First Republic Bank at Bank of America Merrill Lynch Banking and Financial Services Conference

Nov 13, 2012 AM EST

FRC - First Republic Bank
First Republic Bank at Bank of America Merrill Lynch Banking and Financial Services Conference
Nov 13, 2012 / 03:30PM GMT

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Corporate Participants
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* Jim Herbert
First Republic Bank - Chairman and CEO
* Paul DiBetta
First Republic Bank - Managing Director
* Kellie Abreu
First Republic Bank - Senior Managing Director
* Todd Valoff
First Republic Bank - Managing Director, Preferred Banking

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Conference Call Participants
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* Russell Gunther
BofA Merrill Lynch - Analyst

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Presentation
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Russell Gunther, BofA Merrill Lynch - Analyst [1]
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(Audio in progress) -- It's my pleasure to introduce this morning Chairman and CEO Jim Herbert of First Republic. Headquartered in San Francisco with nearly $33 billion in assets, First Republic focuses on servicing high-net-worth customers in urban coastal cities on the East and West coast. You will recall the Bank completed its IPO in December 2010, continues to be one of the fastest-growing banks in the industry and announced its first wealth management acquisition a week and a half ago. With that, I'll turn it over to Jim.

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Jim Herbert, First Republic Bank - Chairman and CEO [2]
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Thank you, Russell. Let me just introduce folks that are here with you. Good morning. We will go through some slides and then we can take questions. And I'll go fairly quickly. To my left, Paul DiBetta, who is up at Time Warner. Why don't you go ahead and introduce yourself?

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Paul DiBetta, First Republic Bank - Managing Director [3]
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My name is Paul DiBetta. I'm a relationship manager at our Time Warner Center location. I've been with the bank for 5.5 years and I've been in banking for over 10 years.

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Kellie Abreu, First Republic Bank - Senior Managing Director [4]
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Good morning. I'm Kellie Abreu; I'm Deputy Regional Managing Director here in New York. I'm also a relationship manager, managing clients bi-coastally. I've been with the bank for over 12 years.

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Todd Valoff, First Republic Bank - Managing Director, Preferred Banking [5]
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Good morning; I'm Todd Valoff. I'm the Managing Director with our Preferred Banking team. I've been with the Bank since 2001. I handle the deposit side of our business.

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Jim Herbert, First Republic Bank - Chairman and CEO [6]
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Good, thank you. So they are along to tell you about the business at the actual level where it's getting done, and I will do an overview. So I'm going to be brief and then we will go to some anecdotal items from them and some questions.

First Republic -- we started it in 1985, been profitable every year it has been in existence. We are about $3 billion in assets. We have about $25 billion in wealth management. We just announced Luminous, an acquisition of $5 billion of assets under management. We can talk about that in a moment, if you'd like.

Tier 1 capital is strong. We've never had a loss year. We have 13 basis points of delinquency, and that's it. It's a very strong, clean kind of balance sheet. The fundamentals are simple. We have had a continuity of leadership for the whole time the Bank has been in existence. Our President and Chief Operating Officer, Katherine August-deWilde, and I, have been partners for 27 years, but we have leadership continuity all down through the enterprise.

Simple business model, we'll talk about that; very attractive geographic markets, not to be overlooked at all, often underestimated, and a strong brand which is developing, which Kelly and others can speak to here in a moment.

Over the past year or so, we have grown very nicely. It's a growth enterprise. We do a really good job with clients and they tell their lifetime friends, and they get quite passionate about the enterprise. So it's growing very strong, 20% plus on almost all fronts, except Wealth Management, although it is having a very good year this year.

Our approach to banking is simple. We surround the client with service. They have a single point of contact. Each one of these three folks with me represents that single point of contact in varying places in varying ways, depending on how they come at the business. We sell about nine products per person. We deliver that. It's a very good -- it's a good ratio, unusually good.

The very simple model -- this is a list of things we don't do -- proprietary trading, we would like to put on the top of the list, and a number of other items. So it's been a simple model for a long time. We have avoided a lot of things, including sub-prime. This is a part of our marketing and give you a sense of how we market. This lasts just not a minute. This might be soothing.

(plays video).

That marketing strategy -- it's not moving on here; let's see if we can get -- there we go. That marketing strategy has permeated everything we've done for several years now. And the result is the growth rate that you see on these charts. It's really about one person at a time loving the service they get, one relationship at a time, telling a like kind friend about it and not telling them in a passive way, but actually raving about the service. And then they bring them in. So about 70% to 80% of our client acquisition each year, new clients, come from a referral of an existing client.

We are geographically concentrated in a nice way -- coastal, urban, New York, Boston, San Francisco, LA, mostly the west side, west of downtown, and San Diego. Portland, Oregon is a small market for us. Silicon Valley, including San Francisco proper, which has become, in fact, Silicon Valley, which is interesting -- is about a third of the Bank. So the growth in Silicon Valley translates directly into our growth.

Balance sheet -- I won't spend a lot of time on this slide. But we are a single-family home lender. HELOCs are a big part of our business to the same clients. Geographically we are about 70% California, 30% in the East.

The home loan clients -- who are our clients? This is an interesting profile. The median net worth of our clients is about -- just short of $3 million. They borrow a little less than $1 million, on the average. Loan-to-value ratio, importantly, is 60%. That's why we have a loss record that is very, very low. Average is much higher. We have some very wealthy clients.

The credit record is really strong. If you look at the top line, in particular, single-family home loans -- we've done a lot of them, $50 billion, $60 million. We've had 5 basis points of cumulative loss in 27 years. The worst year we ever had for actual losses in this chart was 2008, as you might expect. 2008 was 48 basis points, which is actually quite modest, given the storm that was on us all in 2008. And the results have gone back to more normal for us since. The long-term average is about 10 basis points a year in losses.

Business banking, a very big deal -- we basically bank businesses that are run by people that already use the bank privately. We met most of our business banking relationships through a home loan, surprisingly enough -- very simple model. But who do we make home loans to? We make home loans to people that are deciders. They are influencers. They run funds, they run law firms, they run accounting firms and they bring those firms to us after they have a good experience personally. So when you are talking about acquiring a business client, you are not at the front door like everybody else is. You are coming in kind of the side door. You have a friendly reception before you even try, in most cases. It has worked very well.

That has become -- business banking has become 46% of the deposit base of the Bank. It didn't exist 10 years ago, so it's a very big change for the better.

Our deposit mix has shifted. We've pulled away from CDs, as most people have. We've moved towards checking, driven in large part by the business banking growth. It's been very successful. It allowed us to bring down our cost of funds quite significantly.

Office size -- we have a great office system. We have about 65-68 offices right now. The average size is one of the largest in the industry. That obviously translates into profitability on the branch system, very stable source of deposits.

The business model is very scalable. This is one of the things we get asked a lot about. And yes, we can grow the business quite successfully. We have landed our core efficiency ratio in the 58%-62% range. It's holding rather nicely; we actually improved it slightly in the last quarter. This is driven in large part by the efficiency of our people. The average assets per person that we have is about 2.5 times the industry average. That comes from two or three things. We have very, very good people that work really hard. We also have a very clean client base so we are not distracted by trouble. And the average transaction that we do with our clients is larger than most banks by quite a lot, at every level.

Private Wealth Management is a growing part of enterprise, very nicely so. We just announced the acquisition of Luminous, which will add $5.5 billion to our asset base. If you look at the 2011 year end, it was about $20.4 billion. With the growth of the Bank so far, the wealth management so far this year and Luminous, we will end up with about $30 billion to $31 billion for year end. So we are up 50% in a single year on Wealth Management.

When we bought the Bank -- we sold the Bank to Merrill Lynch, and they sold to BofA, the conference at which we are, and we bought the Bank back from BofA. Since we bought it back, we have purchase accounting which is positive. We bought loans at a discount. That's coming into income. What we look at is core non-GAAP earnings. GAAP is only positive; we have about $400 million, $375 million yet to come into income.

But looking at core earnings, we have managed to grow our net interest income very nicely. There's a lot of talk about NIM pressure. We can talk about that in Q&A. But the thing that pays the bills is net interest income, and it's going very nicely. That is translated into core earnings per-share and core growth in earnings per share very nicely over the last several quarters. We have managed to outrun the NIM compression, which we can talk about.

Our net interest margin is actually relatively stable. And again, this is core, not GAAP. GAAP would be higher. But we may be out of running room on the deposit cost side. So we are now probably at the point where this is going to inflect.

We have had a very rapid growth in book value, which at the end of the day is the real core measure of bank success, in our opinion, the accretion of book value. Grown very nicely in the last year and a half, two years, 17% growth rate.

This is the enterprise value of First Republic. We have managed to increase enterprise value quite dramatically. Because we had to take the chart up to 1400, it puts the time frame of 2002 to 2006, right before we sold, in low perspective. But that went from 100 to about 350, so we ran up very nicely, even before we sold it to Merrill Lynch/BofA.

Our job at the end of the day is to make this chart keep going up aggressively. We had private equity ownership when we came out of Bank of America. That has been reduced very nicely. We've had a couple of secondaries, we have had some block trades. Most recently, there was a block trade for 6 million shares done overnight by Credit Suisse. 5% of the bank traded. Next day, stock traded down about $0.15. It was very, very efficient. The largest holders, Colony and General Atlantic, which are great friends of ours, are down below 8%.

We did some capital stress tests on ourselves voluntarily; we are not actually required to do so, and we stand out very nicely. This matters a lot because our depositors are smart, very educated, understand how to read a balance sheet. So they care a lot about the strength of the bank and they understand how to figure it out. So the transparency is very important.

With that, let me shift for a second to some of the folks I have with us. Maybe, Kelly, you could lead us off and describe how we do the business on both coasts.

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Kellie Abreu, First Republic Bank - Senior Managing Director [7]
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Okay, it's actually very similar in that most of our business, and specifically my business, is from that crazy little home loan. Typically, a client is looking to buy a home or is the client of another bank and wants to refinance a home. And so they are referred to us by existing clients who are happy, and we talk to them about having a relationship and what that means. We are not just pricing our loans just to do a transaction, we're pricing them to do a relationship that will last for many, many years. So we have that discussion up front.

It is a very competitive market, but we pick carefully the clients that we want. We close the home loan, we open a bank account. We set up their automatic deposits and then start working on selling across the balance sheet. Most all of my business accounts that I have, corporate accounts for private equity and private services are from a home loan. So they have a great experience with us. They talk to their fellow coworkers and we work on their business banking, their business lending. And, oh, by the way, they are running a nonprofit agency or involved in a private school, and we follow them through those very relationships. So that grows year in, year out and quite substantially.

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Jim Herbert, First Republic Bank - Chairman and CEO [8]
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Great. Todd, maybe you could speak for a moment about how we support that, and then also if you could talk about some things going on in sort of the Eagle Lending on behalf of Erin.

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Todd Valoff, First Republic Bank - Managing Director, Preferred Banking [9]
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Sure, absolutely. So it is about keeping close to our clients -- very close, actually, to be able to be there for the small things and the larger opportunities, when they are there. I think that is one of the key drivers of our success. They know that they can call me at any time and/or a strong team member, Kellie, that we are both on the other end of the phone. We work very nicely as a team without the silo aspect. We can walk right down the hall or pick up a phone and get a quick answer. Clients really value that. And as we have already said, then they tell their friends.

So it is a customized approach, one client at a time, and the growth goes from there. We are relationship-based, so we love to talk about our different services, and we love to compete. So when deals come up, we want to know how is it we can help and add value to that. And sometimes -- most times, we will win. I think -- I can think of only a very few times where we were not interested in doing something or being part of a banking relationship.

To Jim's point, our partner lending program, our Eagle products, as we call them, have been very successful. These are, again, a way into young, up-and-coming folks who maybe have not had the point to buy a home yet, but perhaps they are buying into their company. We can get on the ground level and do a great job. So when that next opportunity comes, they are coming to us.

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Jim Herbert, First Republic Bank - Chairman and CEO [10]
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Paul, could you describe for a minute the business banking side of it?

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Paul DiBetta, First Republic Bank - Managing Director [11]
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Sure. So as Kelly and Todd said, we build the business through relationships, and it doesn't really matter where it starts. Mine starts on the business banking front. And I'm working with executives at bringing their businesses and they bring in their consumer relationships. And over time, I'm deepening those relationships by expanding into whatever business need that they bring to my attention. Whether it's business lines of credit or term loans or commercial real estate or residential lending on the consumer side, I am wherever my client needs me to be. I'm the point of contact, and I will bring in partners that I work with to work on that relationship.

But in all instances, I am the quarterback for the relationship and it gives me the time to develop and expand into their businesses and their needs overall, and that grants me access into their senior level executives, whether they are senior vice presidents or vice presidents, and that provides me more opportunity to capitalize on their business.

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Jim Herbert, First Republic Bank - Chairman and CEO [12]
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Great. With that summary, let me -- the backbone of First Republic is its service culture and its people. The stability and quality of the people are the key. We have grown about 20% a year compounded for a long time. It's not our target, it's just results. But it is very, very helpful in the current environment, particularly to overcome the compression on net interest margin.

With that, let me open for questions, Russell.

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Questions and Answers
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Russell Gunther, BofA Merrill Lynch - Analyst [1]
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(Inaudible question - microphone inaccessible) can we talk about the loan growth opportunities by geography? It's clear that the tech sector is driving a fair amount of growth on the West Coast. The growth drivers in New York and Boston? And what could be a realistic or mature concentration in those markets over time?

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Jim Herbert, First Republic Bank - Chairman and CEO [2]
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The driver in the West is technology, but it's only a part of the story. Kellie, you might be best to respond for the West, if you could.

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Kellie Abreu, First Republic Bank - Senior Managing Director [3]
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Sure. Tech is certainly a driver, but there are businesses still coming from large law firms, CPA firms, private equity firms. So the growth is everyone's buying a home, everyone wants to acquire real estate in the West. And that is -- the tech is the driver, certainly driving up the prices because there are more people in the market buying. But it is definitely spread out through all the various businesses.

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Jim Herbert, First Republic Bank - Chairman and CEO [4]
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One of the things that drives our growth the most is the competitors' service metrics. To the extent that the competitors' service metrics are stable to declining, we pick up clients. But the actual thing that drives clients to us is the velocity of activity. And the velocity of activity in the mortgage market is really, really strong, both refinance and purchase. And when we talk about refinance, 40% of our business in the last quarter was purchase. But, actually, the refinance business is not all refinance of us; it's refinance going on at Wells Fargo or BofA or JPMorgan or wherever. So when we bring a mortgage client over that was refinancing somewhere else, we book it as refinance, but it's not just rolling our paper.

In the East, Paul, what would you say is driving the East -- or Todd? Anyone?

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Paul DiBetta, First Republic Bank - Managing Director [5]
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A lot of our growth is just based on our presence now. We've been in New York for 11 years. The name and reputation has definitely come a long way and we are getting a lot of referral business. I'd say about 70% of our business is coming from referrals and 30% is walk-in traffic. And it's all service-oriented. On both the business consumer front, we are just bringing in one relationship at a time. And Todd, do you want to speak to anything more specifically?

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Todd Valoff, First Republic Bank - Managing Director, Preferred Banking [6]
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Sure. I have seen a lot of growth and a lot more opportunity in the hedge fund world, family offices and entertainment here in New York.

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Jim Herbert, First Republic Bank - Chairman and CEO [7]
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There's something to think about. The cities we are in connect with each other along various channels, and entertainment is one that connects LA and New York. We have a strong presence in LA. So you have the personalities, not just the ones you might think of, the front personalities, but in fact the producers and directors and technicians -- the lawyers, importantly, and the business managers, traveling along that route, so to speak, and carrying our reputation from one city to the other.

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Russell Gunther, BofA Merrill Lynch - Analyst [8]
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Along those lines, the interconnectivity of the markets, are you in all of the markets where you currently want to be? Or are there spots where --

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Jim Herbert, First Republic Bank - Chairman and CEO [9]
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Well, let's just put it -- the election has enhanced Palm Beach, near as we can tell, which is going to be one of our -- is one of our new locations. But the answer is, we're in the markets we want to be in. I don't see us adding a major market for quite a while, and I can't even predict when. The Palm Beach addition is mostly a service point for New England, and it turns out as recently as yesterday for San Francisco. We had people say, I've had it, I'm out of here. And Palm Beach seems to be on the target list.

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Unidentified Audience Member [10]
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Jim, just two questions. One is, given the quality of your mortgage portfolio, does your tier 1 common ratio improve under Basel III? And then, secondly, do you see improving secondary market access for the kind of jumbo loans that you originate, sort of high quality, high balance? And what do you think -- does that improve your ability to manage your balance sheet going forward?

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Jim Herbert, First Republic Bank - Chairman and CEO [11]
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Well, Basel -- the one thing that is out on the capital front that's a negative for us is the question of whether -- we do some interest-only initial period ending -- quite a lot, actually. About 70%, 80% of our portfolio is interest-only for 10 years. The loss record that you see includes interest only. We don't think it's a bad product at all. Quite the contrary, we think it's a very good product, but it has to be done right. The regulators are not yet of that opinion, and they may not end up there. For some reason, interest-only is -- it's like the building that was foreclosed. The building wasn't bad; the owner was, but that's not how they think. And so interest-only is likely to be disadvantaged and be considered a category 2 asset.

We are still fine. We have put this in our 10-Q. We are still fine on capital strength, although obviously it is disadvantageous, a bit. In terms of the secondary market and mortgages, I've been doing this since -- I started back before this one, in the 80s. I've been doing this since 1980 in the mortgage banking business. I've never seen a better market, ever. All of a sudden -- it has been good, now it's explosive. And the reason, of course, is the drive in rates. And so we have multiple bids on every package we put out. We are getting very, very good pricing.

The total market may not be back, but for quality of assets of the type that we have, there's an almost seemingly unlimited demand. The QE3 is helping that, I'm sure, because they are buying mortgage assets. We sold about $750 million in the last quarter. Could have sold a lot more, but that's the amount we choose to sell. We delivered about $300 million into Fannie/Freddie, by the way, mostly Fannie, and that's an ongoing piece of our business at very nice rates, very nice prices.

So our growth constraints are removed by mortgage banking, actually, in the sense that we can control the size of the balance sheet growth very handsomely and at a profit. We always keep servicing, never sell it. And so it's an interesting time.

The obvious question on everyone's mind, looking at bank investments, is net interest margin. But you don't eat net interest margin, you eat net interest income. And net interest income in our model can be driven by growth -- by three things, really -- by some cost control, by growth in assets, even at an incrementally lesser margin, but nonetheless a positive margin, as long as you have capital adequacy to support it, and by secondary market sales and profits on mortgage banking, which we -- all three tools we have. So, so far, we have been able to outrun the net interest margin compression rather well.

Other questions?

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Russell Gunther, BofA Merrill Lynch - Analyst [16]
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Maybe I should hop to the Luminous acquisition. You have been growing organically aggressively on the wealth management front. Maybe just talk to what the decision to do a deal and then perhaps if your appetite would extend to a depository at some point.

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Jim Herbert, First Republic Bank - Chairman and CEO [17]
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And the answer to the latter is no. We are just not acquirers. Now, you never say never, but very unlikely that we would buy a depository. We bought one bank in 27 years, so we are just not acquirers; we are builders.

Luminous is a very, very interesting acquisition. We have looked at a lot of things in the wealth management area and passed on a lot of them -- all of them except Luminous, actually. It's unique in how much aligned with us it is. Their culture is the same. The six partners are very competent, very capable people who built a business from scratch, but over many years and through a couple of iterations. They are geographically on top of us -- Palo Alto, or Portillo Valley, technically, but Palo Alto and Century City. Their client profile is entirely representative of our client profile -- dispersed around the country a bit, too, not just locally. And a fair number of their clients already bank with us. A fair number of our clients have them as wealth managers, so there has been cross-testing, and our clients and their clients speak equally well of the two organizations.

And they have some alternative asset access that we haven't developed. Maybe we could, but we haven't. That will bring product sets, so to speak. And they have some excess capacity. So we have, in our bank, a number of clients that have not been touched yet for wealth management because we came to wealth management later than we did to banking. And so we have a back cross-selling opportunity that's of considerable magnitude. We need more capacity in order to optimize that. They bring some of that capacity.

So I think, net-net, it's a really good acquisition. These things always come down at the end of the day, however, to culture and to integration. And if you don't get the integration right, you don't get the culture right, they can work in a range of success to failure. So what we look at more than anything else is, does it feel like the culture is going to fit? And it does. And we've looked at a lot of them where the numbers made sense and all the other stuff made sense; culture didn't feel right, so we passed.

Other questions? Actually, let me introduce Bill [Dessem]. He is a lead of -- here in New York, just joined us a few minutes ago. Other questions anyone has? If not --

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Unidentified Audience Member [18]
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(technical difficulty) -- control costs? What are you doing on the cost side? And sorry if I missed this.

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Jim Herbert, First Republic Bank - Chairman and CEO [19]
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We have pretty well announced -- announced is a little strong, but we have spoken publicly about a hiring pause. That is really coming about -- it has to do with cost control, but it has more to do with culture control. This enterprise lives and dies on its culture, its teamwork, its cross-selling, the quality of the people, the client care, putting the client first very fundamentally is how we actually exist. And when you have that kind of tight culture predicated on very low turnover and a stability of people from top to bottom for a long period of time, when you add too many new people, you put the culture at risk. And we had added a lot of people as we came out of Bank of America. We had had a hiring freeze, in fact, inside Bank of America for a while, and an office opening freeze. Those two things we have pushed down the gas on as we came out of BofA. We started to ramp up new hiring, particularly relationship managers, portfolio managers, as well as support people. And we have opened a number of offices. We have a pipeline about 10 offices yet to open.

We stopped adding to the pipeline, and we have stopped hiring relationship managers, business bankers and portfolio managers. There are a few exceptions, things that were already in the works, but not very many. So what we have done is we have taken the pressure off the culture for a while with new, and that has the laudatory additional impact of containing cost growth.

Now, that's -- the volume we are doing is in spite of that. So it clearly hasn't hurt our volume and we have had a number of people that we have added in the last year and a half. Usually a relationship manager joining us takes about a year and a half to ramp up to full capacity. But it takes about six months to get the culture, six to eight months, maybe a little longer. And so by pausing only for a couple of quarters we can reduce the culture damage that was going on.

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Unidentified Audience Member [20]
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(Inaudible - microphone inaccessible)

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Jim Herbert, First Republic Bank - Chairman and CEO [21]
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It's kind both. We liked it from both angles. So when we are discussing what to do, both were in the room -- both issues were in the room. But, mostly, I don't want to lose control of the culture. That's the main thing. If we lose that, we're dead.

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Russell Gunther, BofA Merrill Lynch - Analyst [22]
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Maybe I can just quickly follow up on the expense line of questioning. You stated in the past you would not hesitate to reinvest purchase accounting-driven earnings --

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Jim Herbert, First Republic Bank - Chairman and CEO [23]
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Right.

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Russell Gunther, BofA Merrill Lynch - Analyst [24]
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(inaudible) for growth. And it's clearly what you're doing now. So can we think about the decline in expense growth commensurate with the decline in the impact of accretable yield in what might be a more normalized year-over-year growth rate?

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Jim Herbert, First Republic Bank - Chairman and CEO [25]
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I think what will happen also as we see the decline -- I don't pay much attention to the declining rate in accretable yield from the purchase accounting. It's there and I know it's there and it's adding to book value and it's helping support the growth of the balance sheet. But the philosophical use of it has already been committed. So it's more the growth rate of the net interest income, not NIM, but net interest income versus expense growth that we focus on. And so far, the net interest income has outrun the growth of expenses very nicely. Is this on? I want to go back -- why is that the not -- yes. Well, I can't get it to work.

But in any event, we have a slide on net interest income. But -- there, it went back one. Can you go to page 24 for me? Can you run it from back there? Okay, thanks.

That's Private Wealth Management, that's not -- one more? One more up? No. Yes, go one more, if you can. Sorry. Okay, there's core net income and earnings per share. If you look at the growth rate of this quite steadily, we have managed to outrun it every quarter. And this is not by accident. We work hard at this. And it's coming from growth of assets, loan sales, containment of expenses offsetting NIM stabilization and decline. So I don't know how long we can do it, but so far it's working out fine.

Other questions? Okay, thank you all very much. We appreciate it.

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