[Starts Abruptly] the US regional bank research effort. It’s my pleasure to introduce this morning Chairman and CEO Jim Herbert of First Republic. Headquartered in San Francisco with nearly $33 billion in assets, First Republic focuses on servicing high network customers and urban coastal cities on the East and West Coast. If you recall the bank completed its IPO in December 2010, continues to be one of the fastest growing banks in the industry has announced its first [inaudible] management acquisition a week and a half ago.
With that I’ll turn it over to Jim.
Okay. Thank you. Thank you, Russell. I’m going to just introduce the folks that are here with me this morning. We’ll go through some slides and then we can take questions and I’ll go fairly quickly. To my left, Paul Better [ph] who’s up at Time Warner. Why don’t go ahead and introduce yourself, Paul.
My name is Paul Better, I’m a relationship manager at our Time Warner Center location. I’ve been with the bank for five and half years. I’ve been in banking for over 10 years.
Good morning. I’m Kellie Abreu. I’m deputy regional managing director here in New York. I’m also a relationship manager, managing clients bicoastally. I’ve been with the bank for over 12 years.
Good morning. Todd Valoff, I’m the managing director with our preferred banking team. I’ve been with the bank since 2011. I handle the deposit side of our business.
Good. Thank you. So they’re along to tell you about the business that the actual level where it’s getting done and I’ll do an overview. So we might be brief and we’ll go to some anecdotal items from them and some questions.
First Republic – we started it in ‘85 and for whatever it’s been in existence. We’re about $33 billion in assets. We have about $25 billion [inaudible]. We announced Luminous, an acquisition of $5 billion of assets and the management. We can talk about that in a moment if you’d like.
Tier one capital strong. We’ve never had a loss year. We have 13 basis points of delinquency and that’s it. It’s a very strong, clean kind of balance sheet.
The fundamentals are simple. We’ve had a continuity of leadership for the whole time the bank has been in existence. Our President and Chief Operating Officer Katherine August deWilde and I have been partners for 27 years but we have leadership continuity all down through the enterprise.
Simple business model, we’ll talk about that. Very attractive geographical markets, not to be overlooked at all, often underestimated and a strong which is developing, which Kellie and others can speak to here in a moment.
Over the past year or so, we’ve grown very nicely. It’s growth enterprise. We do a really good job with clients and they tell their like kind of friends and they get quite passionate about the enterprise. So it’s growing very strongly, 20% plus on almost all fronts except wealth management, although it’s having a very good year this year.
Our approach to banking is simple. We surround the client with service. They have a single point of contact to each of one of these three folks with me represents that single point of contact in varying places in varying ways depending how they conduct the business.
We’ve sold about nine products per person. We deliver that. It’s a very good ratio. Unusually good. The very simple model, this is a list of the things we don’t do. Proprietary trading, we’d like to put on the top of the list and a number of other items. So it’s been a simple model for a long time and we have avoided a lot of things including subprime.
This is a part of our marketing and give you a sense of how we market. This lasts just not a minute. It’s light and soothing.
That marketing strategy – moving on here. Let’s see if we can get – here we go. That marketing strategy has permeated every – we’ve done for several years now. And the result is a growth rate that you see on these charts. It’s really about one person at a time loving the service they get, one relationship at a time. Telling a like kind of friend and not telling them in a passive way but actually raving about the service. And then they bring them in. So about 70% to 80% of our client acquisition each year, new clients, come from a referral of an existing client.
We are geographically concentrated in a nice way. Coastal urban, New York, Boston, San Francisco, L.A. mostly the west side, west of downtown and San Diego – Portland, Oregon is a small market for us. Silicon Valley, including San Francisco proper which has become in fact Silicon Valley, which is interesting, is about a third of the bank. So the growth at Silicon Valley translates directly into our growth.
Balance sheet. I won’t spend a lot of time on this slide but we are a single-family home lender. Key locks [ph] are a big part of our business to the same clients. Geographically, we’re about 70% California, 30% in the East.
The homeland clients. Who are our clients. This is interesting profile. The median net worth of clients about just short of $3 million. They borrow a little less than a $1 million on the average loan to value ratio, importantly 60%. That’s why we have a loss record that is very, very low. Average is much higher. We have some very wealthy clients.
The credit record is really strong. If you look at the top line in particular, single family home loans, we’ve done a lot of them, $50 billion, $60 billion. We’ve had 5 basis points of accumulative loss in 27 years. The worst year we ever had for actual losses, in this chart, was ‘08 as you might expect; ‘08 was 48 basis points, which is actually quite modest given the storm that was upon us all in a way. And the results have gone back to more normal for us since. With a long term average is about 10 basis points a year in losses.
Business banking, a very big deal. We basically bank businesses that are run by people that already used the bank privately. We met most of our business banking relationships through a home loan, surprisingly enough. Very simple model. But who do we make home loans to? We make home loans to people that are deciders, they’re influencers, they run funds, they run law firms, they run accounting firms and they bring those firms to us after they have a good experience personally.
So when you’re talking about acquiring a business client, you’re not at the front door like everybody else. You’re coming in kind of a side door. You have a friendly reception before you even try in both cases. I’m sure it’s very well. That has become – this is banking has become, 46% of the deposit base of the bank. It didn’t exist 10 years ago. So it’s a very big change for the better.
Our deposit mix has shifted. We pulled away from CDs as most people have. We move towards tracking, driven in large spurred by business banking growth, then very successful. A lot of it is to bring down our [inaudible] quite significantly.
Office size. We have a great office system. We have about 65, 68 offices right now. The average size is one of the largest in the industry. That obviously translates into profitability on the branch system. Very stable source of deposits.
The business model is very scalable. This is one of the things we get asked a lot about. And yes, we can grow the business quite successfully. We’ve landed our core efficiency ratio on the 58% – 62% range, totaling rather nicely. We actually improved slightly in the last quarter. This is driven in the large part by the efficiency of our people. The average assets per person that we have is about 2.5 times the industry average.
That comes from two or three things. We have very, very good people that work really hard. We also have a very clean client based, so we’re not distracted by trouble. And the average transaction that we do with our clients is larger than more banks by quite a lot at every level.
Private wealth management is a growing part of the enterprise. Very nicely so. We’ve just announced the acquisition of Luminous which will add $5.5 billion to our asset base. If you look at the ‘11 yearned, it was about 20.4 billion.
With the growth of the bank so far, the wealth management so far this year and Luminous, we will end up at about $30 billion to $31 billion for year end. So we’re up 50% of the single year on wealth management.
When we bought the bank, we sold the Bank of Merrill Lynch and they sold the Avila Bay [ph], the conference of which we are. And then we bought the bank back from Avila Bay. Since we bought it back, we have a purchase accounting, which is positive, we bought loans at a discount. That’s coming in the income.
What we look at is core non-GAAP earnings. GAAP is only positive. We have about $400 million, $375 million yet to come into income. But looking at core earnings, we’ve managed to grow our net interest income very nicely.
There’s a lot to talk about NIM pressure. We can talk about that in Q&A. But the thing that pays the bill is that interest income, and it’s growing very nicely. That has translated into core earnings per share and core growth and earnings per share very nicely over the last several quarters.
We’ve managed to outrun the NIM compression which we can talk about. Our net interest margin is actually relatively stable. And again, this is core; not GAAP. GAAP would be higher. But we may be out of running room on the deposit cost side. So we’re now probably at the point where this is going inflect.
We’ve had a very rapid growth in bulk value, which at the end of the day is the real core major of bank success in our opinion, the accretion of both value grown very nicely in the last year and a half, two years, 17% growth rate.
This is the enterprise value of First Republic. We have managed to increase enterprise value quite dramatically. Because we have to take the chart up to 1400, it puts the timeframe of ‘02 to ‘06 right before we sold in low perspective. But that went from 100 to about 350. So we ran it very nicely even before we sold the Merrill Lynch Avila Bay.
Our job at the end of the day is to make the chart keep going up aggressively. We have private equity ownership when we came out at Bank of America. That’s been reduced very nicely. We’ve had a couple of secondaries. We’ve had some black trades. Most recently, there was a black trade for $6 million shares done overnight by Credit Suisse, 5% of the bank trade next day, stock trade was down about $0.15. It was very, very efficient.
The largest holders, Colony and General Atlantic, which are great friends of ours, are down below 8%. We did some capital stress test on ourselves. But voluntarily, we’re not actually required to do so, and we stand out very nicely.
This matters a lot because our depositors are smart, very educated and understand how to read the balance sheet, so they care a lot about the strength of the bank and they understand how to figure it out. So, the transparency is very important.
With that, let me shift for a second to some of the folks I have with us. I mean, Kellie, you could lead us off and describe how we do the business on both coast, in fact.
Okay. It’s actually very similar and that most of our business, and specifically my business, is from that crazy little home loan. Typically, a client is looking to buy a home or is a client of another bank and wants to refinance the home.
And so they referred to us by existing clients who are happy and we talk to them about having a relationship and what that means. We’re not just pricing our loans just to a transaction. We’re pricing them to do a relationship that will last for many, many years.
So, we have that discussion upfront. It is very competitive market, but we pick carefully the clients that we want. We close the home loan. We open a bank account. We set up their automatic deposits and then start working on selling across the balance sheet. Most all of my business accounts that I have, corporate accounts for private equity and private services are from home loan. So, they have a great experience with us, they talk to their fellow co-workers and we work on their business banking, their business lending. And oh, by the way, they are running a non-profit agency or involved in a private school, and we follow them through those very relationships. So, that grows year end, year out and quite substantially.
Great. Todd, maybe you could speak for a moment about how we support that and then also if you could talk about some things going on and some of the Eagle Lending on behalf of Erin [ph].
Sir, absolutely. So it is about keeping close to our clients, very close actually, to be able to be there for the small things and the larger opportunities when they’re there. I think that is one of the key drivers of our success, that they can call me at any time and/or strong team member, Kellie, that we’re both on the other end of the phone.
We work very nicely as a team without the silo aspect. We walk right down the hall or pick up the phone and get a quick answer. The clients really value that and we’ve already said that they tell their friends.
So, it is a customized approach one client at a time and the growth goes from there. we are relationship based. So we love to talk about our different services and we love to compete. So when deals come up, we want to know how is it that we can help and add value to that.
And most times we’ll win. I think I can think of only a very few times. We’re not interested in doing something or being a part of the banking relationship.
To Jim’s point, our partner lending program are Eagle products, as we call them, have been very successful. These are, again, a way into young up and coming folks who maybe haven’t had the point to buy a home yet, but perhaps they’re buying into their company.
We didn’t go in the ground level and do a great job. So when that next opportunity comes, they’ll come to us.
Paul, could you describe for a minute the business banking side of it.
Sure. So, as Kellie and Todd said, we build the business through relationships, and it doesn’t really matter where it starts. Mine starts on the business banking front. And I’m working with executives to bring in their businesses and they bring in their consumer relationships.
And overtime, I’m deepening those relationships by expanding into whatever business need today bring to my attention, whether it’s business lines, credit or term owns or commercial real estate or residential mandate on the consumer side. I am wherever my clients needs me to be. And I’m the point of contact, and I’ll bring in partners that I work with to work on that relationship.
But in all instances, on the quarterback for the relationship, and it gives me the time to develop and expand into their businesses and their needs overall. And that grants me access into their senior level executives whether it’s senior vice president or vice president. And that provides me more opportunity to capitalize on their business.
Great. So in summary, the backbone of First Republic gives us service culture, and as people, the stability and quality of the people are the key. We’ve grown about 20% of your compound for a long time. It’s not our target, it’s just results. But it is very, very helpful in the current environment particularly to overcome the compression on net interest margin.
With that, let me open for questions.
[Inaudible] Can we talk about the loan growth opportunity by geography? It’s clear that the tech sector is driving a fair amount of growth on the west coast. What are the growth drivers in New York and Boston, and then what could be a realistic more mature concentration in those markets overtime?
The driver in the west is technology. But it’s only a part of the story. Kellie, you might be best to respond for the west, if you could.
Sure. Tech is certainly a driver, but there are businesses still coming from large law firms, CPA firms, private equity firms. So, the growth is everyone is buying a home, everyone wants to acquire real estate in the west. And the tech is the driver certainly driving up the prices because there are more people in the market buying.
But it is definitely spread out through all the various business.
One of the things that drives our growth the most is the competitor’s service metrics to the extent that competitor service metrics are stable to declining, we pick up clients. But the actual thing that drives clients to us is the velocity of activity. And the velocity of activity in the mortgage market is really, really strong, both [inaudible] purchase. And when we talk about refinance at 40% of our business in the last quarter was purchased. But actually, the refinanced business is not all refinanced of us. It’s refinanced going on at Wells or BofA or JP Morgan or whatever. And so when we bring the mortgage client over that was refinancing somewhere else, we book it as refinanced. But it’s not just rolling our paper.
In the East, Paul, what you say is driving the east or Todd?
A lot our growth is just based on presence now. We’ve been in New York for 11 years. The name and reputation has definitely come a long way and we’re getting a lot of referral-base – referral business, side table. 70% of our business is coming from referrals and 30% is walk in traffic and it’s all service oriented, not both the business consumer front. We’re just bringing in one relationship at a time. And Todd, do you want to speak anything more specifically?
Sure. I have seen a lot of growth and a lot more opportunity in the hedge fund world, found the offices and entertainment here in New York.
There is something to think about. The cities we’re in connects with each other along various channels and then entertainment is one of the [inaudible] connects to LA and New York. We have a strong presence in LA. So you have the personalities, not just the ones you might think of, the front personality but in fact, it produces a very, technician. The lawyer is importantly – and the business managers travelling along that route so to speak and carrying our reputation from one city to the other.
Along those lines, the interconnectivity of the markets – are you in all of the market where you currently want to be or are there –
The election has enhanced Palm Beach, as we can tell, which was kind of be one our new locations. But the answer is we’re in the markets we want to be in. I don’t see as a adding a major market for quite a while and I can’t even predict when the Palm Beach addition is mostly a service point for New England. And it turns as recently, so I have to leave San Francisco.
Sam, how do you know I’ve had it. I’m out of here. And the home base seems to be on a the target list.
Jim, two questions. One is – given the quality of mortgage portfolio their tier one comment ratio improved under Basel Three. And then secondly, do you see sort of improving secondary market access for the kind of jumbo loans that you originates their high quality, high balance and what you think – did that improve your ability to manage your balance sheet going forward.
Well Basell, the one thing that is out on the capital front, it’s a negative for us. It’s the question a brother – we do some interest-only and make sure a period [individual] actually about 70%, 80% of our portfolio. It just only for years 10. The loss record that you see includes interest only. We don’t think it’s a bad product at all, quite the contrary. These are very good product but it has to be right.
The regulators or not yet of that opinion, and it may not end up there for some reason and then just only as – if I could building that was foreclosed. The building wasn’t bad, the owner was. They don’t know. And so interest only is likely to be disadvantaged and be considered category two outset. We’re still fine. We put this in our 10-Q. We’re still fine on capital strength although obviously, it’s disadvantageous a bit.
In terms of the second end market and mortgages, I’ve been doing this since we started the bank before this one in ‘80. So the [inaudible] since 1980 and the mortgage banking business. I’ve never seen a better market ever. All of sudden, it’s been good. Now it’s explosive. And the reason of course is the driving rates. And so we have multiple business on every package we put out. We’re getting very, very good pricing.
The total market may not be back but for quality assets of the fact that we have, there’s almost an unseemingly unlimited demand. The QE 3 [ph] is helping that I’m sure because they’re buying mortgage assets. We sold about $750 million in the last quarter [ph], could have sold a lot more but that’s not we chose to sell. We delivered about $300 million in the Fannie, Freddie by the way, mostly Fannie and that’s an ongoing piece of our business at very nice rates, very nice prices.
So our growth constraints are removed by mortgage banking actually on the sense that we can control the size of the balance sheet growth very handsomely and at a profit. We always keep servicing, never sell it. And so it’s an interesting time. The obvious question on everyone’s mind looking at bank industries is net interest margin. But you don’t need that interest margin, you didn’t need have interest income and that interest income in our model can be driven by growth – by three things really; by some cost control, by growth in assets even at an incrementally lesser margin but nonetheless a positive margin as long as you have capital adequacy to support it. And by second end market sales and profit from the mortgage banking, which we all three tools we have. So, so far, we’ve been able to outrun the net interest margin compression rather well.
And to just follow-up on the Tier One comment. I think based on the Q, it’s around 9%, if the MTR [ph] stands today. First, are there any mitigation, do you have any ability to mitigate that RWA and if not, if it’s 9% where we’re going what’s a decent floor for you, in terms of comfort level?
In terms of capital?
Tier one leverage. We’re guided by Tier One leverage capital which is our driver. That’s the agreement we made with the regulators as a new charter when we came out of BofA, and our target is 8%. I think you need margin for at least a 0.5%. I wouldn’t want to be closer to the eggs [ph] than that at any time. We do have our source of growth capital is retained earnings, running 10%, 11% core – where are we right now? Purchase accounting which is still coming in for the next two to three years, adding a couple percentage points to that.
We have more capital that we need right now. And of course, there is the preferred stock option as well as the common stock option.
Maybe you have to, to the limit of the acquisition, you’ve been growing organically, aggressively on the loan management front. Maybe just talk to what this – the decision to do deal and then perhaps if your appetite would extend to a depository at some point.
And the answer to the latter is no. We’re just not acquiring now. You never say never but very unlikely that we would buy depository. We bought one bank in 27 years until we’re just not acquirers, we’re builders. The Luminous is a very, very interesting acquisition. We have looked at a lot of things in the wealth manager area and passed on a lot of them. All of them except Luminous actually.
It’s unique in how much aligned with us it is. Their culture is the same. The six partners are very confident, very capable people who build a business from scratch but over many years and through a couple of iterations. They are geographically on top of us, Palo Alto or Portola Valley technically but Palo Alto and Century City. Their client profile is entirely representative of our client profile. This first round of the country a bit too, not just locally. And a fair number of their clients already banked with us. A fair number of clients have them as wealth managers. So there’s been cross testing and our clients and their clients speak equally well with the two organizations.
And it brings to – and they have some alternative positive [ph] access that we haven’t developed. Maybe we could but we haven’t. That’ll bring products sets so to speak and they have some excess capacity. So we have in our bank, a number of clients that have not been touched yet for wealth management because we came to wealth management later than we did the banking.
And so we have a back cross-selling opportunity that’s of considerable magnitude. We need more capacity in order to optimize that. And they bring some of that capacity. So having that is really good acquisition. These things always come down at the end of the day, however the culture and to integration and I f you don’t get the integration right, you don’t get the culture right, they can work in a range of success to failure.
So what we look at more than anything else is that it feels like the culture is going to fit, and it does. And we looked at a lot, the numbers made sense and all the other stuff made sense, the culture doesn’t feel right, so we passed.
Other questions? Actually, I’m going to introduce Paul. He’s the lead here in New York. He just joined us a few minutes ago. Other question, anybody have? There’s none?
[Inaudible] control cost, what do you do on the cost side survey?
We have pretty well announced that a little strong. We’ve spoken publicly of hiring pause. That’s really coming about. It has to do with cost control, but it has more to do with culture control.
This enterprise lives and dies on its culture. It’s team work; it’s cross-selling, the quality of the people, the client care, putting the client first very fundamentally is how we actually exist. And when you have that kind of type of culture predicated on very low turnover and the stability of people from top to bottom for a long period of time.
When you add too many new people, you put the culture at risk. And we had added a lot of people as we came out of Bank of America. We’ve had a hiring freeze, in fact, and sold Bank of America for a while. And they office opening freeze. Those two things we push down the GAAP as we came out of Avila Bay. We started to ramp up new hiring particularly relationship managers, portfolio managers, as well as support people. And we have opened a number of offices.
We have a pipeline of about 10 offices we have to open. We stopped adding to the pipeline. And we have stopped hiring relationship managers, business bankers and portfolio managers. There are a few exceptions, things that were already in the works, but not very many. And so what we’ve done is we’ve taken the pressure off the culture for a while with new. And that has a lot of additional impact of containing cost growth.
Now, the volume we’re doing is in spite of that. So, we currently hasn’t heard our volume. And we have a number of people that we’ve added in the last year and a half. Usually, a relationship manager joining us takes about a year and a half to ramp up to a full capacity. But it takes about six months to get the culture, six to eight months, maybe a little longer.
And so, by pausing only for a couple of quarters, we can reduce the culture damage that was going on.
It’s kind of both. We like it from both angles. So we’re discussing what do, both are in the room. Both issues are in the room.
But mostly, I don’t want to lose control of the culture. That’s the main thing. We do. If we lose that, we’re dead.
Maybe just a quick follow up on the expense line of questioning. It is stated in the past, you would not hesitate to reinvest purchase accounting driven or anything to plan to seek for growth. And it’s clearly what you’re doing now.
So can we think about the declining expense throughout commencing with the declining impact of accretable yield? And then what might be your normalized year over year growth rate?
I think what will happen also as we see the deep, I don’t pay much attention of the decline rate and accretable yield from the purchase accounting. It’s there and I know it’s there and it’s adding the volume and it’s helping support the growth of the balance sheet. But the philosophical use of it has already been committed.
So it’s more of the growth rate of the net interest income, not NIM but net interest income, versus expense growth that we focus on. And so far, the net interest income has outrun the growth of expenses rather very nicely.
Is this on? I want to go back. Is it not? Yes. Well, I can’t get it to work. But in any event, we have a slight on interest income. But there, it went back on. Could you go to page 24 for me? Can you run it from back there? Okay, thanks.
That’s private wealth management. One more up. No. Go one more if you can, sorry. Okay. There’s core net income and earnings per share. If you look at the growth rate, it is quite steadily. We’ve managed to outrun at every quarter.
And this is not by accident. We work hard at this. And it’s coming from growth of assets, loan sales, containment of expenses. Offsetting NIM stabilization and decline. I don’t know how long we can do it, but so far it’s working out fine.
Okay. Thank you all very much. We appreciate it.
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