First Republic Bank's (FRC) CEO Jim Herbert on Q2 2014 Results - Earnings Call Transcript

Jul.16.14 | About: First Republic (FRC)

First Republic Bank (NYSE:FRC)

Q2 2014 Earnings Conference Call

July 16, 2014, 2:00 PM ET

Executives

Dianne Snedaker - EVP and CMO

Jim Herbert II - Chairman and CEO

Katherine August-deWilde - President

Mike D. Selfridge - COO

Willis H. Newton Jr. - Chief Financial Officer

Mike J. Roffler - SVP and Deputy CFO

Analysts

Steven Alexopoulos - JPMorgan

Erika Najarian - Bank of America

Ken Zerbe - Morgan Stanley

Ryan Nash - Goldman Sachs

Casey Haire - Jefferies

Dave Rochester - Deutsche Bank

Joe Morford - RBC Capital Markets

Lana Chan - BMO Capital Markets

John Pancari - Evercore

Aaron Deer - Sandler O'Neill

Paul Miller - FBR Capital

Tim Coffey - FIG Partners

John Moran - Macquarie Capital

Julianna Balicka - KBW

Operator

Greetings and welcome to the First Republic Bank's Second Quarter 2014 Earnings Conference Call. During today's call, the lines will be in a listen-only mode. Following the presentation, the conference will be open 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 second quarter 2014 conference call. Speaking today will be Jim Herbert, the Bank's Chairman and Chief Executive Officer; Katherine August-deWilde, President; Mike Selfridge, Chief Operating Officer; Willis Newton, Chief Financial Officer; and Mike Roffler, Deputy Chief Financial Officer.

Before I had the call over to Jim, please note that we may make forward-looking statements during today's call that are subject to risks, uncertainties and assumptions. In addition, some of our discussion may include non-GAAP financial measures.

For a more complete discussion of the risks and uncertainties that could cause actual results to differ materially from any forward-looking statements and reconciliations of non-GAAP financial measures, see the Bank's FDIC filings, including the Form 8-K filed today, all available on the Bank's website.

And now, I'd like to turn the call over to Jim Herbert.

Jim Herbert II

Thank you, Diane, and thanks to everyone for joining our call today. This was a very solid quarter, and we're quite pleased with the results. We'll cover the quarter in more detail in a minute, but I'd like to depart a bit from our usual format.

Let me take just a couple of minutes to talk about the significant additional investments we're making to address new and heightened regulatory standards and to discuss our business model.

Through a wide range of macro and microeconomic conditions and in highly competitive markets, First Republic has been quite successful and continuously profitable for over 29 years.

The key to this long-term stability and success has been a very simple business model, springing from a core culture that emphasizes credit quality, carefully managed asset liability matching, strong capital at all times, lack of operational silos, and a focus on exceptional client service delivered by a very tight and long-standing culture.

As you all know, institutions with over $50 billion in assets are required to operate under significantly heightened regulatory and compliance standards. We currently anticipate that our four quarter ending moving average assets will reach this $50 billion mark about the end of 2015, or roughly six quarters from now.

Our work to meet these standards is well along and is also very ongoing. This includes initiatives to enhance systems and procedures in many areas such as enterprise risk management, BSA/AML, capital and liquidity stress testing, compliance, resolution planning, and the still pending liquidity coverage ratio.

In terms of our expenses, as reflected by our core efficiency ratio, we currently anticipate that these incremental expenses will translate over time into an adjusted range of 59% to 62% efficiency ratio for at least a while.

Based on current estimates, we hope to be able to bring the efficiency ratio back down to 60% or below sometime in 2016. This will occur as some of the initial costs of these investments plateau, and we reach a new, somewhat elevated, expense run rate.

The expense level as a result of these initiatives will be commensurate with the asset size and risk profile of First Republic. These enhancements, we believe, will make us a stronger institution while not fundamentally changing our core client service model.

Let me talk about the model for a moment. The reason we believe we can successfully integrate these additional safeguards is the fundamental simplicity of our business model. When people think about larger institutions, they almost automatically assume a much greater complexity.

With First Republic, this is, in fact, not the case. For example, First Republic does not have a bank holding company. First Republic has only four operating subsidiaries. We have an extraordinarily simple corporate structure.

First Republic also services far fewer accounts and relationships than other banks of a similar size. For example, we maintain our approximately 275,000 deposit accounts in the entire Bank.

Based on public data, this number of accounts is equal to less than 20% of the number of accounts at banks of a similar size. Having fewer accounts provides us with an opportunity for much better individual account oversight and better client service.

Other examples of the simple nature of our business model are the many activities we don't engage in. For instance, we don't do proprietary trading. We don't do internet deposit gathering, we don't do subprime lending. We have no leverage lending, no credit derivatives, no foreign subsidiaries or cross-jurisdictional activities, et cetera. These are just a few of the over 30 additional activities in which many larger banks engage, but in which First Republic does not.

Another key hallmark of our business model is its long-term consistency of operations. For example, our business model today versus 10 years ago; the loan geography 10 years ago was San Francisco, New York, and Los Angeles accounting for about 76% of our total loans.

Today, these same markets account for 80% of our loans, virtually unchanged. 10 years ago, home loans and HELOCs totaled about 65% of our loans. Today, they total 62%, virtually unchanged in a decade.

10 years ago, our average loan-to-value ratio on single family loans was at 58%. Today, they are 61%. Our borrowers' FICO score 10 years ago was 744, today it is 762, virtually unchanged in a decade. 10 years ago, our funding mix consisted of deposits of 78%. Today they are 84%; even stronger. Tier 1 leverage ratio 10 years ago was 7.1%. Today it is 9.7%; even stronger.

Importantly, and Katherine will speak more about this in a moment, loan sales have been a consistent component of how we have managed the bank since it was founded. This approach has also unchanged. In fact, this recent quarter was our largest loan sale quarter ever.

We've operated for decades in a very consistent and deliberate manner with very little change in our core model. What has changed, however, is the competitive landscape of the banking industry.

The banking industry is substantially more concentrated today than it was 10 years ago. For instance, America's four largest retail banks; Citi, JPMorgan, BofA, and Wells, today have $8 trillion in assets, controlling a staggering 54% of all banking assets in the entire country. 10 years ago, these same four banks had only a 36% concentration. For perspective, First Republic has approximately one third of 1% of such banking assets.

However, First Republic successfully provides competition to these four giants every day by providing superior, highly coordinated, relationship-based service that results in a high level of client satisfaction and loyalty.

As an example, First Republic's Net Promoter Score, which measures client loyalty is twice as strong as the banking industry as a whole.

In summary, First Republic is closing in on an important milestone as we prepare to operate as a $50 billion plus institution. We are very systematically enhancing our infrastructure and systems, so that we will not only meet the heightened regulatory standards, but also allow us to continue to operate successfully.

We are guided in this process by a business model and a deeply established corporate culture that is uncomplicated, highly coordinated without silos, and which delivers extraordinary client service one client at a time.

Now, let me turn the call over to Katherine.

Katherine August-deWilde

Thank you, Jim. I would like to run through some key numbers for the second quarter and then talk about loan volume, loan sales and Wealth Management. Core revenues were up 17% year-over-year. Core earnings per share was $0.69, up 8% year-over-year.

Loan volume increased this quarter to $4.7 billion and our loan pipeline continues to be strong. Overall, our franchise continues to perform well. Credit quality is very strong. Non-performing assets remained low at only 11 basis points of total assets.

Net charge offs for the quarter were less than one basis point. Importantly, we continue to underwrite very high quality loans without any adverse credit migration. The weighted loan to value on our single-family loans was 61% for the quarter. The weighted loan to value on new multi-family and commercial real estate loans was only 51% this quarter.

Significantly, purchase activity remains strong in all of our markets. Home purchases for the second quarter accounted for fully 65% of our single-family originations, the highest percentage in many years.

Elevated home purchase activity illustrates the vibrancy of real estate in our market. Many homes continue to sell with multiple offers. Our differentiated service model is particularly effective in purchase markets.

Let me speak briefly about our record volume of loan sales for the quarter. For 29 years we have consistently sold many of our home loans into the secondary market. We've retained the client relationships and have an opportunity to cross sell other products, including deposits, Business Banking and Wealth Management.

In the second quarter, we continued to take advantage of the strong demand for our loans by selling $1.3 billion of home loans into the secondary markets. We plan to remain active in the secondary market to help us manage our asset growth, while improving our asset liability matching. This is particularly valuable as we prepare for an eventual rise in interest rates.

We would note that for the first half of the year, on an annualized basis, unpaid principle loan balances, excluding loans held for sale, grew 13%, more slowly than our historical rate. The second quarter is often our largest quarter of loan growth. This is usually driven by strong spring sales.

We would note that the growth rate of average loan balances as disclosed in our quarterly earnings releases has declined each quarter for the past four quarters. Based on current estimates, we expect growth in unpaid principle loan balances, excluding loans held for sale, to be approximately 11% to 13% for the full year.

Private Wealth Management had another strong quarter. Revenues were up 28% compared to the same quarter a year ago. Assets under management were up 34% year-over-year. For the quarter more than 60% of the growth came from net client inflows.

Clients continue to be attracted to our open architecture solutions which are customized to meet their needs. Overall, we are very pleased with this quarter's result.

Now, I will turn the call over to Mike Selfridge.

Mike D. Selfridge

Thank you, Katherine. We continue to be very well capitalized. Our Tier 1 leverage ratio remained strong at 9.7%. Our Tier 1 common equity ratio also remained strong at 10.9%. Book value per common share was up 14% from last year to $26.82.

Total deposits were $35 billion and importantly, checking now represents 53% of total deposits. We are pleased to have achieved a decline in our cost to deposits during the quarter, down from 21 to 19 basis points.

Our Business Banking franchise continues to develop nicely. It's centered on our existing core business verticals were we follow our satisfied individual clients to the businesses they manage or the non-profits they influence, and this strategy continues to be successful.

As Jim said, we continue to build and invest substantially in our compliance and enterprise risk management systems and capabilities. We are pleased to have strengthened our management team with the additions of two Senior Executives Bill Ward and Gaye Erkan.

Bill Ward, Chief BSA/AML Officer, is a very experienced executive and he will lead a number of strategic initiatives. As Co-Chief Risk Officer and Chief Investment Officer, Gaye Erkan, further strengthens our ongoing proactive enterprise risk management and investment functions.

In terms of asset liability management, we took certain actions during the quarter to manage interest rate risk. On the asset side, as Katherine mentioned, we sold a significant number longer duration loans. And with respect to our non-deposit funding, our $5.5 billion of fixed rate term, FHLB advances are lattered and have a remaining life of approximately three years.

Also during the quarter, we successfully entered the investment grade term debt markets, raising $400 million in a 5-year fixed rate, unsecured note offering, which further extends our liabilities in the face of potential rising interest rates. We were extremely pleased with the robust demand of this offering which subsequently is traded even tighter than the issuance rate.

First Republic's core markets continue to perform very well, in particular, economic activity in the San Francisco Bay area remained strong, mainly due to the innovation economy were First Republic has many long-standing relationships.

Now let met turn the call over to Willis Newton.

Willis H. Newton Jr.

Thank you, Mike. I would like to talk about net interest margin, our high quality liquid asset portfolios and purchase accounting.

Our net interest margin remained consistent with the prior quarter, declining one basis point to 3.16%. Our contractual loan yield declined three basis points this quarter, which was partially offset by a two basis point decline in deposit cost as Mike just mentioned.

We believe NIM will continue to be under modest pressure for the next few quarters as new loan originations continue to have slightly lower rates than our current average loan portfolio yield.

As we discussed on our last quarter call, we are systematically building a high-quality liquid asset portfolio in accordance with the proposed LCR rules. This is progressing as planned.

Now that we've completed four years of divestiture, I would to summarize our purchase accounting. We started with 760 million of loan discounts and have accreted three quarters of this amount. We had a 144 million of liability premiums. Most of this amount has been recognized as income.

As a offset we had a 127 billion of intangible assets to be amortized and we have expensed two-thirds of this amount. These purchase accounting entries have gone as expected and are now contributing a diminishing amount to our earnings.

The remaining net purchase accounting income will increase our book value per share by about $0.59 over the next few years.

Now, I would like to turn the call over to Mike Roffler.

Mike J. Roffler

Thanks Willis. I would like to cover our loan loss reserve and provide a bit more detail about our expense levels. During the second quarter, we added 22 million to our loan loss reserve due to growth in loans outstanding, particularly business loans, as we've seen utilization rates on our business line increase during the quarter, which we views as good sign of economic activity in our markets.

This provision brought the total reserve to 181 million at quarter-end, approximately 56 basis points of loans originated, since our independence, which does include in unallocated reserve. We would expect that our loan loss reserve will be in the range of 55 to 60 basis points on newly originated loans over time.

Now let me turn to expenses. Our core efficiency ratio was 56.3% this quarter which has improved slightly from the first quarter. Expenses were up 2.4% from the prior quarter due largely to higher professional fees and information system costs related to regulatory initiatives.

As Jim mentioned, we are accelerating the strength of our infrastructure as we get closer to becoming the $50 billion institution. This will have associated expenses, some of which were permanent and ongoing and some of which are near term.

The increase in future expenses is primarily around compensation related to additional employees, information systems, consulting and other professional fees. We have already added staff and we will continue to do for the rest of 2014 and next year to meet these higher standards.

Based on current estimates, these higher level of staffing technology cost along with the elevated consulting fees will result in a near term increase to our efficiency ratio in the range of 60% to 62% beginning this quarter, and likely last until the end of 2015.

We expect the efficiency ratio to peak in the first quarter of 2015 given the seasonal nature of payroll taxes. Based on current estimates, we think the efficiency ratio could return to a range below 60% in 2016.

Now I would like to turn the call back to Jim.

Jim Herbert II

Thank you, Mike. Thank you all. We are very pleased with the way the models performing at this time. We are willing to take questions. And why don’t we open up operator for questions. Thank you very much.

Question-and-Answer Session

Operator

Thank you. Ladies and gentlemen, we will now conduct the question-and-answer session. (Operator Instructions).

Our first question comes from the line of Steven Alexopoulos from JPMorgan. Your line is open.

Steven Alexopoulos - JPMorgan

Hey, everyone.

Jim Herbert II

Hi, Steve.

Steven Alexopoulos - JPMorgan

Maybe I will start -- maybe to follow-up on Mike's comments with the efficiency ratio going above 60%. Mike, it is probably helpful for us if you could talk about where you see the run rate of actual operating expense going right from $223 million this quarter, like where should we expect that to trend near term?

Mike J. Roffler

So, we do think that starting the third quarter, we will head towards around 60% or a little bit above that range. So, using the current revenues of the quarter, that math is, you know, probably around $15 million or so, maybe a little bit more.

Steven Alexopoulos - JPMorgan

And Mike, that figure would jump over a quarterly basis. Is that additional headcount to these people you are hiring? Is this professional fees as you bring in consultants?

Mike J. Roffler

Yes. So, it’s in a couple places, Steve. It’s in headcount where we are bringing in additional staffing. There is some consulting that is -- some of that's going to be near term for the next several quarters, and it gets replaced to a little bit over time by headcount, and there is also a little bit of technology cost as we are investing systems for various other regulatory initiatives.

Steven Alexopoulos - JPMorgan

Got you. Okay. And I wanted to follow-up on Katherine's comments for the -- I think you said unpaid principal loan growth in the 11% to 13% range. I don’t know if that number was right. But what exactly -- was that full year of loan growth you were guiding to?

Katherine August-deWilde

That's full-year loan growth, yes. Full-year loan growth of unpaid principal balance, yes, and it’s excludes loans held for sale.

Steven Alexopoulos - JPMorgan

Great. So, Katherine, if we think about where the originations have been trending, I guess that implies a material step-up in loan sales for the year, is that correct?

Katherine August-deWilde

As we always have, we expect to use the secondary market loan sales to manage our loan growth and our balance sheet growth for the rest of the quarter.

Steven Alexopoulos - JPMorgan

I mean, is this the function of just more customer preference for fixed rates, so you are selling more, or is this a balance sheet management just to sell more loans, what’s underlying this?

Katherine August-deWilde

It’s both things. It’s a function of preference for higher duration loans, and it’s also management of the balance sheet.

Steven Alexopoulos - JPMorgan

Okay. And maybe just one final question. The refi originations stayed lot stronger than I was expecting. What's driving refi volumes here? I can imagine people having refi to take advantage of lower rates, yet, so just wondering what's driving that at this point? Thanks.

Katherine August-deWilde

There are always some people who didn’t refi before or people who are refinancing because they are renovating their homes or taking cash out or other reasons. There is a variety of reasons they may do that, but you are right it is surprising, and if someone has refinanced recently, we don’t expect them to refinance again unless they are doing something new to the house.

Steven Alexopoulos - JPMorgan

Okay. Thanks for the color.

Operator

Our next question comes from the line of Erika Najarian with Bank of America. Your line is open.

Erika Najarian - Bank of America

Yes, good afternoon. Just asking the other side of Steve's question. You know, I noticed that you, Mike, answered his expense question based on this quarter or last quarter's revenue run rate. I guess as we think about the near term 60% to 62% efficiency ratio, can we just ask what your revenue assumptions are or are you just annualizing your run rate for revenues this quarter?

Willis H. Newton Jr.

So, some of the revenues will be driven by a couple of parts of the business. One will be the loan growth that Katherine spoke to along with, you know, wealth management fee income and sort of -- and then the sort of $15 million to $20 million increase in expenses, sort of factored all in leads us to that 60 -- to low 60 range in efficiency.

Erika Najarian - Bank of America

Okay. So just to clarify, both sides, is the equation -- both the numerator and denominator in that target are dynamic, it’s not just accounting for higher expense, it’s also accounting for better revenues.

Willis H. Newton Jr.

That's absolutely correct.

Erika Najarian - Bank of America

Okay. And, you know, Jim, you have talked about -- you know, your growth trajectory has suggested that you would hit $50 billion when you are planning to, I guess, I am just wondering were you surprised at sort of what you needed to do, you know, to get to that level? I think that we are all a little bit surprised as to the level of investments that you have to make when crossing that threshold.

Jim Herbert II

The answer is, yes, a little bit. The speed of getting there has a lot to do with the cost of getting there. We are looking at the -- so we have got -- we have about a year and a half basically, and this is a full quarter moving average. So -- and we are very anxious to stay ahead of it as opposed to get behind it, and so that forces us or encourages us to invest more rapidly in some of the systems procedure, and we are trying to frontload the people aspect of it as well to make sure they are onboard that we have got the right people that they are working together as a team and are ready to run this. It isn’t just about getting there, it’s about running it.

And so, we are trying to anticipate regulatory needs as much as we can in addition to just responding.

Erika Najarian - Bank of America

Got it.

Jim Herbert II

We have found generally over the years that investing in advance is very valuable.

Erika Najarian - Bank of America

Got it. And just to take a step back -- thank you for all the detail that you've provided in terms of how you believe your efficiency ratio is trending. But we -- if the industry doesn't get any help from interest rates, is the message there that being a $50 billion bank comes with something like a 500 basis point tax on efficiency on your natural efficiency ratio?

Jim Herbert II

We really can't speak to other institutions. Our experience is that there is a component as Mike said of getting there and there is a component of operating there. We are clearly more clear to stage on getting there than we are on operating because we haven’t been there yet.

The -- anytime you have an inflection upwards on expense -- expenditures around a particular moment in time out of an event, you are always going to get a component of short term and long term investing. And we are experiencing that around this one.

Erika Najarian - Bank of America

Okay. And just one more, if I could sneak one in. If I were looking in a very long-term earnings trajectory for this firm -- you've mentioned, prior to today that you were comfortable operating between 55% to 59%. I guess even beyond 2016, is the message that you would need rates to get to this lower end of that 55% to 59% because of the cost of running, as you mentioned, will obviously be in the run rate?

Jim Herbert II

The 55% to 59% is probably going to end up landing at a somewhat higher level, but hopefully not much. And that is an estimate without really substantial benefit from a rate rise; some, but not much.

Erika Najarian - Bank of America

Got it. Okay, thanks for all the answers.

Jim Herbert II

Thank you.

Operator

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

Ken Zerbe - Morgan Stanley

Hey, thank you. I'm just going to keep pressing on this expense issue. Jim, if you could just help us understand -- what changed, like what happened? Because it feels like last quarter, things were fine. And I think at times you had addressed that you were spending to comply with the $50 billion asset crossing.

But it's almost like something very material happened, in terms of your thinking, in terms of what you've been asked to do, that led to such a dramatic shift from last quarter to this quarter in terms of what the ultimate regulatory expense is going to be. Can you just help us understand what that was?

Jim Herbert II

I think there's a difference, Ken. I appreciate the question. I don't mind it at all. I think that the real question here is not so much what changed in the overall needs, but our speed with which we decided to get at it.

The liquidity stress testing -- stress testing itself, enterprise risk management review and getting it up to speed -- we've front-loaded a lot of those by bringing some people in to get us moving on them quite quickly.

The other thing that happens is that the regulators do not wait until you're $50 billion to impose some of this guidance on you. And in respecting their process as we do, they basically will give you guidance and counsel along the way on what they're expecting, with greater clarity as you get closer. That's helped, actually, to illuminate for us to where we need to be.

I would hasten to add, we don't find any of this particularly threatening. It's just work that needs to get done and systems and procedures that need to be improved. You can stretch it out, or you can get it out -- you can establish those new procedures and systems and personnel level quickly. We have chosen to do the latter.

Ken Zerbe - Morgan Stanley

Okay. Well, that helps a little bit. Second question for you, just in terms of provision expense. You've obviously had very good loan growth in the past, but without a corresponding increase in provision to the magnitude that we saw it this quarter.

I mean is it because -- I mean I heard a mention about C&I. Is it just simply because C&I carries much higher than, say, the 55 to 60 basis point reserve allocation? And as we see better C&I, we're going to see even -- I'm just trying to get a sense of why it was as high as it was.

Mike J. Roffler

Ken, I think you're on the right direction. Obviously, the business lending does come into the process through at higher than the 55 to 60, compared to the home loan, which is much less than that.

So, given the increase in utilization that occurred in business lines -- and it did help increase the outstandings during the quarter -- that led to higher provision levels, given that little bit of change in mix that occurred compared to what you may have seen in prior periods.

Ken Zerbe - Morgan Stanley

So, on a go-forward basis, if you're at 50 basis points reserve today, we should eventually blend up to 55 to 60?

Mike J. Roffler

Yeah. That's right.

Ken Zerbe - Morgan Stanley

Okay. Thank you.

Willis H. Newton Jr.

And Ken I would point you to a table in our press release that splits out our portfolio between the old loans that don't really have much allowance on them, and the new loans that we have to provide as we grow that portfolio. That is currently at 56 basis points, which is right in the middle of our 50 to 60 range overall.

Ken Zerbe - Morgan Stanley

All right. Thank you.

Operator

Your next question comes from the line of Ryan Nash with Goldman Sachs. Your line is open.

Ryan Nash - Goldman Sachs

Yes, hi, good afternoon. Just to follow up on the last question that Ken asked, I'm just trying to make sure I understood it right. In terms of getting to the 55 to 60, should we expect that to happen over the next couple of quarters, or is this something that's more longer term oriented?

Mike J. Roffler

Probably next year, six quarters, something like that. As Willis just mentioned, as the acquired loans continue to decline and the new loans become a bigger portion of the total, we'll get closer to the 55 to 60.

Ryan Nash - Goldman Sachs

Got it. And then in terms of the actual dollar amount of expenses that you talked about, as we think about the much longer term of the 2015 or so, how much of that do you actually think stays in the run rate as we get into 2016? And is there a timing element -- is there -- between when you're actually spending the money versus when it actually hits the financials?

Mike J. Roffler

I would say that much of that 15 to 20 increase that we're going to see here in the near-term likely continues into the future 2015 numbers. Some of it is going to be -- we use consultants today that are going to be replaced by permanent staffing as we build up over time.

Ryan Nash - Goldman Sachs

Okay. And then Jim, you gave some color on what this reinvestment program entails. But can you just give us a little more context in terms of what program specifically you're investing in? Where do you feel that you don't have the -- where are the areas where regulators felt you didn't have the right infrastructure? And how long is maybe the timeframe on each of those?

Jim Herbert II

Well, let me start with the fact that there are no places where we don't have the right infrastructure in terms of the enterprise risk management, stress testing, et cetera. It's us responding to what we believe we're going to need and to indications of some of the greater clarity that we're going to need.

The places that we are spending most of the money are enhancing our AML/BSA area, enhancing enterprise risk management. For instance, give you an example there or let me give you a stress test liquidity example.

Our stress testing, in terms of liquidity, we run three or four scenarios. The guidance for a larger institution is eight or nine scenarios. So, we have to build up to that and that takes a considerable additional database and quantitative capability. It also takes an ongoing reporting capability that we have, but needs to be enhanced.

So, the -- and obviously, we're also a big mortgage lender. And QM has imposed upon us a considerable number of additional reporting and issuance guidelines in the mortgage area. So it's not all about $50 billion; it's also about the new rules of the mortgage field.

So there's a wide range of things. The list, quite frankly, is quite long. But most of the -- we're doing a form of all of these and we're basically enhancing in every single case. There is nothing in the list that is brand new -- unless, Mike, I'm missing something. There's really nothing that's brand new. We're enhancing across the Board. But this isn't about $50 billion. Just stand back for a second.

We run -- one of the reasons you all have invested in us or your clients have -- and we've run it well over the long time is -- we think ahead. And this is ahead. And we need to be not a $50 billion bank; we need to be an extremely well-run $60 billion bank and thereafter. And we intend to be as equally good in the future as we have been in the past. And that means investing heavily and spending properly at the right time. This is the right time.

Ryan Nash - Goldman Sachs

Got it. Thanks for taking my question.

Operator

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

Casey Haire - Jefferies

Hey, good morning guys. So, question on the LCR bill, Willis, it sounded as though you guys were steadily making progress. I think you had mentioned you wanted to get to $1 billion by year-end. I'm just curious how -- if you are -- where are you on that timeline or towards that $1 billion goal? And how could that be -- how could you be making progress with the securities yields actually climbing slightly on the quarter, if you are building your HQLA?

Willis H. Newton Jr.

The HQLA investment portfolio for the quarter increased from about $300 million to about $600 million. And you are right; we are systematically building that over the year towards a $1 billion. We have plenty of cash right now and so that, I would remind you, is a high-quality liquid asset as well.

Casey Haire - Jefferies

Okay. Was it -- I mean, did you guys buy at the end of the quarter, because I'm just struggling to see if you are -- that HQLA, I assume, comes at like a 2% yield and you have the securities yield going up two bps on a quarter, it just seems -- I mean, unless you are investing pretty aggressively someplace else I'm trying to figure out how you can get securities yield going up if it's getting more HQLA concentration.

Jim Herbert II

The -- we are not investing anywhere else at all. And it's really just a case of moving out and cashing in the HQLA and the HQLA yield composite has been 2% roughly.

Mike J. Roffler

Yeah, Casey. This is Mike. There is some buying that would have occurred later in the quarter and again the large part of the securities portfolio hasn’t changed, it still continues to be held maturity municipal portfolio.

There are some securities like the federal home loan banks that also will impact the yields from quarter-to-quarter depending on their dividend rate which was pretty good this quarter.

Casey Haire - Jefferies

Got you. Okay. And then apologies if I missed this, any -- did you guys provide any color on -- in terms of were gain on sale margins are early on in the third quarter here?

Katherine August-deWilde

In the second quarter they were about 1.13%. What they will be in the future is subject to two things, one, how strong the market is and the demand for loans in general and securitization market. And second, well the coupons are on the loans we put out as well as the duration. So we don’t know what will happen this quarter, but we will plan to sell loans.

We get a very wide range of bids. We put out a packet and we may get eight to 10 bids and there is usually a bit of competition. But what they will be, we will have to let you know next quarter.

Casey Haire - Jefferies

Got you. Okay. And then just lastly, multi-family originations were down little bit, we've kind of seen some of the multi-families players talk pretty constructively about loan growth this quarter. I'm just curious why the lower production level for this quarter -- for you guys this quarter?

Katherine August-deWilde

I think it's just a matter of what our clients are doing at the moment and I don’t think it was material.

Casey Haire - Jefferies

Okay. Thank you.

Operator

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

Dave Rochester - Deutsche Bank

Hey, good morning, guys.

Jim Herbert II

Hi, Dave.

Dave Rochester - Deutsche Bank

Back on your investment plan. I was just wondering if you anticipated any of this -- the ramp up of the processes and systems that have any kind of an impact on the growth of the franchise overall as you are going through this over the next year and change. Are you expecting any kind of distraction for people internally? Is that impacting all of your slower loan growth guidance?

Jim Herbert II

Actually, no its not, Dave, I appreciate that question. Because, in fact, as you heard throughout the call, it's easy to get distracted entirely with the expense issue. The franchise is firing on every cylinder. The real issue in terms of asset growth is managing in just kind of a modest way towards 50 billion, coordinating that with our timing in terms of our enhancements.

And to the extent that we have client demand for loans, client inflow into Wealth Management, deposit flows, to be perfectly frank we've never seen it better.

Dave Rochester - Deutsche Bank

Great. Thanks. And just one other question on the non-interest bearing growth, that was very strong this quarter. Can you just give a little more color on what drove that? If there were any lumpy deposits in there and maybe what the breakdown was between business customers and high net worth customers? Thanks.

Mike J. Roffler

So the deposit split, Dave, within the quarter is about 50-50 between business and consumer. And I think as Jim just said, we've seen good client activity which led to the growth you saw in deposits during the quarter.

Dave Rochester - Deutsche Bank

Any large deposits come through that that could have boosted that? It was pretty strong growth.

Katherine August-deWilde

Not particularly with our typical client mix with no particular change in client mix. There has been over the last several quarters a slight tilt towards bit more business deposits.

Dave Rochester - Deutsche Bank

All right, great. Thanks.

Operator

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

Joe Morford - RBC Capital Markets

Thanks. Good morning everyone.

Jim Herbert II

Hi, Joe.

Joe Morford - RBC Capital Markets

First, I guess, just following up on Casey's question. Can you just, I guess, talk a little bit more about the changes you saw in the secondary market in the second quarter that enabled you to sell a much greater volume loans and at higher margins as well. And clarify expectations going forward with this slower portfolio growth, should we expect similar gains in this range of around $15 million a quarter?

Katherine August-deWilde

In terms of the opportunity to sell loans in the secondary market, we saw considerable demand. We've put out quite a few packages and we had aggressive competition for those packages.

We -- with the plan, we thought the market would be strong and we had a plan to sell loans to manage growth. We have a plan to sell loans in the third quarter and fourth quarter with the prices as determinable right now and it will depend on what the appetite is and what the coupons are on those loans.

I don’t mean to be vague about it, but it's something we don’t normally know from quarter-to-quarter, because it is a market and the market seeks.

Joe Morford - RBC Capital Markets

Right. Understand. I guess, the other question, the commercial business originations were very encouraging this quarter. Can you quantify the increase in the utilization rate you saw and talked about, as well as just in general talk about any other drivers to the current strength there?

Mike J. Roffler

Sure. The drivers continue to be our same business verticals as Mike Selfridge has talked about and utilization rates have been running sort of at 31%-32% and they ticked out to around 36% given some strong activity that we've seen in the markets and among our client base.

Joe Morford - RBC Capital Markets

Would you say that’s increased confidence from borrowers or anything else…?

Mike J. Roffler

Yeah, I think so.

Joe Morford - RBC Capital Markets

Okay. Great. Thanks Mike.

Operator

Our next question comes from the line of Lana Chan with RBC Capital Markets [BMO Capital Markets].

Jim Herbert II

Hello Lana? Operator?

Operator

One moment, we are experiencing some technical difficulty.

Jim Herbert II

Operator, are you still there?

Operator

Yes, I am. One moment please.

Jim Herbert II

Okay.

Operator

Lana Chan with RBC Capital Markets [BMO Capital Markets] your line is open.

Lana Chan - BMO Capital Markets

Hello, can you hear me?

Jim Herbert II

We can Lana. Thank you. Thanks for your patience.

Lana Chan - BMO Capital Markets

No problem. It's Lana Chan from BMO Capital Markets. On the expenses when I look at -- just in terms of your guidance of the efficiency ratio and building in the infrastructure for the regulation. I guess, how do you give us comfort that the 60 -- or 59% to 62% is the right level for size, bank that’s crossing CCAR.

I mean, when I look at other banks that are CCAR, their expense ratio as a percent of average assets, the median is about 3%. I don’t know if you've looked at that way.

Mike J. Roffler

Lana, we are aware that people have said that 3% for an institution like that. We believe our corporate structure helps us being the simple business model, not many operating subsidiaries, not having systems that were migrated over many acquisitions, so its bit simpler for us to get a data.

So we think that the increase we talked about is a reasonable estimate today, but regulations, obviously, evolve also. I think we commented the number of accounts for a bank our size is much lower than you would expect for an institutional of $45 billion. And all of that helps us and gives us some confidence that the expense level increase we're talking about is a reasonable estimate today.

Lana Chan - BMO Capital Markets

Okay. Thank you. And just another follow-up on the LCR. As you continue to build the securities to potentially comply with LCR, I mean should we expect the securities yields to start being under some pressure? Again, just following up on the previous question, seems like highly liquid assets -- or high-quality liquid assets would be coming in at much lower securities yields.

Willis H. Newton Jr.

Lana, this is Willis. I think that's clearly right. One of the reasons why we're not buying a lot of assets today is we think that there might be better opportunities for higher yields in the future. But we will be ramping up the portfolio in the interest rate environment that exists over time.

Lana Chan - BMO Capital Markets

Okay. Thanks, Willis.

Operator

Your next question comes from the line of John Pancari with Evercore. Your line is open.

John Pancari - Evercore

Good morning. Along that securities yield question, what would a be fair, all-in, LCR compliant, blended securities yield -- let's say by the end of 2015 -- that you would expect, once you are finished with the HQLA build?

Jim Herbert II

Probably -- end of 2015 of course is speculative on rates. But ignoring that for a minute, I would guess it's around -- in today's rate environment -- around 1%, 1.25%, something like that.

John Pancari - Evercore

Okay. And I guess what I was getting at is the blended yield for the entire securities portfolio. I'm just trying to -- kind of along the line of Lana's questions that if the overall securities portfolio yield should be pressured as you dial up the HQLA, is it fair to assume that the overall blended yield for your bond book is in the ballpark of I don't know maybe upper 4s?

Jim Herbert II

That's actually a much tougher question. Can we get back to you on that because I don't want to do that on the cuff here.

John Pancari - Evercore

No, that's fine. That's fine. And then--

Jim Herbert II

We need to look at size blending as well as rate, okay?

John Pancari - Evercore

That's fine. Okay. And then back to the loan growth. The 11% to 13% year-over-year guidance, that is on average balances, correct?

Katherine August-deWilde

No. That's on quarter-end balances; quarter-to-quarter and year-to-year.

John Pancari - Evercore

Okay, okay, right. And so does that -- as we're just trying to look at the numbers here -- does that imply that end of period balances from here through the rest of the year, they should continue to grow at a -- but at a slower pace -- I mean is it fair to assume that is a high-single-digit type of pace?

Katherine August-deWilde

We expect to continue to grow loan balances. What we were guiding you to was 11% to 13% year-over-year loan growth rate.

John Pancari - Evercore

Okay. I'm just trying to get and see how this will actually play out through the quarters. And then to get a little bit more of that color behind the driver of the reduced outlook there, if I understand it correctly, so you're going to continue to push portfolios like the commercial portfolio, but step up sales in the resi book, correct?

Katherine August-deWilde

That's -- we're going to step up sales in the resi book. Yes, that's correct. We're going to plan.

John Pancari - Evercore

Okay, okay. And that is purely going off of your commentary before, particularly what Jim had just mentioned, that's mainly as you're targeting the glide path towards that $50 billion target. This isn't anything that is regulatory-driven, in terms of the Bank of being told to slow the pace of your growth.

Katherine August-deWilde

It's exactly what Jim said -- to manage the flight path to that four quarters of $50 billion. We want to do it well; we want to do it carefully; and we can manage our loan growth to help us make that objective.

John Pancari - Evercore

Okay. All right. And then lastly, sorry to hop around, but back to the margin. I'm sorry if you already gave color on it. But how does the securities yield outlook, as well as the impact on loan yields, play into your overall view on the margin in coming quarters?

Willis H. Newton Jr.

Well, the margin is going to be under pressure, as the deposits are about as low as they can get. And we also did the $400 million of investment grade, five year, unsecured notes. We will have to absorb that for a full quarter.

But the loan yield is coming in relatively consistent to where our average loans portfolio yield is. So, there will be a little pressure from continuing low rates on loans, and a little bit also from the other two factors I just mentioned.

John Pancari - Evercore

Okay. All right. Thank you.

Operator

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

Aaron Deer - Sandler O'Neill

Hi, good morning guys.

Jim Herbert II

Good morning Aaron.

Aaron Deer - Sandler O'Neill

Most of my questions have been answered. I just have two quick follow-ups. One is, Mike Roffler, if -- I might've missed it, but did you give the utilization rates on the C&I book? And if so, can you give us that, and where it was last quarter and a year ago?

Mike J. Roffler

Yes, so on our lines; it's about 36% this quarter. It has been hovering around 32% last quarter; and similarly, I think, around that range last year.

Aaron Deer - Sandler O'Neill

Okay. And then, Willis, you mentioned that the purchase accounting impacts, you're still looking for that to have an effect over the next few years. I think there's somewhere around $180 million left on the loan book in terms of discount that remains. At this point, is what's left going to just bleed off at a steady pace? Or do you still expect it to be more front-loaded than with some tail extending into that third year?

Willis H. Newton Jr.

It all depends on when those loans pay off. And they've been paying off -- in this low rate environment, they've been paying off a little more rapidly than we might have thought. I would -- my guess is that it's going to trail off and then become a very insignificant part of our financial results after about three years.

Aaron Deer - Sandler O'Neill

Okay. All right.

Willis H. Newton Jr.

It's $0.05 to $0.06 a quarter right now.

Aaron Deer - Sandler O'Neill

Yeah. Okay, great. Thank you.

Operator

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

Paul Miller - FBR Capital

Yeah, thank you very much. On the 1.3 -- if you said this, I missed it -- on the $1.3 billion, was that all that you sold into the market? Was that a mixture of legacy and brand-new stuff or was that mainly brand-new stuff that you originated in the quarter?

Katherine August-deWilde

It was a mixture of legacy and brand new. And I don't have the breakdown between them.

Paul Miller - FBR Capital

Okay, but most of it was long-duration type stuff, I guess, right, I guess 20-year I mean 20-year plus?

Katherine August-deWilde

We sold 30s, 15, 10s, and 7s.

Paul Miller - FBR Capital

Okay. And -- you've been living with it for well north of a year. Wells Fargo has been -- or I should say a big competitor has been very competitive in the market. How are you able to compete with that type of competition, where they just have a huge appetite for these type of loans?

Katherine August-deWilde

We compete quite effectively against larger banks, primarily by delivering a higher level of very personalized service. We also compete particularly well when it's a purchase market.

Realtors like us. They trust that we will close the loans. Our commitments mean something in all of our markets. And our relationship managers work very closely with their clients.

Their clients like us, and refer their colleagues and friends to us. And the professionals in the real estate -- the real estate professionals, the CPAs and lawyers -- are happy to refer their clients to us, and that's how we succeed.

Paul Miller - FBR Capital

Have you seen the same struggles that the conforming market has seen in the purchase world as in the jumbo world? I know the jumbo has a different dynamic, but it just seems like the overall purchase market is not as strong as a lot of analysts like myself thought it would be, on the conforming side. But how has it been so far on the jumbo side?

Katherine August-deWilde

Well, on the conforming side, we tend to sell loans one by one to Fannie Mae. And we make a loan, we lock it in, and we sell it. And so that's how we deal with that, we don't see any problem doing that. So, I'm not sure I understand your question.

Paul Miller - FBR Capital

Well, I guess the question is, on the overall market, the purchase market is probably at the same level it was 25 years ago. Are you seeing the same dynamics in the jumbo market as the conforming players are seeing in the purchase markets, on a macro sense?

Katherine August-deWilde

We're in very strong markets, with a very active purchase market and a tremendous amount of activity. There's new construction in all of our markets and it's a very vibrant market, so we are seeing an awful lot of business.

Paul Miller - FBR Capital

Thank you very much.

Katherine August-deWilde

The market is strong. Okay.

Paul Miller - FBR Capital

Thank you very much. Bye.

Operator

Your next question comes from the line of Tim Coffey with FIG Partners. Your line is open.

Tim Coffey - FIG Partners

Thank you. Good morning everybody. With the new expenses related to all the items you've mentioned already, are you anticipating a slowdown in any investments in the wealth management unit?

Katherine August-deWilde

We're not seeing a slowdown in wealth management. Our wealth management growth was strong, as I think I mentioned. 60% of the growth was from net new client inflow, so we're seeing good demand.

Tim Coffey - FIG Partners

Great. And what about investments in that unit?

Katherine August-deWilde

There was a bit of investment in that unit that is in our plan and that's in the numbers. And obviously as we grow the investment management business, we need to always make sure we not only keep up with, but get ahead of, what our clients need for their reporting and for proper trading and other systems.

Tim Coffey - FIG Partners

All right.

Katherine August-deWilde

And we feel very comfortable with our plan there.

Tim Coffey - FIG Partners

Okay. Thank you. And then you earlier mentioned the deposits growth this quarter was kind of just an average quarter. Are you anticipating that's going to continue, going forward? I guess what I'm asking is, do you anticipate there will be any kind of extraordinary seasonality like there has been in the past year or two?

Jim Herbert II

No, probably not. I mean the seasonality in the enterprise is the second quarter is a stronger purchase market for home loans, as Katherine indicated. Fourth quarter of the year sometimes is stronger for things closing at the end of the year -- deals, et cetera.

But there is less -- the first quarter is the slowest quarter, usually. So, that pattern of seasonality has reasserted itself. Last year it was a little off. If you look at this year's volume so far and you compare it to 2012, for instance, the seasonality is about the same.

Tim Coffey - FIG Partners

Okay. Those were all my questions. Thank you.

Operator

Your next question comes from the line of John Moran with Macquarie. Your line is open.

John Moran - Macquarie Capital

Thanks. Just a real quick -- two quick follow-ups, actually and then one bigger-picture question on the competitive dynamic. I just want to make sure I'm crystal clear on the loan growth guidance for the full year. That was 11% to 13% on a year-over-year basis, but looking at quarter end, right?

Katherine August-deWilde

Yes, that is correct.

John Moran - Macquarie Capital

Okay, great. Thanks. And then second follow-up was just with respect to the utilization rates. I know 36% this quarter; 31% to 32%, kind of hovering there the last year or so. What was that running kind of pre-crisis? Or if it's mean reverting, what does it mean revert to?

Mike J. Roffler

I don't have that right with me, so we'll have to get back to you. I think we're more focused on what it is today, I think, than back then.

John Moran - Macquarie Capital

Got it, yes. But if it did -- I guess up to the point is, if it jumped from 32% to 36% drives a big increase in LLT and we mean revert somewhat faster than what we expect maybe that provision 55 to 60 basis points needs to get there quicker, is I guess what I'm driving at, but happy to take that one offline.

And then the last one, with the Home Loan Bank in Chicago exploring a possible conduit structure, and some of the mortgage REITs getting access to low cost funding with I suppose really sort of an implicit backing of the Federal Government. Do you guys have thoughts on how that may impact the competitive environment in the core jumbo product? Or is it just way too early to tell?

Katherine August-deWilde

It's way too early to tell. Anytime there are people who want to buy loans we're happy about that, because it increases our opportunities to sell them when we want to.

John Moran - Macquarie Capital

Got it. Thanks very much.

Operator

Your next question comes from the line of Julianna Balicka with KBW. Your line is open.

Julianna Balicka - KBW

Good morning or afternoon right now.

Jim Herbert II

Good morning, afternoon. Just kidding.

Julianna Balicka - KBW

I have a couple of questions. One, to follow-up on the wealth management segment, last quarter you said the efficiency ratio in that segment was running at 20% margin, 80% efficiency, right? Has that stayed steady and what's kind of the outlook, how quickly are you going to improve the margin there?

Katherine August-deWilde

The margin last quarter was not quite 20% and our goal is to get it to 20%...

Julianna Balicka - KBW

Okay, so…

Katherine August-deWilde

And we will drive in that direction.

Julianna Balicka - KBW

So what was the margin last quarter and how should we expect the 20% margin?

Mike J. Roffler

Julianna, I would add, the first quarter margin is -- impacted just like our results are by some of the seasonality in the compensation line. So the first half of the year it's probably running in the low teens to 13 and we would hope over time that it gets closer to 20 as we've continue to invest in the business over the last few years. But we think a longer term 20% is a good place for us to be.

Julianna Balicka - KBW

And given the strong growth that you've had in the Wealth Management assets and revenues this quarter, how should we think about ongoing growth in those assets for the rest of the year, next year?

Katherine August-deWilde

Growth in Wealth Management assets comes from two things, client net inflows and the market. So we can't comment on the market, but we expect to continue to be able to bring in net new clients.

Julianna Balicka - KBW

So at a similar pace or we should be looking for slowdown from the net client inflows. I mean, something little bit more tangible?

Katherine August-deWilde

I can't really comment on what client -- how much client inflow there would be. We are optimistic, but we really can't look ahead that clearly to tell you what -- how much would come in nor can we tell you where the market would be.

Julianna Balicka - KBW

Okay. And then to follow-up back on the loan growth questions, 11% to 13% EOP to EOP 2014 loan growth. A, that’s the newly originated portfolio as opposed -- that includes the runoff of your buyout portfolio or is that just the newly originated loans?

Katherine August-deWilde

That is total growth loans.

Julianna Balicka - KBW

Total growth…

Katherine August-deWilde

….net of sales.

Julianna Balicka - KBW

Net or ex?

Katherine August-deWilde

Excluding loans held for sale.

Julianna Balicka - KBW

Okay. And underlying that 11% to 13%, what is your outlook for origination growth year-over-year?

Katherine August-deWilde

2013 was a particularly strong year because we had a considerable amount of refinancing, refinancing in home loans, single-family loans, all kinds of loans as you could imagine. Those are down because people did lot of the refinancing they were going to do. So it’s more of a purchase market. So we expect more a year like we had in 2012 in terms of originations.

Julianna Balicka - KBW

Is that -- in 2012 you had total originations, let me double check, 15.5 billion, so we should be looking at similar levels for the next couple of years then?

Katherine August-deWilde

In a range approximately, you are correct.

Julianna Balicka - KBW

And to get to 11 to 13, then should we be thinking more of that is coming from a higher level of prepays runoffs or is more of that coming from significantly higher level of loans that you are going to sell?

Katherine August-deWilde

It comes from loans that we plan to sell as well as runoffs.

Julianna Balicka - KBW

And is your runoffs higher this quarter than it was last quarter, is there any change there?

Katherine August-deWilde

There is not much change and of course if rates go up the runoff will slow as well. But on balance, we are looking at that target of 11% to 13% to manage loan growth to that level and we have a number of tools to do that.

Julianna Balicka - KBW

Okay. Thank you.

Operator

I will now turn the call back over to Jim Herbert for closing remarks.

Jim Herbert II

Okay. Thank you all very much. We appreciate it. We understand that we've put out some new information, we're glad to share that with you and we look forward to actually -- a good quarter coming with the impact of the expenses as we indicated.

Thank you all very much.

Operator

And this concludes today's conference. You may now disconnect.

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First Republic Bank (NYSE:FRC): Q2 EPS of $0.69 misses by $0.07.

Revenue of $388.8M (+17.2% Y/Y) misses by $22.43M.