First Republic Bank (FRC) 2019 Q3 法說會逐字稿

Greetings, and welcome to the First Republic Bank's Third Quarter 2019 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 Third Quarter 2019 Conference Call.

Speaking today will be Jim Herbert, the bank's Chairman, Chief Executive Officer and Founder; 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, please see the bank's FDIC filings, including the Form 8-K filed today.

All are available on the bank's website.

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

Thank you, Shannon.

It was a very good quarter.

Growth continues to be quite strong across our franchise.

In fact, in terms of loan originations, this was by far our best quarter ever.

Let me share a few highlights.

Total loans outstanding were up more than 19% year-over-year.

Also, year-over-year, total deposits have grown 15%.

And wealth management assets are up more than 7%.

This strong growth led to strong financial results, particularly in the face of a similar challenging interest rate environment, both in terms of the yield curve as well as somewhat lower rates.

These results reinforce once again the power of our growth model as well as the strength of our active client base and the markets in which we operate.

Year-over-year, total revenue growth grew approximately 9%.

Net interest income has grown 10%, and tangible book value per share has increased 11%.

I would note that tangible book value per share since we bought the bank back in mid-2010 has grown over 15% compounded annually.

Our credit quality remains very strong.

Net charge-offs for the quarter were only $4.3 million, while we added $17 million to our loan loss reserves due to the continued growth in our loan book.

Nonperforming assets were only 12 basis points at quarter end, down a bit from last quarter.

Capital is also very strong.

Our Tier 1 leverage ratio was 8.5% at September 30.

In this interest rate environment, net interest margin has declined a bit.

However, net interest income has continued to grow very nicely.

Mike will talk about these in a moment.

The lower rate environment does, however, represent a terrific opportunity to attract high-quality new households through home loan refinance.

This was the driver of our record loan volume.

We continue to grow safely and organically.

First Republic produced net interest income growth of 10% for the quarter.

As we head into the fourth quarter, economic conditions in our urban coastal markets continue to be quite good.

Our loan pipeline also remains very strong, and we're optimistic about the level of business.

Overall, it was a very good quarter.

Let me turn the call over to Gaye Erkan, President.

Thank you, Jim.

We are very pleased with our third quarter results and the consistent growth across the franchise.

Loan origination volume was a record, over $11 billion for the third quarter, which was up 18% over last quarter's, also record, of $9.4 billion.

Single-family residential volume was a record at $4.9 billion for the quarter.

I would note that the average loan-to-value ratio for single-family residential originations during the quarter was a conservative 58%.

The decline in interest rates has shifted the mix of home loan originations towards refinance.

Refinance activity accounted for 63% of single-family originations in the third quarter.

We are quite pleased that the majority of the refinances are for loans previously held at other institutions.

Refinance remains a great opportunity for First Republic to acquire new clients.

Most importantly, credit quality remains very strong.

We continue to maintain our conservative underwriting.

We have not and will not compromise our credit standards.

Business banking also had a very strong quarter.

Business line commitments were at $20.6 billion, up 29% year-over-year.

This is a key metric for business banking because it reflects our ability to acquire new client relationships and deepen existing ones.

The utilization rate of these business lines fluctuates regularly, as we have noted on previous calls.

During the third quarter, utilization rates decreased from 37% to 33%, resulting in a slight decrease in outstanding balances.

Turning to funding.

It was another quarter of very good growth.

We are pleased total deposits were up 15% from a year ago, and we continue to maintain a diversified deposit funding base.

Checking deposits remained strong and represented 58.5% of total deposits at quarter end.

Business deposits represented 58% of total deposits consistent with the prior quarter.

Turning to wealth management.

Assets under management grew 7% year-over-year to $140 billion.

Our client-centric culture and our integrated banking and wealth management model continue to attract very successful wealth managers.

Since our last call, we are quite pleased to have welcomed 4 new wealth management teams, in Palm Beach, Los Angeles, Silicon Valley and the New York metro area.

We look forward to welcoming their clients to First Republic over the next couple of quarters.

We are pleased as well with the continued diversification of our wealth management business.

Insurance and foreign exchange fees, for example, are collectively up 40% year-over-year.

Finally, as Jim noted, our client acquisition continues to be strong.

Our success in household acquisition and our low household attrition rate are the result of our ability to consistently deliver exceptional client service.

Our client satisfaction level, as measured by the Net Promoter Score, remains more than double the banking industry average.

Overall, we are very pleased with the quarter across the franchise.

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

Thank you, Gaye.

Let me start with an additional comment about wealth management.

On our last call, we said we expected to retain approximately $2 billion of assets related to the second quarter departure of some wealth managers.

In fact, we are pleased to have actually retained approximately $3 billion while completing the resolution of their departure.

In mid-September, we announced the redemption of our Series D preferred stock, which occurs this Friday.

Following the redemption, our ongoing quarterly dividend on preferred stock will be $10.2 million.

For the fourth quarter of 2019, it will be approximately $10.7 million.

Our liquidity position remains very strong as high-quality liquid assets were 12.7% of total average assets in the third quarter.

We will continue to maintain HQLA to average assets above 12%.

As Jim mentioned, the inverted yield curve continues to have an impact on net interest margin, which declined to 2.80% for the third quarter.

For perspective, since our last call, the 10-year treasury fell from about 2.10% to as low as 1.45%.

It has, of course, rebounded a bit recently.

We currently expect net interest margin for the fourth quarter to be about 2.75% and, therefore, we expect our net interest margin for the full year 2019 to be approximately 2.82%.

Importantly, I would note that net interest income was up 10% year-over-year and continues to be powered by our strong growth.

The efficiency ratio was 63.8% for the third quarter.

For the full year of 2019, we now expect our efficiency ratio to be about 64.5%.

Our effective tax rate for the quarter was 18%.

For the fourth quarter, we expect the bank's effective tax rate to be between 20% and 21%.

For the full year 2019, we expect the effective tax rate to be about 18%.

Overall, this was a very good quarter.

We continue to grow loans at a strong pace, which drives the growth of net interest income.

At the same time, we continue to effectively manage the growth of our expenses.

Both of these contributed nicely to this quarter's 10% year-over-year EPS growth.

Thank you.

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

Thank you, Gaye and Mike.

It was a very good third quarter, and we have strong momentum heading into the fourth quarter of the year.

Over the bank's 34-year history, our business model has succeeded in a wide variety of yield curves and interest rate cycles.

As always, we focus intensely on superior client service.

Our credit quality and capital strength also remain excellent.

We continue to execute our straightforward business model and look forward to the fourth quarter.

Thank you very much.

We'd be happy to take questions.

(Operator Instructions) Our first question will be from Steven Alexopoulos with JPMorgan.

I wanted to start on the NIM.

Mike, I appreciate the updated guidance for 4Q.

If we assume the forward curve holds, we get just about 2 more cuts.

Do you think that NIM could stabilize in the 2.75% range beyond the fourth quarter?

How are you thinking about that?

So I think it's a good question.

I think one of the questions that follows that is what will be the shape of the curve, because, obviously, in the last week, it's steepened a bit, which is a bit beneficial, but I think 2.75% in the fourth quarter is sort of a good launch point for next year and then it will really depend on the shape of the curve going forward.

Okay.

Okay.

That's helpful.

Over the past year, when you look at loans, you've grown 19%.

Deposits have lagged at 15%.

So loan-to-deposit ratio is now over 100.

Do you guys expect the need to ramp deposit growth, like to more match loan growth moving forward, which I imagine would put some pressure on NIM?

So I'll take that one.

This is Gaye speaking.

Hi Steve.

We are actually very pleased that with the mid-teens guidance that we have given before that the deposits have grown organically at mid-teens.

So as you know, it's a relationship model, and we seize opportunities with our clients as they deepen the relationship.

And I would also note that the full-service banks that have come out today on their earnings calls showed our total funding, just to take it beyond deposits because we are largely deposit funded, not every bank is as such, our total funding rate was at 89 basis points compared to the 3 full-service top 3 banks at 138 today disclosed.

So it's 35% lower cost of total liabilities and almost 3x growth on the deposit side.

So we're pleased with that.

Okay.

And maybe just one final one for Mike Roffler in terms of CECL.

I was hoping this would get delayed, but looks like it's coming.

What's the expected Day 1 impact from CECL for you guys?

And how should CECL impact provisioning on a quarterly basis?

Yes.

So we've done -- we're in the middle of our third parallel run.

At this point, the impact to our reserve looks to be immaterial, and the capital impact is just a few basis points, sort of a reminder that our history of credit is very important when you think about the life of loan.

It could cause provisioning to be maybe a little bit more up and down in a given quarter, depending on your economic outlook.

But as a growing company, we've already had a provision that's been sort of greater compared to others because of our loan growth.

So I don't think the delta is that significant.

Our next question will be from Casey Haire with Jefferies.

Wanted to touch on efficiency.

Obviously, a pretty good job this quarter.

Just wondering how sustainable is this going forward?

Obviously, the shape of the curve is tough for net interest margin, but you guys, obviously, did very well this quarter.

Did you defer a lot of things or you just did better than you expected?

So we're certainly mindful of the shape of the curve and the pressure on net interest margin.

It's about the pace of growth in expenses, and we're trying to contain.

Certain of our headcount has slowed a little.

We really aren't deferring anything important and that has a big impact on client service, but if there are other things that may be conveyed, and we can contain ourselves, then that's what we're trying to do to better match the revenue outlook and sort of the growth in net interest income.

Okay.

Great.

And just on the capital front, it sounds like you guys are not going to refinance the recent redemption.

Just wondering -- I know that Tier 1 leverage is what you guys look at.

At what point would that ratio prompt you to act and address capital?

Well -- it's Jim.

We would -- we don't expect to at least immediately replace the preferred or reducing, but as you know -- refunding, rather.

As you know, we are very opportunistic when it comes to capital markets.

The growth of the enterprise usually dictates that.

We're very comfortable with our capital right now, particularly in the current credit climate, but we will be in touch -- we'll watch the capital markets very carefully.

All right.

Great.

And just last one.

The tax rate -- if I'm reading the release correctly, it looks like the stock option expense benefit, if memory serves, it expires next year in the third quarter '20.

Is the right tax rate around 21%?

Yes.

So the options mostly will be exercised by the end of the second quarter in 2020.

And so you're right, sort of, 20%, 21% is a good after that go forward.

Our next question will be from Ken Zerbe with Morgan Stanley.

Mike, just a follow-up on the stock option question.

So if the right tax rate is 20% to 21%, if I heard you right, I thought you said guidance for the fourth quarter was also 20% to 21%.

Are you assuming no additional stock option exercises?

No.

There is still a little bit left, but they were a bit larger in the third quarter, and based on what's left, that benefit should drop off a bit.

Got it.

But still -- sorry, but just to be clear on your guidance.

So if the benefit drops off, should the tax rate -- does the 20% to 21% include the expectation for ongoing or additional stock option exercises?

It does include an expectation in the fourth quarter for a very modest benefit because there aren't a lot of options left.

Got it.

Okay.

That definitely helps.

And then just in terms of loan growth, I mean, obviously, this quarter was amazing in terms of how strongly you guys grew.

Can you just talk about the outlook especially for resi mortgage given the rates are still, let's call it, fairly low?

I mean is there something that could continue on the resi side for at least a quarter or 2 or 3 more?

Yes, it could.

I mean it really depends on the rates.

The -- as Gaye indicated, we were over 60% refinance, which is a shift over the last few quarters from 55%, 60% purchase.

The refinance markets are, obviously, heavily rate-driven.

We take aggressive advantage of them because, as Gaye indicated, we can pull clients -- most of them "refinances" are actually new clients to us coming from other banks.

And they are refinancing at that bank, and it gives us an opportunity to bring in new households, which we take, as you know, historically, quite aggressively, because the acquisition of the quality households that you have for 20 or 30 years is a very special moment.

And so we see the opportunity lasting for at least a couple of quarters.

Our next question will be from Brock Vandervliet with UBS.

Great.

Just coming back to Steve's initial question on NIM for next year, the forward curve has a modest steepening throughout the curve, but certainly 2's, 10's into year-end 2020, that would bode well given your earlier comments.

I would think we could also see some relief on the funding side as you get the full benefit of deposit repricing late in 2020.

Could you speak to that?

Yes.

I mean, I think, as the Fed has moved, there is an ability, I think, on funding to have some slight, modest reduction, but I think one of the things is that also, as part of that first question, we are a growing company and so we may not have as much sort of leverage to that because you are funding a growing balance sheet and a growing loan portfolio, and rates are, obviously, just lower overall, and so that's driving strong competition in the lending book, and you're not really able to raise rates a great amount.

And so I think that's why we're cautiously optimistic on the curve steepening a little bit, but still competition will be a big driver.

I would add to that just what you saw in this quarter is the power of growth.

I would note that some other -- the institutions that have reported this morning already had a net interest income growth that was actually negative a couple of percentage points.

We're up about 8 or 9. And the power of growth comes through in this environment.

Not only do we acquire new households, but the balance sheet growth that comes from the intrinsic growth of the current clients we already have and the acquisition of new households is very powerful and far outweighs a few points of compression on NIM.

In Q4, Mike, should you get more of a benefit in lower FHLB costs?

So on any short-term type funding we do, it definitely gets a benefit there.

And new advances we're taking out as they come -- as they roll off, they're slightly lower than what rolls off, but the bigger benefit probably doesn't come to that till the middle of next year when those start to roll off.

Our next question will be from John Pancari with Evercore Partners.

On the loan growth front, just -- I appreciate the color on the residential mortgage side and everything.

I wanted to see how you're thinking about growth in the business loan growth.

It looked like it declined on a linked quarter basis.

If you can give us a little bit of color, if that was the VC, private equity portfolio that impacted that and what type of trends you're seeing there.

The primary -- and Gaye had mentioned this in our conversation.

The primary metric on business banking longer term is in fact the growth of outstanding commitments.

And that's been up year-over-year 28%, 29%.

The volatility lies -- and the unpredictable volatility lies in the utilization of primarily our just in time lines of credit for venture capital and private equity funds.

We were down this quarter.

I think she noted that we were at about 33% utilization versus about 37%, but the long-term trend of commitments and business banking relationships alone outstanding amounts is up, and it's running probably over a 2- or 3-year period regularly in the mid-teens to low 20s.

All right.

That's helpful.

And could you just remind us what the new money loan yields are for that -- for the VC, private equity portfolio right now?

On the capital call lines, it ranges from Prime minus 50 to Prime minus 100.

Okay.

Great.

And then one last topic on the credit side.

I know last quarter, you had about $100 million relationship that had moved on to nonaccruals related to a spec real estate credit on West Coast.

Could you just give us an update on that credit, if you've seen a resolution?

And then separately, any other developments in the real estate portfolio worth mentioning?

No other developments in the real estate portfolio worth mentioning, actually.

And that particular situation is still about status quo.

It's still paying.

It's current.

And there are some action on the sale of the homes, but nothing has closed yet.

Our next question will be from Jared Shaw with Wells Fargo Securities.

Just a couple of follow-ups here.

I guess on the single-family residential portfolio, could you share with us what the new origination yield was in that portfolio as well as what percent are ARMs in the portfolio?

The -- on the -- let me comment on the yields.

New originations are in low 3s on the single-family residential.

The 6-week rate lock yield is in line with the origination yields in the third quarter.

And the pure adjustable on the home loans is a pretty modest percentage, typically tied to LIBOR, but it's pretty modest.

Okay.

And then I guess, when you look at the 2.75% margin guidance, is that assuming that we continue to see the single-family residential growth at the relative pace it is, sort of taking us through the end of the year?

Or is that more of a static analysis of where the balance sheet is right now?

It does forecast sort of volume in new business into the future and right now the pipeline in the backlog of single-family is pretty strong given where rates have been.

And so we do expect it to continue to grow at a nice pace.

Okay.

Great.

And then looking at the brokerage revenue this quarter, it was really a strong quarter.

Could you break that down in terms of how much is coming from new client origination versus increased volatility and if it is taking advantage of the market?

And is that a good level to jump off of for the rest of the year?

So I think the latter thing you said was important.

Obviously, with the volatility in the quarter, it did drive our clients to be a bit more active and look at different products and offerings.

So it may be a little bit high as you head to the fourth quarter depending on what volatility would be, but we're really pleased that it did have a very strong result for the quarter.

Our next question will be Arren Cyganovich with Citi.

On the single-family side, we've seen gain on sale margins increased for the industry, yet it doesn't seem like you're kind of getting back into the mode of selling those mortgages.

Is there any thought to maybe selling some and helping fix some of the mismatch between the loan originations and the deposit growth?

We did -- we had a very small -- modest amount of sale at about 13 basis points of gain, but the secondary market is still a bit disconnected from the mortgage origination market.

So we'll be opportunistic, and as we see the opportunities, we'll definitely take advantage of that.

Okay.

And then I had a question recently from an investor about the unicorn valuations coming down.

Obviously, some weakness in Silicon Valley.

How would that affect your business, if at all?

Probably very little, if any, impact.

We don't lend into that sector directly and generally not even indirectly very much.

It's currently going to have some ripple effect on some funds, but we don't anticipate any real direct effect at all.

Our next question will be from Aaron Deer with Sandler O'Neill + Partners.

It looked like you're starting to see a little bit of benefit in bringing down the deposit costs.

I was wondering if you could give us maybe what the spot rate was on deposits at September 30 relative to June 30 and then also where they stand today.

So the spot rate for 9/30 was mid-60s.

And -- you asked about the relative, so last quarter, we said low 70s, and our deposit rate quarterly average came in at 65.

So the mid-60 spot rate for 9/30 does not yet fully reflect the September rate cut.

Okay.

Subsequently though, you have continued to bring that down.

Yes.

A bit.

I'll revert back to the NIM and the NII guidance that we have provided on that.

That is all baked in.

Okay.

And Mike, you mentioned LIBOR.

I'm curious -- I think you guys have discussed switching to SOFR on new originations.

I'm just curious to know what some of the volatility that we've seen there has caused any -- caused you to rethink the direction that you're going in terms of what your time rates do going forward?

Yes.

So good question.

Just to clarify, we are not tying any loan originations are indexes to SOFR.

Maybe for just the reason you sort of hint at is, it is a bit volatile and does move around.

And, if you think about our business being consumer based in great part, that may not be a good thing for consumers.

And so obviously, we're studying it, but there are other indices that you can use, like the 1-year CMT, for example, that behaves in a much more logical fashion from our perspective, and we think consumers also benefit from that.

We have been originating on that index for the last several months.

Our next question will be from Christopher McGratty with Keefe, Bruyette & Woods.

Mike, if I look to 2020, the source of deposit growth, I think, is going to be important for the industry.

How should we be thinking about the composition of getting the deposits next year?

I mean last year, it was lot of CDs for the industry, but with rates moving down, wondering your thoughts on the mix change.

So in 2019, the barbell strategy between checking and CDs has worked out pretty nicely.

That still continues to be the case.

Having said that, with rates -- with the short-term rates coming down, it actually looks our money market checking and money market savings to be more attractive than it used to be and also makes, as we have discussed, the other borrowing vehicles more attractive too.

So we'll be doing a -- we always do a dynamic optimization across all the funding sources, and we see strong organic growth given the household acquisition and retentions.

Great.

And one more on the spot rate.

I'm wondering, Gaye, if you could talk about securities you purchased in the quarter, the yields that you purchased in Q3 and maybe what you're looking at today.

Thank you.

So we have purchased about $2.1 billion in total securities.

This is before all the runoff.

And that was about, call it, mid-3s and mostly in the -- some munis and some HQLA.

And net net, the growth was about $1.2 billion in the investment portfolio.

And now with Q3, kind of where the rate dropped recently, how those -- are they still kind of in the mid-3s or maybe in the low-3s?

Yes.

For the HQLA, it's more high-2s, and for munis, that would be 3% to 3.25%.

Our next question will be from Matthew Clark with Piper Jaffray.

First question just on other noninterest expense.

Just wondering if there's anything unusual in that line item this quarter.

Nothing unusual.

It's a reflection sort of our containment.

When you hire a few less people, you have less recruiting costs.

You have less sort of internal events.

And so it's been a real conscious effort on part of the team to really focus on what adds the most value for -- internally for our colleagues.

And to add, I would just say, everybody in the bank has done a fantastic job and that speaks to the entrepreneurial spirit of First Republic where great prioritization everyone pitching in and being really agile.

Okay.

And then just on operating expense growth for this year, it looks like you're going to -- you could come in slightly below your prior guidance of low to mid-teens growth for this year.

Can you just speak to expense growth for next year knowing that there's going to be some step-up for the expansion into Hudson Yards?

Just give us some range of expectations maybe?

Yes.

So on Hudson Yards, the cost, so to speak, will probably not start till late 2020 and even more fully in 2021.

So I don't think that causes a big step-up next year.

We're going to end this year sort of in the low double digits.

It looks like a little bit less than, as you mentioned, low teens.

For next year, obviously, we're still going to try to contain ourselves while continuing to invest in the franchise, and we'll have sort of more to say, I think, as we get towards the end of the year on relative growth percentages.

Okay.

Just last one for me on the weighted average rate on originations.

Not just SFR, but can you give us the overall rate in the portfolio this quarter?

Yes.

If you look at real estate lending, which is obviously a bulk of what we do, it's about 3.25%.

And then when you factor in business banking and others, it goes up sort of 10, 12 basis points from there.

Our next question will be from Lana Chan with BMO Capital Markets.

Sorry if I missed this, but did your margin guidance in fourth quarter include a potential October rate cut?

It does include one more rate cut for the year, yes.

Okay.

And then just a question on your brokerage fees.

Any potential impact from the discount brokerage all going down to 0 in commissions?

So very little.

We do not earn much in the way -- I think it's less than $1 million from online commissions and, obviously, we will be acting accordingly compared to what's happening in the market in the near future.

Our next question will be from David Chiaverini with Wedbush Securities.

Question about your commercial real estate office portfolio.

With co-working space companies having come under pressure with the WeWork IPO delayed.

How much of an impact, if any, do you expect to slow down in the growth of co-working space to have on your office portfolio?

Probably not very much.

We have no WeWork space in any buildings that we have loaned on.

So that particular situation has no impact on us at all.

To the extent that they're not going to grow in commercial real estate for a while if -- it will take a little -- it will put a little space of money going with them back on the market, but I don't think it's going to be much of an impact, to be honest with you.

Okay.

And my follow-up.

Could you provide an update on your millennial strategy and the student refi products?

The student refi product and the professional loan program products are going very well in fact.

This year, they're running about the same as last year, which is -- which was a tremendous growth year.

And the deposit-to-loan ratio inside that portfolio is stronger this year than it was, which is indicative of the fact that we are their full-service bank.

We're right around 25,000 such households at this point in the bank, and we actually couldn't be more delighted with the progress of that whole activity.

At this time, I'd like to turn the call back over to Jim Herbert for closing remarks.

Thank you very much.

Thanks, everybody, for listening today.

We appreciate it.

Thank you.

Ladies and gentlemen, this concludes today's teleconference.

You may now disconnect.