First Republic Bank (NYSE:FRC)
Citi 2013 US Financial Services Conference Call
March 5, 2013 11:20 AM ET
James Herbert - Chairman and Chief Executive Officer
Scott Dufresne - Executive Managing Director
Fatema Arande - District Manager
Todd Rassiger - Managing Director
Thanks for being here this morning. Let me go through the slidedeck, and then will turn on my colleagues here. The idea here is that they're on the line and have probably more to offer than I do, in terms of how the business actually works day-to-day. Here in Boston, Scott really started this off here in Boston, about seven years ago now. So let me go through the slidedeck fairly quickly and then take questions, and I'll ask them to make comments as we go along.
First Republic as most of you know is I'm going to presume so, but we started the bank in 1985, it was de novo. It's almost entirely an organic growth story. We make occasional acquisition, about once every 10 years or so, fairly modest in size usually. We recently bought Luminous, which is an asset management company of about $5 billion.
We've been profitable every year, since we started. I started back in '80 and sold it in '84, it was also profitable each year. We have $34 billion in assets, loans deposits, and I don't need to read the list for you. Our Tier 1 capital is strong, and basically we are service oriented and credit oriented. Those are the two pillars of the organization.
It's a simple business model. It's a bit old fashioned in a way, but it's focused on a higher-end niche and is focused on coastal urban markets, San Francisco, Los Angeles, Boston, New York. We have very attractive client segments and we work hard to build the brand continually.
The loan balances in the last year, we had a very good year. In 2012, loan balances grew very dramatically, 20%-plus. Deposits were up likewise, we're almost entirely deposit funded actually. Wealth management assets grew 55% that does include the acquisition. The underlying assets grew at about 27%, non-acquisition.
We're probably pretty sure, we built the bank for many, many years, went public in '86 and sold in to Merrill Lynch in '07, and we bought the bank back from Bank of America in '10. Since we have come out of the bank in 2010, we've been growing fairly rapidly, and the core incomes up nicely. We do have some GAAP accounting income, it's plus, not minus. We tend to focus on core net income.
We raised $500 million last year in Tier 1 preferred perpetual, seemed like a good time to do it. We acquired Luminous recently, I mentioned. We've done the Series C Preferred Stock offering. This is a graphic depiction of our concept. It's really very simple. The clients' at the center of everything. We have very low turnover of people. They stay with their clients, sometimes for their whole life. We have people that have been with us for 20, 25 years. Scott's in with us 20 years. And they like doing what they do, they take care of clients. It's what we get up in the morning and hope to do well that day, and it's a very, very strong referral business.
This is just a very quick version of how we market, testimonial based. (video portion of presentation) That's basically been our marketing thrust for a number of years, because the only way you can really improve service is to have testimonial by satisfying clients. And so we've worked hard to arrange that. The end reports, which are spread out here in the room, you'll see the same thing.
What are the growth drivers? We've compounded 20%-plus for a long time. What's the growth driver? The growth driver is two things, the second one is more obvious, well it's actually three things, but the second one is more obvious than the first. Very passionate clients that really like the service tell their like-kind friends. We all talk about that, but it actually happens with us.
But before that, the clients that we bank are on the average growing more rapidly than the economic environment in which they operate, they are the A types. And basically if San Francisco is growing at 3%, our client base is probably growing at 6% or 7%. So we have an intrinsic growth rate that exceeds most organizations by virtue of the client base that we have.
Then we do the obvious things, we hire new bankers or portfolio managers that bring client bases with them. We have very targeted marketing. And we open new offices in new locations with strong people. We opened about five or six last year, we're opening eight or nine this year.
The geographic markets in which we operate outperform, we said this for years, we've finally decided and see if we can prove it. This is done by Rosen Consulting in over Berkley. And basically the GDPs of the markets we're in operate, have survived the downturn much better than others and have come back more rapidly, San Francisco, LA, New York, Boston, and up and down around San Francisco, Los Angeles and Southern California basically.
Attractive markets, this is a Capgemini study. They're the people that do the World Wealth Report. We've had them do a report on our markets and on our client bases for every other year for about eight years now. I think this is the fifth study actually. The markets in which we operate represent 21% of the households of America, but 55% of the high net worth households by their definition, which is $1 million liquidity per household or more. That's their standard metric.
In San Francisco, in the nine counties, we have about 13.5% of such households banking with us, and therefore you can push the model. Look at the opportunity here in Boston and New York, where not quite 2% in Boston and 1.1% in New York. So the upside opportunity in the markets we're in is considerable. We don't expect to add new markets. We just expect to mine the markets we're in. We did just add Palm Beach, that's a service point, more than anything else for the North East.
Our share of the highest net worth households, which is the $5 million and $10 million liquidity households, which is our subsets of the $1 million, in fact, are growing very rapidly. We had about a 9% compounded growth rate on the $5 million and an 18% compounded growth rate on the $10 million households and above.
This is our total loan and total deposit growth rates. They are preceding a pace. It's not necessarily a target for us, it just happens. The business comes in as it comes in. Since we're so credit oriented, so quality credit-oriented, we never go chasing deals. We find as many good ones as we can and then that's the amount of business we do.
Silicon Valley represents about one-third of the bank. So one of the things you are betting on is Silicon Valley a bit, when you buy us. That's three counties, San Francisco, San Mateo, Santa Clara.
The makeup of our balance sheet is fairly straight forward. We are very heavily a single-family home lender, particularly including HELOCs. That has been our asset of choice for a number of years for two reasons: number one, it's a great way to acquire clients and to know everything about them; and number two, it's a very safe product than the way we do it, which seems a little counterintuitive, given what happened in LA. I'll come to this number to in a minute.
Geographically, we're half San Francisco, second largest market is New York, after that Los Angeles, then Boston. This is the profile of our home loans clients, call it a $1 million loan. Loan to value ratio is 60%. Liquidity is equal more or less to the loan, even in the case of the median.
Net worth a couple million dollars to $14 million, the average is skewed by the fact that we have some very wealthy clients. Credit scores in the high 700s. And that kind of profile, which has been going on for three decades almost, we have lost 5 basis points cumulatively on $60 billion of home lending in the last 27 years, 28 years almost. It's a very different credit story than you use to.
Our cumulative loses on all types of lending, cumulative, were 18 basis points for 27 years. We are very, very careful. In loss experience we wrote-off a basis point last year. We do interest-only loans and these have gotten some press recently, so I thought I would talk about those for a second.
By the way, our loss numbers on home loans include loans that we sell, but service, not just what we keep, and that included last year about $700 million of Fannie, Freddie. We've had very few loses on interest-only loans. We amortized them over the back 20 years, interest-only for 10. We underwrite them as if they were amortizing. Loan sizes profile is about the same as what you saw on the prior page. There is no real difference. We've been doing them since '95 and then this is a percentage makeup in terms of LTV, most of them are under 70%.
Business banking, this is the story inside First Republic that isn't self-evident, and actually not the most people think of us as. But, in fact, the business banking is about half our deposits now. And what's happened is, in business banking, if you think about who we bank, they are influence and decision makers. They are on the boards of non-profits, they run firms, law firms, accounting firms, private equity, venture capital, and so we have designed about seven or eight verticals in business banking that we follow them to their businesses, to work out extremely well.
We don't go in the front door with everybody else and knock on, we go through side door. We already know, the decision maker, they're already happy as a bank client. So it's a very different conversation. This is also very self funding to put a mileage about four times self funding. We have almost $12 billion of deposits and about $3 billion outstanding.
Our largest version here, and it's hard to speak about this in a moment is private, as non-profit schools and non-profits. Next largest group is private equity and venture capital funds. We bank about 800 funds in the country. We bank about couple of 100 schools and another 100 non-profits. Of course, when you think about non-profits, it's a great world to be in, in terms of who's on the boards.
Our deposit franchise is diversified, this is not quite half. Consumer deposits are the rest, 58%. We also have the way we think about three channels. We have preferred banking offices, which Fatima can speak to here in a moment. Preferred banking deposits, which are loans attached primarily to relationship managers like Scott, who bring in wealthy individuals. And then wealth management sweep accounts coming off of our wealth management division.
The mix has changed. We've sold CDs, not those that are attached to a larger relationship. And we're checking is now over half the bank. The deposit office sizes, we've been very fortunate, people who run them do a great job. And we've got good sized branches, which are very profitable, pretty much the largest that we can find in the country.
Our efficiency ratio has been pretty steady, right in the high 50s is the high-touch model, so it's not likely to be cost driven and efficiency driven, but it has held steady in the 58% to 62% range for quite a while. Our people are very good and very efficient doing larger size business clean as to model basically. Keep it larger, keep it very clean, have the best people you can possibly hire. And as a result, the assets per person in the bank are 2.4 times the norm. Profitability is 2.6 times. Pre-tax profitability is 2.6 times the norm per person.
Private wealth management for a minute. Private wealth management has grown nicely it's a natural adjunct to the banking. We came from banking and moved into private wealth management about 12 or 14 years ago, but it's growing very rapidly and the cross-sell is very strong. And we are now succeeding much more than we did only a few years ago, because the platform is complete at this point.
Fee income is growing very nicely. This does not have Luminous in it. Luminous has about a $30 million run rate on revenues per year. Net interest income has been very strong. This is non-GAAP, since we came out of BofA, nice steady increase and more to the point, earnings per share have been very steadily. Core earnings per share are going very nicely, 28% or so since we came out.
Net interest margin, very stable, we worked hard at this. We stayed very matched, but as you can see the stability has held up pretty well. We are under some pressure like everybody is, but we're managing to fend it off a little better than I thought we could actually so far. It will decline slightly if the Fed does what they say they're going to do, which we think they will.
Rapid growth in book value per share. At the end of the day this is the key measure and we've done well in this regard, about 70%. Stock performance, before we sold, we outperformed and subsequent to buying it back, we've managed our performance well.
Private equity ownership. When we bought the bank back, we had about 75% private equity backing us. Colony and General Atlantic were the two leads and we had a number of others in. Subsequent to that we have reduced them down to 11% ownership. So that overhang so to speak is gone. And at this point, we moved 49 million shares last year from them into the public market. So that's very deep traded market in the stock now basically.
Capital stress test, we ran that voluntarily, we're not in the top. We're now over $50 billion. We stand out from the others. This was the main reason we ran it.
Conclusion is pretty simple. It's been leadership continuity the whole time. Katherine August-deWilde and I, she's our present Chief Operating Officer and I run it together along with a great team of people for a long time and we're very focused. We have a unique service culture, very intense service culture.
One of the key ingredients to that is, there are two key ingredients, empowerment of the people to make the decision on behalf of the client at all levels and very low turnover, so that they have the experience to make that decision. It is a growth model for sure. It's not necessarily that we target it, but it does happen. And we have very targeted client base and very attractive markets.
With that summary, let me turn maybe if I could, Scott, could you give us a quick summary on Boston.
Good morning. My name is Scott Dufresne. As Jim mentioned earlier, I'm a 20-year First Republic employee. We opened our Boston business in February 2006, with literally four of us, we're up 444 all-in. We just opened our third and fourth location on Federal Street, Post Office Square, Boylston Street in the Back Bay and we opened in Wellesley as well.
The Boston business today has 17, what we call Relationship Managers, plus another five business bankers. We grew our deposits little over 20% just here on the Boston market last year, we're up to almost 2.5 billion of deposits in our all-in lending for the Boston team, it was about 2.2 billion of lending and that was up 30% from the prior year.
One client at a time, cross-sell all the services of the bank, in the last year we've added our full complement on the wealth management side. We now have three Portfolio Managers. We have folks on the broker-dealer side, First Republic Securities. We have three wealth advisers that access the interface to the client, bringing them all the products and services on the wealth side, as well as three Portfolio Managers. So in the past year, we've fully grown our Boston team, where we now have all the products and services of the bank.
Fatima will talk about the office there.
Good morning, everyone. My name is Fatema and I manage the Boston offices. We've got, as Scott mentioned, four offices in Boston currently knowing that we are in effect for the clients, we serve as the marketing piece for the bank. And what we try to do in the office is, our group of season bankers are there to provide the day-to-day banking on a consultative approach rather than transactional.
We also take a very holistic approach when we're acquiring new clients. We go in as a team to provide that best possible service to meet all of the clients' needs and our service model is very high-touch and as Scott said, one client at a time.
So you're in the team with us for?
13 years. I was in San Diego prior to coming to Boston about one-and-a-half years ago.
This is Todd Rassiger. I've been with business banking and with First Republic for two years now. And as Jim mentioned, credit is the bedrock of our approach in underwriting loans strong credit. And that's characterized by very clean deals that our cash flow is strong, and that's always our primary repayment source, but also we have strong collateral and almost in all circumstances have guarantors as well.
From the strategy standpoint, the types of vertical that we're involved with our business is that drive deposits to the bank, as Jim mentioned the 4.2 to 1 ratio between deposits and loans is very substantial, but also create cross-sell opportunities. So for us, particularly, in Boston the top three verticals, the private equity/venture capital, non-profit institution, schools, museums, cultural institutions and also investment management firms and professional service firms, we're fortunate that we've got strong opportunities within all of those segments.
And just to highlight one, you might be surprised that non-profits represent one of the largest components of our outstanding loans. I'll give you a few examples here in Boston, so we bank close to 20 schools in this area, and if you look at schools and the face of it, we've got terrific credits, many schools here have been around a 100 plus years, great operating history, strong enrollment base and donor base as well.
We lead with loans, day-to-day banking, we're getting stronger in endowment management as well. But then there is also a layer underneath that, which are the trustees and parents of the schools, which tend to be our individual client. So we're getting great exposure through those individuals, in fact, the team and I we're on a call yesterday with a trustee of a school, that we build a relationship with and that person is bringing over their mortgage to the bank as well as an investment management relationship.
So we really seek to go deeper into those relationships. And some of those relationship to loan, we don't necessarily have to grow our loan base over the next few year's, but it's going deeper building endowment, investment management and also it's handling the trustee personal banking business.
The integrated nature of the model that Todd just referred to in terms of the quality is really one of the key ingredient that differentiates us. We pulled everyone you needed in the room. And the service in the offices supports the service at the private banking level. It's not two organizations kind of fighting. It's a big deal actually. With that summary, let me open up for questions.
Correct me, if I'm wrong. But I'm assuming the company is organized around either branch or city profit centers. What I'm just trying to understand is to what degree are the city's or the branches incentivize in terms of achieve certain sorts of targets on annual basis, in terms of growth in deposits, loans, other metrics and to what degree do the employees and the mangers benefit accordingly? So if you achieve a 10% goal, you get paid X. If it's 15%, you get X plus so that the employees really feel as if they are in essence entrepreneurs within the company that gets paid based on the success they do or do not have.
Let me ask them to answer that. But let me give an overarching answer which is important. The one thing we seldom incentivize is growth. We do incentivize the acquisition of an individual new client. And the difference that I'm drawing, particularly in lending is we don't have growth targets for lending, because if you have a growth for lending, you're going to make a mistake, because you'll hit the target. So we operate on that basis. About 85% of the employees in the company are incentivized directly and objectively on various programs. And we tend not to think about cities, we tend to think about teams or individuals.
Sure, absolutely. I think Jim hit on the goal issue, when I joined First Republic 20 years ago, I come from an institution that clearly was goal driven and we do not have specific growth goals on the loan side and the issue with we don't want to reach for deals that don't need to do. So that's foremost and frontline and that has been our culture here at the bank.
The individuals are incented on individual booker production that they bring in. We have keen goals and it goes right across the whole spectrum, whether it's the loan side, the deposit side, the wealth management side. We also have an additional incentive program where the more products we have with a client, okay, and the deeper we go in theory that increases the incentives for the team.
And the issue is we don't want it to be just a quote, checking account in a home loan and that we never interact with that client again. We want to get investment properties the wealth management side, trust services, and that's been in our and in place for a long time now.
Fatema from the office point of view.
I think as Scott mentioned, for our bankers we empower them to do the right thing and we incentive well. And again taking that consultative approach and deepening relationships and then bringing in the team of experts to expand that relationship even further.
(inaudible) And each year, I try to talk about this, frankly saying, but each year we have a program that we sign with the Relationship Mangers is between 10 and 12 pages, now some of that maybe 15. We signed it up formally, every year. Importantly, by the way, we've had a clawback provision on credit since 1986 where as the person that makes the loans that goes bad in the first four or five years of the loan, they are clawed back four or fives time or six times, what they have repaid on that loan. They take a first loss. We've had that for almost three decades. It works. It's not that we claw back a lot of money, yet it makes you think differently about lending money because it is your money. Todd, business banking?
I'd say where we excel where most banks, maybe don't is that since we're a client-centric, a lot of times, particularly, in business banking, commercial lending, it tends to be product centric. You bring in a client that needs commercial loan. If they don't need a commercial loan then you move on to the next opportunity or if you close your commercial loan, you move on to the next loan.
Here it's about the relationship, what's the need of the client. And as a business banker, if I close $1 million as net new loans for the year, but brought in $50 million as deposits and $50 million in investment relationship, I'd say the bank would be pretty pleased with that and my incentive and comps would reflect that.
So it's about what can we do for that client, and what's the opportunity in front of us. So if it's not business banking initially, it could be a mortgage, and that's one of the things that I have grown in terms of the culture and affecting my book of business, I came on board, somewhat with that mentality, but now a good portion of my overall book of business for individuals and their personal banking.
There are almost all examples by the way, our approach to this is that they are no companies, they are just people. Companies don't have character, people do. And so we came at it completely from the individual point of view. Even the largest companies, the largest funds companies, let's say, the sector that we have they're run by people, as we needed to get to know those people and take care of their personal needs, we will migrate to the business often. We also go the other way, obviously as Todd just implied. Another question.
You may have touched on this earlier, if you qualify for mortgage, the proposed rules on qualified mortgages, does that change how you look at underwriting at all? Which loans are you going to do, which loans you won't do?
Not very much, actually and that's why we put up our experience in IO from 1995. We had a very strong credit experience in IO. Our credit experience in interest-only is literally not differentiated at all from fully amortizing mortgages. Zero difference. We understand whether CFPB was coming from returns of interest-only, because interest-only was one of the abuses of sub-prime lending.
It is also however product that fits the needs of a lot of clients, particularly those who have bonus-type arrangements, whether or not sure what the bonus will be? And so we like the lending. We will probably tighten down our loan-to-value ratios a little more than they already are.
Just because if you have to go to a foreclosure, on the collection of an IO loan, you'll probably have an additional legal barrier in front of you to prove that they were qualified to get the loan that's going to take a little time. So that's translates into loan-to-value ratio to cover you on the time. But quite frankly we have so few full closures that it's not very relevant to us.
It looks like the new securitization market for prime jumbo mortgages is trying to get a little bit alive. Regular trust is guiding to twice as many deals this year as they did last year. How does that help you in mortgage business going forward?
It's actually probably positive for us generally. Because of the quality of our assets of generation, our assets are very highly desired by the folks doing securitizations. We become almost the core product inside the securitization around which they've build that. We've done a lot of business with, as you probably know. Their securitizations last couple of years have been about half of our products.
Going back in history, we're a mortgage banker in terms of need, because we have always had more business origination than we've been able to fund on the balance sheet. And it's actually not quite the case now. We never sell servicing. So the mortgage banking model for us, mortgage comes in, gets done well hopefully, gets sort in the secondary market, maybe had a nice profit certainly right now, that's for sure. And the servicing we keep and then we do the other eight products on the average with the client.
That's actually a very good model for return on capital, because the biggest capital requirement is to hold that long, particularly if the loan is going to be an interest-only loan because that's going to require a 100% risk-based capital. So that model actually works very well for us, and we're good at. Our secondary desk has been active since day one, actually.
And importantly inside the company our secondary desk handles internal pricing and external secondary, so we don't get out of sink. So we have market knowledge every hour of everyday basically on our pricing sheets. This is a good time for us actually. This maybe close to optimum and it's just coming alive. And I think it's generally good for the economy because you're getting more consistent pricing.
And can I ask just handful example, your customers tend to be savvy, so hypothetically someone in Wellesley, they want to borrow $750,000 for a residential mortgage. And I'm just making a assumption they'll see a 30-year fixed rate mortgage. The average offering on the west is no points and 3.5% interest rate.
What I'm just trying to understand is what you were left to do, you're going to match the average in the market, will you charge 50 basis points premium because of the extra high service public offers, how do you try to price yourself relative to the market when you know the customer knows what their other options are and they can borrow money from five different places but what is it you'd do to make sure they decide that you're place they want to borrow from?
It's needless to say we have to compete every day, but we always talk about internally not competing just on price. If you think of the residential mortgage sale, it has a time duration especially if it's a purchase. And especially if you're in hot real-estate markets and if you look at the markets First Republic operates in between the Bay Area and city of Boston, and the west side of Los Angles, these are all competitive residential markets.
So maybe we have to be competitive but the most important thing is execution. If it's a purchase and you're looking at 45 day closed today or at less, it can't be other institutions actually make it happen and that's where you will get some like price differentiation. You're not going to get 100 basis points to be clear. But you'll clearly get probably, between, 10 to 20 extra basis points on the deal.
And we've been competing with that current market for many, many years. We're talking some of our markets, where a cash buyer on a home purchase today with a commitment letter from First Republic knowing from the real estate brokers that First Republic will deliver and they will deliver it on time is as just as good as an on-cash buyer, we guess we do like to compete.
There are lot of other factors, very much in LA and San Francisco. Brokers will favor a buyer with one of our commitment letters, when they have five offers. It's really something. And so if you come in with one of our letters, you're going to have an advantage.
No. Maybe, maybe not, depending if you gave us a big banking relationship, we might charge under the competition. We have a matrix pricing and if you just want a mortgage from us, you won't like our rate, and quite frankly, if you just want a mortgage we'd rather, you went somewhere else. What we want is banking relationship, we want a total relationship. And we know it's the beginning of a relationship if you're new to us.
But even at the beginning, we want you to move your banking over, we want the automatic deposits, we want the mortgage obviously, and other things if you have them, and because we build the bank on relationships, not on transactions. It's a 100% of our relationships. We only have about 30,000 borrowing customers, 35,000. 33,000 right now I think actually. And we have about 110,000 total relationships, the 48th largest bank in the country. So we are looking for a few clients every year, 5,000 maybe new clients.
So I think we have time for about one more question here, and I'll speak it through. Under the CCAR process, obviously, you're not one of the top 19, and you fall below the $50 billion in assets. But towards the late '13 and '14 under Dodd Frank you will have to submit some sort of a stress test or a capital plan. Can you just outline for us, what the main differences are for an institution of your size versus the larger banks that have to go through the process that are currently going though the process?
Well, we have done the stress tests as if we are one of CCAR banks from the first year. And we intend to do them voluntarily. As far as I know, we're the only bank of our size that has done that. And we publish them. We will publish another one in March. We published this last year and we'll publish it again this year, when we complete it, which will be in the March timeframe.
And we just feel like it's good to have the discipline along before we get there with good practice, but also its good discipline. These tests are burdensome, but they have a lot of good thought behind them actually. Our whole approach to the regulatory scheme has never been adversarial, we just don't believe that.
We actually think that you should learn from the experience they have moving around the system, because they've seen all the problems, so they have a much more open mind, much more of knowledgeable base than we do as one institution. So we tend to be very proactive with the regular. Our regulars are the FDIC and then the State of California or state bank, no holding company. I don't like double leverage. So we don't have a holding company.
So I don't think it's going to change how we operate very much to be honest with you. I think we're already into it. That would be additional reporting requirements over $50 billion, but they're not particularly doing something. And the main reason is our business line is quite simple. The real burden comes in on some proprietary trading, so I think we don't actually do derivatives of that nature there. For instance, we don't use derivatives to address our liability matching. If I want to extend my liabilities, I extend my liabilities, I don't do in the derivative markets to do it. You never know how they're going to come out, as people learned recently. Is there another question?
We have about 200, including business bankers to 25, somewhere in that range.
The attrition at the customer level is 1% or 2%, it is not measurable almost. At the employee level, we have about a 10% turnover a year. We caused probably a third of that and the rest is moving on during something else. It's quite low. It's about half the norm in banking.
I think that's all.
Thank you all very much. We appreciate it.
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