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First Republic Bank (NYSE:FRC)

Q1 2013 Earnings Call

April 15, 2013 2:00 pm ET

Executives

Dianne Snedaker - Executive Vice President, Chief Marketing Officer

James Herbert - Chairman of the Board, Chief Executive Officer

Katherine August-deWilde - President, Chief Operating Officer, Director

Michael D. Selfridge - Senior Executive Vice President, Deputy Chief Operating Officer

Willis Newton - Chief Financial Officer, Executive Vice President

Michael Roffler - Senior Vice President, Deputy Chief Financial Officer

Analysts

Steven Alexopoulos - JPMorgan

Erika Penala - Bank of America-Merrill Lynch

Herman Chan - Wells Fargo Securities

Ken Zerbe - Morgan Stanley

Dave Rochester - Deutsche Bank

Casey Haire - Jefferies

Joe Morford - RBC Capital Markets

Lana Chan - BMO Capital Markets

Aaron Deer - Sandler O'Neill & Partners

Matthew Clark - Credit Suisse

Thomas Laterno - FBR Capital Markets

Julianna Balicka - Keefe, Bruyette & Woods

Timothy Coffey - FIG Partners

Operator

Welcome to the First Republic Bank's first quarter 2013 earnings conference call. During today's presentation, the lines will be in a listen-only mode. Following the presentation, the conference will be opened for questions.

I would now like to turn the call over to Dianne Snedaker, Executive Vice President and Chief Marketing Officer. Please go ahead.

Dianne Snedaker

Thank you, and welcome to First Republic Bank's first quarter 2013 conference call. Speaking today will be Jim Herbert, the bank's Chairman and Chief Executive Officer, Katherine August-deWilde, President and Chief Operating Officer, Mike Selfridge, Deputy Chief Operating Officer, Willis Newton, Chief Financial Officer and Mike Roffler, Deputy Chief Financial Officer.

Before I hand the call over to Jim, please note that any forward-looking statements made during this call are made as of today are based on management's current expectations and are subject to risks, uncertainties and assumptions. Potential risks and uncertainties that can cause the bank's business and financial results to differ materially from these forward-looking statements are described in the bank's periodic reports filed with the FDIC, including the bank's current report on Form 8-K filed today.

In addition, some of the financial information discussed on this call includes non-GAAP financial measures. The bank's earnings release, which was issued this morning and is available on the bank's website, presents reconciliations to the appropriate GAAP measures and explains why the bank believes such measures are useful to investors.

Now, I would like to turn the call over to Jim Herbert.

James Herbert

Thank you, Dianne, and thanks to everyone for joining our call today. This was an outstanding first quarter. We are very pleased. First Republic reported record earnings, record first quarter loan origination volume, record loan sale gains and very strong growth in wealth management assets as well as end revenue. Business banking also continues to do quite well and our asset quality remains very strong. Because of our strong results, we are also pleased to announce an increase in the regular quarterly dividend to $0.12 per share.

Let me focus on a couple of key financial highlights. We sold more loans than we normally do in the quarter and we made a very nice profit. Our Q2 loan pipeline is extremely strong. Wealth management is very strong. Deposit growth was flat but that appears to be due primarily to clients putting money to work in the equity and real estate markets.

Net interest margin pressure is real but we are still doing a great deal of business. If we would have kept loans instead of selling them, loan growth would have been annualized at about 11%, which is only slightly lower than normal. Core net income was up 55% compared to the first quarter a year ago and core earnings were up fully 47% per share.

Also, book value per share continues to grow rather nicely and is now up 50% since we bought the bank back less than three years ago and is $22.96 per share. Also quite importantly, the ownership of our original private equity investor group which backed us to buy the bank back continued to decline in the first quarter and now represents less than 10%. That’s down all the way from 73% at the time of our IPO in December of 2010.

During the quarter, mortgage banking ended particularly strong. Let me give some additional perspective for this. The favorable conditions in the secondary market which has recovered tremendously recently allowed us to originate a greater volume of longer-term fixed rate loans. This is in response, in fact, to client demand. Due to low term interest rates in all financing markets clients increasingly want longer-term fixed rate loans which is not surprising. We sell most of these loan rather than keep them on the balance sheet and always have historically primarily for asset liability matching reasons.

In the first quarter, we chose to capitalize on the strong pricing and robust demand for the high-quality loans that we originate and we sold an unusually large volume. Gains in the quarter were obviously quite good, twice the average to last year. Whether we hold a loan or sell it, the transaction and the flow of business creates an opportunity to satisfy an existing client or to acquire a new client. In either instance, we also have a very good opportunity to cross sell banking and wealth management products which we do quite successfully. Thus the additional volume whether kept or sold is very viable to us.

As this quarter demonstrates amply, mortgage banking remains a very good alternative funding source and business for First Republic. This is one I note that we have been quite active and since we started the bank in 1985.

Despite the strength of the first quarter results some challenges are ahead. They include continuing pressure on net interest margin, potentially less attractive pricing in the secondary loan market, hard to tell, and so far this year deposit growth has been a bit of challenge for us which we will discuss more in a moment. Slower deposit growth does however appear to be not only a function of lower rates but also reflects the positive outlook of our clients, interestingly enough. In effect, our clients tend to be on the leading edge of investing and many drew down deposits in the first quarter to very actively take part in the real estate and equity market improvements that occurred, as well as business expansion opportunities.

Now let me turn the call over to Katherine.

Katherine August-deWilde

Thank you, Jim. I would like to discuss a key number of factors for this quarter. Compared to the first quarter a year ago, bank assets were up 18% year-over-year. Loan originations were up 12%. As Jim noted, it was our highest first quarter ever for loan originations. First quarter is usually seasonally a bit lower in terms of origination. Loans outstanding grew 20% and this is despite record loan sales. Deposits, year-over-year, increased 15% and wealth management asset rose fully 60%. This includes assets from the recent purchase of Luminous along with strong asset growth from our base of existing business.

Lending activity continues to be very strong and we were extremely pleased with our current loan pipeline. The success of our lending is driven by our reputation in the marketplace, the quality and efforts of our relationship managers, the efficiency of our loan closing process and the economic strength in our markets.

Let me spend a few minutes on loan sales since they such a meaningful part of the quarter. We continue to benefit from strong pricing and strong demand for our high-quality home loans. Loan sales volume for the first quarter was $1.2 billion. This is two times the quarterly average in 2012. Loan sale pricing was also very good. The gain on sale was 2.1% of loans sold. This is approximately one-third higher than the 2012 quarterly average. Of the loans we sold, 37% were interest-only loans. The higher volume of loan sales contributed to lower loan growth on our balance sheet. As Jim said, if we had operated at last year's quarterly average then about $600 million in loan sales, our loan portfolio would have grown at an annualized rate of 11% this quarter. This was a deliberate decision to take advantage of the favorable conditions in the secondary mortgage market.

We are very pleased with the growth in wealth management. Wealth management fees increased 71% compared to the first quarter a year ago. Luminous contributed $7.6 million in fees. This is 25% of private wealth management fees for the quarter. The remaining growth in wealth management fees came from cross-selling bank clients and from portfolio managers and wealth advisors acquiring new clients. Wealth management assets grew 11% in the quarter or $3.6 billion. More than 75% of this growth came from net client inflows. Overall we are very pleased with the quarter.

I would now like to turn the call over to Mike Selfridge.

Michael Selfridge

Thanks, Katherine. Let me comment on conditions in our geographic markets and then talk about deposits, business banking and loan originations. The San Francisco Bay Area economy is outperforming the broader U.S. economy with very strong regional trends in employment and housing. This is driven by several factors including the vibrant innovation sector in Silicon Valley. The Bay Area, as a reminder, accounts for approximately half of our loan outstandings. Boston and New York which are primarily knowledge and professional services based economies also outperformed the U.S. as a whole. While Southern California did not grow as fast as our other markets, we are seeing clear signs of improvement, particularly in housing.

Our new First Republic markets economics index also confirms that our key markets are doing better than the national average. This index compares economic activity in First Republic's markets with the national economy. It will be updated quarterly as a part of our investor presentation which is available on the investor relations section of our website.

Loan originations for the quarter were $3.5 billion. Home loans accounted for 65% of total originations of which 30% were for purchases. Multifamily lending was strong in the quarter as evidenced by the 9% increase in outstanding loan balances. We remain pleased with the development of our business banking franchise. Our volume of new business loans was good and our pipeline is strong. On average, our business banking brings in $4 of deposits for every $1 of loan balances. Our business banking strategy continues to be highly effective.

Deposit activity slowed in the first quarter as total deposits declined 1% from the previous quarter. As Jim noted earlier, our clients began to move money into real estate and equity markets. Importantly, however, checking deposits continued to be more than half of total deposits. As expected some deposits moved out of the bank due to elimination of the unlimited deposit insurance. Because of the expiration of deposit insurance, we reclassified $800 million of deposits from non-interest-bearing checking to interest-bearing checking accounts which pay one basis point.

We would note year-over-year deposits were up 15%. Although focused on this, we are not overly concerned. New account opening rates are very strong. As part of our continued efforts to grow our franchise and better serve our clients, we recently opened a preferred banking office in Palm Beach and at Madison Avenue and 56 Street in Manhattan. We expect to expand our deposit franchise by opening six more offices in 2013. Overall we are quite pleased with our results.

Now I would like to turn this call over to Willis Newton, our CFO.

Willis Newton

Thanks, Mike. I have some color to add to a few of the numbers. Our net loan growth is impacted by the rate at which our borrowers repay their loans. The repayment rate on our term estate loans last quarter was relatively consistent with the prior few quarters at the 18% to 20% annualized rate. However we did experience a higher level of repayment on our home equity lines of credit, our business lines, and other lines of credit. The average utilization of our HELOCs declined 3% to 43%. There was a similar decline of 3% in our business line utilizations to 33%. We believe this is mostly a seasonal pay down from a peak level at year-end.

For the first quarter, core net interest income was up 1.3% compared with the prior quarter. Our core net interest margin was 3.42%, down four basis points. Our NIM will continue to be under pressure due to the low interest rates on new loans, the sale of higher-yielding fixed rate loans and deposit costs which really can't go much lower. In aggregate, the increase in our noninterest expense as compared with the prior quarter is the result of two unusual items and Luminous acquisition.

First, as expected, our payroll taxes added $5.4 million to salary and benefits in the first quarter. This is a one-time first quarter only cost. Secondly the cost of tax credit investments rose $5.1 million. As Mike Roffler will discuss in a minute, these costs are projected over each calendar year and are completely offset by higher tax benefits. As the Luminous, in the initial quarter, they added $2.2 million to salary and benefits and $2.1 million to the amortization of intangible assets.

However these costs are more than offset by their incremental revenues. Our core efficiency ratio was 57.3%. We realize this ratio did benefit from the unusually large gain on loan sales. If we use about half of the first quarter's gains, our core efficiency ratio would be been 59.6%. Our credit quality remains excellent. Non performing assets were a low 14 basis points at quarter-end and net charge-offs totaled less than one basis point. It was indeed a positive quarter.

Mike?

Michael Roffler

Thanks, Willis. During the first quarter, our cost associated with tax credit investments grew $5 million from the fourth quarter to approximately $11 million as we continued to invest in the housing needs of our communities over the past few years. Let me briefly explain this expense. The bank invests in funds that operate low income housing properties and receive benefits in the form of tax credits. As we record these benefits, we need to reduce our recorded investment by a charge to noninterest expense. While we have increased quarterly expenses due to our additional investments in low-income housing, we also benefited from higher tax credits. These increased tax credits reduced our effective tax rate approximately 3% and are the primary reason our effective tax rate has declined to 26.5%.

In 2013, we project the run rate for this expense and the corresponding tax credits will be approximately at the first quarter's level for the remainder of the year. There is a current proposal at the FASB that would change the separate recording of this expense in the income statement. In our case it would reduce operating expenses by moving this cost to income tax expense. However it would not change net income. This reporting change would improve our reported efficiency ratio while increasing our effective tax rate. We support this clarifying proposal which could possibly become effective late in 2013.

Now let me turn the call back to Jim.

James Herbert

Thanks, very much, everyone. I would reiterate that we are very pleased with the first quarter results. Core earnings per share were very strong, substantial increase in book value per share continues, ongoing diversification of our shareholder base has been quite successful, strong growth in the franchise particularly wealth management has added up to a very good quarter. The increase dividend, we are pleased to be able to report.

What you saw in the first quarter was really the resiliency and flexibility of our overall model. While growing rapidly, acquiring clients, continuing to cross sell, we were also opportunistic in selling loans because of the very favorable pricing in the secondary market. Our ability to do so has relied upon many years of active mortgage banking and building reputation in the secondary market.

I wouldn’t make too much out of one quarter's loan sale volume, one way or the other. As Katherine said, our backlog remains very strong. Business remains good and very importantly, our markets are strong and expanding relatively rapidly.

Thanks for your time. We would be happy to take questions. Operator?

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Steven Alexopoulos from JPMorgan. Your line is now open.

Steven Alexopoulos - JPMorgan

Hi, everyone. I wanted to start, Jim, with a couple if questions on the loan side. Looking at the originations declining from $4.3 billion last quarter to $3.5 billion this quarter. From your view, is this an expected seasonal decline or were other factors at play? Maybe a shift in refi purchase or something?

James Herbert

No, its pretty much seasonal, I would say, Steve.

Steven Alexopoulos - JPMorgan

Okay, and then, Jim, if we look at the decline in the funded loan volume percentage, would this tie to more of a customer appetite for fixed rate loans or were you more active in selling variable-rate production as well?

James Herbert

Katherine, you want to answer that?

Katherine August-deWilde

We sold fixed rate or long term hybrid fixed rate loans.

Steven Alexopoulos - JPMorgan

Okay, but was that similar through the quarter because I know rates moved up early in the quarter. I wasn’t sure if you say, maybe more of an appetite for fixed rate early in the quarter?

Katherine August-deWilde

No, we tend to take the loans that our clients are asking for, be they fixed or adjustable or a hybrid and we sell those that have a longer duration. We do that all the time.

Steven Alexopoulos - JPMorgan

Okay, so if we think about the funded volumes?

Katherine August-deWilde

(inaudible).

Steven Alexopoulos - JPMorgan

Okay, got you. So when we think about the funded volumes, should they be around the $1 billion level? Is that what you are thinking because I know it has been running around $2 billion, right?

Katherine August-deWilde

Our loan originations were down slightly from the fourth quarter but they were up significantly from first quarter of last year. You should think of it as having sold about twice as much as we usually sell.

Steven Alexopoulos - JPMorgan

Okay, but should we think about what ends up in portfolio as declining? Because I think the gross was around $2 billion, $2.2 billion, right? We're down to 900 some odd million this quarter?

Katherine August-deWilde

The biggest reason for that was the higher loan sales and the fact that some of our lines had lower utilization than they had a quarter ago.

James Herbert

Steve, that was what Willis was getting at when he pointed out that on the balance sheet loans the CPR is running about the same as it has been. The only real decline on the balance sheet was the draw under HELOCs and bank and business lines which, at least at this point, looks like it’s a seasonal pay down.

Steven Alexopoulos - JPMorgan

Got it. Jim, just one final question on the incremental NIM. You had spoken about 3% as where new business is going on? Is that still about the case?

James Herbert

Yes, maybe a little lower.

Steven Alexopoulos - JPMorgan

Little lower. Okay. Thanks for the color.

James Herbert

Operator, is there another question?

Operator

Your next question comes from the line of Erika Penala from Bank of America-Merrill Lynch. Your line is now open.

Erika Penala - Bank of America-Merrill Lynch

Good afternoon. I just wanted to follow-up on Steve's question because it seems like the pace in both loan growth and mortgage banking were similarly unusual relative to what we are used to seeing in 2012. I think, Jim, you mentioned, of 11% loan growth this quarter, if you hadn’t sold, where Katherine mentioned twice as much, but the pace was about 24% last year and I understand that you sold twice as much as usual but I think the mortgage banking number at the beginning of last year was much smaller at about $5 million pace than it was in the beginning of the year. Could you give us a sense of what we should be expecting in terms of how those numbers can shake out for the rest of the year? Because it just seems unusual just for this quarter relative to, if we look at the historical trend in all of 2012.

James Herbert

We are not feeling as if it is that unusual. The quarter was, as we said, the best first quarter we have ever had but it wasn't up 20% over last year, so to speak. I would say that this time last year was very, very strong, as you know. However, we were about as busy as we have ever been. Our backlog, as Katherine referred to earlier, is extremely strong. So I think it's a combination of percentage growth on larger base, a little bit, because the base year is about 20% above the base at this time last year. Then you have the loan sale decision on our part, unusually large loan sale decision on our part.

So I would say the 11%, 12%, 13% range is probably how it feels like it's operating to us, net growth. The thing that's a little unusual for us was the pay down of both HELOCs and business lines from the end of the year. Strictly a guess, but I am going to guess that that will climb for the rest of the year but we don't really know.

Erika Penala - Bank of America-Merrill Lynch

Got it, and I know this fluctuates so much but is it fair to assume a $10 million quarterly run rate on mortgage banking?

James Herbert

Well, it does fluctuate and we don't know. The market does continue at this very moment to be strong.

Erika Penala - Bank of America-Merrill Lynch

Okay, and if I could just slip one more. An terms of your level of cash, I know that in previous calls we had talked about the deployment of this and that seemed to happen this quarter, are we at the correct level or not correct but the right level of cash for your size of balance sheet at this point? And if we could just a little bit more color in terms of what drove the significant decline in securities yield quarter-over-quarter and what we should expect, given your reinvestment strategy going forward?

James Herbert

The level of cash is about where we would like to see it. $500 million, $700 million range for the balance sheet as at its current size. The reinvestment rate on investments was driven to some extent by the slight mix change in investments. Willis, you want to speak to that?

Willis Newton

Sure, Jim. During the quarter we added to our portfolio of available-for-sale investments some of high quality adjustable rate CLO paper and that had a lower than average yield relative to the municipals and other assets that were in that category.

Operator

Your next question comes from the line of Herman Chan from Wells Fargo Securities. Your line is now open.

Herman Chan - Wells Fargo Securities

Thanks, the flat balances in commercial business, was there anything in the quarter that drove the flow of the loan growth aside from the lower utilization rate?

Michael Selfridge

I am sorry, Herman. Could you repeat that again?

Herman Chan - Wells Fargo Securities

Sure. The flat balances in commercial business, it looks like it was flat quarter-over-quarter and the commentary mentioned that utilization rate in some of the lines was lower versus the fourth quarter. Was that really the driver for the flat balances in Q1?

Michael Selfridge

Yes, that was predominantly the lower utilization in lines of credit and again as we mentioned, the acquisition of new clients remains very good.

Herman Chan - Wells Fargo Securities

Great, and I just want to get an update on the recent hires that you guys have done in recent years. Now that they have been integrated into the First Republic culture how is their productivity looking relative to expectations? Have these hires turned a profit in the normal one to two year time frame?

Katherine August-deWilde

The hires are doing exactly as well as we expected. They are turning a profit as we expected depending on when we hired them. We are very pleased that they are coming on stream and over the next several quarters we will continue to see very good production from them.

Operator

Your next question comes from the line of Ken Zerbe from Morgan Stanley. Your line is now open.

Ken Zerbe - Morgan Stanley

Great, thanks. Just had a question, in terms of the funding of your loans. You talked this quarter about deposits, how they really didn’t grow that much, as your customers were doing other things with their money. When you think long term if, heaven forbid, the equity market keeps going up, as customers still have a use for their funds or their deposits, how do you guys think about funding or where is the incremental funding source for the deposits and maybe a different question is if your expectations are deposits stay, I am going to say, flattish, does that naturally imply that we just sell off or that you sell off a lot more of the loans through securitizations?

James Herbert

It’s a good question, Ken, and its really a matter of finding a balance. Your comment about, heaven forbid, the markets stay good. Let us presume they do for a moment to be optimistic and let us presume the real estate stays good as well. Then our real challenge is to have the growth rate, the rate of our acquisition of new clients outrun the growth rate of the loan demand. We have always looked at mortgage banking as a valve, as a control valve. We can sell assets at a profit almost always. If you go back many, many, many quarters, 15, 20 quarters, you would find that we very solemn did not make a profit in the sale in the mortgage banking market. A few quarters we didn’t but not very often.

So we have a valve that is a control mechanism for managing the growth of the enterprise. We find that actually extremely attractive and somewhat unique in the model versus others. We utilize it as we see appropriate. We also use it for asset liability matching. I don't really want to be booking a low 3%, 30 year fixed rate mortgages at this point and we are going to. So what we have to do is outrun the decline in the excess liquidity that our particular type of clients.

Remind yourself of the makeup of the client base of the bank. It is not a broadly diversified mass consumer funding source. It’s a concentrated version of a type. Mostly people who have self made a fair amount of money. They tend to be very activists. When they see a turn, they act. That’s what's going on. We saw the run up of the size of accounts on the average, both actually business and consumer and we basically took the approach of managing that run up in our asset liability matching thinking by putting the amount of run up in a more volatile category.

That has proven to be somewhat correct. We put it there not for the risk on the downside in economy but in fact for the risk on the upside. What's happened is that its actually taken place. That got coupled with the termination of unlimited insurance which impacted our deposit base probably slightly more than other deposit bases. That hasn’t been a particularly large thing as near as we can tell but it clearly has been a slight negative.

So, we were at this particular point where we just need to outgrow that dip whether its one-time or not. I think it probably is. So its going to be a new client acquisition challenge which we are up to.

Ken Zerbe - Morgan Stanley

Okay, great and just a quick follow-up. The loans that were sold in the quarter, were they all newly originated loans and or is there a little bit longer life loans in there? I mean did you originate them recently?

Katherine August-deWilde

They were both newly originated and originated in prior quarters. What we do when we go to sell loans is we decide what type we are going to sell and we accumulate them all and we put them out for a bid and we don't look at when we originated them.

Ken Zerbe - Morgan Stanley

But some of those, from prior quarters, could have had higher yields than where you would have originated them currently?

Katherine August-deWilde

Not really. Most of them were originated in the last three quarters and the yields where about the same.

Operator

Your next question comes from the line of Dave Rochester from Deutsche Bank. Your line is now open.

Dave Rochester - Deutsche Bank

Hi, good morning, guys. Jim, back on the loan pipelines real quick. You mentioned that's extremely strong. I was just wondering if there are any particular areas of strength in terms of product or geography there? Then I was also wondering if you are seeing just a typical seasonal uptick in the pipeline coming into 2Q? If you're seeing more strength given your clients are getting more confident with that they are seeing in the economy?

Katherine August-deWilde

We are seeing uptick across the board and our pipeline is strong compared to where it was a quarter ago. It's also strong compared to where it was a year ago. So that would say it's more than seasonal. Our clients, as Jim has said, are quite active, and the markets are good and they are very engaged in buying things and we are financing them.

Dave Rochester - Deutsche Bank

Great, and then you mentioned, I think I caught this, the incremental NIM being a little less than 3% today. Did I hear that right?

James Herbert

Yes, on the new bookings, not including business banking.

Dave Rochester - Deutsche Bank

Okay, so, is all in loan production that's still above 3% I would guess, mostly above 3% NIM?

James Herbert

All in loans productions are a bit above 3%. That's correct.

Dave Rochester - Deutsche Bank

Would it be fair to say that spreads have continued to be relatively stable versus last quarter then?

James Herbert

I think that's right. Yes, I would say so.

Dave Rochester - Deutsche Bank

Okay, great, and just one last one, real quick. You mentioned you are down to six branches that are opening this year. I was just wondering how much of those expenses are now on the run rate at this point and when those will fully be in the numbers?

Willis Newton

Probably about two-thirds of the three quarters of the expenses are in the numbers. They are under construction. The signs are up. We are paying the rent but we just don't have them fully staffed and we are not depreciating.

Operator

Your next question comes from the line of Casey Haire from Jefferies. Your line is now open.

Casey Haire - Jefferies

Hi, good morning, guys. So I was wondering if you could give us an update on how gain on sale margins are holding up versus that 2.13% that we saw in the quarter.

Katherine August-deWilde

Gain on sale is always something we are not sure of until we put the loans out to sell but it seems like they would be relatively good and we don't predict but so far secondary markets have been holding up nicely.

Casey Haire - Jefferies

Okay and then the multifamily bucket was down, prior to this quarter it had some decent momentum. I was just wondering if you guys could provide some more color as to what's driving that?

Katherine August-deWilde

We are originating multifamily and commercial real estate loans. We have a few more people hired who do that business and our clients are interested in that asset category.

Casey Haire - Jefferies

Okay, and then just lastly, on the CLO floaters that you guys put on in the securities book this quarter. Was that relatively spread throughout or was that front loaded or back loaded? Just trying to get a sense on timing how much of it hit the quarter.

Willis Newton

That was relatively evenly through the quarter. It was mostly done by, I would say, the middle of March and it is adjustable rate and we are pleased to have added that asset category.

James Herbert

We got into it a little early and so the most recent tiding on spreads has slowed down our investing.

Casey Haire - Jefferies

Okay, I got you. Just the incremental yield on that, did you guys disclose that?

James Herbert

We did not.

Operator

Your next question comes from the line of Joe Morford from RBC Capital Markets. Your line is now open.

Joe Morford - RBC Capital Markets

Thanks, good morning, everyone. I guess just a quick follow-up. Can you talk about the sizeable increase in the securities portfolio? Overall was it partly because the loan growth was slower this quarter? What should we expect in terms of incremental securities particularly as the deposit earns aren't growing as much?

Willis Newton

I think we are pretty comfortable with where our securities portfolio is right now in terms of a percentage of our assets as a whole and where the yields are.

Joe Morford - RBC Capital Markets

Okay, and then the other question was, how much did prepayment fees or prepayment penalties contribute to net interest income this quarter and how would that have compared with last quarter's same?

Michael Roffler

Joe, it was probably a little bit lower than it had been in prior quarters, which I think we are running at about 6 or 7 basis points. So it's just a little bit lower.

Operator

Your next question comes from the line of Lana Chan from BMO Capital Markets. Your line is now open.

Lana Chan - BMO Capital Markets

Hi, good afternoon. Is there any way to quantify how much of the money shift from deposits you saw into your wealth management assets this quarter? Is that possible to quantify?

Katherine August-deWilde

I don't think we can quantify that. We had a terrific quarter on wealth management. We grew $3.6 billion and 75% of that was net new assets but we really don't have a way to judge how much shifted from deposits. Many of them were new clients and so that wouldn't have been a deposit shift.

James Herbert

You are on a point that's very attractive to us. It's worth noting that business banking and wealth management now fund more than half of our deposits in total. That's quite a game changer in the last 18 to 24 months.

Lana Chan - BMO Capital Markets

Okay, thank you. Then on the loan loss provision, that came in lower than expected this quarter. What is the expectation for the rest of the year?

Willis Newton

Well, Lana, we will continue to provide for loan losses given the growth in the newly originated loans that we are making and as we had a lower growth in loans and we had lower growth in our business loans, that's what contributed to the lower provision. If we continue to grow similar to the growth in last year's quarters, we would be providing it at a similar rate.

Operator

Your next question comes from the line of Aaron Deer from Sandler O'Neill & Partners. Your line is now open.

Aaron Deer - Sandler O'Neill & Partners

Thanks, Steve. Hello, everyone. Actually, I am just following up on that last question, Willis. What's the kind of basis points provision that you are giving delineating between, say, the new residential mortgages versus what you are doing on the commercial side?

Willis Newton

Well, we provide at the lowest level for our hard quality home loans and our business lending is more at the 1.80% to 2% level. So when our business loans don't go that much the average incremental provision has been running around 60 basis points.

Aaron Deer - Sandler O'Neill & Partners

Okay, and then, Katherine, discussing the pipeline and expectations going forward, it sounds like the pipelines are still very strong. Can you break that out also between what's going on in the residential side versus the commercial side and where you expect growth to predominantly come from or how you see that playing out?

Katherine August-deWilde

That’s a very good question. We actually don't break out our pipeline by either geography or by type. So what we are expecting is the pipeline is strong across most of our types of lending and most of our geographies. I am sorry to say we don't have that breakout right now.

Operator

Your next question comes from the line of Matthew Clark from Credit Suisse. Your line is now open.

Matthew Clark - Credit Suisse

Hi, good morning, guys. Can you update us maybe first on QM and then how maybe the loan sales this quarter, whether or not that played a role in anticipation of QM and your thoughts maybe on pricing, when you start to see the risk retention rules come out in implementation?

Katherine August-deWilde

We did sell 37% IO loans this quarter and that was the percentage that was in the buckets that we decided to sell. So we did go out of our way to sell it but those were the ones that we sold and there doesn't seem to be any difference in pricing on IO loans versus fully amortizing loans.

Matthew Clark - Credit Suisse

That 37% compares to what in the prior quarter?

Michael Roffler

It's probably a tad bit higher but it's mostly focused on again what the client demand was in those different product types.

Matthew Clark - Credit Suisse

Okay, and on the tax rate, as we go into 2014, is it fair to assume that we will stay at that 26.5% for now?

Willis Newton

Well the tax rate, once again, is coupled with the increase in the expense item that we talked about. So it would have been 29.5% if you take that expense item and put it down into the tax line. So if you are going to follow the way we are currently reporting our numbers, 26.5% would be the level that we would expect and that we would have a run rate on a quarterly basis of about $11 million in the non-interest expense line item.

Operator

Your next question comes from the line of Paul Miller from FBR Capital Markets. Your line is now open.

Thomas Laterno - FBR Capital Markets

Hi, guys and this is actually Thomas Laterno on behalf of Paul. Most of my questions have already been answered, but I do have one quick follow-up, just to make sure I am thinking about this the right way. You have had an elevated level of loan sales for a few quarters now. Would it be fair to say that gain on sale margins would have to retreat back to sort of 2Q '12? I believe they were just more than 1%. Would it be fair to say that they would have to go well south of here for you to start to portfolio more product? How should I think about that?

James Herbert

It's a good question, Thomas. The answer is, we are driven to some extent by profits but each quarter we deliver out on a flow basis to certain amount of loans as well which end up in the sold category. Our agency delivery is that way. We have some forward commitments or lock-ins, so to speak, with various buyers, loan-by-loan. So, we have always had some loan sales ranging dramatically obviously in the '08, '09 and '10 period down to almost zero but since then they fluctuate.

Pricing yield is one of the elements that is taken into consideration. Not wanting to hold long-term fixed rate is the next, and actually the most important element. We simply will not hold a 30-year fixed-rate mortgage. So it's going to be sold. If people want those mortgages then we are going to be selling a little more. But it's very important to think about this in the right way.

We sell eight other things on the average to a mortgage client. If we can take a mortgage and lay it off into the secondary market at a very handsome profit, keep servicing and keep the eight other things, that is the single best return on capital model that exists for this bank.

Thomas Laterno - FBR Capital Markets

Right, that’s fair.

James Herbert

So this is not the bad news. This is the good news.

Thomas Laterno - FBR Capital Markets

Yes, I understand. I was just trying to make sure I am thinking about it the right way. Thanks for taking my questions.

Operator

Your next question comes from the line of Julianna Balicka from Keefe, Bruyette & Woods. Your line is now open.

Julianna Balicka - Keefe, Bruyette & Woods

Good morning. I just wanted to follow-up on a couple of topics that were even discussed. In terms of thinking about the volumes which you choose to sell versus portfolio, if your pipelines continue to be strong and your markets continue to do well, although you call this quarter unusually strong in terms of gain on sale, there really isn't any particularly good reason to consider this to be unusual and that it could be recurring for this year.

James Herbert

Theoretically it could be, yes.

Julianna Balicka - Keefe, Bruyette & Woods

All things being equal. Okay. Then in terms of the gain on sale margins, could you differentiate between what you were seeing on conforming versus nonconforming loans?

James Herbert

Katherine?

Katherine August-deWilde

At the moment, the conforming loan margins are slightly lower than the jumbos.

Julianna Balicka - Keefe, Bruyette & Woods

Right, but can we get a little bit more quantification?

Katherine August-deWilde

I don't think we are giving out that quantification right now but it's an unusual anomaly right now, that it's a little bit less.

Julianna Balicka - Keefe, Bruyette & Woods

Okay.

Katherine August-deWilde

A bit lower. That's not normal. Normally you get higher pricing on conforming but at this moment, we are not.

Julianna Balicka - Keefe, Bruyette & Woods

Okay, got it and then switching topics for a second to the wealth management. The asset growth has been really good. In terms of thinking about how to improve the profitability of those assets that you are gathering, how should we think about the outlook for profitability and growth, in terms of the revenues generated off the assets and stuff like that?

Katherine August-deWilde

One of the biggest differentiators is which assets we are booking. So we earn our highest return on investment advisory. We also do some custody and some money market mutual funds where we have very low basis points. So as you see the growth in investment advisory and trust which is hard to grow quickly but pertaining to the value of investment advisory that will lead to a slightly higher overall growth in the basis points on our assets. It's a mix issue.

Operator

Our last question comes from the line of Tim Coffey from FIG Partners. Your line is now open.

Timothy Coffey - FIG Partners

Does the company have a target or preferred loan to deposit ratio?

James Herbert

I wouldn't say we operate with a target. If you look at us over a fairly extended period of time we tend to revolve right around 100%.

Timothy Coffey - FIG Partners

Okay, how do you feel about where the company is right now on the loan to deposit ratio?

James Herbert

I would like to see the deposits catch up a little bit with the loans but I am not very worried about it.

Timothy Coffey - FIG Partners

Okay then a second question. I am sorry if I missed this earlier but the number of buyers for your non-agency mortgages, has that number increased recently or is there any kind of change in the buyer market right there?

Katherine August-deWilde

As you may have noticed there are a lot more securitizations being done. So that has changed the mix a little bit to the people who are securitizing mortgages and there are more of them but we have always a good number of bidders when we put out a package. Mix changes from time-to-time. This is more heavily securitization.

Timothy Coffey - FIG Partners

All right. Do you have any opportunity to forward sell contracts rather than the non-agency mortgages at this point?

Katherine August-deWilde

We could perhaps do that, but that's not the way we chose to operate. When we are ready to sale loans we put it in a package and there are always some fixed or long-term adjustable rate loans that we could sell. We get better pricing when we put it out to the bid rather than forward.

James Herbert

Our experience in this area is instructive in that regard because we never have to sell mortgages. It's discretionary. Being in that position is always the best rather than locking in forward and trying TO anticipate forward events.

Operator

There are no further questions in the queue. I will now turn the call over to Jim Herbert, Chairman and Chief Executive Officer, for any closing comments.

James Herbert

Okay, well, thank you all very much. We appreciate it. It was a good quarter from our perspective and the business has a very good backlog and a lot of momentum. We look forward to speaking to everybody during the next quarter. Thank you.

Operator

Ladies and gentlemen, this concludes today's conference call. You may now disconnect.

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