First Republic Bank at Credit Suisse Financial Services Forum

FRC - First Republic Bank
First Republic Bank at Credit Suisse Financial Services Forum
Feb 11, 2014 / 06:45PM GMT 

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Corporate Participants
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   *  Katherine August-deWilde
      First Republic Bank - President & COO
   *  Willis Newton
      First Republic Bank - EVP and CFO

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Presentation
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Unidentified Participant   [1]
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 Okay. Next up, we have First Republic. I'm sure most of you know the story very well, a high-quality franchise here, straddling both coasts in high-growth urban metro markets. A 20% grower, if not more. Historically leading with the prime jumbo mortgage, but has done a great job in recent years of diversifying the mix and growing the business bank at a healthy clip.

 You can sleep at night on credit here, it's all about growth in the margin. I think their efficiency ratio is pretty much within the long-term range I think with where they want it to be. Mortgage gain on sale, pretty much washed out; and they've also had some good success on the wealth management front. That's a contribution that we would expect to continue to build over time.

 It's been a topical story, of late. They find themselves dealing with QM quite a bit, here with an new QM roll-out earlier this year. They are quickly approaching $50 billion in assets and the need for capital. Capital for growth is also at top of mind.

 We're very happy to have President and COO, Katherine August-deWilde here with us; and CFO, Willis Newton. With that, let me turn it over to Katherine.

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 Katherine August-deWilde,  First Republic Bank - President & COO   [2]
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 Thank you very much. We're delighted to be here. We have been a bank doing the same thing for many years, for 28 years; and have grown assets, deposits, loans, and investment management at a very fast clip. Today, we're a $42 billion bank, with almost $42 billion in assets under management.

 Non-performing assets, only 14 basis points of total assets. Leverage ratio is over 9%. Those of you who know us may know that we have our de novo charter and through 2017, the middle of that year, we're required to keep 8% Tier 1 capital. Loan originations in 2013, almost $18 billion, that was a very strong year. We may see a bit lower in this next year, as most people who could refinance have refinanced.

 Why First Public? What are we? We're a very strong brand. We are in outperforming urban markets, coastal urban markets. San Francisco Bay area is about 50% of our business. Our credit quality is very strong. It's a simple business model. We are a private bank, a private business bank and a private wealth management firm. We make loans and take deposits for individuals and the businesses and non-profits our clients own, run, and manage; and we are a full-service wealth management firm, focused on customization, transparency, and meeting client needs. We are in targeted high-end client segments, good leadership continuity, a very strong focus on service and all of this growth has been organic.

 2013, again, we had a good year in terms of deposit and loan growth. Our Wealth Management grew 33%. Book value is up 11%. Because we purchased ourselves back from Bank of America, we have both GAAP net income and core net income. We tend to focus on core net income and that's up 33% this year.

 We have a very simple business model and it has a single point of contact. The yellow circle in the middle is the client and the client has a quarterback. The quarterback is the person who brought the person to the bank. That might be a private banker who comes, brings a client in for a mortgage; it might be a business banker who meets the client when they have a business need; it might be a Wealth Management professional; it might be a deposit taker. That quarterback determines the client needs, explains our services and products, and brings in other product specialists that they know we'll be comfortable with their client to offer other products and services, but they stay always involved. The client has a single point of contact and that client knows who to call when they need more products, more services, or something as simple as a wire transfer.

 We have an incentive structure that leads to the growth of relationships and very strong credit. We've always had a clawback if a loan becomes delinquent. We also -- our bankers are expected to work out the troubled loan and since they earn less than half of their compensation from loans and the rest from liquidity that a client will bring to us, they tend to look for clients who are highly liquid, those clients tend to be extraordinary good credits.

 A tremendous amount of our business comes from word of mouth. We have a strong group of satisfied clients who talks about us and refers us to their friends and colleagues. I'm going to show you a brief 30-second video.

 (video playing).

 Our clients say it best and our clients refer us their friends and colleagues. Many of you may be familiar with the net promoter score. It looks at the percent of people who promote you, who talk to their colleagues and friends about you, minus the percent who would say negative things about you. And the average bank in the banking industry is an 18% score. The companies who have very high net promoter scores tend to be Amazon, Apple, places like that.

 First Republic, when we are the lead bank, has a net promoter score of 74%, that compares with 76% at Amazon, 71% at Apple. This is because primarily of a very high focus on client quality. There is a bit of difference and you'll see on this chart. If we are the lead bank, our net promoter score is about 20 percentage points higher than if we're not. Being the lead bank means the client does more with us. It's a sticky relationship and so we're working harder to do more with the client, but yet it's still a structure where we offer the clients the services they need. This is not a hard sell type of bank where we have certain products that we must sell a client as do some of our competitors.

 People ask us how we get our business. Our clients have an above-average rate of growth; they tend to be doing well, they tend to be wealthy as an average, and they have events happen. They have a child in need of trust, they need a larger house, they need a [pipeline] on college savings plans for their kids. And so, because of who they are, they do more with us over time. Each year, they tend to do more with us, as they understand more of what we can offer, that matches up to their needs. In addition, they're passionate about working with us. They really like us and they refer other people to us.

 So, a lot of this is really truly word-of-mouth business development. That's about 75% or 80% of our business. The rest of our business comes, as you might expect, from hiring experienced relationship managers and wealth managers; from opening new offices in markets that our clients want us to be, within our existing footprint; and we have very focused marketing; we know where our clients live, we know where they go to school, we know exactly how to market to them.

 With that, let me turn this over to Willis to talk about our markets in more detail.

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 Willis Newton,  First Republic Bank - EVP and CFO   [3]
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 Great. Thank you, Katherine. We're fortunate to be positioned in some very good geographical markets and what we've done here is mimic the regional GDPs the markets that we're in and tracked against them the national average. San Francisco, in particular, with the technology and the software industries, has been leading the nation as a whole and is about 15% above the national average over the last three years to four years of recovery; New York and Boston are doing very well; and we're pleased that our Southern California markets are also off bottom and rapidly improving. This gives our clients an opportunity to improve their liquidity, their net worth; their businesses are doing well, home values are rising, and the prospects for our banking activities are very good.

 We are in very attractive markets, in the coastal markets of New York, Boston, now in Palm Beach as well as the coastal California markets. 21% of households in the country are located in these markets, but 55% of the high net worth households are in these particular markets. So, it's a particularly target-rich environment that we are operating in. And we've done an increasingly good job of attracting additional high net worth clients to our bank. We're now banking about 4% of the high net worth households in our entire markets. And increasingly, we're improving not only our penetration in the markets in general but in the segments that have additional high net worth, the $5 million and up and the $10 million and up which are included in the definition of $1 million and up households. Over the last year, we grew -- the last time we did the study, and we're currently working on an updated study, we were growing at 9% for the $5 million and up and 18% for the $10 million and up.

 For a very long time, First Republic has been a strong organic grower. Both our loans and deposits have grown at over 20%, our compounded annual growth rate for the last decade. You would keep wondering if the law of large numbers are going to catch up with us, but so far, our people have been delivering such good service that word of mouth and client acquisition has continued at a rapid pace.

 We are an active secondary market participant. We have sold loans in every year since 1985. This does several things for us. It allows us to manage our interest rate risk, it allows us to offer a full range of products from adjustable-rate mortgages to 30-year fixed-rate mortgages when we only can keep the shorter-term hybrid ARMs, adjustable-rate mortgages on our balance sheet. And since when we sell a loan, we always retain the servicing, this generates service fee income, the client realizes that we're their bank, they don't think that we've sold their mortgage, we don't have to send them a goodbye letter, it is a strength of our organization.

 We have taken advantage of the secondary market when conditions are good and when clients have demanded more of the types of loans that we sell such as the last few quarters 30-year and 15-year fixed-rate loans, we've originated more of those, we've sold more of those, and we've made profits and taken advantage of market conditions. The last several quarters, the loan sales were down and the outcome for 2014 will depend upon the demand in the marketplace and the interest rate markets as a whole.

 Roughly a third of First Republic Bank's offices, products and services are being delivered in the Silicon Valley Bank, so Silicon Valley banking area. That is comprised of San Jose to San Francisco; and increasingly, the technology companies are in San Francisco, the individuals who are employed at these companies, Twitter, Square, Salesforce.com, even the people who work on the Facebook campus, want to live in the Bay Area. So about a third of our loans and deposits in our offices are in this particular area. We bank over 350 venture capital private equity and other firms and funds that are in the Silicon Valley. It's an opportunity for a lot of very strong business growth.

 Turning to our balance sheet, our balance sheet is diversified by product type as well as geography. A little less than two-thirds of our loans are single-family home loans and home equity lines of credit. About 20% are income property loans, both multi-family and commercial real estate loans. Our business banking is growing and is now about 10% of our loans.

 By geography, the geography is also diversified, with the San Francisco Bay area representing 47%. New York has been a growth market for us. Boston is coming online and we continue to have a strong presence in Southern California. And we have been in Florida for just about a year to the date.

 We have very attractive home loan clients. This slide shows the attributes of the home loan clients that we've originated over the last two years, but it really hasn't changed much over the last decade. What you see is our borrowers have on average about $1 million home loan size, loan-to-value right around 60%. The liquidity after they make their loan on average and median is almost enough to pay off the debt or more in the average case. The net worth is quite high, which gives us opportunities to cross sell and the credit scores are strong. All of our loans are fully underwritten and fully documented. We never did any subprime loans. We have very low charge-offs and our credit quality is second to none.

 Our historical losses on all loan product types over 28 years are shown on this chart. We've done over almost $70 billion worth of home loans and had in 28 years cumulative losses of only 5 basis points. Now, this includes our home equity lines and all the loans we've sold since we retained the servicing. This is truly remarkable almost Treasury-type lending. Looking at the lending as a whole over our entire existence, we've had less than 1 basis point of loss per year for the entire 28 years or 16 basis points in total.

 Our ten-year charge-off experience, last year, we had charge-offs of 5% of average loans; and over the last ten years, we've averaged 9 basis points, which is about 20% of the average for the top 50 banks as a whole. Business banking has been an increasing part of our business and source of strong growth. Deposits over the last several years have grown 27% and loans 24%. This is higher than the total loans and total deposits on average. Our average business loan is about $1.9 million. And importantly, we have 4.1 point deposits to every loan outstanding, to the average loans outstanding. So four times the deposits as the loans and these deposits are very low cost. In the fourth quarter, the contractual rate paid on our business deposits, most of which were checking accounts, was only 11 basis points.

 We've specialized in a number of areas; in particular, schools and non-profits are a good source of both loan and deposit business, our private equity and venture capital funds. And we also do a lot of business with other verticals shown on the page here. We have about 10% of our total loans in business banking and 45% of our deposits are business banking deposits.

 Our deposit franchise, as we mentioned, is diversified. 55% is consumer, 45% is business. And looking at the chart on the right-hand side, we have about 35% of those deposits, which come from our offices, which are most commonly called branches, we call them preferred banking offices and these are people who will walk into our locations and do deposit services with us. The balance, it comes in either through a personal relationship with the lender, a business banker, a deposit taker, a wealth manager, and then increasingly we have about 6% of our deposits or a little over $2 billion that are swept out of the assets under management, they are the cash balances that are represented in the wealth management accounts.

 Finally, over time, we've been able to improve our deposit mix. This has also helped reduce our cost of funds, as we've increased the average amount of our checking deposits from about a quarter five years ago to almost a half in 2013. Our goal is to continue to attract checking deposits and have an interest rate environment where we can make more money than we currently are making on those low-cost deposits, but we will also continue to raise other liquid accounts where we find the need for them.

 Now, let me turn it back to Katherine.

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 Katherine August-deWilde,  First Republic Bank - President & COO   [4]
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 Thank you. Before I begin, Willis and I have worked together for a long, long time; and I've never seen him make a number mistake, but just so we don't have a heart attack, I think you know we had 5 basis points of losses, not 5% of losses. My first correction in 26 years.

 We've worked very hard over the last decade and particularly the last several years to grow our franchise from the individual client who comes to us often for a jumbo mortgage, to cross sell deposits, cross sell business banking, and cross sell investment management. And we generally start with that client who came to us with some credit need and cross sell other products. So let me talk to you for a minute about the investment management platform.

 We offer investment management advisory, which includes financial planning, brokerage, and trust. It's an integrated model with one brand. We have an unbiased perspective. We don't manufacture our own products. We don't have a for-profit trading desk. So that means if you want to buy a bond from us, we want to figure out what is the right bond in terms of maturity and credit for you as opposed to which one can we make a profit on.

 We have a customized and totally transparent solution to investment management and that has caused us to be able to grow our assets under management very nicely. We're up 33% in terms of existing -- in terms of -- I'm not sure what that is, 33% this year in terms of assets under management and this comes from three different places. The investment management professionals we have who joined us a long time ago bring in new clients. New investment management professionals bring in their existing book of clients and our bankers and lenders cross sell to their clients, wealth management; they do it through serious amount of training, both in product and in sales skills. It is a different product and it's very, very important that they understand who the product specialists are and that we train them and that the product specialists work closely with them so they understand what their clients will be doing with them.

 You can see that on the chart on the left, in 2012, we made an acquisition. We bought Luminous Capital, it had $6 billion of assets, it's grown nicely but so has the rest of our investment management. The fastest-growing part of our business is FRIM, which is First Republic Investment Management, that's we offer investment advisory, portfolio management, including alternative and best-of-breed selection of outside managers. We're indifferent to whether you choose an outside manager, whether you choose our portfolio manager, the investment advisor will work with you to figure out what's best for you. Very different from some of our competitors, there is no right answer, the right answer is what's right for our client. Our fee income has also grown nicely and we're growing at -- since we were independent 3.5 years ago at a compounded average annual growth rate of 40%.

 We have a very scalable business model. Our sufficiency has been very stable. Our goal for efficiency is between about 55% and 59%. That's a rate at which we have been running our efficiency ratio. Could it be less, people ask us? Yes, if we weren't growing so quickly. Also, the Investment Management business tends to have a higher cost to it. It also doesn't require any capital.

 We also look at efficiency differently from other banks; at times, we look at it, looking at the efficiency of the people who work for us. So compared to other banks in terms of assets per person, we have 2.5 times assets per person than our competitors, revenues at 1.7 times and pre-tax profit is 2.6 times. How does this work? What are the keys to the efficiency of people? We hire very qualified people. We've put them through a screening where they meet many people that they'll be working with to make sure people think there is both a cultural fit, a work ethic fit, and that they and their clients will fit. We have a lot of stability, low turnover, and a low turnover of both clients and employees.

 Our average transaction size is larger than average; and historically, and into the future, we have very clean assets. So we spend very little time working them out. Most of our clients have auto debit of their payments from their bank account with us, that makes it a very efficient loan servicing structure.

 In terms of our core net interest margin, it's been very stable, [because of] what's happened to Fed funds. There obviously is NIM pressure in an environment when rates stay this low for this long and clients pay off their higher-rate loans for lower-rate loans. So we are under some NIM pressure. We've taken to growing net interest income, but we will see a bit of NIM pressure through the rest of this year, we believe, until rates come up again.

 We've seen very strong net interest income growth. This is our non-GAAP core net income growth. It's been 16% a year on an average annual basis. Core EPS growth, non-GAAP, 22%, compounded average annual growth rate; and rapid growth of book value, we've grown book value per share 15% a year. And there are some of these books in the back you'll see [adjusting] our core ROE and our GAAP ROE, but those of you who are looking at us, we would advise you to look at the way we look at it. We should be looking at core earnings, core net income.

 First Republic has grown very nicely in terms of performance against the indices. There are two indices here. One is prior to our sale to Merrill for the five years before that, we are the green line; and the right side is the 38 months since our IPO, where we've beaten the indices by about 1.9%; our goal is to work hard for our shareholders and work hard for our clients and our employees and we have done that nicely over the years.

 As I believe you know, when we did a management-led buyback, we had private equity support of about 73%. As of the end of July 2013, the private equity has been able to exit at very attractive rates and so we have primarily long-only holders right now. We're pleased with that. Our private equity sponsors are also very pleased.

 We've had a commitment to our shareholders over time. Institutional investors has had an annual ranking of corporate leaders as seen through the eyes of investment professionals. We were delighted to be voted Best IR Company on the sell-side in financial institutions, bank in mid-cap category. Our CEO was voted Best CEO by buy-side and sell-side in financial institutions for the bank in mid-cap category. And Willis Newton was voted Best CFO by sell-side in financial institutions as well. We were ranked overall among the Top 20 banks honored in this category and we are very pleased with that. We believe it's our responsibility to take care of our clients and also our responsibility do a good job for our shareholders.

 We've seen very nice growth in enterprise value. Over the last 27 years, we've grown enterprise value at a 23% compounded average annual growth rate. What I'd like to do next is -- we have, it looks like, about 10 minutes -- is turn this over to questions or do you want to add to --?

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 Willis Newton,  First Republic Bank - EVP and CFO   [5]
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 (inaudible).

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 Katherine August-deWilde,  First Republic Bank - President & COO   [6]
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 Okay.

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 Willis Newton,  First Republic Bank - EVP and CFO   [7]
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 Sure.

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 Katherine August-deWilde,  First Republic Bank - President & COO   [8]
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 Thank you.

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Unidentified Participant   [9]
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 Feel free if you want to take a -- get more comfortable. I'll start off. Maybe we could start with the proposed LCR rules and then kind guess what else needs to be done? You guys historically have had a larger muni portfolio at least since you separated from -- you became independent, but just curious what else needs to be done to grow and also diversify away from munis?

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 Willis Newton,  First Republic Bank - EVP and CFO   [10]
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 Well, thank you for the complexity of that question to start off here. First of all, we had some proposed rules that apply to bank holding companies, which we're not and for companies that are $50 billion, which we are not yet at as well. We are studying the rules; these rules would more likely than not require us to maintain on our balance sheet additional high-quality liquid assets such as treasuries or other qualifying assets in addition to the cash and some of the qualifying assets that we currently have on our balance sheet. We would like to see the final outcome before we get into speculating whether or not it's going to need us to make any alterations to our business model, but we think it probably is the right direction for the industry as a whole to go.

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Unidentified Participant   [11]
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 Okay, but I guess the outlook on the core margin being down modestly throughout the year, I assume that doesn't take any consideration, the steps you are taking to prepare for LCR. Is that kind of above and beyond that guidance? (multiple speakers).

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 Willis Newton,  First Republic Bank - EVP and CFO   [12]
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 Our net interest margin is going to be under a little pressure given the low interest rates, but we do have quite a lot of cash, that's earning 25 basis points. If we chose to put it into work into some of the high-quality liquid assets, we would earn more on that in the very near-term, but this is a long-term game.

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Unidentified Participant   [13]
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 Yes, okay. And then, we'll take questions from the audience. Feel free to raise your hand as well, but in the meantime, I'll ask another. I guess can you also talk to -- update us on QM and the secondary market? I know we tend to ask that all the time, but --

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 Katherine August-deWilde,  First Republic Bank - President & COO   [14]
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 QM had tremendous amount of attention in the last six months. First, you probably know, we have always made mortgages to people who could afford to pay us back and as shown by our 5 basis points of losses in 28 years, they have paid us back. One of the most important pieces of QM for us is that we also make interest-only loans and those loans are not qualified under the QM definition. We will continue to make the loans that our clients want and about half of our clients tend to want interest-only loans. As it turns out, the large competitors who also make jumbo mortgages have not backed away from making interest-only loans. So, our plan here is to continue to make loans to people who can pay and to make the kinds of loans that people want, whether or not they're QM. It does look to us at this point in time, which could change, that the secondary market is interested in buying loans from us, whether they are qualifying or not and whether they are IO or not.

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Unidentified Participant   [15]
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 Okay. Is there a sense though in the meantime you're shifting more of your production or are you seeing more of your production go to 5171s instead of 10-1s? [I don't think] you're retaining a lot more of this?

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 Katherine August-deWilde,  First Republic Bank - President & COO   [16]
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 We are seeing more of our production go to 51s and 71s because the customer has chosen that as the yield curve has steepened and 30 and 15 and 10-year rates are higher. It's really been a customer choice. We tend to sell our longer-term fixed-rate loans and keep our intermediate or shorter-term, but we really do the kind of lending that our customers ask for.

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Unidentified Participant   [17]
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 Okay. And then, maybe on the wealth management front and the opportunity that Luminous has brought you, can you talk to the operating leverage that exists from what you currently have and trying to think maybe longer-term, what do you think you can get the fee contribution up to?

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 Katherine August-deWilde,  First Republic Bank - President & COO   [18]
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 I don't think we've ever speculated on what we can get it up to. It took us some time and quite a lot of expense for the first 2.5 years of independence to build the platform and hire the people that we wanted. We've now done that and we are pleased with where we are in terms of fee contribution. We will continue to grow that business, we expect to grow it nicely and to continue to hire top producers. We also expect over the next several years to grow the fee margin, but we haven't told anybody to what we hope it will grow.

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Unidentified Participant   [19]
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 Okay. And then, as you quickly approach the $50 billion threshold, I guess, can you talk to the things you're doing to prepare yourselves forward? I know stress test is obviously not much of an issue for you guys, but just curious, what else needs to be done?

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 Willis Newton,  First Republic Bank - EVP and CFO   [20]
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 Sure. We've been a public company for 25 years and we know the burdens of additional governance and being regulated and so there's no big jump-up or ramp. We are preparing for the ultimate being over $50 billion as we go along. We've done a couple of voluntary stress tests already. We have added to our staffing in terms of compliance and enterprise risk management; we are writing policies and documentation, internal audits growing; all of these things, we think, are in line and it goes back to the simplicity of our business model. We're a domestic bank, we don't have any complex derivatives, any counterparty exposures, we have very limited complexities that we're not as significantly important financial institution. So complying with these heightened rules and regulations should be something that we are prepared for and we're working towards that and it will be a couple of years or at least the year-and-a-half until our average assets exceed $50 billion the way they're calculated.

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Unidentified Participant   [21]
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 Yes. And then, on capital preferreds are at 23% of Tier 1, bumping up against the 25% threshold. Just curious, how should we think about the timing, the amount, the mix of another raise?

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 Willis Newton,  First Republic Bank - EVP and CFO   [22]
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 Well, 25% is our self-imposed limitation. We believe that we have good earnings prospects where we still have about $1.00 per share of the purchase accounting to accrete and we're starting with about 9.2% leverage ratio. It would be a balancing act over the next three years until we can complete the seven-year period where we have a minimum Tier 1 leverage ratio of 8%. But right now, we're most likely to continue our prospects of raising small amounts of capital before we needed if we see the opportunities that are out there, that's been our pattern for 25 years and I wouldn't expect it to change.

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Unidentified Participant   [23]
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 Okay. Any questions in the audience? Alright, we're close to being out of time. We'll leave it there. Thanks so much for coming. Appreciate it.

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 Willis Newton,  First Republic Bank - EVP and CFO   [24]
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 [Thanks].

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 Katherine August-deWilde,  First Republic Bank - President & COO   [25]
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 Thank you very much. Thank you, all of you.




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