First Republic Bank at Morgan Stanley Financials Conference
Jun 13, 2012 AM EDT
Thomson Reuters StreetEvents Event Transcript
E D I T E D V E R S I O N
FRC - First Republic Bank
First Republic Bank at Morgan Stanley Financials Conference
Jun 13, 2012 / 02:20PM GMT
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Corporate Participants
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* Jim Herbert
First Republic Bank - Chairman and CEO
* Kellie Abreu
First Republic Bank - Senior Managing Director
* Paul DiBetta
First Republic Bank - Managing Director - Preferred Banking Offices
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Conference Call Participants
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* Ken Zerbe
Morgan Stanley - Analyst
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Presentation
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Ken Zerbe, Morgan Stanley - Analyst [1]
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All right, why don't we go ahead and start the next presentation. We have First Republic. Speaking to start off is going to be Jim Herbert. Jim's the Chief Executive Officer; he has been with the Company since the beginning. So it's been -- he's seen a lot of interesting things happen over the years in terms of being taken out, being spun off again. It's a great story. It's one of our top overweights at Morgan Stanley. I'll let Jim introduce the rest of his team, but with that, Jim?
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Jim Herbert, First Republic Bank - Chairman and CEO [2]
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Great. Thank you very much, Ken. Thank you all for being here this morning. Let me introduce others with me here very quickly. Kellie Abreu, who is co-head of the New York region for us, has been with us about 10 or 11 years and was previously in the west and moved here two years ago. Paul DiBetta, who's up at Time Warner, who -- it's about five years, Paul? Okay -- and handles personal and business banking up there. The reason they're here, among others, is to give you a sense of exactly how we really do the business. So feel very free when we get to Q&A to go to questions with them. They actually know a lot more about day-to-day than I do.
I'm Jim Herbert, CEO. We started the bank in 1985 and let me just go through this. I'll go through the presentation relatively quickly and then go to Q&A. This is a private bank. We have been on the ground in what I think of as five markets, really. San Francisco is our home market, and we're in the nine counties, pretty much, of San Francisco, Los Angeles and southern California, we think of maybe as two, and then New York and Boston.
We are coastal, urban, higher net worth focused, home loan driven to a large extent. We're $30 billion in size. Our wealth management assets, we have a full platform of wealth management now, it's about $22 billion. We are very credit focused. Our credit losses over the years have been quite low; we'll come to a chart in a moment, and we're strongly capitalized.
We sold to Merrill Lynch in 2007. Bought it back in -- actually made the deal in late 2009 and closed in 2010. And we've been backed by private equity investors. We went public at the end of 2010 and that's worked out very well. We'll come to where we are on their ownership in a minute.
This is the last 12 months of activity in the bank -- nice growth. We're very much a growth entity and I'll come to why in a moment.
What are the fundamentals? We have a very simple business model, actually. The devil is in the execution. And we execute intensely every day, and Paul and Kellie are very good standout examples of how we can do that. We're in attractive markets. These -- the GDP that we operate in has outperformed the GDP of the country, generally.
We have been profitable every year. We've never had a loss year -- I'll touch wood here; I think it's wood. And we have a very strong brand that we've developed over a period of time.
Leadership continuity -- I've been with the bank since the beginning. Katherine August-deWilde, who is our President and Chief Operating Officer, has been with us since the beginning. We've been partners for 27 years. Our senior credit officer joined us in 1986. The average of our senior executive officers is about 17 years with the enterprise.
We are very client-centric. That's the entire model. The entire model is deliver the whole bank through the various points of contact, and the points of contact can be a relationship manager, it could be a business banker, it could be a portfolio manager in wealth management. It could be an office leader. But through that point of contact, they are the quarterback in the relationship. So what you get is a single point of contact, or if you want, you can have multiple. We don't have a lot of silos inside the organization.
It's a straightforward business model. This is a list of what we don't do. It's available online. There's a whole lot of things we don't do. You know that the top one is important recently, but also credit derivatives and others. We're simple folks. We keep this really simple. Sometimes that's good, sometimes it's not, but it isn't going to surprise us.
We just do this -- this is how we market. This is short testimonial is a way you can market service, basically.
(video playing)
Did I do something wrong by pushing that too quickly? There we go, thank you. That gives you a sense of how we market. The annual report, which we have here in the room, I think, is a series of testimonials every year, about 25 new ones each year. We actually have an inventory of nice testimonials now. But the point is, people really like the bank. And they really like it because of Kellie and Paul and the other people that work at the bank.
And they become -- they do a lot with us. They'll do about nine things on the average with us, a single-family home loan client. They become passionate as a result of the number of contact points and that number of good experiences they have, and they recommend us highly to like kind friends. And that's about 70% of the growth every year.
Then, we do the obvious things to grow the bank. We hire new relationship managers, new bankers, new portfolio managers -- I'll come to a chart in a moment -- and we open new offices. We have very focused marketing because we generally know who our next likely new client is, and what their profile is and where their kids go to school, where they live, etc. So we can be very targeted in our marketing.
Let me talk about profile of clients and markets for a moment. In the markets that we operate, the left-hand chart represents basically 20 -- the households in America, 20% of them are inside our markets. The Cap Gemini World Wealth Report definition of a higher net worth household is about $1 million of liquidity. We have used them now for a decade to measure us every other year. I wanted to set a bar so we'd know how we're doing. 53% of all such households are in the markets we are in. So we basically service more than half of high-net-worth households in America, in terms of market reach already. In those markets, our share climbs each -- these are every other year. We're doing one right now; we'll have it in about a quarter, and we have increased our share. It's not particularly a target; it's just a measure.
What are the -- how far can you push the model, and what are the opportunities? San Francisco I think represents reasonably well how far you can push the model. This is our share of households of that nature in nine counties in San Francisco. We have a 16% market share. In New York, where we're sitting, is the biggest single target there is. We have about a 1.2% market share, almost three years ago. That's up since then for sure.
About 40 -- we have about 110,000 clients in the bank in total. We have about 30,000 borrowing clients. About 40,000 to 45,000 of that total client base is in this high-net-worth category.
Strong growth, organically. This is organic growth. In 27 years, we bought one bank, a small bank in the East Bay of San Francisco. Otherwise, we started with 10 people and a storefront, and actually no federal insurance. But we did have a flow of clients, because I'd started a bank in 1980 and sold it in 1984 and started this in 1985, and we had done a lot of jumbo home lending in the Bay Area. That was in Sunnyvale that we started, but we came up to the city.
So we had a flow of jumbo home lending clients even then, so we've been dealing with this high-net-worth client in the loan business since 1980. But it's been organic growth. One office at a time, one good banker at a time, and one client at a time. It compounds relatively well because we do a good job and people tell their friends.
Silicon Valley -- I said I think earlier about 35% of our business is in San Francisco, San Mateo, Santa Clara County, so we have a bit of a concentration there. Good growth, one-year loan growth, I won't belabor that point.
Balance sheet makeup -- we're about 67% single-family home loan. Most places, maybe, that wouldn't have been so good. Our lending experience is such that we've had -- we've had done about $50 billion, $51 billion of home loans that we've originated at retail in 27 years. We've lost 6 basis points, cumulatively, in 27 years. The geography of San Francisco, Silicon Valley still -- half the bank, call it -- and the other half is elsewhere -- Los Angeles, San Diego, being the largest share, and New York being the next largest, Boston being after that.
We do business lending; I'll come to that. Here's the profile of our clients, median -- the home loan clients -- median and average. Let's focus on the median. Loan size is $700,000-$900,000 kind of range; that's where we are. The average is more pertinent there, probably $900,000, almost $1 million. Big loans, but if you think about this -- think about New York, that's not a particularly large home loan, actually.
And then loan-to-value ratio, 60%, average and median. Liquidity of the borrower, high; net worth, $3 million; average net worth, $16 million. We have some very, very large clients. We bank some very big families.
Here is the -- this is in response to the new banking rules that came out recently. I'll do this quickly, but 44% of all of our home loans are 60% or less in LTV and not 1% are over 80%. We are a very conservative lender. And importantly, the person that borrows that little on their home is more likely to be the candidate for other products, cross-sell. They're more liquid. We're focused there.
Our credit has been very good. We've lost 6 basis points in home loans; that's the circled one on the top. The total of our credit losses of all type since 1985 is 21 basis points cumulatively in 27 years.
Ten-year charge-off experience, actual write-offs right through the little storm we all experienced and still seems to be going on, but not so much in the credit area as it was. But we hit it -- we peaked at 48 basis points right off in 2009. That was -- we were inside BofA/Merrill but we ran our own books. That was very important. That's the reason we could come out.
Business banking -- this is bit of an untold story inside us, really. What we have done, if you think about the profile of those clients, who are they? Well, they're decision-makers. They run things, they influence things. They sit on nonprofit boards. They run companies, they're entrepreneurs. And so we go from them to their businesses -- their law firm, their real estate firm, their fund firm -- venture capital, private equity. And we go -- we follow them, as a way I think about it, we follow them to their passion -- their kids' school, their arts organization, their charity, whatever they care about in their community, and we bank a lot of nonprofits of all kinds.
So the business banking piece has grown quite dramatically. It's now 40% of our funding base. It is, of course, almost entirely checking. And we have $1.8 billion outstanding in loans.
Deposit franchise -- it is 40% business, 60% consumer. And then we have really three channels. We have a preferred office banking channel, as you would normally think of that. Then we have a preferred banking channel, working through folks like Paul and Kellie and their teams. Then we have the wealth management base, sweep account type deposits, which are becoming much more important.
The mix over the last couple of years, we've managed to run down our CDs, thus reducing our cost of funds. Our running room there is diminishing and we can speak of that in a moment, but we've made a lot of headway. We like the improvement very much. Checking is about 43%, 44% now, which is terrific.
Office size, just so you know. This is a private bank with offices. We have 60. We have 10 opening up in the next 12 months, roughly. They're sit-down; one is pretty close to here, over here on 51st and Park. That was the first one here in New York. If you go in, it's a different environment, it's all sit-down banking. It always has been sit-down banking, low velocity, high attention, just a different environment.
About 30% of our private banking activity is actually carried on in the offices. Our office size of $280 million, $300 million, those are, I think, after two year the size branches in every case. So we get a lot of bang for the buck out of these offices.
Core efficiency ratio -- we're a high touch business, so our efficiency ratio tends to revolve around 60%, roughly. Some of that, of course, comes from the wealth management business where the efficiency ratio is in fact higher. This is a -- the higher is negative, those of you who are not bank followers. You want this to be as low as possible.
Our people -- we hire the best people we can possibly find. We think they're the best in the business. We pay them very well. They do a lot of work. And they handle very good clients, so we have been efficiency intrinsic in the model. And that efficiency is larger average size of virtually everything. Checking accounts are larger, branches are larger in totality, home loans are larger, etc. Clean, super clean business, so we don't have distraction from noise.
Less clients to deal with, doing more with them, very good people, well compensated, who care a lot, and we have low turnover. We operate had about a 10% or less turnover ratio. And that for banking is quite high. That includes offices, which tends to be 50% or 75% in many banks.
We have more profit, we pay more per person, we have more profit per person.
Recently we've been expanding. We decided with the private equity folks we would do so. We hired a lot of people in the last couple of years. They are new to us, they are not new to banking necessarily. Most -- a loan officer will have about 15 years average experience when they come over. And we've opened a lot of new offices. We've planted a lot of seeds in the last couple of years. We're pulling back slightly on the pace of that in each case, and letting it now grow.
Wealth management -- assets under management have grown nicely. We've spent an enormous amount of time consolidating this. We actually learned a lot being inside of Merrill, in terms of the wealth management, in terms of how to operate it. This is an open architecture kind of platform. We have a trust department we started from scratch. We have a broker dealer, and we have a First Republic investment management, which is mostly open architecture. We do run some money inside, particularly from legacy folks that we've bought in some RIAs.
Core earnings are growing nicely, core net interest income. We emphasize core, by the way, because we have purchase accounting coming out of -- when we bought the bank from BofA, the assets were inside Merrill. The charter had been given up. We bought assets and liabilities. They had been marked by BofA when they bought Merrill. We marked them again to market in July of 2010. So we had originally about $700 million of purchase accounting. That is now being taken in income. So we focus on core, we ignore that.
Core net income and net earnings, you can follow this elsewhere. This is our net interest margin. The other piece of discipline we spend a lot of time on is asset liability matching. We do it kind of the old-fashioned way -- we sell long-term assets. We borrow some long term money from the FHLB at fixed rates so it can stay matched. So far, quite frankly, we've borrowed about $3 billion. It's been 100% wrong. We didn't need to do so, but we want to stay matched at all times. We run a book of about 5% positive asset right now.
The NIM, on the other hand, has been very, very steady. This is a 10- or 11-year chart. So we work really hard not to surprise anybody. One of the things we think is much undervalued is predictability and stability. We'd rather be that than have a bang-out year and then pay for it next year.
Book value has been growing very nicely, and that's a combination of core earnings at about 9% to 10%, plus income -- plus purchase accounting accreting in.
Same thing -- private equity ownership, real quickly. We started out with P/E, as you might expect, up around 73% of total earnings -- total ownership, sorry. We're now down to about 31%. We've done -- the IPO was actually mostly secondary. And then we've done to secondary offerings since then. Our largest owner is Colony Capital and GA, who have been absolutely terrific partners, as has all of our partners. They're on the Board and they're represented by Tom Barrack at Colony and Bill Ford at GA, each of whom leads their firms. And we've known them in various ways for a number of years, including Tom Barrack was on the board of the bank for many years before we sold.
The results since Merrill Lynch -- this is interesting. We sold to Merrill Lynch off of 12/31/06 numbers, and here is our 5.25-year growth through an interesting period of time for all of us. And it's been a pretty good run, but most importantly, the market value of the enterprise has gone up very nicely during this period and is quite measurable, because we were public the day before we announced the deal. We're public today, and it's exactly the same bank, except a little larger.
Stress test comparison, I won't bore you with that. We did a stress test, although we are not required to. We went ahead and ran one as you might expect because at credit it came out well.
So that's kind of a quick summary. Maybe, before I turn to Q&A, I might ask Kellie and Paul to give us maybe just a minute each of how you do your business, or a minute and a half of how you do your business here and so on. Thanks.
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Kellie Abreu, First Republic Bank - Senior Managing Director [3]
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Again, I'm Kellie Abreu. I've been with First Republic Bank for over 11 years. I started in the San Francisco market, moved to New York about three years ago. I have clients who are mostly referred to me by existing clients. My best clients start with a home loan. We get to know them, we do full documentation home loans, and we grow the relationship from there, work on their investment management, their trust services, as Jim mentioned, bank their private schools, and we do that one client at a time, one product at a time. We are experiencing tremendous growth here in New York. We've hired, as you saw, some tremendous relationship bankers who have brought their relationships to the bank. We think this is a terrific market for us and we look at repeating what we've done in San Francisco here in New York.
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Jim Herbert, First Republic Bank - Chairman and CEO [4]
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Great, thanks. Paul?
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Paul DiBetta, First Republic Bank - Managing Director - Preferred Banking Offices [5]
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My name is Paul DiBetta. I've been with the bank for over five years at the Time Warner Center location, and my relationships start off relatively simple. They start off with a checking or savings account, but the key to our success is actually being able to go deeper into those relationships. And from those individual relationships, going into the business deposits, the owners, the executives and providing residential mortgages, working lines of credit for their businesses, commercial real estate loans, or providing deposit and lending for their fund businesses. The deeper we get into the relationships, the more powerful they become, and the bigger the referrals we get from those clients. And I've been doing that for over five years with some very good success stories.
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Jim Herbert, First Republic Bank - Chairman and CEO [6]
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That's putting it mildly. Questions?
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Questions and Answers
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Ken Zerbe, Morgan Stanley - Analyst [1]
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Great. I'll kick it off with the first one. Your ability to grow loans has been one of the key standout positives over the last several years. So I ask this just in mind of -- it probably matters tremendously for your multiple, but how are you seeing loan growth shaping up in second quarter? And, given where rates are and given where the economy is, if you look at over the next couple quarters, is there any reason to think that you can continue to grow as strongly as you have been going forward?
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Jim Herbert, First Republic Bank - Chairman and CEO [2]
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Well, the best answer is buried in the activity level in the markets that we operate in. And the activity level in the markets we're operating in is actually quite high. We have, I think we said on our first -- no, we said on our first quarter call -- our backlog was a record level then; that has not changed. The velocity of activity in San Francisco, which is the home market -- it's about half the bank -- is really strong, as you might expect. And people -- it isn't just on the revenue side of people and what's going on in the Valley; it's on the supply side. We -- one of the things we like very -- we focus intensely and quite consciously on supply-constrained markets. We love urban supply-constrained markets where it's hard to replace a home or build a new one. And that has been one of the keys to the success.
The very definition of that is the Peninsula. The -- in San Francisco. Our loan volume -- but the loan pricing, on the other hand, is a negative and a positive. Very low loan pricing is drawing borrowers, so there's an almost historic level of refinance beginning to occur. If you look at the national numbers, that's not true, but if you look at the numbers and the markets we're in, it's absolutely true. And that makes for opportunity and challenge. Challenge is price, opportunity is a whole lot of activity going on, a lot of opportunities to do business. Not just are we being refinanced, but everybody is being refinanced.
The purchase markets are good, so that activity is quite strong. I think we're running about -- I think we have said we're running about 35% to 40% purchase activity, of our total lending, that's a good number. It was way down about a year and half ago. Other questions?
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Unidentified Audience Member [3]
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Hi. In looking at the four core markets you showed a few slides back, the population concentration dynamic is pretty different in Los Angeles versus the other three. Is there a different strategy you are employing there to attack that market?
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Jim Herbert, First Republic Bank - Chairman and CEO [4]
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That's a very perceptive question. LA is the most challenging market we're in because of the horizontal nature of it. It is concentrated two places -- Century City and downtown. But those are the biggest concentrations and they're nowhere near a New York. And so the strategy has been to stay relatively confined geographically, as much as possible, so that we get the ricochet effect of compounding. And that's harder to do there than it is anywhere else, but we've been pretty successful.
A branching strategy for LA is the place that that mostly impacts, actually. But the proximity of our kind of clients is the key, and New York is the best example of that. And San Francisco is a pretty good one, but New York is the best. And so I think ultimately, in fact the opportunity here is quite extraordinary, but we need to get -- we are getting there now, to the point where we meet ourselves coming around the corner. You have to get to a certain -- the compounding breaks out at a certain point, and I think we're there in New York now.
LA, will be probably -- it's a very good market, we have a decent market share there, 3.5%, 4%, not bad. And LA, by the way, is the one market where those numbers are off the most, because the definition of the market includes the least area that we operate in.
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Unidentified Audience Member [5]
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Given your substantial business in the San Francisco/Silicon Valley area, I have two questions in relation to that. The one is, if you go back to 2000 to 2002 when the tech industry went through some tough times, just wondering what impact that had on your business. That's the first question.
And the second question, which is perhaps a bit of an unusual one, is, again, given your substantial exposure to that region, just wondering if you've done any sort of stress tests around -- if there was an earthquake, for example, in the region, which is clearly more vulnerable than most parts of this country, what protections do you have in place? What mitigations measures, do you have -- insurance, etc.?
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Jim Herbert, First Republic Bank - Chairman and CEO [6]
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The former question is, I went back to this chart on page 18 in the little book you have. In 2002, 2003, 2004, we had very modest losses. We have a lot of loans down in the Valley the whole time, actually. I don't think we had a 60-day delinquent in those years down there, and it's because of how we lend money. We lend money for the storm, always. We always have. People forget -- 1981 was not fun at 21%, and 1989 and 1990 were not fun either. We have a lot of experience base in the bank. We've had -- and that takes me to the second question -- we went through the Northridge earthquake in LA, and we went through the Loma Prieta in 1989 in San Francisco. They are difficult.
The worst loan losses we've had actually as a percentage, not as absolute but as percentage, were 1994, and they came out of the earthquake, the Northridge in LA. We had loans on brick buildings that we had help to upgrade for seismic upgrading. The upgrading worked, but people moved out. The buildings held up, but the people moved down out. Nobody was hurt; that was the good news. But we worked through it and we got through it, and we didn't lose money that year, although we sure tried hard.
So earthquake is a risk, though. It's a real risk, and we are aware of it. Earthquakes are very specific, geographically. Okay. And that's part of the answer. One of the reasons we're in the markets we're in, is we diversified quickly; we got away from that risk.
Number two, with 60% LTV in California, in these very high-priced urban markets, about 50% of the value of those homes is in the land. So at 60%, your actual exposure on structure is fairly low.
And then number three, look at the liquidity of the borrower. So our historical experience, which may not be projectable, but in the two that we faced, was we had no home loan losses at all, in either one. We had some apartment building losses in LA that we had to work through. And we don't land on brick buildings anymore; we actually stopped that in 1992. We just didn't stop it quite soon enough. But that would be a problem for sure, and there could be business interruption of our enterprise. We do not have insurance. We have insurance for business interruption; that's a pretty big deal, actually. But a lot of our borrowers to have insurance, by the way. Randomly --
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Unidentified Audience Member [7]
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(inaudible) insurance, I wasn't -- the insurance, I just don't know how it works. I wasn't sure if you could get as a borrower (multiple speakers)
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Jim Herbert, First Republic Bank - Chairman and CEO [8]
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Well, borrower, you can get -- no, you can get earthquake insurance.
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Unidentified Audience Member [9]
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Right.
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Jim Herbert, First Republic Bank - Chairman and CEO [10]
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But the negative of it is, it's fairly expensive, and it's 15% deductible usually. But even then, about 20% of our borrowers have it. But most of them are -- most of them do not. And to require it is not market standard, you couldn't get it.
So the main protection -- this is a risk, number one, we call it out for sure. Number two, my feeling is the biggest risk to the enterprise is probably business interruption, and we spend a lot of time on disaster recovery and things like that, as you might expect, because we've been through this. We got through it, but it wasn't fun.
Okay. Time's up, I guess. Thank you all very much, appreciate it.
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