First Republic Bank's (FRC) CEO Jim Herbert on Q3 2016 Results - Earnings Call Transcript

| About: First Republic (FRC)

First Republic Bank (NYSE:FRC)

Q3 2016 Earnings Conference Call

October 13, 2016 10:00 ET

Executives

Dianne Snedaker - EVP and Chief Marketing Officer

Jim Herbert - Chairman and Chief Executive Officer

Mike Roffler - Chief Financial Officer

Mike Selfridge - Chief Banking Officer

Gaye Erkan - Chief Investment Officer and Chief Deposit Officer

Bob Thornton - President, Wealth Management

Jason Bender - Chief Operating Officer

Mollie Richardson - Chief Administrative Officer

Analysts

Erika Najarian - Bank of America/Merrill Lynch

Steven Alexopoulos - JPMorgan

Dave Rochester - Deutsche Bank

Ken Zerbe - Morgan Stanley

John Pancari - Evercore ISI

Jared Shaw - Wells Fargo Securities

Chris McGratty - KBW

Aaron Deer - Sandler O’Neill & Partners

Casey Haire - Jefferies

Paul Miller - FBR

Matthew Clark - Piper Jaffray

Geoffrey Elliott - Autonomous Research

Operator

Greetings and welcome to First Republic Bank’s Third Quarter 2016 Earnings Conference Call. [Operator Instructions] 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 third quarter 2016 conference call. Speaking today will be Jim Herbert, the bank’s Chairman and Chief Executive Officer; Mike Roffler, Chief Financial Officer; Mike Selfridge, Chief Banking Officer; Gaye Erkan, Chief Investment Officer and Chief Deposit Officer; Bob Thornton, President of Wealth Management; Jason Bender, Chief Operating Officer; and Mollie Richardson, Chief Administrative Officer.

Before I hand the call over to Jim, please note that we maybe making 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 and reports, including the Form 8-K furnished today, all available on the bank’s website.

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

Jim Herbert

Thank you, Dianne, and thanks everyone for joining our call today. We are very pleased with the third quarter results. Let me highlight a few metrics for this very busy quarter. Quarterly earnings per share were $1, up 22% year-over-year. Revenues grew 19% year-over-year. And very importantly, tangible book value per share is up 13.5% over last year. Our loan volume was $6.5 billion. This is actually the second busiest loan quarter we have ever had. We are essentially, however, making the same kinds of loans in the same limited geographies using the same successful disciplined approach that we have since the bank was founded. Needless to say, this loan volume brings with it a great number of new clients.

Credit quality remains excellent. We are pleased with the growth of our deposits, which were up 24% year-over-year. Gaye will speak more about it in a moment. Wealth management had another good quarter as well and we now have $80 billion in total wealth management assets. Business banking, a continued driver was very strong with loan outstandings up quite nicely. Business banking continues to be a major contributor to our deposit gathering franchise as well. During the quarter, we were pleased to have further strengthened the capital base with a very successful 30-year fixed rate subordinated debt that Mike will talk about in a moment.

Let me comment for a second on the backbone, the basis, in fact the very essence of First Republic’s culture. We continue to perform very well, because we remain completely and absolutely focused on what we do best, delivering exceptional service to our clients as we have for 30 years. We don’t only focus on client service, we measure it. We use regularly the Net Promoter Score survey, a widely used independent measure of client satisfaction. Our overall net promoter score is 62%, a very strong level and basically almost twice that of the industry.

Half of our clients consider us their lead bank and when they so designate us, their score of our service goes to an even higher 77%. At this 77% level, by half of our clients, we are up above the world’s most respected brands such as Apple and Amazon. This extremely strong First Republic client satisfaction level is directly correlated to the number of services that the clients use with us. The more clients do with us, the higher our net promoter score. It is a linear relationship.

Our clients’ very strong satisfaction is based upon principles that are the very bedrock of this institution. We build deep, stable relationships with clients one at a time and we do the right thing for them every time. The strength of our relationship translates into two significant benefits to the bank in addition to many others. First, our client attrition is extremely low. It’s only 2% per annum versus 10% for the industry. This dramatically reduces our need to acquire new clients in order to grow, thus taking new risk as well. Our long-term client retention rate is very strong. Second, deeper client relationships result in higher client satisfaction. More than 50% of our growth in both loans and deposits every year comes from the expansion of relationships with existing clients doing more with us. The next 25% is the direct result of these very satisfied clients who refer their friends and colleagues.

Simply put, First Republic’s growth is almost entirely the result of exceptional client service, delivered by our people everyday. The service drives client satisfaction and results in clients who do more with us and refer their friends and colleagues. This straightforward approach has been the backbone and success of First Republic. Additionally, we remain very conservative, focused on the model and on doing exactly what we have been doing for a long time. The consistent results of this quarter are similar to those over the last 30 years.

Now, let me turn the call over to Mike Roffler, our Chief Financial Officer.

Mike Roffler

Thanks, Jim. I will focus on total capital, core net interest margin, the efficiency ratio and income taxes. During the quarter, we were very pleased to have issued $400 million, 30-year, 4.375% fixed rate subordinated notes to further strengthen our capital position. This subordinated debt qualifies as Tier 2 capital. As previously disclosed, we intend to use half of these proceeds to redeem our $200 million, 6.7% Series A preferred stock at the end of January 2017. We recently received regulatory approval to do so. The portion of the subordinated notes that we intend to use to redeem the Series A preferred has an after-tax quarterly cost of $1.3 million. This will replace the equivalent quarterly preferred dividend of $3.3 million, a net savings of $2 million a quarter.

We would note that until the redemption of the Series A occurs at the end of January, we will have a double carry of these costs. During the third quarter, we incurred this double carry for 2 months. Overall, the subordinated notes offering, coupled with the Series A redemption, will result in an approximately net $190 million increase to the bank’s capital position.

Let me turn to core net interest margin. Our core net interest margin was 3.11%, down 5 basis points in the third quarter. This slight decrease was due largely to the interest expense of the newly issued subordinated debt, along with higher average cash balances, which were approximately $1 billion above last quarter. Importantly, net interest income, which represents more than 80% of our revenues, was $505 million on a tax equivalent basis, up 19% year-over-year. Regarding expenses, the efficiency ratio for the quarter was 60.5%. The efficiency ratio was impacted by the interest expense of the subordinated debt and by higher FDIC cost due to the new large bank surcharge. The surcharge became effective this quarter and will continue through the end of 2018.

Turning to income taxes, the GAAP reported tax rate was reduced to 15% in the third quarter compared to 17.8% in the second quarter. On a year-to-date basis, our effective tax rate is 17.5%. The tax rate declined this quarter due to a higher volume of employee stock options exercise and an increase in tax benefits from low income housing tax credits.

Now I would like to turn the call over to Chief Banking Officer, Mike Selfridge.

Mike Selfridge

Thanks Mike. Let me touch upon economic conditions in our markets as well as lending activity, credit quality, business banking and our multifamily and commercial real estate portfolios. Economic conditions in our knowledge based urban coastal markets remained strong with clients active across the board. In our largest market, the San Francisco Bay Area client activity also remained strong. The appreciation of home prices and rents has moderated which we consider to be healthy for the market. Opportunities in all of our markets remain robust, supported by a diversity of industries and the appeal of these dynamic urban centers as attractive places to live, work and grow a business.

Loan origination volume was $6.5 billion during the third quarter driven by strong activity in residential lending. Of this single family residential volume, 42% was purchase and 58% was refinance. Nearly half of the activity referred to as refinance came from First Republic refinancing loans from other institutions. We view refinance activity as the terrific opportunity to acquire new clients. Our loan pipeline remained strong and is up from June 30. We see continued robust demand for lending that meets our high credit standards. Very importantly credit quality continues to be strong. Non-performing assets remained low at just 8 basis points. During the quarter, net charge-offs were just $627,000 or 1 basis point of average loans. We added $18 million to our loan loss reserves in the quarter to support loan growth.

Turning to business banking, it was a very good quarter. Business loans outstanding were up 22% year-over-year. Usage on our capital call lines of credits was robust in the quarter. Utilization rates for these capital call lines of credits were 41% at quarter end, up from 34% at June 30. This was largely driven by private equity fund activity. Multifamily and commercial real estate also had a strong quarter. The median multifamily loan was only $1.3 million with a conservative weighted average loan to value of 54% and the strong debt service coverage ratios. The median commercial real estate loan was also modest at $1.5 million with a conservative weighted average loan to value of 50% and also strong debt service coverage ratio. We continue to apply the same disciplined underwriting standards to multifamily and commercial real estate as we always have and as we do with all of our lending activity. Overall, we are very pleased with the activity across the enterprise and the continued strength of our geographic markets.

Now, I would like to turn the call over to Gaye Erkan, Chief Investment Officer and Chief Deposit Officer.

Gaye Erkan

Thank you, Mike. I will talk about our deposit franchise and investment portfolio. Total deposits were $55.1 billion, up fully 24% from a year ago. Checking deposits represented 61% of our total deposits. The average rate paid on total deposits during the quarter was 15 basis points. Deposit growth was strong across all channels and client types. As Jim mentioned, business banking continues to be an important contributor to our deposit franchise. Business deposits continued to grow and now represent 55% of total deposits at a rate of 6 basis points. Deposits from wealth management sweep accounts also grew nicely and are now 9% of total deposits. These diverse deposits have an average size of just under $175,000 at a rate of 9 basis points.

Turning to investments, our total investment portfolio grew to $12.8 billion, up 57% from a year ago. This growth is largely driven by the increase in high quality liquid assets. HQLA including eligible cash totaled $6.7 billion at September 30 or 10% of average total assets. We expect HQLA to meet our target of at least 12% of average total assets by year end. The yield on our total investment portfolio remained stable in the third quarter at 4.2%.

Now, I would like to turn the call over to Bob Thornton, President of Private Wealth Management.

Bob Thornton

Thank you, Gaye. Wealth management had a good quarter. Wealth management assets are $80.2 billion, up 14.6% annualized since the start of the year. The growth for the first nine months of the year has been primarily from net inflows of client assets. Net client inflow represented 62% of growth while market appreciation was 38%. Importantly revenues were up 17%, year-over-year excluding the benefit of our acquisition of Constellation Wealth Advisors, which closed on October 1, 2015. With Constellation, revenues were up 27% year-over-year. Our new wealth management teams have been successful at First Republic and are a great fit with our high touch client centric culture. While we did not add new wealth management teams during the third quarter, we continue to have ongoing conversations with additional teams. Wealth management also continues to be both a strong source of new banking relationships and deposits in particular. I would also note that adherence to the Department of Labor’s fiduciary rules which takes place next year will not have a material impact on our business. Non-fiduciary retirement accounts represent less than 1% of wealth management fee revenues.

Now, let me take a moment to provide some perspective about the growing contribution of private wealth management of First Republic. Since year end 2010, our sweep deposits have grown from 5% to 9% of total deposits. Our number of client facing wealth management professionals is growing from 69 to 180 and our revenues from wealth management have increased from 6% to 13% of First Republic’s total revenues. Overall, we are very pleased with the growth in wealth management as well as the opportunities ahead.

And now let me turn the call over to Jason Bender, Chief Operating Officer.

Jason Bender

Thank you, Bob. As we continued to invest in the franchise, let me highlight a few of our key initiatives to enhance the client experience at First Republic. In particular, I would like to talk about our new digital banking experience, workflow process improvements and wealth management data integration and performance reporting improvements. We will soon begin the rollout of our new digital banking experience for consumer clients. This platform includes a new substantially improved online banking desktop and mobile experience. The new banking interface provides our clients with a more comprehensive view of their financial picture along with streamlined money movement capabilities and many other features. In addition to enhanced functionality, the underlying technology platform for this consumer online experience also provides us with more control over the user interface and greater flexibility to innovate moving forward.

Turning to wealth management, we began to rollout to our clients a new much enhanced performance reporting system which also provides a more customizable interface as well as inter-quarter reporting capabilities. We have also invested substantially in building our wealth management technology infrastructure. This will allow us to offer our wealth management clients among other things a fully paperless experience from account opening to reporting. Along with initiatives to enhance the client experience, we are also heavily focused on continually improving our operational capabilities while continuing to emphasize client safety and information security. Over the past year, we piloted a new end to end workflow system for our smaller loan products which significantly streamlines the number of key processes necessary to close the loan. And its completely integrated paperless process the data that clients enter into the online application portal flows directly through to loan closing. Since the launch of the system five months ago we have substantially reduced the amount of time required to process loan requests and to close loans.

Finally, we are particularly excited about our increasing ability to use data and analytics to further support our high-touch model and to enhance the client experience. All of these investments are designed to achieve our strategic objective, which is to provide extraordinary service. As Jim has described, service is what drives the growth of the franchise. We are excited about the many opportunities just ahead and the investments we are making to bring them about.

Let me now turn the call to Mollie Richardson, Chief Administrative Officer.

Mollie Richardson

Thank you, Jason. Let me provide an update on our community outreach efforts and our initiatives to attract, reward and retain talent. We are pleased to have recently announced our newly formed Community Advisory Board, which is comprised of well-recognized community leaders whose mission is to further strengthen First Republic’s programs for low-to-moderate income and underserved minority communities. We also continue to expand our community lending teams during the quarter by adding key hires in several of our markets.

In support of our employees, we are very pleased to have launched a student loan repayment assistant program in the third quarter, whereby the bank provides a monthly contribution to help full and part-time employees pay down their student loan debts faster. We continue to invest in the ongoing development and education of our employees. In addition to regularly offered internal programs on service, culture and leadership, we have sent the top 75 members of our management team through executive education offerings at top business schools throughout the country during the past 2 years. This converts to an equivalent of 6 years of education combined.

We plan to send more colleagues to these programs over the next few years. We are also very pleased with the response to First Republic’s $20 minimum wage, which the bank implemented in all of its markets at the beginning of the year. This applies to all full-time, part-time and temporary employees, including interns on our payroll. These programs are just some of the many ways we are working to attract, develop and retain talent in our highly competitive market. We believe that happy colleagues translates into happy clients and that advancing the financial and professional goals increases their satisfaction and results in low turnover, which is key to providing consistent extraordinary service. Community and employee engagement efforts remain a continued focus of the bank and we are very pleased with the success of these initiatives.

And now, let me turn the call back to Jim.

Jim Herbert

Thank you, everyone. In short, it was a really good quarter. We grew clients quite strongly. We are very pleased with the results. We remain entirely focused on executing our simple, straightforward client focused business model. We are operating in the same markets we have always operated in, doing the same kind of lending we are always doing. We are gaining clients’ share quite rapidly. Our clients continue to validate our service-focused model as seen by deeper client relationships, lower client turnover, high client retention and strong client loyalty. This results in a safe, steady growth and remains our primary competitive advantage.

And we would like to take questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Erika Najarian with Bank of America/Merrill Lynch. Your line is open.

Erika Najarian

Hi, good morning.

Jim Herbert

Good morning, Erika.

Erika Najarian

My first question is we are getting a lot of feedback from investors that despite the 19% revenue growth, there is some confusion on what’s core on the fee income side and sort of how we can think about the expense base going forward. So Mike, if you could – understanding that you are going to take us back to the efficiency ratio range, could you perhaps point out what in the non-interest income bucket would be one-time in nature? On the expense side, whether there were expenses that were accrued more heavily this quarter because of the revenue performance? And third, how we should think about the tax rate going forward?

Mike Roffler

Sure. So, if I look at non-interest income, nothing really that unusual. I think the wealth business was pretty normal and expected. You see a small increase in life insurance. That periodically happens from time to time as we get updated values from the carriers. So, that might be a little bit elevated, but not materially. Expenses, you are right, we are going to come back to the efficiency ratio. We are quite pleased that it’s remained around 60% this year. We think the low 60s is a pretty good place for us to operate given the increase in wealth management as a contribution and a lot of the investments that Jason mentioned that we are making in the franchise, many of which support our current growth, but are also really important when we look at the opportunities for future client acquisition and future client deepening of relationships. And that’s all a part of that. And some of those investments come early before the revenue growth might come at the same time.

On the tax rate, turning to that, this quarter had a little bit higher stock option activity from employees. And if you recall last quarter, when we adopted this, we talked about that the rate is probably going to vary a little bit from quarter-to-quarter. Obviously, the stock price was a little bit higher this quarter; that tends to lead to employees maybe exercising a little bit more than they did the prior quarters. So, there is a variability that’s probably introduced that wasn’t there in the past.

Erika Najarian

Got it. And my follow-up question is we really appreciate the prepared remarks on your operating model. The question we are getting the most for all the banks that we cover given in light of the Wells controversy is if you could share how your relationship managers are compensated? That would be really helpful.

Gaye Erkan

Sure. This is Gaye. Our compensation and incentives are tied to building deep, stable, long-term relationships with clients one time at a time and doing the right thing for them all day, everyday. And there are three key elements to this. And these are all incenting retention of existing business after all the best client is the one that you already have. And those three key factors are: one, it’s volume, it’s not unit base. There is no artificial goals or targets. We are not counting the widgets that we are selling. Number two, credit clawback, we have a conservative credit culture where the relationship manager is put in the first loss position. And number three, as important as the other two is the trailers, the multiyear deferred compensation that is incenting on the long-term nature of the relationship and the stability. After all, it’s all about service and keeping our clients happy.

Mike Roffler

Yes, just to add to that too. As Jim mentioned, the results of this compensation and this approach really are seen in our client behavior. Clients vote with their actions. They vote with their feet. And so I think when you see things like client satisfaction levels that are 2x the industry, you see growth that comes 50% from existing clients and another 25% that come from referrals from those clients and you see a low attrition rate that’s about a fifth the industry, I think you are seeing strong indicators that, that system is working.

Jim Herbert

Erika, if I might add, it’s Jim. The approach to this that we have had for 30 years, quite frankly, is the exact opposite of the problem in the market. Our growth comes from existing clients and they vote with their feet. If they are satisfied, they give us more business. It’s as simple as that actually. And it’s been the way we have built the enterprise from day 1.

Erika Najarian

Thank you for that. Appreciate it.

Operator

Your next question comes from the line of Steven Alexopoulos with JPMorgan. Your line is open.

Steven Alexopoulos

Hey, good morning everybody. I wanted to start on the deposits where you had tremendous growth in the quarter. Was this a strategic build to give you more gunpowder to get the HQLA balances where you need next quarter?

Gaye Erkan

Hi, Steve. This is Gaye. As we have indicated in the second quarter call, the second half tends to be stronger in deposit growth than the first half. It’s one, as we all know it’s the tax seasonality in the first half. And second, the way that the average account balances tend to be, we are very pleased with the growth in the deposit franchise in the third quarter and it was very diversified.

Steven Alexopoulos

Okay. Gaye, just following up on that since you are still targeting to get to 12% by the end of this year, it looks like you are going to need to add at least a $1.5 billion next quarter. Can you talk about the yields that you are likely to get and the expected impact on the margin next quarter?

Gaye Erkan

Sure. We remain to target – we aim to target at least 12% of average total assets by year end given the liquidity and the availability of the high-quality liquid assets. We are very pleased with the momentum and we don’t see any problems achieving that. The yields have been roughly in line within 10 basis points of mid-2s to take it as a benchmark of the third quarter, absent any market rate changes that’s the similar yield range that we would expect.

Steven Alexopoulos

Okay. And maybe for Mike Roffler, just following up on the commentary around the tax rate, last quarter you guys guided to 18% to 20% given the new guidance, when you look at the amount of increase you have on the tax credits, is that still a realistic range 18% to 20%?

Mike Roffler

So I think we would prove this quarter and the year-to-date that ‘17 is a possibility. 17.5% was the first nine months of the year, so the range might be just a tick wider. I do think that this quarter had a little bit of unusual elevated exercise activity from employees, that only goes for another couple of years, because the options do have a finite life to them. So 17% to 20% might be a little bit better range given what we just saw.

Steven Alexopoulos

Okay. And then just one final one, I am trying to better understand the quarter-over-quarter change in the comp line, because originations were strong but they were basically flat quarter-over-quarter while management fee growth slowed a bit, were these incentives tied to deposit growth, I am trying to understand that? Thanks.

Jim Herbert

Steve, it’s Jim. Mostly where it’s coming from is the build-up of trailer as well as new business. But don’t underestimate this trailer that Gaye referred to, approximately a third almost 40% of the all the comp paid has to do with trailers, so the more business we build-up, the more are the trailers built. We consider that to be the best possible measure of client success that there is.

Steven Alexopoulos

Okay. Thanks for all the color.

Operator

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

Dave Rochester

Hi, good morning guys.

Jim Herbert

Good morning Dave.

Dave Rochester

On the efficiency ratio, you talked about the low-60s is a good area in which to operate going forward, I just want to make sure that that comment actually apply to 2017 and is that sort of a more official revision of that 57% to 61% historical guidance that you guys have talked about?

Mike Roffler

So we – given the things we discussed earlier on wealth management and franchise investment, I think that is a low-60s as we look forward for the balance of this year and into next year. The other part that’s an important element of that is obviously the denominator. We focus a lot on expenses in this analysis, but it is the ratio and the margin is really a reflection of a big piece of that since it’s over 80% of our revenues. If you just play this out and intermediate rates have risen recently and maybe there is some benefit to that that can come in the future, you don’t know yet, because frankly, the pipeline does not reflect those rate rises. But if you got a little bit of margin relief, your ratio would tick down a little bit. And so we are focused on both sides of this equation in terms of looking at revenue growth in addition to the expense side of it. And this is just some we would remind people of is that that’s as important if not more.

Dave Rochester

Thanks for the color. And I guess following on that, it sounds like just as wealth management get to be a bigger piece, you could actually potentially see that efficiency ratio rise from where it is this quarter?

Mike Roffler

That’s absolutely correct.

Dave Rochester

Yes, okay. And I guess switching to the C&I loan growth, that was great this quarter, I know you talked about the increased utilization there in the capital call lines, how much of that book actual grow this quarter and how large is the portfolio at quarter end?

Mike Selfridge

Hi Dave, this is Mike. Sorry, about that. In terms of growth, for the private equity and venture capital business, it’s about 36% of the total business banking loans. And we did see nice originations in private equity more so and a little bit in venture capital neither capital call lines of credits.

Dave Rochester

And you said it’s for - the dollar amount of that growth this quarter to get a rough idea?

Mike Roffler

Dave, if you look at the growth in business was about $700 million roughly from June 30, the lion’s share of that would have been contributed from capital call – private equity capital call.

Dave Rochester

Any other lumpy growth you might have had in there and what pockets of strength have you seen outside of that?

Mike Selfridge

I would say it was pretty consistent across the seven or eight segments we focused on with the exception of the increase in the utilization on capital call lines of credits. And as I mentioned it was more specifically centered on private equity activity.

Dave Rochester

Okay, great. And then switching to the securities purchases, I appreciate the color on the HQLA yields, I was just curious what the yields were on what you bought outside of the HQLA book this quarter and where those yields stand today, on incremental purchases going forward?

Gaye Erkan

It wasn’t – it was a modest decline from the second quarter, more around 5% tax equivalent yields.

Dave Rochester

And what was the duration on that stuff?

Gaye Erkan

And the duration was also in line with the second quarter around 6 years, 6.5 years, just on the non-HQLA obviously the HQLA duration is a lot shorter.

Dave Rochester

So outside even stronger deposit growth, next quarter I would imagine that most of your securities purchases are going to be more focused on the HQLA book for the next quarter, is that a fair statement?

Gaye Erkan

That is a fair statement, yes.

Dave Rochester

Okay. Thank you, guys very much.

Operator

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

Ken Zerbe

Great. Thank you. I guess first question, just in terms of loan growth, last time we spoke, your guidance was sort of that mid-teens loan growth obviously loan balances were coming in pretty strong for most of the year, are you guys sticking with the mid-teens growth or could it be more of the higher teens? Thanks.

Jim Herbert

Ken, it’s Jim. It could be the higher teens and we don’t have targets, as you know. We have never said targets for loans in the history of the bank. It is what it is. But the markets, as Mike Selfridge indicated that we are operating in are actually quite active. The price of homes and other products, real estate has moderated or stabilized and we like that actually. But the velocity is still quite active.

Ken Zerbe

Got it. Understood. Okay. And then just I think Mike had talked about CRE originations, I know your book is probably very pristine, but can you just talk about what you are seeing more broadly in commercial real estate in your markets?

Mike Selfridge

I would say broadly, my comments were centered on the moderation and it’s probably consistent in some of our larger markets moderation of rents, moderation of cap rates. But we are still seeing good transaction activity in both commercial real estate and multifamily. And let me remind you that for what we do, the sizes are very modest, strong debt service coverage ratio and low loan to value.

Ken Zerbe

Understood. But when you say moderation, is that moderation in growth or actual declines in rent rules for example?

Mike Selfridge

I would say moderation in rents. I would say for us, the activities are consistent and there are still plenty of opportunities in our markets.

Ken Zerbe

Got it, understood. And then just totally random question, but the $20 minimum wage, what kind of impact did that have on the comp line?

Jim Herbert

Not a very large impact, Ken. It’s more a philosophical issue. It did have some impact, but modest and has helped, in fact our attraction of young people as you might imagine.

Ken Zerbe

Great, alright. Thank you very much.

Operator

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

John Pancari

Good morning. Just want to ask – back o the comp question, I just wanted to make sure I understand, so the – based upon what you are saying, what the drivers were of the comp increase, is it fair to assume that the $193 million is a good base to continue to grow that line off of?

Mike Roffler

Yes, I would say that is a good base as we go into the fourth quarter.

John Pancari

Okay, alright. And then separately, back to the loan growth. Thanks for the color on the VC private equity portfolio, so I know you indicated that the – that that accounted for the lion’s share of the growth, so obviously fair to assume that all the other portfolios like your non-profits and other business portfolios were stable for the quarter and are there any trends there to flag, are you seeing moderation at all in those portfolios?

Mike Selfridge

No. I think it’s consistent there, as you just noted and I would also point out we still have plenty of opportunity in our markets.

John Pancari

Okay, alright. And then lastly, on the deposit growth, is there any – were there any big items whatsoever that could cause this – us to see some volatility in those balances outside of some of the seasonality that Gaye had mentioned and is there any large balances as well, worth flagging that could exacerbate some of the moves that we expect next quarter?

Gaye Erkan

On the contrary, actually it was one of the quarters, where we had great diversification across not only consumer end business as well as within business across the industry. The non-profits you mentioned on the lending side was a great contributor on the deposit franchise, professional services, medical services and so on. We were very pleased not only by the growth, but also by the mix.

John Pancari

Okay, thank you.

Operator

Your next question comes from the line of Jared Shaw with Wells Fargo Securities. Your line is open.

Jared Shaw

Hi, good morning. Thanks.

Jim Herbert

Hi, Jared.

Jared Shaw

Hi. On the expense side, you had mentioned in the release also an increase in expenses due to regulatory costs. Are those hiring – increased hiring due to regulatory systems or is that more implementing new technology that we could see abate going forward?

Mike Roffler

Sure, Jared. Just a couple things, largely the regulatory investment and increase is in the numbers than in the past. We have a couple of things that we are finishing. One is around hiring in our enterprises risk area. So, there is a little bit of comp increase that was tied to that. And the second as we have talked about our resolution plans due at the end of the year and so we have some people internally working on that and we also have some outside advisors helping us to finish that up and submit by the end of the year here.

Jared Shaw

So in terms of other, there shouldn’t be any other new initiatives on the regulatory side as we look through the end of the year?

Mike Roffler

Other than supporting a growing institution and continuing to invest in those things as we grow, that’s really it.

Jared Shaw

Okay, thanks. And then on the capital side as we look out over the next 12 months, there is a few other preferred offerings that become callable. Is this something that we could potentially see continuation of replacing some of the preferred with sub debt as we go through the rest of – through the next 12 months?

Mike Roffler

So, it will obviously depend on sort of the future outlook and the rate environment. This particular preferred Series A is one of the higher dividend rates. So, it was a good decision especially to be able to issue a 30-year piece of debt that not many banks have done in the past. So, we thought that was very attractive and good for the long-term of the franchise. That will really be a facts and circumstances decision when we get closer to those call dates.

Jared Shaw

Okay, great. Thank you.

Operator

Your next question comes from the line of Chris McGratty with KBW. Your line is open.

Chris McGratty

Hey, good morning. Thanks for taking the question. Actually, the credit numbers look great. But if I am calculating it right, the provisioning rate was about 15 basis points versus around 10 to 12 in prior quarters. Understanding the mix, you are originating more commercial loans, is this about – is this a new or reasonable run-rate for provisioning requirements given what seems to be a little bit of a remixing?

Mike Roffler

So, I think that you are definitely right. The change in the provision will be driven by the mix and what’s on the balance sheet. I think when we look at the overall reserve to loan, we have sort of been about 60 basis points and that feels about right to us given the high credit quality in the portfolio currently. I think we have – in the past we have sort of been between 55 and 60 and we are sort of at the high end of that range, which feels about right given the current mix of business. If you saw it change much more, it might tick up a little more.

Chris McGratty

The 60 could – upper bias to 50?

Mike Roffler

That’s right.

Chris McGratty

Okay, great. And maybe I missed it in the earlier questions, the $1 billion of cash, I can’t remember if you guys mentioned the right level and then the timing that what you might get there. Is that a multi-quarter event or is it – can you go down as quick as you went up?

Mike Roffler

So, it’s really a timing of deposit flow and when we invest and lend. We are not going to rush to build investments or to lend. And if the deposits come to the bank, we are happy to have them fit in cash. And if it puts a little pressure on the margin, we are okay with that. As Jim mentioned earlier, we do the good business that’s in front of us when it comes, not – we don’t try to rush and into something. So, we have ranged, call it, between $1 billion and $2 billion of cash. That feels about right to us. In the second quarter each year, it’s usually a little bit lower given taxes. In other quarters of the year, it tends to be a little bit higher.

Chris McGratty

Alright. That’s very helpful. Thank you.

Operator

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

Aaron Deer

Hey, good morning. Most of my questions have been addressed. Maybe just one for Mike, regarding you have commented on the low loan to value ratios, I was wondering if you could also maybe provide some debt service coverage ratios on your new multifamily and commercial real estate business that you are putting on the books?

Mike Selfridge

We don’t disclose that, but I would call it well above typical underwriting standards, well above let’s say 1.25%. And as you know, we stress each individual loan in addition to that to make sure that if vacancies increase or other factors influence the credit that they can withstand those stress scenarios.

Jim Herbert

We also do underwriting at an enhanced rate and full amortization. So, the cash flow coverage ratio Mike is referring to is in fact the coverage ratio on rates and full amortizations that are reflective of a more negative amortization and cost of debt factor that is actually the case on the loans we make.

Aaron Deer

Sure, okay. And Jim, you have also mentioned in the past that obviously very healthy real estate market here in the Bay Area, but having some not concerns, but certainly being thoughtful about looking out a couple of years given some of the sublease space and new supply that’s coming on the market over the next 12, 24 months. What’s kind of your longer term view on real estate, particularly I guess in the Bay Area at this point?

Jim Herbert

It’s interesting. It’s a good question, Aaron. I think that the real drivers are the combination of job creation and supply availability. You stop and think about it. Those are the elements of demand and supply. And the job creation continues to be very strong in the Bay Area, all the 8 or 9 counties depending on how you think of the Bay Area. And it’s over – it’s often envisioned as a technology demand and it is, but some of it – but the biggest demand is in really large companies now, Google, Apple, Intuit, the biotech group, Facebook, and these are not startup companies. They are very big enterprises and they are growing like crazy. And then – and they are headquartered here. And then the biotech business – biotech industry employs almost more people and this is expanding rapidly, particularly around Stanford and U.S., UCSF. And then the supply constraints around the Bay Area are quite stunning both from a permit point of view, the land mass itself, environmental constraints, et cetera. It is very difficult to build new housing in the Bay Area. And so I think you have a supply – you have a demand supply equation that’s – that it creates a great deal of stability. In fact, it has recently created the excess pricing on the high end, which is now tempering and I think its right. So, I would say, the next couple of years are probably relatively safe. The commercial, the new office market, is slightly different. There is a lot of new office space coming into the city itself and in fact, a fair amount down the Peninsula, but most of it down the Peninsula is corporate campuses not available for generally public consumption. And – but the city maybe fairly close to a somewhat slight excess supply for a while. The thing the people will overlook is that there are a lot of new buildings coming in and they are not occupied yet and they will be full of people who want to live near them. And so the demand for housing in the city just continues.

Aaron Deer

Sure. Okay, great. I appreciate your thoughts.

Jim Herbert

Thanks.

Operator

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

Casey Haire

Thanks. Good morning. Follow-up question on sort of the NIM outlook, with the HQLA builds coming this quarter, you guys do have some potential offsets to mitigate that NIM drag. I am looking at the loan to deposit ratio at 91%, is there an appetite to take that up? And then also the securities book at 19%, is there an appetite to run with a larger mix there with incremental yields at 5% that Gaye had talked about?

Mike Roffler

So relative to loan to deposit, we have been running pretty consistently in the 90 to little higher range and we feel pretty good about that. Casey, it’s a good question, again, it’s a ratio question. What we are very focused on is net interest income growth. Ultimately, that’s what pays for all the expenses and costs we have and that’s what pays the bills. And so as you look at the mix of security portfolio, we are pretty pleased that we have been keeping the yield where it is. And you have done that through two portfolios really, the liquidity portfolio and then also where we have built the municipal portfolio over a period of many, many years. And we think that will continue into the future and that does help protect sort of the margin within a range.

Casey Haire

Okay. And just switching to the capital outlook, I know you guys are comfortably above the CET1 ratio at 10.4, but you guys used to look at the Tier 1 leverage ratio, is that still – I mean is there an appetite to take that – I mean, is there an appetite to take that below 9% as you sort of swap out some of these preferreds for the sub-debt?

Mike Roffler

So one of the things we have talked about, philosophically we believe in a very strong capital base. And you have seen the growth opportunities that we have had and also how we have grown over the years. That’s led to small incremental capital raises over time that we think were good while we have that de novo constraint with us. And it’s always in advance of such growth, the capital is raised. Now that we are fully transitioning to a Basel III model, the leverage ratio probably could come down a little bit below the 9% you mentioned, but I also caution that wee are going to stay well capitalized at all times and be ready to take advantage of opportunities as they exist.

Casey Haire

Okay, great. Thanks.

Operator

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

Paul Miller

Yes. Thank you very much. In the past, you guys have been very disciplined growing your balance sheet especially loans at the same level you are growing your deposits, in this quarter, you grew your deposits a little bit faster than your loan growth, is – and your securities growth – and your securities book grew about to 19% of your total balance sheet, is that – was that planned or was that just you just had so much deposit growth, you just wanted to keep what you had?

Gaye Erkan

Well, first and foremost, we are here to serve our clients. We are pleased that the deposits had a strong growth. And we are very happy to have addressed our clients’ needs on the deposit side. And also, just like you said, the fact that deposits were funding the securities portfolio growth is by and large was driven by the liquidity portfolio, which strengthens the balance sheet from a liquidity risk management perspective. It was a great quarter from that sense.

Paul Miller

So, I guess going forward, could we see that securities portfolio grow if – because you want those deposits and it’s difficult to grow that loan book as fast as you are getting these deposits today?

Gaye Erkan

So the 12% target that we have mentioned, it is a dynamic target. So the denominator of that ratio is average total assets. So it will be cognizant of the growth of the balance sheet to keep up at the liquidity portfolio, number one. And number two, again on the deposit side, there is seasonality of the deposits portfolio and the second half tends to be stronger than the first half.

Paul Miller

Thank you very much.

Operator

Your next question comes from the line of Matthew Clark with Piper Jaffray. Your line is open.

Matthew Clark

Good morning. I am just curious what your new money yields were in the loan portfolio this quarter?

Mike Roffler

They were pretty consistent actually with the last quarter, just slightly under 3%.

Matthew Clark

Okay. And I think last quarter you talked about the overall margin ticking lowering, obviously that was without the sub-debt raise, but just thinking about the HQLA build here in the last quarter to get to 12% and maybe redeploying some of that cash, is that still – I assume that’s still fair?

Mike Roffler

It’s going to obviously depend on the intermediate part of the curve also and where we are buying the HQLA at. There has been a little bit of a tick-up recently. We are not sure, you don’t know if that’s going to be sustainable or not. And the redeployment of some of the cash when you are earning 50 basis points, if you put it in the 2.5, that is a protective measure in the margin already.

Matthew Clark

Yes, okay. And then just last one from me, on the pipeline, just curious if it has been up in the quarter or not?

Mike Selfridge

The pipeline is strong going into this last quarter and it was up from the last quarter, correct.

Matthew Clark

Great. Thanks.

Operator

Your next question comes from the line of Geoffrey Elliott with Autonomous Research. Your line is open.

Geoffrey Elliott

Hello. Thank you for taking the question. Coming back to the tax rate, what would earnings have looked like if you were still reporting under the old accounting treatment, if you haven’t early adopted those changes back in July?

Mike Roffler

So we don’t have that right here in front of us. There was – in several senses, were contributed by that change. And we are not modeling that or evaluating that, GAAP is GAAP.

Geoffrey Elliott

And I guess to follow-up, you mentioned you benefited from the fact the stock price has been going up and that means it’s been greater exercise of options, how much uplift do you think there would be to the tax rate, if your stock price didn’t do that, say the stock price was just stable, what increase in the tax rate do you think that would imply?

Mike Roffler

So it’s really hard to predict that. People exercise options every quarter and the price is where it’s at. So I think it’s a contribution to the tax rate, but it is variable is what I would tell you.

Geoffrey Elliott

Thank you.

Operator

I would now like to turn the call over to Mr. Jim Herbert, Executive Officer for closing comments.

Jim Herbert

Thank you very much. Thanks everybody, for the questions. We are actually very pleased with the quarter. It was a tremendous client build quarter for us. Clients are obviously happy. They are voting with their feet. A lot of deposits are coming in. Loan growth was the second best ever in terms of volume and we go into the fourth quarter very pleased. Thank you all very much.

Operator

This concludes today’s conference call. You may now disconnect.

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