First Republic Bank (NYSE:FRC)
Goldman Sachs Financial Services Conference
December 10, 2013 2:00 p.m. ET
Jim Herbert - Chairman and CEO
Mike Selfridge - Senior EVP and COO
Glenn Degenaars - Senior Managing Director and Portfolio Manager
Chris Ramos - Private Banker
Ryan Nash - Goldman Sachs
Ryan Nash - Goldman Sachs
Hi, we’re going to get started. Up next we are pleased to have First Republic joining us to the conference for the first time. Since its management led buyout from Bank of America in 2010, First Republic has been one of the fastest growing banks, doubling its assets to $40 billion today, driven by its intense focus on client service and relationship banking for net worth clients, which I am sure Jim and team will tell us more about. Its outsized growth has helped its shares to rerate over 50% year to date. So joining us today are Jim Herbert, Chairman and CEO along with his team. With that, I am going to turn it over to Jim.
Thank you very much, Ryan. Good afternoon. We are going to go through a quick presentation and then we will open up for questions. I have with me here today on the far end Chris Ramos is the preferred banker here in New York, has been with us 12 years; Glenn Degenaars is the wealth management leader here in New York, he’s been with us a couple years, and Mike Selfridge who is the Senior Executive Vice President and Chief Operating Officer who have been with us couple of years; Mollie Richardson who handles our IR for us and is the Deputy Chief Administrative Officer of the company who have been with us 10 years, and I am Jim Herbert, I founded the company in ’85.
We are – we have been profitable ever since we started. We have had a focus on client service and one of our lead products has been home lending for a long time. The formula hasn’t changed very much at all. As Ryan implied we sold the bank in ’07 to Merrill Lynch, they in turn sold to BofA and we bought it back from BofA in about three years ago – now three and half years ago. We are both a bank and a wealth management enterprise. We came to wealth management little late. We started that really in 2000, we will talk more about that in a minute. We focus on very high quality assets, our delinquency today is about 13 basis points. We have done about 70 billion of home lending in 28 years and we’ve had about 5 basis points of cumulative loss in those years. So our focus is very high quality service, high quality assets.
We think we’ve got a good brand. When you invest in us, you invest in few of our limited geographies, urban coastal, San Francisco with about 45%, 47% of the bank, the whole Bay Area; LA and North and South from LA Orange county, and Santa Barbara, San Diego, New York, mostly Manhattan up in the Fairfield now and we have clients of course in the Greater Area and then Boston. Katherine August-deWilde who is our Chief Operating Officer and President and I have been working together for 28 years. We’ve had quite consistent management the whole time. Our senior credit officer has only worked at this bank, only job he ever had.
Balance has been [ph] – we continued to grow nicely third quarter, growth was strong. Wealth management sales up nicely as well, that’s both market and new accounts. And the book value per share continues to grow. Core net income, we do have some purchase accounting coming out of BofA -- from our acquisitions from BofA and so we think core income primarily is up about 20% plus, 23% year over year.
The focus is simple – the client. This is one of the larger banks in the country now, about number 40 or so. We only have 35,000 borrowing clients, approximately the relationships and we have approximately 135,000 total relationships in the bank. Jumbo home loan is our lead product on the consumer side. We follow the clients through their businesses and we will talk more about that or to their heart -- meaning they are non-profits, they are schools, they are churches, they are arts organizations that they are very involved in. So our approach to bank is there are no companies, they are just people, we want a bank with people, and we will go where they take us, if we like where they take us, we will do business.
We have used that testimonial approach to marketing for a long time and it works, because it’s really the only way it can prove service. People ask us what the growth drivers are on the bank, and there really are couple that are by far and away the majority of the growth. First and foremost, the clients we already have and to be economic out-performers, they are highly educated and they are working in economic and very vibrant urban coastal markets and they themselves outperform. We are mostly a first generation bank. We have some inherited wealth but not that much. We are beginning now to develop more of that as our clients from 30 years ago are now the wealth clients.
But that growth all by itself is about half the growth of the bank. The client base we now have will this year grow about 8% or 9% in terms of their net worth and importantly they will grow in complexity and they will need more things. We do on the average 9 things with every home loan line. Then they are very satisfied customers and we will come to a slide little later on this subject and they refer passionately, like-kind individuals that become clients. We open new branches and we hire new people.
The markets that we are in have done well. This is the Ken Rosen study of our markets compared to the U.S., which is about 112 on this or 113 on this chart, San Francisco is a real stand-out obviously. We have – the markets we are in represent about 20%, 21% of all the households in America but they represent only 55% of all the high net worth households, measured by Capgemini $1 million of liquidity or greater. So we have a target-rich environment.
We have increased our share of the higher net worth household each year. This study is actually two and half years old now, we engage in this study every two years. We are doing a new one as we speak. Our households that have more than $10 million of liquidity have grown about 18% per annum in recent years. Mike?
Yes. Thank you, Jim. I am going to cover a few things. I am going to talk about the growth of the enterprise in general and then few distinct segments, one, business banking, secondly, credit quality and also private wealth management and we have Glenn here who can speak to that in a little bit more detail with Q&A.
So given the markets we are in that Jim mentioned the types of clients we have, the cross-sell opportunity and distinctly the relationship management and extraordinary service model we have been able to grow the franchise on loan and deposit side at about 22% CAGR for the last 10 years and these numbers are very consistent with other segments that we operate in.
We have been active despite current trends in the secondary market. We have been active since we founded the bank and a few points here. One, of the $104 billion we’ve originated since inception we’ve sold in the secondary markets about $20 billion, so just about 20%. But the important point is really that we retain the servicing of any loan that we sell in the secondary markets and we are currently servicing about $6 billion in loans that we have sold off over time.
Jim touched on Silicon Valley, the Bay Area represents almost 50% of the enterprise, and Silicon Valley as we define it’s about a third of the bank. We are very well situated in the Valley, we have been there the longest, we have invested quite substantially since divestiture and those people that we have hired are now contributing quite nicely to the enterprise. We are focused on a number of things, one, the professional service firms in those areas, venture capital private equity, we bank now about maybe just a little over 250 venture capital private equity investment management firms in the Bay Area, and this region is about 35% of our total deposits.
Balance sheet loans, single family – the hook that Jim mentioned, the jumbo is still the hook that gets us the client, brings them into the bank and allows us to cross-sell other opportunities although we have become more diversified by loan type and also by geography. So about 48% of the loan book I mentioned being in Silicon Valley, Bay Area region although now with about two thirds of our loans in California we now have good traction in New York and Boston.
The types of clients that we bank at First Republic on single family side are very attractive. We have always fully underwritten and fully documented our loans and our clients are liquid. Our loan to values are, we think, very safe and the net worth tends to be about four times the average loan outstanding or the medium loan outstanding for a single family client.
Credit quality, a track record since inception is very solid, so $104 billion in originations that I mentioned and a 17 basis point net charge off ratio. Single family, Jim touched on, $67 billion originated with the 5 basis point net charge off ratio. And a comparison to the top 50 commercial banks in the United States, our net charge-off has been about 9 basis points over the last almost 11 years, it’s about five times less than the top 50 commercial banks in the US.
Business banking has been around at First Republic for about 11-12 years. I would say in the last 7 years, the compounding effect on business banking has been extraordinary. We – I will cover a few [inaudible] focused on but this has really been a great vehicle for us to diversify the deposit franchise and help us collect deposits. So business banking now represents about 48% of our total deposits, the growth looks good and the important point here is that for every dollar we put out in loan outstanding we get about $4.6 in deposits. And we focus on about 9 distinct segments. The most significant would be schools and non-profits, from there venture capital, private equity those two combined are about 62% of our loan outstandings.
Deposit franchise, we spend a lot of time again trying to diversify the deposit franchise. I mentioned business banking is 48% of the franchise, consumer deposits 52% and then also the channels, so the preferred banking offices what you would call branches are about a third of our deposit gathering mechanism and 58% comes from our business bankers and relationship managers that are in the markets we serve. And the deposit mix as well has improved over time, so we now have about 48% of our total deposits in checking accounts.
Private wealth management has – also had exceptional growth. We have hired since divestiture about 92% of our wealth management professionals. They have brought new business to us and also worked very well with our relationship managers. They tend to be on the same floor and they work very well together. There is not a siloed approach to cross-selling wealth management and banking and that works very nicely. Our growth in wealth management when we came out of divestiture, we were about $14 billion in assets under management. We just touched $38 billion at the end of last quarter and our fee income from wealth management continues to grow nicely. Jim?
Thanks, Mike. The margin has held pretty steady over time, it’s under little pressure now as everybody I think is. And we’ve had -- efficiency ratio has been steady as well. The dotted line on this efficiency ratio chart is taking into account a GAAP accounting change that appears to be about ready to occur, which is the new investment, low income housing tax credits, you don’t have to amortize the expense of them against the P&L, against the expense line but it goes against taxes where it ought to go. And so our efficiency adjusted for that would be about 55.5%, taxes would be higher. Tax rate would be higher.
The efficiency of people for a minute, we think this is somewhat – I don’t know other banks -- you don’t see this number too often but we have about $17 million, $18 million per person of assets, it’s banking assets and not wealth management. That’s 2.5 times the average, we have very, very good people, we have clean assets, the average transaction is larger on almost everything we do, not a complicated formula actually and we make about 2.5 times as much per person in spite of the fact that we pay more per person. So we can attract those people.
Core net interest margin, I mentioned this a second ago, it’s holding pretty steady but it is declining and it will be under pressure for a while yet. The loans going on the book are still a little lower than the loans coming off the books. The steep yield curve helps us bit and it won’t solve the problem entirely.
Our core net interest income, which is actually what pays the bills, is growing fairly nicely. You can outrun NIM compression with gross to some extent as long as the growth is controlled in terms of quality. Earnings per share, pretty nice growth since we have been out in public and book value per share is growing nicely.
Let me go to -- we have done well, I think for our shareholders over time. That chart on your left is before we sold to Merrill but not including the 40% premium we got from Merrill and the chart on the right is since we’ve broken again here [ph]. The private equity investors that helped us were fantastic partners when we bought the bank back, are now out, has sold all of their positions and that includes most of our large investments at the time including an individual family [indiscernible]. So the market is now a true public market.
This is something we’ve just done recently, the net promoter score, my apologies, for the amount of information on the page but the top section is basically a listing of what we call net promoter score. This is a [indiscernible] kind of thing as they have done for years on many companies. First, the public stands are very well. When we are the lead bank for clients, we basically rank as – we have about 74% net promoter score. The higher net promoter score the more likely your clients are to refer lifetime basically friends to you. Banks on the average have about an 18% net promoter score, even when we are not – when we are not lead bank, we have a 55%. So it’s kind of a proof of quality of service that we have been looking for a while and haven’t had before. We have run stress test, we are coming up on $50 billion here, we now have our first mandatory stress test coming up this year and we ran them two years in a row voluntarily for many reasons, including being getting our system up and ready to go, and we ran pretty well there. This is the enterprise value over 27 years as shareholders, been pretty well.
So with that summary, let me open up the questions.
Ryan Nash - Goldman Sachs
So I guess, Jim just starting big picture, if you think about year to date you have been able to outgrow the entire industry when the industry has struggled to find growth, and as I look ahead to 2014, our economists are calling for a pickup in GDP market’s higher, steeper yield curve and improving real estate values, in this kind of environment what are your expectations for your customer base in terms of continued demand for loans as well as usage of their deposits for alternative uses?
Well I think let me answer quick, then I will turn to Chris and Glenn here. But the markets we are in are doing well, they will probably continue to do well for ’14. The clients we have are generally doing well. There is always an exception. And so I think the growth rate in ’14 is likely to be equal to ’13 or a little better with – in terms of activity of clients. In terms of balance sheet growth rate, the refinance boom has probably passed, and so that, that slows down our opportunity to pick up new clients. But it actually has a positive impact in terms of cross-sell ratio. Chris, maybe you can speak for a moment to that.
Yes, I think the formula is simple as, I think Jim touched upon earlier as that service – you deliver good service and lot of opportunities are going to arise, even after the refinance boom with sourcing and uptick in the amount of accounts that we open as well as new opportunities going to back to our existing portfolio and clients and discovering more of a private wealth management opportunities.
Glenn, do you feel the same on wealth management?
Yes, on the wealth management side, it may be counterintuitive but it’s not as much as driven by the economy or the markets or the yield curve, it’s driven more by having a differentiated service offering that you need to bring forth to the client. As Chris said, the service culture is pervasive throughout the entire company. So whether it’s the banking side or lending side, or wealth management side, we tend to lead with the service driven model.
Mike, do you want to add – you might respond in terms of velocity of business banking?
Velocity of business banking is strong, again 9 segments, two make up a majority of that and yes, I would say traditionally your comment about the jumbo being the hook and then bringing the relationship on the private banking side and that would extend to the business, we are now in a position where business is referring other businesses in the segments we serve and that’s bringing a great momentum to us in the core markets that we serve.
Ryan Nash - Goldman Sachs
So you talked about jumbo obviously being the lead product and jumbo prime obviously has been a product that’s gotten extremely competitive from some of the bigger banks pricing through conforming. Now that we have actually seen rates back up a little bit, are you seeing any easing on the competition front and is it hindering your ability to win relationships?
We’d love to say yes but the answer is no. There is not an easing on competition front at all. There is a little bit of crack in standards which we find to be disturbing. But the competition is ferocious, everybody 10 years ago nobody wanted jumbo lending really, all of a sudden it’s what everybody wants to do. But it’s still about service, at the end of the day it’s about service. And the net promoter score that I just put up is really an indication that we get a lot of referrals. One of the things that we think about in terms of growth is that because of the nature of our client base, if we didn’t even – if we brought no new clients at all the bank would probably grow between 7% and 10% because of the momentum of the client base we have and who they are, and how they are growing. And so we have an intrinsic growth rate that’s quite extraordinary, particularly as you have a slowdown of refinance going on, we haven’t [inaudible] Another thing – I am going to Chris, how many clients have you had leave you this year?
None. Just a handful, it’s been more from a standpoint that is there are investments that they are making in our private business and they needed the liquidity from their investment portfolio but we have very little attrition of clients.
This is a very fundamental point, we don’t fight a riptide – we don’t have an outflow of clients. If you want to grow 8% a year and you have 4% [indiscernible] 12%. So we don’t have – we lose clients, we are not perfect by any means but we don’t lose very many.
Ryan Nash - Goldman Sachs
And just a quick follow up on the point you made about the crack in standards – can you give us some example of the types of behaviors that you are seeing in the market? Can you give us some example of the types of cracks in standards that you are seeing in the market?
Mostly relatively speaking up, that’s the main one and the amount of advance rates it’s where it’s beginning, and that’s quite frankly over a long period – long time, that’s what we always see [ph].
Ryan Nash - Goldman Sachs
You had a lot of success growing into the New York and Boston part of the franchise, Mike talked about San Fran being 50%. Those obviously make up the much smaller part of the bank but given the strong growth rate that you’ve had, how big of a piece of the bank do you think that could be over time?
I think it could be enormous, particularly in New York. Well there is two aspects to the New York and the Boston that are slightly different. Boston is about the most consolidated banking markets in North America, so the opportunity to compete with the larger guys is the best there. We consider that an opportunity, not a problem and then New York North [indiscernible] so the size of the market, the magnitude of the market is second to none. But’s harder to get positive word of the mouth because it’s harder to have critical mass of referral. We sort of just appear to have just gotten there.
Ryan Nash - Goldman Sachs
And given that you’ve now gotten there, are you starting to think about the potential expansion into other markets beyond the three – four core markets?
Ryan Nash - Goldman Sachs
Switching gears for a sec to wealth management, obviously the build-outs have been a big success, but where do you think you are in terms of product, personnel and client penetration standpoint. But are we in the early innings and do we have a lot of runway to go?
Well, in New York as we can tell, of the 500,000, 550,000 -- $1 million households a couple years ago, it’s probably larger now probably 10% larger. We have about a 2%, 2.5% share, so we have a long ways to go. Boston is about the same, numbers are different of course, San Francisco, we’re at about 13% to 15%. So we have plenty of the runway and even in a more secure markets, San Francisco and the generation rate of new middle and upper income households in San Francisco is stunning. It’s very important to note that our – the average, or the median net worth for home loan clients is about $2 million, that’s very respectable number and it’s not a staggeringly high number. We do lot of professional lending, lot of professional lawyers, doctors, venture capital -- so one of the challenges we have on the bank is to always be adding the new – the younger member of all those professionals and at the older end, the bank is the highest and the best clients in the bank – the larger clients in the bank rather are probably in the late 50s. So we have a lot of younger clients coming up, so we have been very successful last couple years of regenerating that part of the bank.
Ryan Nash - Goldman Sachs
You talked, Jim, about the net interest margin remaining under pressure, the core margin at 330 but given the expectation of tapering starting either this month or next months [ph] 75% chance it happens and assuming we get steepening of the yield curve, what do we need to see for the actual core margin to begin to stabilize, and then we could actually start to see net interest income growing along with the loan portfolio.
Now the steepness of the yield curve will be very good for the bank, well, it’s good for most banks, it’s good for the economy too historically but it’s going to take a little time. I think the margin turns probably 4 to 6 quarters away, but that’s okay. And that I don’t know from our perspective we think the steepness will increase a bit. So we are pretty close to historical steepness right now, it doesn’t last usually if you go back [inaudible] last that long.
Ryan Nash - Goldman Sachs
Any questions from the audience. I guess I will continue. One of the things that’s been contemplated in Washington has been taking down overall GSC [ph] loan limits whether it’s in some of the markets that you guys participate or just in the broader market down from 417, had we thought long term – would this be a big tail wind for your business in terms of your ability to acquire customers and grow the loan portfolio.
It helps, it helps because we do – we did -- last year we did about three quarters of billion with Fannie business, agency business, and this year we will be in that range. So we do a lot of that but also to be drop in income tends to impact disproportionately the markets we are in. Those larger sizes are heavily coastal San Fran [ph], so it actually opens up more probably in our markets than anywhere else. But still a big business for us. The bigger issue is how are they going to resolve the GSCs but I have trouble imagining them going away quite frankly.
Ryan Nash - Goldman Sachs
One of the other big areas you guys had had growth has been the business bank, you said it’s been in business 10 or 11 years, kind of traded in number of verticals, where do you think you are in terms of building out each of the verticals that you have, I would say, both by a product and by the geographical perspective and are there any other verticals that you think would make sense just giving getting client mix?
I would say we are well situated. Obviously when you serve a certain vertical you want a certain individual that’s going to be an A player and able to speak the language to a private equity firm or non profits, so we are selectively higher and I think we are being methodical about the growth and the growth is still quite good. As far as new verticals I can’t see anything that we would get into at this point, and having said that we have added verticals by doing a deal and two deals and four deals and on and on and then realizing we had an expertise and the credit quality, first and foremost, was there. So it’s hard to say in the future will be something we could explore but at this stage there is nothing on the horizon.
Ryan Nash - Goldman Sachs
Jim, one of the big questions a lot of people have asked about the CCAR process, obviously you guys are not part of that process just yet. But as you look forward two to three years and become a $50 billion bank, I think you have talked about in the last call that there will obviously be some incremental expenses – but can you just give us a broader context – what have you done to prepare for that, what is still left to do in terms of preparation?
I think we are pretty well prepared on the stress test, we have done that three years in a row already. And the intensity of so to speak the real thing is a little greater but not that much. The additional regulatory scrutiny on all the things that we do particularly focused on AML, BSA and the things that nature, will cause us – and is causing a step up in invest in software. I think a fair amount of that is behind us already. The big change out there is liquidity coverage ratio and of course the graph is just out [indiscernible] and that’s going to have a two-step, it implements over 3 or 4 years and it has a two step [58 to 250]. So we are not – it won’t hit us for about two years, two and half years something like that. But that will cause us to increase our liquidity holdings. And that will have not so much a cost but a margin impact. We do have adequate capital in our planning forward, we’ve got to model them, I think, pretty correctly. So I think it’s mostly the intensity of all reporting. And remember one of the main things that is just behind that answer is we are pretty simple. We don’t do a lot of stuff. We keep it simple, and we don’t have this stuff very often. And so basically what we have been doing we have been doing for quite a while and it is core of banking [indiscernible] And the lending is of very limited type. And we don’t have a lot of things that the CCAR activities, not just the stress test but all the others focus on it.
Ryan Nash - Goldman Sachs
Probably time for one or some more questions.
So I think there is really three things that we bring to the table that differentiates us. One is customization. So a very few of our clients [indiscernible] for $5 million, and say I have no concentration in my life, no liquidity constraints, just give me your best banking. They want us to look at their total asset and liability picture and create a custom solution for that. A lot of firms have moved much more towards asset allocation buckets, doing more with less, we don’t do that. Two is objectivity, we do not create or manufacture proprietary product which brings through a lot of people and stuff in our industry, where it’s an industry that’s been riddled historically with conflicts of interest that come there and say we are fully open architecture, we are purely going to pick managers based on their merits, I am not going to enter into fee sharing arrangements and we are not going to sell you product.
And lastly it’s the service side, so again, the clients had a good experience on the banking side, on the lending side, it’s pervasive throughout the culture in the bank, being there at 4 o’clock or 3:59 on Friday to answer the client calls [indiscernible] so I think that’s really the differentiating characteristic.
A lot of that is really important too – where if Chris refers a banking client over to Glenn, Chris has a choice of wealth advisors and he mashes up the client with Glenn or someone else, and it’s not restricted to the team that’s going to decide [ph] in San Francisco, a very personal business, and he knows the client, and the other thing is of course Chris has seen the balance sheet of the client. So the referral is not only personally targeted but opportunity target and not a waste of time – not miss target. And then our turnover is very low, turnover is extremely low. So the consistency of player on both the banking side and the wealthy management side is very important.
Hi, just given that you lead, admittedly you lead the customer relationship with the jumbo origination. How does the QRM rule that’s going into effect in couple weeks change our strategy around that and then do you have that capacity to absorb all those loans on your balance sheet since you supposedly -- presumably can’t sell anymore?
The QRM part of the question, it doesn’t change very much what we are doing. That’s why Mike was referring to when he made the point, we have done fully documented, fully underwritten loans -- now that’s all we’ve ever done. And we do it that way because we see it as a relationship. You think about our holistic approach to banking over a 20-year period which is actually how we think. [indiscernible] it’s a four, five year asset, and it’s like 20% of your relationships but the relationships stay forever if you do a good job. That’s what we are after. The loan in order to have that kind of thinking it has to be fully underwritten or you wouldn’t do anything else. And we won’t do alone without a relationship [indiscernible]. And so it’s a little different. So QM doesn’t impact us in some ways. Now in another way it impacts us a lot -- probably most of you know as well, we do a lot of interest only lending and we do that mostly because our clients want it, if we didn’t make it up. And they like it, and they like it because many of our clients have uneven cash flows in the form of bonuses annually and so they like to be able to manage their cash flow and then make a principal payment out of bonus. And so that piece of our lending will be more subject to secondary provisions which are not clarified yet. So we may or may not be able to sell quite as many but I don’t think it’s going to have an overwhelming impact on us, I don’t want to be naive, we’ve focused on it intensely that enormous amounts of training, documentation changes et cetera obviously but income qualification we have been doing that from day one.
Ryan Nash - Goldman Sachs
Very well, please join me in thanking First Republic.
Thanks for having.
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