.

How much of that is conforming stuff that maybe you're offloading to Fannie and Freddie versus product that's being securitized?

You're right, about the term.

It is virtually all 30 and 10 year products.

We sell to Fannie Mae on a flow basis most of the time, but occasionally we have packages loans, generally small, that we sell to the market instead of selling to them, because we can sometimes get better execution.

In terms of the jumbo 30s, we sell them in two ways.

We sell some of them on a flow basis and we sell them in packages when we believe that's how we will get the best execution.

That's what we did in the first quarter, and generally, we use it with the mix that we think will give us the best execution.

Aaron, we had $115 million or so that we sold to Fannie Mae in the first quarter, and that was up from $75 million in the first quarter a year ago.

Okay, and then I was wondering if you could talk a little bit about the hiring of Mike Selfridge, and seems like a good pick up for you guys.

I'm curious if that changes at all your strategy in terms of, you've obviously been active in the venture space, with respect to capital call lines.

I'm wondering if this might also be an entry for you into doing venture backed company lending?

The answer is no.

It is not a change in strategy.

We're delighted to have Mike with us and he's a great addition to the management team, but that was not the purpose of his specific hire.

Okay, thanks for taking my questions.

Thank you.

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

Please go ahead.

Just a question on the capital.

Nice to see the dividend.

On the capital level, that you guys are managing to, do you guys look closely at Tier 1 or TCE or how should we think about that going forward?

Chris, we are currently managing to a minimum Tier 1 leverage ratio of 8%.

That's under our de novo charter requirement for another few years.

Having said that, we are looking at all of the other elements of the capital that's evolving, and we believe that with managing to that, we will be well-capitalized under all of the other various guidelines that are coming out, either the Basel III or the stress testing activities.

Okay, just one clarification on the efficiency guidance.

The high 58% to 62%, that's excluding purchase accounting, that's a cash basis, correct?

That is correct.

So if I hear your guidance correctly, it's roughly 60% of this quarter probably trending to the low 60s before heading to the high 50s, is that the right way to think about it?

Yes, it is.

Okay, thanks a lot.

Thank you.

Our next question comes from the line of Lana Chan with BMO Capital Markets.

Please go ahead.

Hi.

I think you mentioned that there was a lower loan discount accretion this quarter versus the average of the last couple of quarters.

Could you give the reason behind that and is this $38 million a good run rate for the rest of the year in your view?

Hi, Lana.

The purchase accounting loan accretion depends on the repayment of loans, and they did slowed down a little bit this quarter in our balance sheet portfolio from 21% last quarter to 18% this quarter, and also the mix of loans that repaid was more single family as opposed to last quarter.

Or last year, we had a few more multi-family and commercial loans repay, which carried higher loan discounts.

But since the balances are down and we are down to 60% of the original accretable discount, we would expect that to trail-off as we go forward.

The liability premiums are trailing off even faster, and we've given some information in the footnotes of our 10-K that can guide you to the amortization that we expect for the year.

Okay, and one more question.

Have you seen the prepayment speeds slow so far this quarter on the MSRs relative to last quarter?

We haven't seen anything in April yet.

The repayment rate in the first quarter was quite high, particularly in the fixed rate loans, and in the conforming fixed rate loans in that portfolio.

Okay, thanks, Willis.

Thank you.

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

Please go ahead.

Just a question on deposits.

The remix of CDs has obviously been pretty good, down to 15% of deposits.

Just wondering how much farther you can push that down to help protect the NIM?

Well, what we've been doing is to basically focus on the CD holders that are single-product clients with us, and dropping the rates on that.

If the CD holder is willing to become a multi-product client with us, then we're substantially more competitive, but the problem, where it is slowing down, but it's still declining, and it will take us about the rest of this year to work through the whole portfolio in that manner.

Okay, and do we know, have you disclosed how much of the CD book is single-product holders?

We have not.

Okay.

And just a couple on the expenses, so if I heard you right Willis, half the increase in comp is seasonal in nature and won't recur?

That's correct.

Okay, great and advertising and marketing, can we expect that to ramp up as you guys build out your infrastructure from a low 1Q number?

I think we are trying to be more selective with the activities that we do, and I think we might see that be a little higher on average for the year but we are really trying to manage that line.

Okay, and then just lastly on the dividend.

Can you just refresh my memory, it looks like you are targeting a 20% payout ratio, is that what we should expect going forward and will that be revisited annually?

The current, the initial $0.10 a share would be about 15% payout, and we're just happy to get started, and that's kind of where we expect to be just for a while.

Okay, great.

Thank you.

Thank you.

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

Please go ahead.

Thanks, just a question on the 10 new branches that you're opening.

Is there one region in your footprint that you're more concentrated on, or is it going to be throughout the footprint?

There will be throughout the footprint, the concentration will be mostly in the East, New York and Boston, as we were a bit behind there.

We're also improving, we have improvement activities, expansion activities going on in three or four other offices and we are actually relocating a couple to improve their locations this year as well.

Great.

That's the only question I had.

Thanks for taking my question.

(Operator Instructions).

Our next question comes from the line of Tim Coffey with FIG Partners.

Please go ahead.

As we look at the First Republic investment management business, the increase in balances for the quarter, was that a seasonal event or more along the lines of new customers from the new branches?

It's coming from several places.

We have been very active hiring new portfolio managers and wealth advisors, and many of them have clients who eventually join us and work with their existing portfolio managers when they become First Republic employees.

Second, our existing portfolio managers continue to get new clients, and then third, we're doing a better job of cross-selling banking clients with increased training to our relationship managers, so it comes from all three areas, and we hope it will continue to.

It's not seasonal.

Okay, so given that it did come all three, you think the likelihood that this trend continues in the following quarters?

We are hiring people that we would expect to cause us to have it continue, that's our goal.

Okay, thanks for that.

That was my only question.

(Operator Instructions).

Our next question comes from the line of Misha Goberman with Portales Partners.

Please go ahead.

I have a question about your penetration of high net worth households in your major markets.

Taking a look right now at your latest presentation here, and there's a figure of 4.3% for 2009.

I'm just wondering if that figure has been updated recently?

We're in the process of doing that.

We do it every two years, so we should expect to see some new numbers by the Fall of this year.

Okay.

Thank you very much.

Thank you.

Thank you.

At this time, I'm not showing any further questions.

I'd now like to turn it back over to management for any closing remarks.

Please go ahead.

Thank you all very much for listening today.

We appreciate the support and the inquiries, and we were delighted with the quarter, and we are looking forward to speaking with you at the next quarter end.

Thank you.

Thank you.

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

Thank you for your participation.

You may now disconnect.