First Republic Bank (FRC) 2018 Q2 法說會逐字稿

Greetings, and welcome to First Republic Bank's Second Quarter 2018 Earnings Conference Call.

(Operator Instructions)

I would now like to turn the call over to Shannon Houston, Senior Vice President and Chief Marketing and Communications Officer.

Please go ahead.

Thank you, and welcome to First Republic Bank's Second Quarter 2018 Conference Call.

Speaking today will be Jim Herbert, the bank's Chairman and Chief Executive Officer; Gaye Erkan, President; and Mike Roffler, Chief Financial Officer.

Before I hand the call over to Jim, please note that we may make forward-looking statements during today's call that are subject to risks, uncertainties and assumptions.

For a more complete discussion of the risks and uncertainties that could cause actual results to differ materially from any forward-looking statements, see the bank's FDIC filings, including the Form 8-K filed today, all available on the bank's website.

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

Thank you, Shannon.

We continued to deliver safe, strong and organic growth.

It was another excellent quarter by virtually every measure.

Let me share some highlights from the quarter.

The year-over-year total revenue grew 16%, net interest income grew 15% and tangible book value per share increased 11.4%.

Our results were driven by strong growth across the franchise.

Total loans were up 19.7%, total deposits grew 15% and wealth management assets grew 27%, all year-over-year.

Our loan origination volume for the quarter totaled $9.4 billion, our strongest quarter ever.

Both single-family residential and business lending were quite strong.

Importantly, credit quality remains excellent.

Our nonperforming assets were very low 5 basis points, while net charge-offs for the quarter were just $771,000, less than a single basis point, and our capital levels remained quite strong.

We are pleased to have successfully accessed the perpetual preferred market during the second quarter, and Mike will talk more about this in a moment.

The quarter's results reflect continued consistent execution of our intensely client-focused business model.

We continue to deliver safe growth by maintaining the highest possible credit standards, while delivering exceptional client service to our very strong urban coastal markets.

As we noted on our last call, our client satisfaction remains particularly high.

This is reflected by our Net Promoter Score, which is at an all-time high of 75, more than twice that of the banking industry on the average.

Service delivery is our key to growing the relationships with our clients and to help us attract new households to the bank.

Gaye will speak about this household growth in a moment.

The more satisfied our clients are, the less likely they are to leave us and the more likely they are to refer their friends and colleagues.

It's actually a very simple model.

Also, quite importantly, the markets that we operate in continue to be very strong.

Our recently completed Capgemini market study, which we do every other year, shows that our markets now contain fully 59% of all high net worth households in the United States, up from only 46% share in '03.

The number of such households that First Republic serves grew approximately 11% per annum between 2015 and 2017, obviously, a very strong increase.

There is tremendous opportunity still in front of us as well.

Overall, we're very pleased with the quarter and the first half of 2018.

And let me turn the call over to Gaye Erkan, President.

Thank you, Jim.

As Jim indicated, our very high level of client satisfaction and repeat business continues to drive our safe strong organic growth.

Overall, economic conditions in our urban coastal markets continue to be strong and our clients remain quite active.

During the quarter, loan origination volume was exceptionally strong at $9.4 billion.

As Jim noted, it was our best quarter ever.

We are very pleased that single-family residential volume was $3.1 billion during the quarter, representing the largest portion of our overall loan originations.

Importantly, the weighted average loan-to-value ratio on new single-family originations remains very conservative at 59% in the second quarter.

Single-family volume was 56% purchase and 44% refinance.

Business loan volume had an unusually strong origination quarter, up $1.4 billion from the second quarter a year ago.

This was driven mainly by new and increased capital call line commitments to private equity and venture capital clients, and will likely not repeat in the second quarter -- in the next quarter.

The utilization rate on business lines of credit has remained at approximately 35%, consistent with the past few quarters.

Multifamily and commercial real estate loans also had a strong quarter.

Importantly, our weighted average loan-to-value ratios on new multifamily and commercial real estate originations during the second quarter remained very conservative at 50% and 47%, respectively.

We continue to maintain disciplined underwriting standards across the entire business.

We have not, and will not, loosen our credit criteria in spite of the current, very considerable competitive pressures to do so.

Turning to deposits, overall it was a good quarter.

Deposits were up 15% from a year ago.

While balance sheet normalization by the Federal Reserve and rising rates present challenges to all banks, we remain pleased with the diversified deposit growth across all of our channels and geographies.

Checking deposits represented over 60% of our total deposits at quarter end.

Business-related deposits were 56% of total deposits, consistent with last year.

CDs represent 14% of deposits and continue to be a very effective way to attract new households as well as to lengthen liabilities during this period of rising rates.

Turning to private wealth management, the business continues to perform very well.

Year-over-year, wealth management assets were up 27%, and now total over $121 billion.

Private wealth management continues to grow by doing more with our satisfied clients and attracting referrals.

We're also pleased to have hired 4 new teams this quarter, which has contributed to the growth in assets.

Wealth management fee revenues were up 22% compared to a year ago.

Overall, it was a strong quarter.

Now I would like to turn the call over to Mike Roffler, Chief Financial Officer.

Thank you, Gaye.

I'll cover capital, net interest margin, our efficiency ratio, the tax rate and earnings per share.

Overall, our capital position remains strong.

In June, we completed a perpetual noncumulative preferred stock offering of $300 million at a fixed rate of 5.5% for life.

This offering will increase our preferred stock dividends by approximately $9 million in total for the second half of 2018.

Subject to regulatory approval, we currently intend to use $200 million of capital to retire our outstanding 7% perpetual preferred stock at the end of December 2018.

Our liquidity also remained strong.

At June 30, HQLA as a percentage of average quarterly assets, was 12.3%.

Turning to our net interest margin, we are pleased that the margin was 2.95% during the second quarter.

Our earning asset yields were up 7 basis points, while our total funding costs were up 9 basis points during the quarter.

For perspective, the average cost of our total liabilities was 61 basis points and the beta on this overall liabilities compared to the change in the federal funds rate has been approximately 18% since the third quarter of 2015.

We continue to expect net interest margin to be in the range of 2.85% to 2.95% for the rest of 2018.

Our efficiency ratio for the second quarter was 63.5%.

We're pleased to maintain a stable efficiency ratio, while delivering strong revenue growth and investing in the franchise for long-term opportunity.

We continue to expect the efficiency ratio to be in the range of 63% to 64% for the full year 2018.

Turning to our tax rate.

Our effective tax rate for the second quarter was 16.8%.

Our second quarter tax rate is typically a bit lower due to incremental tax benefits resulting from the majority of our outstanding restricted stock awards vesting during the second quarter.

We continue to expect the bank's effective tax rate to be approximately 19% for the full year 2018.

Finally, earnings per share were $1.20, up 13% from a year ago, reflecting our safe, strong organic growth.

Thank you.

Now I'll turn the call back over to Jim.

Thank you, both, Mike and Gaye.

We're quite pleased with the strong and consistent performance delivered during the second quarter and for the first half of 2018.

The client service model continues to work very well; quality of credit is strong; and our acquisition of new households is at an all-time high.

Thank you.

And we'd be happy to take questions.

(Operator Instructions) Our first question is coming from the line of Dave Rochester with Deutsche Bank.

You guys had mentioned a strong capital call line growth.

I was just curious where that portfolio sits now in terms of total balance?

In terms of total balance, it's been about 40% of our business banking of outstanding.

So commitments are obviously a bit larger.

And as Gaye mentioned, we're at roughly a 35% business utilization rate.

So 40% of $9.5 billion is about just under $4 billion.

Okay, great.

And Gaye, I think, you'd mentioned competitive pressures on loans, and you gave all the LTVs on your originations.

Are you guys seeing more banks compete on LTV this quarter or other structure?

It's more we are seeing other competitors stretching in the LTVs.

As you know, we're very conservative when it comes to credit.

We will compete for a strong credit, but we won't stretch in credit terms, which other banks are seeming to do so.

Okay.

Are you seeing any kind of increase in the incidence of that this quarter?

And...

Yes.

Are you seeing that primarily from the bigger banks?

Yes, indeed.

Okay, great.

And then just switching to the NIM, I suppose the June hike, are you seeing any movement on deposit rates amongst competitors at this point?

We have -- the competitive pressure on deposits remains.

So far just to take a step back, we are very pleased with 15% year-over-year growth rate with a 24% beta compared to what has been disclosed in the earnings so far, the banks -- the larger banks are around mid-30s of beta since inception.

Just to take a step back, we're looking just at total cost of total liabilities, which is a better measure in a rising rate environment to take all the diversification of funding into account.

And the beta on our total cost of liabilities has been less than 20% since the first Fed hike, since the end of third quarter of '15.

Dave, it's Jim.

Let me just weigh in on that point for a second because this is something that we actually hear about a lot, and we're a little surprised.

The total liability, for instance, for the bank in the last quarter went up 9 basis points.

The other 4 banks that have reported so far today went up 15 basis points.

Our deposits went up 6 and those 4 banks went up 8. I'm not sure where this is coming from, to be honest with you.

I think people should pay a little more careful attention to the actual facts.

Okay, great.

And I guess, on the funding side, I noticed you added some term funding this quarter.

I was just curious as to what the rates were and the duration of that?

I know you typically do that in 2Q, but was just curious if we can get an update on that front?

Sure.

So -- yes, Dave, we have used the Federal Home Loan Bank as a good source of funding.

It helps us lengthen our liabilities in the second quarter, given some of the seasonality with deposits is the time when we use it more.

We typically go out 2 years, 3 years, and right now those rates are 2.75, 2.80.

Okay.

And then just one more real quick one on CDs.

Just saw that you had a 2% out there and one that was a little bit higher, that was longer duration.

Are you seeing -- are you actually getting new money on those products?

Or are you just seeing more of a shift from some of your other products into those CDs?

Let me just comment for a second, then turn over to Gaye.

To state the obvious, I have been leading the organization for quite a while.

CDs come and go.

A lot of people are not very used to them because we've had low rates for so long.

But, in fact, historically, at First Republic, they've been a very key product for us.

We have a 72-office system, and the size of the office is north of $350 million on the average.

And so this -- so the CD tools, in fact, one we understand very well, it comes in on the retail side as a driver of traffic and as an accommodation to mostly our somewhat more mature savings clients.

But we also cross-sell checking very heavily off it and other products.

And any -- at any moment in time, we'll have special, but that generally is sort of milk in the back of the store.

And well, we will negotiate and cross-sell off of that lead product.

And just to add to Jim's comments.

Over 50% of our CD clients have other deposit relationships with us.

And most of our CD, when you look at the snapshot of our CD balances, over 80% is consumer CDs and the average consumer checking balance of consumer CD clients for a household is over $100,000.

And the weighted average original term is over 18 months.

So it's a great -- in a rising rate environment, not only it's a great diversification of funding, but it's also helping us lengthen the duration of the liability.

So it sounds like it's a combination of the 2 in terms of new money versus clients moving funds, is that a fair statement?

Correct.

Your next question comes from the line of Steven Alexopoulos with JPMorgan.

I wanted to first start, follow-up on Gaye comments that you don't expect the 2Q commercial volumes to repeat at the end of the third quarter.

Are you actually seeing a reduction in the pipeline for capital calls?

Or are you just being conservative with the guidance?

It -- there has been significant client activity given the healthy markets and private equity and venture capital space.

So those drove -- it was a combination of existing clients as well as new activity coming in.

Because of that one-off that we don't expect that to continue at that high level.

Okay.

And Gaye, given that these are typically short-term loans, very short term, how do you think about loan growth in the second half?

So we'll stick -- in general, we'll stick to mid-teens loan growth.

Obviously, we've seen the first half to be stronger.

While we would expect -- when we look at our pipeline, it remains strong.

So we would still stick to the mid-teens loan guidance, Steve.

Okay.

And then just to switch over to the margin.

With the loan-to-deposit ratio moving up quite a bit in the quarter, at 95%, you talk about the funding strategy.

Do you plan to increase promotions further to fund loan growth?

So we have 2 fed hikes modeled for the remainder of the year.

And based on that, we expect a 2.85% to 2.95% NIM range, given those 2 fed hikes.

And we'll be opportunistic in terms of diversification of our funding strategy between the term funding that Mike mentioned earlier, the CDs and the organic growth.

And as you know, the second half tends to be a lot better in terms of the deposit surge and the increase in average account balances.

I would like to note that the tax outflows we have seen in the second quarter have been 45% higher and mostly driven by consumer compared to the last year.

And despite that, the average balances grew nicely.

Okay.

Overall margin pressure was fairly modest this quarter, but the curve continues to flatten and you're keeping the low end of the guidance on NIM.

Are you anticipating margin pressure to intensify in the second half?

Yes, so I think, from here, Steve, it does trend down a little bit.

The fed did just move in June obviously, and as Gaye said, we've a couple more hikes planned.

And you hit on one of the important points, the curve continues to be very flat.

And then competition for lending is challenging.

And so I think we're migrating towards the middle of that range here in the next sort of couple of quarters.

Okay.

And Michael, while I have you, on the expenses, if you look at the first half, expenses were up about 20% versus the first half of '17.

Do we still think mid- to high-teens guidance is reasonable this year?

Or do you think it will be closer to 20%?

So probably high teens is probably better number.

I think that we were pleased that we were 19% in the second quarter year-over-year.

And so that's helpful.

I might think about, as we look at efficiency and sort of how we think about it, we've really done a lot to invest in the franchise to be at this range of 63% of 64%.

We've talked about in the past investing in wealth management, next generation of clients, and then a lot of the technology.

I mean just a couple of the technology things we've talked about, successfully completed a full migration of digital, mobile, new origination system for home loans, the way we onboard clients, and we've really kept in this range of efficiency, while we actually increased net promoter also, which is twice the banking industry.

If we think about the future, this is a good range for us to be in.

We do have some activity that we're in the preliminary stage of, which is around replacing the core legacy banking system.

This is going to be a several year project.

We are very confident in our ability to execute because of the experiences we had, especially with next generation.

And we'll be very methodical about it.

And so that investment will take over the next couple of years, but importantly, a few people have touched on this, the FDIC assessments are right now elevated as they have been the last couple of years.

They're going to come down starting in 2019 because the surcharge that the larger banks pay will go away.

And so we're really pleased that this investment we need to make can fit sort of right into that saving's that we have coming to keep this efficiency ratio of sort of 63% to 64% as we go out over a longer horizon.

Okay.

So that -- the 63%, 64% you're saying extends beyond 2018 and includes all of the cost to operate the core system?

That is correct.

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

I just want to really, really make sure that we get the NIM commentary down right.

So I guess, Mike, you mentioned that you're trending towards the midpoint of that range, but -- so I guess, that would imply -- or sort of over the next 2 quarters, but that would imply this on a full year basis, you end up in sort of the high end of your 2.85%, 2.95% range.

I just wanted to make sure that that's right because otherwise we're sort of building in 2.85% for the next 2 quarters just at the midpoint.

Yes, I think -- sorry so -- if I think of third quarter down several basis points, maybe four, and fourth quarter around that range, maybe a little lower.

But we're -- so if you're thinking 2.95% is not going to be that for the year, I'd come down from there towards the middle -- towards the middle or slightly above the middle.

And just to add, it also depends on how the curve -- is going to play itself, the flattening of the curve.

So that's why we felt comfortable with the 2.85%, 2.95% range.

We assume about two Fed hikes at a 50 bps steepness.

If it were to flatten more, obviously, it would impact it towards the lower end of the range.

Got it.

Understood.

And I guess, more of a detailed question on the NII piece of that -- the impact there.

You mentioned deposit inflows, I think, I heard that right, with stronger second half.

Obviously, you could have NIM compression just because you have more deposits, which is actually a positive for NII, but that versus having NIM compression due to the flattening of the yield curve, which is, I'm going to say, a negative to NII.

Is there -- is the NIM compression weighted more towards the inflows or the flattening curve?

Probably more towards the curve, Ken, which is one of the reasons you actually hit on a good thing.

What matters a lot is net interest income growth because that's what allows us to make the investments and to grow the franchise.

And so you could have a slightly lower NIM from growth, but the curve is probably more of the driver today than that.

And just to add, when it comes to -- that's a great question actually.

I'm glad that you're raising that.

The net interest income is what pays the bills.

So the growth of the balance sheet, especially compared to the banking sector, when you compare First Republic, the growth of the balance sheet, the safe and organic growth is a great lever and mitigant, risk mitigant when it comes to rising rate environment.

So the NII is the multiplication of the growth and the margin, while the margin may see pressure, the growth is actually the bigger driver of the NII growth.

Got you.

Understood.

And then just last question.

When you think about the balance sheet or how you're supporting that loan growth, like given higher short-term rates, given the deposit pressures, albeit small, are you thinking in terms of changing -- or driving or supporting more of that loan growth from the securities portfolio, or you know, that way you can ease off on paying up for deposits -- on new deposits?

Or is it still very much the deposit growth?

Sure.

Maybe let me take a step back for a second.

So the -- we are a service organization, so we are driven by our consumer -- repeat business with existing clients and the consumer household growth.

So we have seen -- we're very pleased that the consumer households have grown 20% year-over-year compared to -- when you look at the prior 5 years, our consumer household growth has been at 9%.

So we're very pleased with that, and obviously, the Net Promoter Score plays into that.

So that's number one.

And when we look at the lending relationship, we don't set goals.

It is a client-driven and credit-driven decision.

When it comes to securities portfolio, the yields that we have seen in the securities portfolio for the amount of duration that we are taking when compared to lending for the first time, the securities did not look as attractive.

They were on top of the lending yields with similar duration.

And yet, with lending, we actually acquire relationship or we delight our relationships.

So that's what has been driving the securities purchases or the lack thereof.

Our next question comes from the line of Jared Shaw with Wells Fargo.

Maybe just on the deposit side, are you seeing any geographic pressure differential maybe between your markets, your East Coast and your West Coast markets?

Or is it fairly standard across the platform?

It's pretty standard across the platform.

Okay.

And then shifting, I guess, following up on the capital call lines, as we've seen the higher rate environment sort of come through, have you been able to maintain the spreads on that?

Or is the competitive environment maybe actually seeing spread contraction on incremental capital call lines?

No.

They've been pretty stable.

I mean, it's competitive, so you've always got to have "A" quality pricing for the business, but it seems like they're consistent with where they have been spread wise.

Okay.

And I guess, just finally, for me just following up a little bit on the margin question.

Should we expect to see some of that cash position be deployed as we move to this higher rate environment?

Or do you feel comfortable keeping cash fairly stable there?

Well, we always want to maintain a strong liquidity position.

And one of the things that happens, Gaye mentioned it, the early part of the second quarter has some tax outflows from our deposit base.

And so our average cash is actually a bit lower during the quarter.

And as deposits start to pick up following tax flows, you start to see a build of liquidity position.

We will put that to work methodically as we always do.

Our next question is from the line of Arren Cyganovich with Citi.

I wonder if you'd just touch on the competitive environment for mortgage, it looks you got a pretty strong production for the quarter.

Just thinking about how you're doing that geographically for the rest of the year?

Arren, the competition is pretty tough as was mentioned earlier.

And in two respects, one, pricing is still very tight, and that's probably the place we're getting the greatest pressure on the -- from the curve, so to speak.

The other one is standards are going down.

I don't think they're bad necessarily yet, but they're not where we like them.

And so we're backing away from an increasing number of transactions.

The biggest constraint on loan volume is actually supply of homes for sale in our urban coastal markets.

Almost without exception there is a supply shortage.

New York would be the exception, but it's mostly at the high end.

And so volume is really pretty strong across the markets, but the competition is more aggressive than it would have been even a year ago.

Okay.

And you mentioned multifamily was fairly strong.

Is that kind of playing into that supply shortage as we're getting some more supply of multifamily in the different markets?

Yes.

Well, the supply is not going up very much in the coastal urban markets, it's pretty hard to build new multifamily housing.

You see a little bit of it in New York again, but not too much anywhere else.

The cash flows on our multifamily properties are probably at an all-time high, cash flow coverage on debt.

Okay.

And then just lastly, on the student loan refis, and maybe you could talk a little bit about how that's progressing?

How many households you've been adding kind of at a more annualized rate?

And just your thoughts for continued growth there?

Sure.

We're actually very pleased with the results of that.

We're running -- the last 12 months was probably about an 8,000 household rate.

We had about another 1,000 for professional loan program.

So we're running between 8,500 to 9,000 annual rate on that younger household acquisition rate.

The next question is from the line of Casey Haire with Jefferies.

I wanted to touch on the loan yields.

You guys had a very nice uptick, one of the largest you've had since the fed began to tighten, just some color there.

Was that positive mixed shift from capital call line?

Or are you just starting to see relief just given the move in the long end of the curve?

Yes, Casey, I think, well, one, obviously, we do benefit a little bit from the rate hike in March and just a fair amount from June.

So that's part of it.

Second is the volume and the rates that new business is coming on has improved.

We hit sort of a bottom in what I will call the third and fourth quarter of last year, and it's steadily crept up.

And so the new yields are coming in a bit better, which is also contributing incrementally to the overall loan yield.

Okay.

Any color on what the new money yield is today versus the 3.51% in the second quarter?

Yes, just to add on that, so for single-family residential, to give you some idea, the second quarter originations were at 3.7%.

For multifamily, the second quarter originations were at 3.9% and CRE at 4.35%.

And for single-family, they're trending slightly higher and for the rest -- around that level.

Okay.

Great.

And then Mike, just switching to capital management, I know you guys have been -- you guys are above your targets.

But obviously, a very strong growth quarter and pipelines are strong.

Can you just give us some updated thoughts on capital management, not just the Tier 1 common, but also the Tier 1 leverage ratio as well?

It's Jim.

We've always tried to stay pretty well capitalized, as you know.

As we see growth coming, we tend to go to the capital markets.

We did that with the preferred.

As Mike noted, we raised $300 million, we're going to use $200 million, if you track the money, which we don't necessarily, but the point is we would -- subject to regulatory approval, we'll redeem $200 million.

We'll need to keep our capital topped up here.

And I would expect that we will be back to market at some time in the next few quarters.

The next question is from the line of Lana Chan with BMO.

I just want to follow up on Gaye's comments earlier on the securities yields now versus the, I guess, the loan portfolio.

Should we take that to mean that you're not going to really build the securities growth going forward?

We will make sure to maintain our HQLA ratio at or above 12%, and anything beyond that on the yield and has some portfolio will be opportunistic.

Okay.

And any color in terms of, I guess, the recent deregulation around the muni inclusion -- potential inclusion on the HQLA?

Yes.

And -- great question.

As you know, we do hold a sizable amount of municipal bonds in our portfolio.

And it's likely that there would be some positive impact to our HQLA as a result -- HQLA ratio as a result of this bill.

Yet, we will work with our regulators in the coming months to determine the appropriate treatment of these muni bonds in our portfolio on a go-forward basis.

Okay.

And just last question, I don't know if I've missed it, but did you give the spot rate for deposits at the end of the quarter this time around?

We did not yet, but you would expect it to be, again, taking into account, we just had a fed hike in June and another one expected in September, it will be around mid-40s.

40s, you said?

Mid-40s.

The next question is from the line of Aaron Deer with Sandler O'Neill.

Just curious, I guess, this kind of ties into some of the margin discussion, but the loan and deposit ratio came up some, and I'm just curious with respect to how you -- to the extent that you're managing toward any specific ratio there.

If you're not seeing the kind of normal seasonal deposit inflows that you typically would expect here in the back half, would you go out and pay up more on the CD side to keep that loan-to-deposit ratio where it is or even push it down some?

Or any thoughts on that front about kind of what the appropriate level is there?

Aaron, no, not necessarily.

It's a ratio, we're aware of, but it's not a driver for how we run the business.

It fluctuates over the years, from the low 80s to the high 90s, I mean.

But, we are -- that's one of the reasons we are focusing entirely now on the total liability costs as well.

Having said that, I think, the second half of the year on deposits should be pretty good.

It will be -- we will use the CD tools, I said earlier, but we've used that over decades very effectively.

The -- but our flow of deposits actually is pretty strong.

The biggest thing that happened was on the negative side.

The -- as Gaye indicated, the outflow of tax payments was unusually high this year, which was not as much of a surprise as all that given the tax planning that people did in the face of the tax bill that happened, particularly our client base, if you think about it.

But the driver is always net interest income on the enterprises because of the growth nature.

Sure.

Okay.

And then Jim, you've mentioned possibly coming back to the capital markets, kind of given where the capital stack is now, any sort of preference in terms of what type of capital you'd be looking at on the next round?

No, we look -- we're no, not really.

We look at -- the only two -- well, we have some term sub debt as you know, but the driver is really our preferred and common, and we tend to toggle back and forth a little bit.

I think it's important -- everybody should remember, we do very small transactions.

We're very -- we try to be very systematic about it.

Okay.

And then just one last one for Mike.

You mentioned kind of -- on a longer-term basis, still hoping to stick with that 63% to 64% efficiency ratio guidance.

Is that inclusive of kind of an expected ongoing shift toward wealth management being a kind of a bigger part of the franchise?

What are your thoughts there?

That's right.

In addition to the things that I talked about earlier, it is a part of that as wealth revenues continue to grow as a part of our total revenue base, which they're now over 14%, that does have an impact a little bit up on your efficiency ratio going forward.

Our next question is from the line of Geoffrey Elliott with Autonomous Research.

Do you think there's a point with rising rates, where you start to see more of a shift out of checking and into either savings or CDs, customers just run with lower checking balances because the opportunity cost is getting higher?

What you just said actually, that's how we model the NII simulation in our 10-Qs.

We do assume some shift from checking to be conservative.

Having said that, our internal liquidity stress tests, we always look at what deposits are of operational nature and thus are there for -- they're there for the service, not for the yield necessarily.

And that percentage seems to overlap with the checking percentage.

And on an average basis, our checking percentage remain at 63%, just to note.

The next question is from the line of Chris McGratty with Keefe, Bruyette & Woods.

Jim or Mike, just one more on deposits, I apologize.

Based on your business mix between consumer, commercial and wealth, interested in kind of how the conversations are going within each and where the pressure points are within the portfolios.

I think, last year, midyear, you had a reset in the wealth deposit rates and kind of interested in conversations that are happening now that we've had more successive rates?

So we did -- our checking, as you know, has remained over 60% in terms of ending balance and the rate on that has not really moved, it's at 5 basis points.

CDs, we try to keep it competitive.

Having said that, over 50% of these clients do have other deposit relationship, including a sizable average checking balance on the consumer side, which brings down the total cost of those.

And the diversification also comes in by the consumer household growth, which I mentioned, that we've increased our number of consumer households by 20% year-over-year, which has been mainly on the deposit side.

So while we are seeing competitive pressures, obviously on the money market checking and money market savings and CDs, which is what's repricing it up quarter-over-quarter.

So far we've been pleased with the lag in terms of beta.

Our next question is from the line of Brock Vandervliet with UBS.

I can't possibly think of more spread-income questions.

So Mike, I guess, if you could just take a deeper dive on some of the expense trends, particularly the professional fees, advertising and marketing, those two areas were a little off from our model.

I'm just trying to get a sense of whether those levels we saw this quarter are levels we should see going forward?

Sure.

So advertising and marketing, we are continuing to, as Jim mentioned, acquire households in our next generation strategy, that does lead to some marketing spending.

The other thing is we did run some TV time for Gradifi again in the second quarter and so that pushes up a little bit along with a few more client events.

On professional fees, it's sort of a mix of combination of legal fees a little bit higher and then some professional fees around different projects we have going on.

$15 million -- $16 million on a professional fees is not a bad run rate and advertising is probably not a bad run rate there either.

Okay, great.

And just in terms of an operational update on Gradifi.

Clearly, the client acquisition funnel is working well.

Any updates on -- when you believe they, maybe, become profitable or range around that, that we should be thinking about?

So probably it would be in the year 2020 because we've been expanding the platform, some exciting updates on that.

So we have added the 529 College SaveUp product, expanding the platform in April 2018.

And we have quite a few number of employers who already have signed to launch this product for their employees.

And we'll also be adding a tuition reimbursement component in 2019 as well.

So we would expect that to be in 2020.

Just a last bit, as you know, Gradifi Refi is also another solution on the platform -- on the HR benefit platform that comes with Gradifi.

The pickup in employers on Gradifi Refi has been very exciting compared to the paydown.

We have significant number of employers on that platform as well.

So right now we have paid down College SaveUp and the Gradifi Refi already ready on the platform, tuition reimbursement to come in 2019.

Our next question is from the line of David Chiaverini with Wedbush.

It was mentioned that the supply shortage is one of the biggest headwinds in mortgage.

But I was wondering is the cap on the state and local tax deduction impacting your clients and mortgage demand?

It's interesting, we keep looking for that, but so far it hasn't been a noticeable impact.

Just a personal opinion that we don't have any evidence of this.

But I don't think that is going to happen until people actually pay the difference in taxes next year.

This year, it's currently theoretical.

Only the -- the only people feeling it right now are the people, who have to estimate their withholding quarterly.

But that may be coming.

But as of now, no, I would say it isn't impacting.

Our next question is from the line of Matthew Keating with Barclays.

I just had a question with the updated Capgemini study out.

If you could, maybe, talk about any differences you saw among your markets in terms of the bank's market penetration rate of high net worth households?

Are those details available yet?

Or should we expect those later in the year?

Sure, thanks.

Well, in the new deck that's out this morning, we did update the page on the Capgemini -- sorry, market penetration numbers that come from Capgemini.

And the -- so that's updated and that's Page #5, I think, right, in our deck.

I guess, maybe my understanding was in San Francisco, you guys used to have a penetration rate in the low teens, right, but then in markets like New York and Boston, it was significantly lower.

So I guess, maybe my question is more around did you see any variation, I guess, in the trends?

Well, certainly, the market penetration rate has picked up a bit versus 2015, have any markets performed better or worse within the footprint?

There is variation among all the markets, but they're all performing well.

Our number of households is up in every market.

Our share growth rate is different from market to market.

Generally speaking, it aligns somewhat with the markets in which we are already the strongest, which is one of the interesting anomalies of the model.

If you think about why that happens, it's the Net Promoter Score.

If you have a high Net Promoter Score, the more people that are in a market that are net promoters, the more likely you have compounding.

That's the reason we stick to the markets we're in.

It's a very simple, but overlooked concept.

The other thing about this study, which is fascinating is that, in fact, on Page 5, you'll see in our new deck, that our share of market has not actually gone up very much.

It's gone up from 4.02 to 4.21 in '15 and it went up from [02 to 21] from '15 to '17.

Our growth rate of households, however, is 11.6% compounded annually.

If you start to think about -- if you think about that, what it means is the market's growing at a very rapid rate.

Got you.

And then maybe just last question along those lines.

We've read earlier this year that the bank has doubled its office space in New York or about doubled its office space in sort of the Rockefeller Center location.

I guess, is that related to any near-term growth initiatives in the New York City market or maybe you can provide some color around that move?

Well, we commit.

Yes, it was a slightly misleading in the sense that -- well, it's accurate, but it's over time.

Our commitment is a forward commitment.

So over about a 5-year period, we're going to double.

At this time, I will turn the floor back to Jim Herbert for closing remarks.

Thank you all very much for being on the call today.

Have a good day.

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