First Republic Bank at Morgan Stanley Financials Conference
Jun 11, 2013 AM EDT
FRC - First Republic Bank
First Republic Bank at Morgan Stanley Financials Conference
Jun 11, 2013 / 04:05PM GMT
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Corporate Participants
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* Jim Herbert
First Republic Bank - Chairman, CEO (Founding) & Board Member
* Jeff Bruce
First Republic Bank - Deputy Regional Managing Director, Relationship Management
* Anna Legio
First Republic Bank - District Manager, 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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Alright. Welcome back, everyone. I'm Ken Zerbe, mid-cap banks analyst at Morgan Stanley. I want to welcome our next presenters so First Republic. We have three people from First Republic. We have Jim Herbert, the Chief Executive Officer; we also have Jeff Bruce, Deputy Regional Managing Director of Relationship Management; and Anna Legio, who is District Manager of Preferred Banking Offices. So with that, why don't I go ahead and kick it off to Jim. Thank you.
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Jim Herbert, First Republic Bank - Chairman, CEO (Founding) & Board Member [2]
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Thank you very much, Ken. Make sure I can work this. Okay. Good morning or good noon. I want to go through the story of First Republic very quickly and then we'll go to Q&A. I have Jeff and Ann with me because they can really tell you what's going on at the day-to-day level in terms of offices and relationship management so I want to involve them as we go along so feel free to ask questions as well.
First Republic, we had a very good first quarter. It was more concerned with mortgage banking and some deposit diminution and I'll talk about that in a minute, which we're challenged with although we're overcoming it and yet the volume of business in our basic model, which is single-family home loan driven, is actually very good. The bank's been profitable since we started it in '85. We're now at about $35 billion in assets. Loans have grown nicely. Importantly, wealth management is coming along very well, which I'll talk more about in a minute.
The core to First Republic from day one has been very strong credit. We have had leadership continuity, myself but many others including our Senior Credit Officer has been with me since '86. Katherine August-deWilde, who is our President and Chief Operating Officer, and I have been partners for 27 years. And we are focused on a very simple model, very strong credit, high service, one client, one relationship at a time. Do a lot with them, do it very well. Take your time. It's going to be a 20-year relationship, 30-year relationship, old fashioned banking. Very intensely focused on a few geographies, coastal, urban. San Francisco number one, Silicon Valley very much included, Los Angeles west side primarily, San Diego up to Santa Barbara in the other direction, New York Manhattan centric, but the Greater Area, and Boston. The segment of clients are wealthier, first working, building wealth not so much inherited well, some of that, but not too much. And we've built a brand over a long period of time.
Year-to-date highlights; first quarter was strong year-over-year. The growth on the balance sheet however, we'll come to in a minute, wasn't that strong because we sold so much into the secondary market mortgage banking, which actually is the core of our business. Deposit growth year-over-year strong; first quarter was sideways and we'll come to that in a minute. Wealth management assets were up very much. We did buy a wealth manager. We bought Luminous at the end of the last year, about $5.6 billion of assets, [roughly seven]. Book value per share is growing very nicely. We've done several non-cum perpetual preferred stock. We did four issues, this was the last one at 5.5%. The composite of the $700 million that we raised in the last 12 months was about 6% cost.
Our focus on clients, this is a diagram of it, but we're very, very client-centric. And Jeff and folks like Jeff or Ann are the central bankers for their relationships and they deliver the whole bank and that works extremely well. The incentive is aligned to do that and it's a strong -- we follow the clients first to themselves, second in some cases to their business, and third and maybe most importantly right after themselves is to their heart. The school their kids go to, the charity they care about, the non-profit they care about. In our business banking, the largest single segment is non-profit. Let me just play this for a minute here, it's less than a minute. This is how we market. (video playing).
Basically, our product is service and the only way to really market that is to have testimonial proof of it and that service leads to how we grow. We've compounded at about 18% to 20% a year since we started the bank, pretty much almost entirely organic and that comes from two things. Look at the two boxes here, the top box is about 70% of our growth. There are two things in here and I want to talk about the first one in a moment. The latter box is really the more obvious; open new branches, hire new bankers, focused marketing. That's only about 30% of our growth. 70% of the growth in the enterprise is word-of-mouth from very, very satisfied clients who are advocates for the service and tell their like-kind friends. And if we've already made a loan to them or chose them as a client or they have chosen us, it's highly likely that that connectivity will work. It's the ultimate algorithm.
Who are our clients? The clients are A performers in the economic environment that they operate in. If San Francisco is growing at about 3% a year, our client base in San Francisco net worth and liquidity is probably growing at about twice that, maybe three times that. 60% have graduate degrees. They live in urban coastal markets and they did not inherit wealth. So what are they doing? They're working really hard all the time building what they're doing and so as a result, they grow and then they have friends of like-kind and they refer them. It's not a complicated formula, the devil's in the execution. You have to be right virtually every time.
The geographic markets we operate in have outperformed the nation. We've done a First Republic GDP, Ken Rosen does it over at Rosen Consulting for us, and basically we have outperformed from the trough up about 7 index points, but twice as well basically. These markets are the ones we know well, all of us. San Francisco is a standout obviously with the technology. About 35% of the bank is in three counties in Silicon Valley, then Boston, New York. These are knowledge-based, high value-add, high educational markets. These markets consist of about 20% of the households of America. For about ten years in a row every other year, we've had Capgemini do a study. They do the World Wealth Report Study and we've taken their algorithms and applied them to our client base and they to our markets. And about 55% of all high net worth families live in the markets we operate in so it's a very target rich environment.
On your right are the size of these markets. 0.5 million households of such a nature, $1 million of liquidity are in the area we're sitting in down to Boston, which has about 100,000. In San Francisco nine counties, we have about a 14% market share. If you take the $5 million liquidity households and the $10 million liquidity households, we have a much larger market share. Our households have been growing very nicely. We get up in the morning and figure out how to take care of the current clients and then figure out how to get 5,000 to 10,000 more households that are of the same kind each year and then do a lot with them. And we don't actually pay much attention to what's going on in the market competition wise, we just get up and go after a new client.
FRC, we've grown in the $10 million households about 18% per annum in the last couple of years. So the upper end of these households are growing actually more rapidly than the $1 million households. That's primarily because of our thrust into wealth management. We've had very strong organic growth, deposits and loans. We are very active in the secondary market for mortgage banking, but I would say it's a volatile business not necessarily negatively volatile, but it's hard to call as to volume and as to profit and we try to point this out in this slide. The Silicon Valley's about a third of the bank. I started a bank in 1980 in Sunnyvale, California before I started this in '85 so I've been banking down in the Valley since '80, long time. There was a Silicon Valley in 1980 just for some of the younger folks in the room and mostly disk drive, hard drive based. But it's been a great run. And now the Valley is moving up into the City of San Francisco and that's a big deal. It's transforming San Francisco like I would never have imagined it could be transformed at a pace that is quite stunning.
Our balance sheet make up about -- on the right hand side, we're about half San Francisco Bay Area and then New York 18%, Los Angeles 14%, and Boston 7%. By type, we have single-family homes and HELOCs are 65% to 70% of the balance sheet pretty much at all times. We like the asset class very much. This is a quick profile of our clients. Our home loan clients, about $30 million average net worth, about $3 million median. Liquidity equal to the loan outstanding and the LTVs on our loans are 59%, 60%, very conservative. We've done about $62 billion of home loan originations. These include loans that we have held or sold, but keep servicing. We've had 5 basis points of cumulative losses in 27 years, 28 years and that includes '08, '09, '10; those images. This is our actual loss charge-off experience, the green line is us. And so the P we peaked at about 48 basis points in '09 coming out of the '07, '08 [vintages].
Business banking is a growing part of our enterprise. We do a lot of interesting verticals, we have about six or eight verticals. We bank a couple of hundred law firms. We bank 850 plus venture capital and private equity funds. We bank 150, 200 private schools, bank a lot of arts organizations. But we follow our clients to where they are and then drill down and do a lot of that. We've picked about six or eight different verticals like we have actually technically nine now. Here is a list of the makeup of our business banking portfolio. Schools/non-profits 38%, almost 40% of business banking is in fact non-profit banking. These are very good places to lend money, they have a lot of interesting people sitting at the Board table, they care a lot about it, it's their heart in most cases.
Our deposit franchise is split between consumer deposits and business deposits. And then by channel, the preferred banking deposits are the strongest. That's really a test of the relationship managers and the preferred banking offices are second. We have basically brought private banking retail with our offices. They're all sit down very friendly environment. We've been improving our deposit mix, I won't dwell on this slide. We dropped our CDs down to about 11% from 37% and maybe a little lower than we would like it actually at this point. Our average branch size is fairly large, almost $300 million.
Private wealth management, we've been expanding this franchise quite rapidly. We have a very integrated model; one brand brokerage, trust, and asset management. It's grown nicely. The acquisition of Luminous was about half of the growth last year roughly and the fee income has gone up very nicely. Core efficiency ratio, we're a high-touch model so we tend to operate in the sort of high 50%s, low 60%s. We've always sort of put out there that we would expect to operate between 58% and 62% efficiency ratio. This is core, this is not GAAP. We had some purchase accounting gains we do not put in here, they would improve the efficiency ratio.
Our people and this is the core of efficiency. We do larger average transactions very clean with low turnover people that we think are better considerably than average in terms of talent and commitment to the enterprise. As a result, we have about 2.5 times the assets per person than most banks have. We make about 2.5 times as much pre-tax profit per person although our salaries are higher, our pay scales are higher. We've worked hard to stay steady on net interest margin. We're under pressure like everybody is, but so far we've held up pretty well, but this goes back 10 or 11 years now, 10 years I guess. And we've worked really hard at SLI (inaudible). We are slightly asset sensitive on the upside of rates.
Our real objective is our real income matters. Net interest margin is interesting, but net interest income is what pays the bills and net interest income has climbed very nicely. Again, this core non-GAAP, GAAP is higher. This is since we became public again after buying the bank back from BofA. Core earnings per share, this is actually since public, the prior was since we bought it back. There were two non-public cores in there and the EPS has grown nicely. Book value per share, which is the real bottom line, has compounded about 17%. And then stock performance is interesting, we did this. The chart on the left is before we sold to Merrill, but not including the Merrill premium, which is a pretty good premium and then First Republic through the end of March so it's a little dated.
And private equity, we were bought back by private equity backers. They owned about 75% of the enterprise. We've gotten them out to the expenses, they are down now below 5% as a group. And so that sort of overhang on the market, which is a pretty big deal actually, we worked hard at this. They have been very happy and the market has absorbed about 60 million shares almost and most recently there have been block trades done overnight. We run voluntary stress tests. We're not part of the group that needs to. We're not $50 billion yet, but we've done them twice in a row. We like to look ahead a little bit if we can and we've come out well in the stress test. This matters a lot. Our clients know how to read a balance sheet and they care so we spend a lot of time explaining the simplicity of the model and the cleanliness of the balance sheet and the strength of capital to depositors.
So quick conclusion. Ken, with that, could I turn to Jeff and Ann for just a moment to give us a kind of an update on what's going on the market. Ann, you want to talk about deposits from an office perspective. Ann co-leads the deposit offices here in the New York area.
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Anna Legio, First Republic Bank - District Manager, Preferred Banking Offices [3]
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On the deposit side, we normally reach out to the clients to tell them what we offer. I think the biggest thing for us is the service portion, want to see what we can do and as Jim over the years has said, it's one client at a time. Let us work with you in bringing the deposits over. What we have found over the years is that rates are not really what they're looking for. I think the majority of the client is looking for the service, someone to call the individual versus 900 number and that's been very successful. We also work closely with our lending partners whenever we have a lending need. And we work as a team approach so in order to make the client feel that he has the connectivity to other people within the organization and we bring in the experts in that particular field.
Our deposits have been coming back in the last couple of months. We have reached out to the clients that had left back in 2012 due to the FDIC change in insurance. So we have reached and so they've all come back for the same thing is we like the way you do things, you've reached out to us. And moreover we are seeing people that are coming back with $5 million, $10 million, $15 million, $20 million even though there is (inaudible) might be worth a little bit more. But they come back with the service. I think that's the main goal that the bank has.
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Jim Herbert, First Republic Bank - Chairman, CEO (Founding) & Board Member [4]
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Jeff, from a lending point of view and your thoughts about sort of the flow of business in the area.
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Jeff Bruce, First Republic Bank - Deputy Regional Managing Director, Relationship Management [5]
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Sure. Flow of business is very strong right now. We've moved from more of a refinance mode. If we look back probably a year, most of our volume was driven by refinances, a lot of those coming from our competitors. But with the strengthening of the real estate economy here in New York and especially in San Francisco, we have a lot more purchase transaction and purchase transactions tend to again be important relationship milestones. A lot of people get referred to us. A real estate transaction tends to be the point at which they actually make an active conversion over to First Republic. We attract deposits, we begin investment discussions, and so our pipeline is very full at this point. And looking through the summer, which is the big buying season especially in the suburban areas with families, we expect things to be very strong through year-end, our most significant volumes ever.
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Ken Zerbe, Morgan Stanley - Analyst [6]
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Okay. With that, I'm going to take questions.
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Questions and Answers
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Unidentified Audience Member [1]
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First question I have is about your residential mortgages. Can you give a rough idea in terms of the adjustability of the five-year arms, three-year arms, seven-year arms just to give us a rough idea in terms of the breakdown?
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Jim Herbert, First Republic Bank - Chairman, CEO (Founding) & Board Member [2]
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Sure. We have a very detailed breakdown in the 10-Q, but just generally speaking we do five ones, seven ones, ten ones, 15-year fully amortizing, 30-year fully amortizing, fixer adjustable. The mortgage of choice today I would say is about probably 40% 30-year fixed or 15-year fixed and those we sell into the secondary market almost immediately upon making them. And that's what the mortgage banking is that you see. We deliver to Fannie if the size fits and we deliver into the secondary market. We keep fives and sevens and we will keep some tens depending. We mostly sell tens as well now. So if you look at the duration of the mortgage book and then we have call it half of the mortgages that are much more adjustable; 11th District, LIBOR, Prime, HELOCs are all adjustable, and then of course the business book is almost all adjustable.
We bought a fully formed book when we bought the bank back so the duration on that book was about three years basically. And if you look at what we have on the balance sheet at any time, the duration is between three and four years at the maximum in the fixed section and closer to three than four basically. And then we have -- about between 40% and 50% of the home loan book at any time is adjustable that we keep when you get done selling, about $600 million to $800 million a quarter into the secondary market. We keep servicing on that by the way when we sell it. Jeff, there's a follow on?
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Unidentified Audience Member [3]
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Can you speak roughly to the annual caps on those loans and lifetime caps?
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Jim Herbert, First Republic Bank - Chairman, CEO (Founding) & Board Member [4]
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Annual none, we don't do that anymore. We learnt that lesson in '94 (inaudible) stuff once. Interim caps we don't do or annual. Lifetime caps --
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Jeff Bruce, First Republic Bank - Deputy Regional Managing Director, Relationship Management [5]
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Generally 5% or so. Most of our loans, it's 5% above the starting rate. In some cases we've moved up to a rate of 10.95% on that cap.
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Jim Herbert, First Republic Bank - Chairman, CEO (Founding) & Board Member [6]
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I would guess that's about right. I would say that probably the composite of the portfolio is about 9.5%. Long ways to go. And the CPR pay-off rate going on in the portfolio at this point is about 20% to 21% depends on type.
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Ken Zerbe, Morgan Stanley - Analyst [7]
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One of the concerns during the first quarter was the lack of the deposit growth and you mentioned that was because your clients were taking their money and investing into equity markets. Obviously we've seen a continuation a little volatile, but a continuation in the growth into equity markets. If that continues, are we entering a point in First Republic's growth where you don't see a lot of deposit growth? Like is it a valid investor concern that the deposit growth slows even if you have more opportunity on the loan side, your cost of funds rise, as a result profitability is hurt. So maybe you could address that concern?
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Jim Herbert, First Republic Bank - Chairman, CEO (Founding) & Board Member [8]
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I'll ask you all to chime in. But the answer is not overall. We're not worried about deposit growth per se. We got caught a little off guard in the first quarter, two or three things happened. One we saw coming the end of unlimited insurance obviously and we programmed in a loss of certain amount for that. We didn't quite anticipate the buildup of cash at the end of the year, which created a little bit of a -- more of a downtick than we would have thought, mostly anticipatory of taxes and paying bonuses early. And then the other thing that caught us off guard is across the board without fail in every market, the consumer accounts went down in size and they went down in size primarily because they went into the market and went into real estate [on mass] in 90 days. We've actually haven't done this a long time.
I've actually never seen an inflection point of that nature or that magnitude that quickly universally. And I agree with mostly the fact that we generally have people that are a little bit on the leading edge of what's going on economically and they decided to go to risk. They got over fear and went to risk in a very short period of time, which is continuing to this day and of course there's no doubt that helped to fuel some of the run-ups we're seeing both in the market and in real estate. That appears to have stabilized a little bit. That one caught us off guard. I'd say the other one that caught us off guard was the reinvestment in our business accounts, they drew down, they are more active. That has stabilized as well. From your point of view, Jeff, we've reached out to accounts that we know have moved money away from us for various reasons.
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Jeff Bruce, First Republic Bank - Deputy Regional Managing Director, Relationship Management [9]
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Correct, especially with businesses. There has been points in time in the past year where we were over deposited and so we were encouraging especially some of our business customers to think about alternative places to park fund; money market, mutual funds, and other products that we offer through the broker/dealer side of our business. And more recently, we've been reaching out to them to encourage them and let them know that we're interested in having those balances back and we've been making some good headway in the last month or so in pulling back in deposits. So I think some of it is a little bit of the turning of a large ship. The message needs to get out to our clients that we're very much interested in having their deposits back in and that's starting to happen.
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Jim Herbert, First Republic Bank - Chairman, CEO (Founding) & Board Member [10]
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I'm about half satisfied with our churn, the way I would say it.
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Jeff Bruce, First Republic Bank - Deputy Regional Managing Director, Relationship Management [11]
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I guess I know what I'm doing when I (inaudible).
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Ken Zerbe, Morgan Stanley - Analyst [12]
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Okay. One last question.
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Unidentified Audience Member [13]
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Hi there. Can you talk about concentration risk amongst your deposit base in particular in light of the geographic concentration, the exposure to the tech sector, as well as it sounds like a reliance on a small number of large depositors within your bank?
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Jim Herbert, First Republic Bank - Chairman, CEO (Founding) & Board Member [14]
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Yes. We are an extreme version of the 80/20 rule when it comes to deposits. The two largest concentrations are of two types and character. One are funds. The largest single type of depositor is the fund business that we have, but that's like an 800-cylinder engine; something's firing at all times and they're pretty unrelated to each other operationally in decision making. They're not unrelated as to the fact that probably several hundred of them are VCs so that business can ebb and flow as a group a little bit. And then private equity is I would say less correlated with each other. From a geographic point of view, they're actually fairly evenly spread surprisingly enough. We have a lot of Boston, New York, and San Francisco, and a few LA in the fund business.
The next largest base in there would be the non-profits, they're very uncorrelated. You go to the individuals; it's a broad range of people, some of whom are really wealthy and so there I would say we are looking at kind of 500 cylinders in terms of the very top end. We run a large client project and focus, which Shannon Houston who's here with us and also runs IR for us manages. And so we put the management team; myself, Katherine, and about 15 of us; have a meal every year with the largest clients in the bank preferably ones we don't know and that's worked extremely well and so we focus in on this. It's a form of concentration, but it's an uncorrelated situation. The one thing they have in common is they care a lot about the balance sheet so our focus on credit and our focus on capital has to stay at the levels that we operate in. Ken?
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Ken Zerbe, Morgan Stanley - Analyst [15]
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Alright. Thank you very much.
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Jim Herbert, First Republic Bank - Chairman, CEO (Founding) & Board Member [16]
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Thank you all very much. Appreciate it.
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