First Republic Bank's CEO Presents at Morgan Stanley Financials Conference (Transcript)

| About: First Republic (FRC)

First Republic Bank (NYSE:FRC)

Morgan Stanley Financials Conference Call

June 11, 2013 12:05 pm ET


James H. Herbert II – Chairman, Chief Executive Officer

Katherine August-deWilde – President, Chief Operating Officer

Jeffrey Bruce – Senior Managing Director


Ken Zerbe – Morgan Stanley

Ken Zerbe – Morgan Stanley

Hi welcome back everyone. I’m Ken Zerbe, Midcap Banks down to Morgan Stanley. I want to welcome our next presenter, First Republic. We have three people from First Republic, they are Jim Herbert, the Chief Executive Officer; we also have Jeff Bruce, Deputy Regional Managing Director of Relationship Management and Anna Legio who is District Manager of Preferred Banking Offices.

So with that why don’t I go ahead and kick it off to Jim. Thank you.

James H. Herbert II

Thanks very much Ken. The, I’m sure I can work this, okay. Good morning or good noon.

I want to go through the story of First Republic very quickly and then we’ll go the Q&A. And the, I have Jeff and Ann with me because they can really tell you what’s going on, on the day-to-day level in terms of offices and relationship management. So well I want to involve them as we go along. So feel free to ask questions as well.

First Republic is, we had a very good first quarter, it was more concerned with mortgage banking and some deposit diminution and I will talk about that in a minute, which we are challenged with although we’re overcoming it. And yet the volume of business in our basic model which is single-family home loan driven is actually very good. The bank has been profitable since we started it in 1985. We are now at about $35 billion in assets, loans have grown nicely, importantly wealth life is coming along very well, which we will talk more about in a minute.

The core to First Republic from day one has been very strong credit. We have had leadership continuity in myself, but many others including our Senior Credit Officer who has been with me since, Senior Credit Officer has been with me since 1986, Katherine August-deWilde is our President and Chief Operating Officer and I have been partners for 27 years. And we are focused on a very simple model, very strong credit, high service, one client, one relationship at a time, do a lot with them, do it very well and take your time, it’s going to be a 20-year relationship, 30-year relationship, old-fashioned banking.

Very intensely focused on a few geographies costal urban, San Francisco number one, Silicon Valley much included, Los Angeles Westside primarily, San Diego up to Santa Barbara in the other direction, New York, Manhattan centric, but the greater area and Boston. The segment of clients are wealthier, first working, building well not so much inherited well some of that been not too much and we've got a brand over a long period of time. Year-to-date highlights, first quarter were strong year-over-year, the growth on the balance sheet however will come to in minute wasn't that strong, because we sold so much into the secondary market mortgage banking, which actually is a core of our business.

Deposit growth year-over-year is strong, first quarter was sideways I'll come to that in a minute. Wealth management assets are very much we did buy a wealth manager, bought Luminous at the end of the last year about $5.6 billion of assets roughly $7 billion. Book value per share is growing very nicely. We've done several non-cum perpetual preferred stock. We did four issues this was the last one at 5.5% the composite of the $700 million that we raised in the last 12 months was about 6% cost.

Our focus on clients is, this is a diagram of it that we are very, very client centric and Jeff and folks like Jeff or Ann are the central bankers for their relationships and they deliver the whole bank and that works extremely well. The incentive is aligned to do that and it’s a strong, we follow the clients first to themselves, second in some cases to their business and third and may be most importantly right after themselves as to their heart. The school their kids go to, the charity they care about, the non-profit they care about, in our business banking the largest single segment is non-profit.

Let me just play this for a minute here, it’s less than a minute, this is how we market.


Basically our product is service and the only way to really market that is to have testimonial proof of it and that service leads to how we grow, we’ve compounded about 18% to 20% a year since we started the bank pretty much almost entirely organic and that comes from two things or actually comes from, look at the two boxes here, the top box is about 70% of our growth, there are two things in here and I’ll come, I want to talk about the first one in a moment, the later box is really the more obvious, open new branches, hire new bankers, focus marketing, that’s only about 30% of our growth. 70% of the growth of the enterprise is word of mouth from very, very satisfied clients, who are advocates for the service and tell their like kind friends and if we've already made a loan to them and chosen them as a client or they have chosen us, its highly likely that that connectivity will work, it’s the ultimate algorithm.

The, who are our clients, the clients are A, performers in the economics environment that they operate in, if San Francisco is growing at about 3% a year our client base in San Francisco net worth of liquidity is probably growing at about twice that, maybe three times that, 60% have graduate degrees, they live in urban costal markets and they did not inherit wealth. So what are they doing, they are working really hard all the time building what they are doing and so as a result they grow and then they have friends of like kind and they refer them, its not a complicated formula the devil's in the execution, you have to be right virtually every time.

The geographic markets we operate in have outperformed the nation, we've done our first republic GDP and Rosen does it over, Rosen consolidating for us and basically we have outperformed from the through up about seven index points, but twice as well basically. These markets are the ones we know well all of us, San Francisco is a standout obviously with the technology, about 35% of the banks in three counties in Silicon Valley, then Boston, New York these are knowledge based high-value add, high educational markets. These markets consist of about 20% of the households of America for about 10 years in a row every other year we’ve had Capgemini do a study, they do the world wealth report study and they have taken, we've taken algorithm and applied them to our client base and they to our markets. And about 55% of our high net worth families live in the markets we operate in, so it's a very target rich environment.

On your right are the size of these markets, 0.5 million households of such a nature of $1 million liquidity are in the area we're sitting in, down in the Boston, which has about 100,000. In San Francisco nine counties we have about 14% market share. If you take the $5 million liquidity households and the $10 million liquidity households, we have a much larger market share.

Our households have been growing very nicely. We get up in the morning and figure out how to take care of the current clients and then figure out how to get 5000 to 10,000 more households that are of same kind each year and then do a lot with them. And we don't actually pay much attention to what's going on in the market competition wise, we just get up and go after a new client.

FRC, we've grown in the $10 million households about 18% per annum in the last couple of years so the upper ends of these households are growing actually more rapidly than the $1 million households. That’s primarily because of our trust into wealth management. We’ve got very strong organic growth, deposits and loans. We are very active in the secondary market for mortgage banking. But this is a, I would say it’s a volatile business, not necessarily negatively volatile, but it’s hard to call as to volume and as to profit. And we try to point this out in this slide.

The Silicon Valley is about a third of the bank, it started a bank in 1980 in Sunnyvale, California before I started this in 1985, so have been banking down in the Valley for since 1980, long time. There wasn’t Silicon Valley in 1980, just for some of the younger folks in the room and mostly disk drive, hard drive based. But it’s been a great run and now the Valley is moving up into the city of San Francisco and that’s a big deal. It’s transforming San Francisco like I would never have imagined it could be transformed at a pace that is quite stunning.

Our balance sheet make up above on the right-hand side we’re about half San Francisco bay area and the other, and then New York 18, Loss Angeles 14 and Boston seven. By type we have single-family homes and HELOCs are 65% to 70% of the balance sheet pretty much at all times. We like the asset class very much. This is a quick profile of our clients. About $30 million are home loan clients, about $30 million are average net worth of $3 million median. Liquidity equal to the loan outstanding and the LTVs on our loans are 60%, 59% to 60%very conservative.

We've done about $62 billion of home loan originations these include loans that we have held or sold but keep servicing. We've had five basis points of cumulative losses in 27 years, 28 years and that includes 2008, 2009, 2010 those [vantages]. This is our actual loss charge-off experience, the green line is us and so the P, we peaked at about 48 basis points at 2009 coming out of 2007, 2008 vantages.

Business banking is a growing part of our enterprise. We do a lot of interesting verticals. We have about six great verticals. We bank a couple hundred law firms. We bank 850 plus venture capital and private equity funds. We bank 150, 200 private schools, bank at a lot of arts organizations.

We follow our clients to where they are and then drill down and do a lot of that, so we’ve picked about six or eight different verticals, I think we have actually technically nine now. Here is a list of our – the make up of our business banking portfolio. Schools non-profits 38%, almost 40% of business banking is in fact non-profit banking. These are very good places to lend money. They have a lot of interesting people sitting at the board table, they care a lot about it it’s they heart in most cases.

Our deposit franchise is split between consumer deposits and business deposits and then by channel the preferred banking deposits are the strongest that's really a test of the relationship managers and the preferred banking officers are second. We have basically brought private banking retail with our officers; they are all sit down, very friendly environment. We've been improving our deposit mix; I won’t drill on this slide. We dropped our CDs down to about 11% from 37% and maybe a little lower than we'd like that actually at this point.

Our average branch size is fairly large, almost $300 million. Private wealth management, we've been expanding this franchise quite rapidly. We have a very integrated model one brand brokerage trust and asset under, and asset management. It's grown nicely, the acquisition was about half, the acquisition of Luminous was about half of the growth last year roughly and the fee income has grown up very nicely.

Core efficiency ratio we’re a high-touch model, so we tend to operate in a sort of high 50s, low 60s, we've always sort of put out there that we would expect to operate between 58% and 62% efficiency ratio, this is core, this is not gap, we had some purchase accounting gains, we do not put in here. They would improve the efficiency ratio.

Our people, this is the core of the efficiency. We do larger average transactions very clean with low turnover people that we think are better considerably than average, in terms of talent and commitment to the enterprise. As a result, we have about two and half times the asset per person that most banks have and we make about two and half times as much pretax profit per person. Although our salaries are higher, our pay scales are higher.

We've worked hard to stay steady on net interest margin. We are under pressure like everybody is, but so far we've held up pretty well. But this goes back of ten years or eleven years now, ten years I guess and we work really hard at asset liability [matching]. We are slightly asset sensitive on the upside of rates.

Our real objective is our real income, matters the net interest margin is interesting, but net interest income is what pays our bills. And net interest income has climbed very nicely, again this is core non-GAAP, our GAAP is higher. This is since we became public again after buying the bank back from BofA. Core earnings per share, this is actually since public to prior was since we bought it back, there were two non-public quarters in there. And the EPS has grown nicely. Book value per share which is the real bottom line has compounded about 17%. And then stock performances interesting, we did this, this is a chart on left before we sold to Merrill but not including Merrill premium, which is a pretty good premium. But, and then the First Republic but through the end of March so it’s a little dated.

And private equity, we revolved back by private equity backers, the owned about 75% of the enterprise. We’ve got in their mouths of the expenses they are down now to 5%, below 5% as a group. And so that sort of overhang on the market which is a pretty big deal actually we worked hard at this, as they have been very happy and the market has absorbed about 60 million shares almost. And most recently there have been blocked trades done overnight.

We run voluntary stress test, we’re not part of the group that needs to, we’re not $50 billion yet, but we’ve done in place in a row. We like to look ahead a little bit if we can and we’ve come out well in this stress test. This matters a lot, our clients know how to read to the balance sheet and they care. So we spend a lot of time explaining the simplicity of the model and the cleanliness of the balance sheet and the strength of capital to investors or to our depositors rather.

So, quick conclusion. Ken with that the, and I turn to Jeff and Ann for just a moment to give us a kind of an update on what's going on in the market. Ann you want to talk about deposits from an office perspective, Ann leads co-leads the deposit offices here in the New York area.

Katherine August-deWilde

On the deposit side we normally reach out to the clients to tell them what we offer, I think the biggest thing for us is the service portion on just see what we can do and as Jim over the years have said it, one client at a time, let us (inaudible). What we have found over the years is that these are not really what they are looking for, I think the majority of the client is looking for the service, some wants to call the individual versus the 900 number and that's been very successful.

We also work closely with our lending partners, Jeff whenever we have a lending need and we work as a team approach so in order that to make the clients feel that it has the connectivity to other people within the organization and we bring in the experts in those particular field. The deposits have been coming back, the last couple of months, we have reached out to the clients that had left back in 2012 due to the FDIC change in insurance. So we have reached and they will come back for those same thing as (inaudible) do things, you’ve wished that to us and a little by little we're seeing people that are coming back with the $5 million, $10 million, $15 million, $20 million, even though the rates are, Federal bank might be worked on a little bit more. They come back with the service I think that’s the main goal to the bank house.

James H. Herbert II

Jeff from a lending point of view, tell us about sort of the flow of business in the area.

Jeffrey Bruce

Sure. Flow of business is very strong right now; we’ve moved from more of a refinancing mode, if we look back probably a year, most of our volume was driven by refinances, a lot of those coming from our competitor. So with the strengthening of the real estate economy here in New York and especially in San Francisco, we have a lot more purchase transactions and purchased transactions tend to again be important relationship milestones. A lot of people get referred to us, our real estate and transection tends to be the point of which they actually make an active conversion over the First Republic, we attract deposits, we begin investment discussions and so our pipeline is very full at this point. And looking through the summer, which is the big buying season for especially in the suburban areas with families, we expect things to be very strong through year end, our most significant volumes ever.

Ken Zerbe – Morgan Stanley

Great. okay, with that we’ll take questions.

Question-and-Answer Session

James H. Herbert II

Right (inaudible) go ahead.

Ken Zerbe – Morgan Stanley


Unidentified Analyst

You guys in residential mortgages, can you give rough idea in terms of the adjustability of the ARMs, five-year ARMs, three-year ARMs, seven-year ARMs, give us a rough idea in terms of the breakdown opening.

James H. Herbert II

Sure. We have a very detailed breakdown in the 10-Q, but just generally speaking, we do five ones, seven ones, ten ones 15-year fully amortizing, 30-year fully amortizing, fixed or adjustable. The mortgage of choice today, I would say is about probably 40%, 30-year fixed or 15-year fixed and those we sell into the secondary market almost immediately upon making, and that's what’s the mortgage banking is that you see. We deliver to Fannie if the size fits and we deliver into the secondary market. We keep fives and sevens and we will keep some tens depending. We mostly sell tens as well now.

So if you look at the duration of the mortgage book, and then we have call it half of the mortgages that are much more adjustable, 11th District, LIBOR, Prime, HELOCs all adjustable and then of course the book of, the business book is almost all adjustable. We've got a fully formed book when we bought the bank back, so the duration on that book was about three years basically and if you look at what we have on the balance sheet at any time, the duration is between three years and four years at the maximum in the fixed section, okay and closer to threes and four basically. And then we have about between 40% and 50% of the home loan book at any time is adjustable that we keep when you get on selling about $600 million to $800 million a quarter into the secondary market. We keep servicing on that by the way when we sell it.

Ken Zerbe – Morgan Stanley

Jeff as a follow-on.

Unidentified Analyst

Can you speak roughly to the annual caps on those loans and the lifetime caps?

Jeffrey Bruce

Annual, none. We don't do that any more. We learnt that lesson in 1994, therefore in those tough ones. We do, in ARM caps we don't do our annual. Our lifetime caps...

James H. Herbert II

Generally the 5% or so. Most of our loans its 5% above the starting rates. In some cases, we’ve moved up to a rate of 10.95% on that cash.

James H. Herbert II

I would guess that’s above rate. I would say the probably the composites of portfolio is about 9.5%, there are long ways to go. And the shipyard pay off rate going on in the portfolio at this point is about 20% to 21%, depends on type.

Unidentified Analyst

Okay. So on the – lot of concerns during the first quarter was the lack of deposit growth.

James H. Herbert II


Unidentified Analyst

And you had mentioned that it was because your clients were taking their money, investing in the equity markets, obviously we’ve seen a continuation more volatile, the continuation in the growth in the equity market. Are we – if that continuous, are we entering a place in the First Republic’s growth where you don’t see a lot of deposit growth? Like is it a valid investor concern that the deposit growth slows, even if you have more opportunity in the loan side, your cost of funds rise as a result, profitabilities hurt so many, how are you going to address that concern?

James H. Herbert II

I’ll ask, you are out of time in. But I, the answer is not overall. We’re not worried about deposit growth per say. We got caught a little off guard in the first quarter. Two or three things happened, one, we saw coming the end of unlimited insurance obviously, and we programmed in a loss of the certain amount for that. We didn’t quite anticipate the build-up of cash at the end of the year, which created a little bit of a, more of a downtick than we would have thought, mostly anticipatory of taxes and paying bonuses early. And then the other thing that caught us off guard is across the board without fail in every market of the consumer accounts went down in size.

And they went down in size primarily because they went into the market, went into real estate, all [March] in 90 days I mean actually never, I have been doing this a long time, I’ve actually never seen and then flection point of that nature, of that magnitude that quickly, universally and I agree with that mostly the fact that we generally have people that are little bit on the leading edge of what's going on economically and they decided to go to risk, they got over fear and went in a risk in a very short period of time, which is continuing to this day and of course that there is no doubt that helped to fuel some of the run-offs we're seeing both in the market and in real estate.

That appears to have stabilized a little bit. That one caught us off guard, so the other one caught us off guard was the reinvestment in our business accounts, they drew down, they are more active that stabilized as well. From your point of view Jeff, we've reached out accounts that we now have moved money away from us for various reasons.

Jeffrey Bruce

Correct, especially with businesses there have been points in time in the past year, where we were over deposited and so we were encouraging especially some of our business customers to think about alternative places to park fund money markets, mutual funds and other products that we offer through the broker dealer side of our business. And more recently we've been reaching out to them to encourage them and let them know that were interested in having those balances back and we been making some good headway in the last month or so in pulling back in deposit. So I think some of it is a little bit of turning of the large ship, the message needs to get out to our clients that we’re very much interested and having their deposits back in and that starting to happen.

James H. Herbert II

I'm about half satisfied with our turn, okay the way I would say it.

Jeffrey Bruce

I guess I know what I'm doing when I’m backing off.

Ken Zerbe – Morgan Stanley

One last question.

Jeffrey Bruce


Unidentified Analyst

Can you talk about concentration risk particular amongst your deposit base in particular in light of the geographic concentration, the exposure to the text sector, as well as it sounds like a reliance on a small number of large depositors within your bank?

Jeffrey Bruce

Yup. We are an extreme version of the 80/20 rule and when it comes to deposits the two largest concentrations are of two types in character. One funds the largest single type of depositor is the fund business that we have and but that's like an 800 cylinder engine something is trying at all times and they are pretty unrelated to each other operationally in decision-making, they are not unrelated as to the fact that probably several hundred or more VCs so that business ebb and flow as a group a little bit and then private equity is, I would say less correlated with each other. From a geographic point of view they are actually fairly evenly spread surprisingly enough we are lot of Boston and New York and San Francisco and a few LA in the fund business.

The next largest base in there would be the non-profits, they are really uncorrelated. If you go to the individuals, it's a broad range of people some of whom are really wealthy and so there I would say we are looking at kind of 500 cylinders in terms of the very top end. We run a large client project and focus which [channel Houston] here with us and also runs IR for us managers. And so we put the management team myself Katherine and about 15 of us adding meal every year with the largest clients in the bank preferably once we don't know. And that's worked extremely well. And so we focused in on this. It's a form of concentration, but it's an uncorrelated situation. The one thing they have in comment is, they care a lot about the balance sheet. So our focus on credit and our focus on capital has to stay at the levels that we operate at. Ken.

Ken Zerbe – Morgan Stanley

All right. Thank you very much.

James H. Herbert II

Thank you all very much. Appreciate it.

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