First Republic Bank at Morgan Stanley Financials Conference

FRC - First Republic Bank
First Republic Bank at Morgan Stanley Financials Conference
Jun 14, 2016 / 01:25PM GMT 

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Corporate Participants
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   *  Bob Thornton
      First Republic - EVP and President of Private Wealth Management
   *  Mike Roffler
      First Republic - EVP and CFO
   *  Mike Selfridge
      First Republic - CBO

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Conference Call Participants
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   *  Ken Zerbe
      Morgan Stanley - Analyst

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Presentation
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 Ken Zerbe,  Morgan Stanley - Analyst   [1]
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 All right, good morning everyone. I want to welcome you to the Morgan Stanley Financials Conference. I am Ken Zerbe, the mid-cap banks analyst at Morgan Stanley. First mid-cap presentation of the day is First Republic. As many of you know, First Republic is one of our top overweight banks, $62 billion in assets, mostly focused on the coastal urban markets.

 Today we have three presenters from First Republic. We have CFO, Mike Roffler; we have Chief Banking Officer Mike Selfridge; and we have Bob Thornton, who is the president of First Republic's Private Wealth Management business. So they're going to give a short presentation, and then we will go to Q&A. Thank you.

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 Bob Thornton,  First Republic - EVP and President of Private Wealth Management   [2]
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 Good morning, all. I thank Ken and Morgan Stanley for inviting us to the conference this year. I and my other two colleagues want to do a brief overview of First Republic and our business. A number of you are familiar with it. We have found it to be a very straightforward and consistent business model that's produced good results.

 So I'm going to start by turning to the first page, which is first quarter highlights. As Ken mentioned, we're about $62 billion in assets, and we are wealth management of about $73 billion. By the way, Mike Roffler, our CFO, will be talking about the recent capital rates when he gets up on the stage.

 The First Republic business model has been successful, largely because it is client-centric. We focus on all needs of the clients. It has a strong credit record and a real emphasis on the cross-sell of the business. One of the highlights is there's a [quarterback] of every relationship, and in many cases, it's the banker who brought in the client. In other cases, it can be an investment professional. But those individuals really are the clients' advocates in the business, and our compensation model and other attributes of how we run our business encourages that cross-sell and is a big part of the success of our growth.

 One of the things that's been very helpful in terms of our continued wealth management and banking growth is really the markets we're in. We're in very strong, vibrant, bicoastal markets that have tended to outperform other markets around the country, even in more difficult economic times, as the slide on page 5 shows. Notwithstanding that growth, there is a lot of opportunity for us to continue to grow. We are about 4% penetration in our markets overall, so that leaves about 96% penetration available to us. And one of the things that's interesting about that is that over the last, say, 2009 to 2013, our penetration stayed largely the same, even though we grew significantly. So we do think there's a lot of growth in the markets we're in.

 One of the things you hear about First Republic is service and the focus on client service, and how that's a big driver of our growth. This slide shows what our net promoter score is, which is the likelihood that a client will refer First Republic to their friends or family. As you can see, we have very high net promoter scores, particularly when we are the lead bank for a client, and we far outperform most of our peers in this regard. And again, we think this is one of the real indicators of our success. One of the things important relative to client referrals is that, although we do have strong client acquisition, approximately 75% of our growth each year comes from additional business from our existing clients, either doing more of the same, or new things with clients, such as wealth management.

 I'm going to now play a video from one of our clients, because we do leverage them from the standpoint of testimonials, and then Mike Roffler will join us on the stage.

 (Video playing)

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 Mike Roffler,  First Republic - EVP and CFO   [3]
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 Great, thank you. I'm Mike Roffler; I'm the Bank's CFO. And as Bob said, I am going to talk about capital activity, but you're going to have to wait until I come back the next time, because I'm going to talk about credit for a second, first.

 You know, Bob talked about really fundamental to the organization is our service culture and our dedication to client service, and that is very tightly intertwined with an extremely strong credit culture, which is really fundamental to everything that the Bank does. As you can see here, very focused, strong credit culture, very good results, 22 basis points. That's cumulative loss over 30 years on nearly $150 billion of lending. And importantly, the home loan, which tends to be a lead offering to our clients, on over $90 billion of lending, just 7 basis points, cumulatively, of loss over that time period.

 If I jump forward a couple, there are some charts here that show us compared to the top 50 banks that you can see. One of the other things that's really fundamental to the bank is consistency and stability over a long period of time. Again, it's just very fundamental to how we look at and how we operate the business. You can see this chart from 2000, 2016, our three largest markets of San Francisco, New York, and LA, about 80% of the business of the lending portfolio in both those periods.

 If I turn to product loan portfolio mix, again, single family and HELOC, 57% today, 57% in 2000. This isn't by coincidence. We stick to what we know, and we do it well. Just do more of the same and keep serving clients in the same way, and you'll grow over time.

 Just a quick minute on underwriting standards. You can see here, again, consistency over time. Loan to values in the 55% to 60% range very consistently, with strong coverage ratios from a debt service perspective.

 I'm going to skip here. This is a good visual of loan to value ratios on our 2010 vintage, compared to the first quarter of 2016, and as you can see, more conservative. It just is our nature and our culture to remain very conservative in all periods. And again, you might notice multi-family commercial real estate dipping below 50%, even. It's really about what are the cash flows that exist in those properties or in those buildings, not what the value of the building is. So we underwrite to cash flow value. That's a result based upon what the cash flows can appropriately support over time.

 Here, again, one of the reasons our strong credit culture exists is banker stability. So over 90% of the loans that the Bank's ever made, that $150 billion that I talked about earlier, over 90% of those loans are still by bankers who are with us today. So again, service culture, banker stability, client stability is really a hallmark of the franchise.

 And now, I'd like to turn it over to Mike Selfridge to talk about some other elements of the bank.

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 Mike Selfridge,  First Republic - CBO   [4]
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 Good morning. Thank you, Mike. Mike Selfridge, Chief Banking Officer. I'm going to touch on organic growth, the deposit franchise, and then a little bit on business banking and hand it back over Bob Thornton.

 From the banking perspective, our strategy is really one that is not acquisitive. We are able to grow organically within our markets, really for a few reasons -- that extraordinary service model that we touched on earlier, the growth drivers that Bob mentioned. So think, a little more than half of our growth coming from the current clients just getting trial and doing more with us over time, and about another quarter of that growth coming from word of mouth referrals. So really, think of about a quarter of our growth being net new-new, and so that model really drives this organic growth opportunity, coupled with the fact that the market penetration, as Bob mentioned, on a composite basis is a little less than 4% in our markets.

 Our deposit mix over time, if you look at a 16-year period, I think we've done a very good job building our DDA over time. A few things going on there: We've added a few branches over that time. We're about 69 branches today in our core markets. The advent and growth of business banking has been a significant contributor to this, and I'll touch on that. And cross-selling -- cross-selling and bringing in new relationships, as well as retaining existing relationships, based on that extraordinary service model.

 The deposit base, as well, has been further diversified, both by channel and by type. So if you look at the deposit base today, about a third is coming through the branch network. We call them preferred banking offices. About 57% coming through our relationship managers, our business bankers, and our preferred bankers. I'd like to acknowledge Martin Gibson in the front row here. She's a preferred banker out of New York here. And then, wealth management has also helped us drive some diversity through sweep accounts that have come into checking.

 Overall, about 53% of our deposits are business banking, 47% consumer. And I would note one stat on the bottom there. If you look at the number of deposit accounts that we're managing as an organization, it's about a fifth of the number of deposits for a bank within our asset size. So it gives us an opportunity to create some good oversight and deliver that high-touch service model.

 Stable deposit funding, about 91% of our total liabilities being deposits, a little less than 8% being debt related, mainly federal home loan bank (inaudible).

 Business banking -- the strategy of business banking started, really, in the early 2000s, and it was really following our consumer clients to the businesses that they own or influence, and over time, that's delivered very nice results. It's really become a core part of our deposit franchise, so every $1 we put out on the business banking front, we get about $4.50 in return through deposits. And you can look at the compounded annual growth rates there on the deposit and loan side, 34% and 35% respectively over a roughly six-year period.

 The business banking portfolio, about 13% of our total loan portfolio is, I would say, very focused on about nine specific verticals, very experienced bankers who have great contacts, relationships in those verticals, and bring in great new business.

 And lastly, the two largest verticals would be schools, nonprofits, and private equity venture capital. Schools, nonprofits, a lot of independent schools supported by UCC filings, real estate, large endowments, strong track records, and they're usually related to any type of improvement or capital campaign related to new facilities on campus. On the private equity venture capital side, these tend to be capital call lines related to funding activity for investments for those particular firms, short-term capital call lines, about 90 days between advance and calling capital. The other category, a little less than 4% of our portfolio, tends to be fairly granular, about $441,000 on average for loan sizes in that particular segment.

 I'm going to hand it over to Bob Thornton. He's going to discuss private wealth management.

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 Bob Thornton,  First Republic - EVP and President of Private Wealth Management   [5]
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 Thanks, Mike. As you can see, we've been fortunate to have very strong growth in wealth management, both in terms of assets and fee revenue. And I want to spend a couple minutes explaining why we've been able to experience such growth, and there are really four drivers to our wealth management business.

 The first is our cross-sell from our banking clients who become wealth management clients. We focus quite a bit with our bankers on making this happen, and that ranges from everything from training to incentive compensation, to having our bankers sit amongst our wealth management colleagues so they really consider them as partners. But that's a big driver of our organic growth on that front.

 The second is really the investment professionals who bring in additional assets. We're a sales and growth oriented culture, and they're very good at doing that, and that's another big lever of our growth.

 The third is hiring new investment professionals to First Republic from other firms around the street. The reason we've become a more attractive home than we would have three or four years ago to those individuals is because we really represent a unique opportunity of a firm that is not as big as the big firms, but large enough to have the breadth of services and sophistication of investments and great banking to serve those investment professionals, as opposed to going out on their own or going to another big firm.

 And lastly, acquisitions. We have made a couple of important acquisitions over the last few years. There are always firms that fit within our footprint and fit within the culture and our business model. So we do expect that growth to continue, and on the next slide you can see the -- shows the growth over the last six years in terms of wealth management and fee revenue as a growing part of the Bank's overall revenue. Now the Bank, as everyone knows, grows quickly, so for us to continue to grow our wealth management as a greater part of that has really come (inaudible) again, the overall strong growth I've shown on the previous slide.

 So I'm going to ask Mike Roffler, our CFO, to come back and wrap things up before we take questions.

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 Mike Roffler,  First Republic - EVP and CFO   [6]
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 Thanks, Bob. So just a few last things we'd like to cover. So, efficiency, again, I think you've heard us talk about stability over time. You know, we've had a sort of a operating range of 57% to 61%. You can see here we've been pretty consistently within that over the last five quarters, and if you go back before that, pretty consistently over time. We are operating a little bit at the high end of that range currently, and part of the reason is what Bob just showed on the last page. As the wealth business becomes a greater part of our revenue stream, it does typically run at a higher efficiency ratio than the Bank, and so I think this probably stays in the higher end of our state range, but still within it at this point.

 Another thing that we really focus on is if you think about we've got client service, exceptional client service delivered consistently to clients. Couple that with extremely strong culture, and then a very disciplined approach to managing our interest rate risk. You can see here over a long period of time a pretty consistent margin of [3% to 3.3%]. There was a couple years there we exceeded it, but really focused on stability over time in all the interest rate environments, which is what we've been able to deliver. As you see, the goal line is the fed funds rate over different periods, and it's a very disciplined approach. We sell our longest dated loans in the secondary market. We've been selling loans since the Bank started. We'll also use term funding, as appropriate, to better match some of our home loans. And it's just a very incremental approach to managing the margin over time.

 Everything we've talked about, you sort of see the results here of revenue growth compounding over time, along with earnings. And then I -- so I'm going to come back now and spend a minute on capital as part of sort of tangible book value per share. Recently, as you all know, we were managed to a leverage ratio requirement as part of our de novo status of 8% over time until the middle of 2017. That was recently lifted in early May; however, it doesn't really change how we think about capital. We really opportunistically thought about accessing capital in very small, incremental sizes. And so that's what you saw just about 10 days ago now, where opportunity presented itself, and we thought it was the right time to raise a small amount of capital. It was about 2% of our equity. And really, we look forward several years when we think about capital planning, so we run very carefully on a five-year business plan, and a part of that is really looking at the capital and what our outlook is. And given sort of the demand and the client acquisition, and the opportunity we see in the markets, it's always important for us to very well capitalized. In fact, one of our tenets is to remain very strongly capitalized at all times, and especially if it's not so good times, to be very capitalized then. Because that will be our opportunity to pick up market share if we go in with strong credit and strong capital, and maybe others might be a little bit distracted, we can gain share at that time.

 Now, one of the things that does change from de novo is sort of the mix of capital that we can think about. Everything that we thought about in the past was very focused on it has to help the leverage ratio. And so we did preferred stock offerings, seven of them, in the last three to four years. As we look forward and you'll evaluate our capital based on the Basel III framework that everyone else runs under, we'll be able to look at different types of capital. So Tier 2 has never really had a place in our capital structure because it hasn't helped us. When you have to maintain 8% leverage, you don't really need any Tier 2 capital. So it's more about flexibility in structure than it is flexibility in levels. So we think maintaining strong capital with some flexibility as to the type will be beneficial in the future.

 If I look at (inaudible) value per share, you can see this -- I guess the bottom-bottom line, we've been growing over time through earnings, and then through some small equity raises, which has added to our tangible book value. And the last one here, you just see some performance charts against different indices over time.

 And with that -- not bad, 10 minutes left -- we're happy to take some questions.

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Questions and Answers
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 Ken Zerbe,  Morgan Stanley - Analyst   [1]
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 All right, thank you. Maybe start off Q&A if you can talk about some of the Bay Area economy, credit. We've certainly seen a little bit of a slowdown in sort of the tech areas. How does that affect you? Are you seeing any notable change in the credit quality of your customers?

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Unidentified Speaker   [2]
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 I'll start, and feel free to join in here. Yes, there is a higher degree of caution. And I think, as we said in our earnings call, certainly the growth rates in certain asset categories are going to be less than they were in the past, and that's actually not a bad thing. If you look at specific sectors like technology, there is a bit more pause going on. Certainly from the venture capital investment perspective, people are just being a little bit more cautious about the investments and the valuations of next rounds of financing.

 So as it relates to First Republic, a few things. I think the general connotation of the Bay Area is that it's all tech, and it's not all tech. Tech is a big influence, but there's a broad, diverse range of corporations within the Bay Area, and if the Bay Area were to stand on its own as a GDP, it would be about the 21st largest economy. And so, think of it as a very diverse and opportunistic, for us, environment.

 So as it relates to us, I think of three things: Credit quality, we've proven that we can do very well in credit cycles in a downturn and keep credit quality high. Two, the opportunity to grow within a downturn in the Bay Area, we still think there's plenty of room to grow, just in terms of market penetration. And three, I would say just look at the diversification of the enterprise itself, other markets. New York for example, where we are here today; even though it was about maybe 7% on the slide we showed you of the total loan portfolio back in 2000, that was a little less than maybe about $215 million, and today it's 21% of our total loan portfolio, about $9.5 billion. So those three opportunities still give us opportunity to grow, even if there's a cooling off in the Bay Area.

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 Ken Zerbe,  Morgan Stanley - Analyst   [3]
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 And have you seen any meaningful slowdown in the private equity or venture capital call lines that you guys do.

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Unidentified Speaker   [4]
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 We did, and we in fact, as we again discussed in the first quarter, there was a decrease in the utilization rates of capital call lines in the first quarter from about 36% to 31%, which led to -- was a key contributor to the dip in business banking loan outstandings.

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 Ken Zerbe,  Morgan Stanley - Analyst   [5]
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 And, Mike, you mentioned in times of stress, market stress, you guys have done a great job of gaining share, taking share in the market. And if I think back, I want to mix up the years and call it 2008. I think you did like 50% loan growth. It was fantastic growth. Given you're now over $50 billion, given the increased regulatory headwinds, if we go into another challenging economic scenario, do you have the ability to grow meaningfully faster than the mid-teens loan growth and [pay] share?

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 Mike Roffler,  First Republic - EVP and CFO   [6]
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 So maybe not meaningfully faster, but I think it -- we'll have opportunity to take share, because we like to run what I'll call warm all the time and be able to serve clients in all environments. And sometimes, you know, when you have to deal with sort of external events or things that impact you internally, people can run hot and cold. And our really objective is to run warm, and that will allow us to probably do a little bit additional business and pick up share, and maybe a little bit more loan growth. But not -- you know, we're balancing that at the same time with service delivery and making sure we keep, you know, our service standards exceptionally high, because you don't want to damage that part of the franchise just to grow a little bit more.

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 Ken Zerbe,  Morgan Stanley - Analyst   [7]
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 All right. And can you just talk a little bit about the expansion in New York and Boston? I remember that was a big part of the story many years ago, and it's -- Silicon Valley became very hot, so to speak. And I know your efforts were focused a little more on the San Fran area, broadly speaking. How much flexibility do you have to ramp up growth in New York and Boston? Do you want to, at this point? Do you still see opportunity in California? How to think about that geographic mix.

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Unidentified Speaker   [8]
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 We're still very committed to these key markets, and Boston and New York are very important to us. But if you think about the model itself, a few things. One, consistency, sustainability over time, and so we tend to, as Mike said, run warm and have a nice trajectory up into the right.

 Second point, the Bay Area, we've been there 31 years, so we just have more resources and more bankers and more brand recognition. So when you look at the percentage of something like loan outstandings, it's hard to outrun that, although I would point to the growth that I just mentioned in areas like New York, that have been quite strong.

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Unidentified Speaker   [9]
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 I might add one thing that is a bit fundamental to the model, too, is that San Francisco has the benefit of 31 years, almost, now. If you think of Boston, about 10 years, and New York about 15, one of the things that benefits us is time in market. That one slide Bob showed you was growth from existing clients, and also referrals. Referrals take time. You know, you have to prove service. You have to experience the service, and as that happens, more and more referrals then naturally happen over time. And so, to get to your one question, there's plenty of opportunity in Boston and New York that we've only scratched the surface on, and part of that is just time in market hasn't been as much as it is in the Bay Area, and so the opportunities remain tremendous.

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 Ken Zerbe,  Morgan Stanley - Analyst   [10]
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 All right, question for Bob. I looked your four points; very clear. Number four was acquisitions, and I thought you made an interesting comment. If I get it right, there are always firms that fit within your footprint and your model. M&A is not a big strong point for First Republic, but with wealth, it has been a little bit recently. How should we think about acquisitions going forward? I mean, it's like you've built out your capabilities at this point to a large degree. Do you need acquisitions? Do you want acquisitions? Are they really going to be a consistent part of your growth going forward?

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 Bob Thornton,  First Republic - EVP and President of Private Wealth Management   [11]
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 I think you touched on the key point. We do not need acquisitions to meet our growth goals. We're very confident of our ongoing organic growth and teams. Again, we look at them as optimistic that they can really add to the franchise and our offerings and other benefits. And while there are firms in our footprint, there aren't a lot that probably fit within our model, so we don't really anticipate that being the driver of our business.

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 Ken Zerbe,  Morgan Stanley - Analyst   [12]
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 But you would consider them, then?

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 Bob Thornton,  First Republic - EVP and President of Private Wealth Management   [13]
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 Oh, we're always open to ideas.

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Unidentified Speaker   [14]
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 We see lots of ideas, as you can imagine.

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 Ken Zerbe,  Morgan Stanley - Analyst   [15]
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 Fair enough. In terms of regulatory costs, you've certainly quickly passed over the $50 billion mark. You're over $60 billion at this point. Are you seeing anything that's surprising to you in terms of unexpected costs or just increased headwinds on the expense side?

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Unidentified Speaker   [16]
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 You know, we're quite pleased that the investments we've made have been pretty well received. We have one thing left, one larger thing, I guess I'll call it left. We have to file a resolution plan by the end of this year, and that's a very $50 billion specific time horizon. And we're finishing building out the enterprise risk management, mostly through hiring of people. But largely, we've done the hiring, and I think the results -- you know, nothing we see causes us to pause and say there's another big step upcoming. It's really just growth in order to continue to serve a larger company and client base.

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 Ken Zerbe,  Morgan Stanley - Analyst   [17]
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 All right, in terms of asset sensitivity, now you guys, I've noticed over the last couple years, you've certainly increased your asset sensitivity. When we think of going forward, is that something you want to continue to become even more asset sensitive as you grow your commercial portfolio? Or does there come a point where -- because we saw that [NIM] chart, which was incredibly stable. If you increase your asset sensitivity, presumably, you're going to kind of go out of bounds at some point. How do you think about that?

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Unidentified Speaker   [18]
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 We really do try to run pretty balanced to slightly asset sensitive, and it's become a little bit more asset sensitive lately, which is a big function of our deposit base converting to more of a checking base than it's had historically. We think this is a pretty good place for us to be. We're not trying to take a strong perspective one way or another, and managing sort of in that bounds makes sense to us. And so, you know, in the past we've taken down term advances to help us think about longer term, not just the near term.

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 Ken Zerbe,  Morgan Stanley - Analyst   [19]
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 I want to open up to the audience to see if there's any questions.

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Unidentified Audience Member   [20]
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 Thank you. It was mentioned earlier relevant to Tier 2 capital spend. Where do you see that going kind of in an interim steady state or an end state in terms of [private capital stack], and any thoughts on structure?

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Unidentified Speaker   [21]
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 So the main sort of structure would -- you know, we see banks our size issue subordinated debt 10 or 12 years, typically. We really haven't sized an amount, but there is a possibly in the future that we would use that type of instrument as we look at our capital planning for the future.

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Unidentified Audience Member   [22]
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 No one is predicting negative interest rates, but could you talk about if that did happen, what would happen to your (inaudible).

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Unidentified Speaker   [23]
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 Oh, boy, that wouldn't be very much fun, would it?

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Unidentified Speaker   [24]
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 Not an environment we would want to operate in.

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Unidentified Speaker   [25]
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 Well, I think it would be a pretty challenging environment for all banks. The one thing I'd say is our deposit costs are already at 13 basis points, so while we don't think they're going much lower, I think it would be a challenge, and we would manage accordingly. But you'd see a little bit of pressure on the margin, because your investment rates would drop a little bit. I'm hoping, even though the German 10-year hit negative yields today, we're not headed towards that.

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 Ken Zerbe,  Morgan Stanley - Analyst   [26]
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 All right, with that, we're out of time. I want to thank Mike, Mike, and Bob from First Republic, so thank you.

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Unidentified Speaker   [27]
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 Thank you.




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