Alright, good morning everyone. I’m Steve Scinicariello, I cover the midcap regional banks here at UBS and we’re very excited to welcome City National, one of the premier business and private banks in the country with one of the strongest core deposit franchises. City National has a long track record of consistent and strong performance, and the wealth management franchise now totals around $60 billion of assets under administration. Excess capital continues to be deployed accretively to expand into attractive markets in addition to California such as Atlanta and here in New York City, and to add on to specialty areas such as equipment finance and investment management.
With us today is Executive Vice President and CFO Chris Carey who will bring us up to date on all of the positive trends going on at City National. Chris?
Well, good morning everybody; Steve, thank you very much. It’s great to be here in New York. Any Knicks fans here? I saw the Knicks won their first playoff game in 11 years – it doesn’t look like we have that many Knick fans here anyway. I didn’t realize it took that long. I’m out in Los Angeles where the basketball teams are playing a little better these days.
Okay, I guess we should get to City National and talk about what’s going on there. We think we have a really good story that is still not quite recognized, so I’ll flip to our first slide. This is just some highlights on our company – the 26th largest commercial bank; 79 offices including 16 regional offices, and one of the things we’ll talk about later is our wealth management business which is one of the distinguishing features of our company.
These are six themes that I’m going to cover today, but one of the themes that I’d like to talk about a little bit, without dredging up the past too much – I’m not going to go back to the whole financial downturn – but one of the things that I think City National did different than many of the regional banks is, for regional banks that were in difficult markets which we were, we came out of the market earlier and we’ve made a substantial amount of investments in our company whether it’s hiring more salespeople or opening more offices. And I do think that we are, and we started seeing it late last year and continue to see it this year, the benefits of adding more salespeople and more offices and more capabilities. So we’re seeing that in numbers.
We’re not surprised that we had a strong Q1 and I think that’s a little bit of a takeaway I’d like you all to have about our company, that we have invested, we are focused on the long term, trying to always do well in the short run but our overall focus is long term. So with that we can look at the results.
We’re always happy when earnings grow 16%, and the highlights in the quarter were clearly very strong loan growth, good quality loan growth. We’re not getting outside and doing anything new that from a credit quality standpoint is going to cause us a problem later. We’re sticking to our knitting, and our credit quality, the other really clear bright spot in the quarter was fabulous – and I guess I shouldn’t take away from the fact that we continue to grow core deposits at a high rate. We’ve been doing that for so long maybe we take it for granted. But we had a fabulous Q1 and we expect to have a very solid year.
This, in terms of understanding our company and what we do is probably the most important slide. That blue middle part which represents the blue of City National is what we really focus on, and as Steve said, we’re a premier business bank with a big wealth management business. We are not all things to all people and partly we talk about what we’re not. We are not in the retail banking business. We think that in good economies it’s a little bit easier to grow when you’re not in the retail banking business. It’s a fabulous business on its own; we’re just not in it. So we kind of operate between these mega banks and the community banks.
Our businesses that we go after are typically $1 million in sales to $250 million in sales, and individuals typically, although we have a new segment we’ve been focused on – preferred banking, which I’ll talk about later – but individuals with investible assets of $1 million and income over $250,000. Also our value proposition, besides having the products and services and investment performance that our clients desire, our big value proposition is service. And we think focusing on this segment we’re able to do that and have the right products for this segment.
And speaking of service, since lots of people talk about service we’ve been recognized continuously, and again in 2011 we got seven awards from Greenwich. So I think it’s one thing to talk about your culture is service; it’s another thing to get the awards. So we’re proud of that and I think it’s just a testament to what our clients say about us when they’re asked.
Okay, our biggest market to start – California, 38 million people, and certainly not represented properly in Washington as most people would know but maybe that’s good the way things are going these days. But 27 million of those 38 million people are in the 11 counties we operate, and part of what we talk about when we talk about California for a moment, is it’s a little bit of a tale of two cities; and while it’s certainly been hit by the downturn we operate in the dense coastal areas that have been much less impacted. And I think largely you’d probably say northern California, particularly San Francisco and going down into the tech sector that’s on fire hasn’t almost been impacted by the downturn.
So but you can see by the stars here we’re in the coastal part of the state where there’s most of the population, and while close to some of that you’ve had some of the housing problems it’s nothing like what’s happened in the outlying areas. So it’s a great market and you know, we’re going to talk about the economy later so I’ll save it but it clearly is recovering and I’ve got some interesting slides to talk about that.
We also are in Nevada which we have to admit we timed that acquisition probably wrong in 2007, so we had a slightly humbling experience, but believe it or not I just spent some time over there and the economy is coming back, and there’s a lot of good business formation. There are opportunities now to lend money there and we still are growing deposits there, so finally that is starting to come back – there’s good news there. We have a big presence in New York; we’ve been here over 10 years in Manhattan. We have over $1 billion in deposits and have consistently added, particularly in the last couple years, a lot more staff to that office. And we’ve had a lot of growth here.
Our really newest venture is part of our entertainment business, which most of it is really in California though part of it does operate out of Manhattan – we started a new initiative, probably opened our first office in Nashville early in the summer last year, and then in Atlanta in December, and this is to focus on the music industry and the entertainment niche. And we’re off to a great start – we have over 22 people hired, I think at the end of the year we had over $50 million in core deposits and $30 million in loans. So a pretty strong start for us and another way, as I said at the start of the presentation, we have been adding staff, opening up offices and investing in our franchises, and that’s one of the reasons why we are showing some of the good growth numbers that we had in the latter half of last year and Q1.
So this is just a quick picture of the markets that we’re in, and you can see we’re in the top four markets and many of the other top markets in the country. I won’t belabor it. Deposits: it’s been a great story for us. It almost feels like the growth is leveling off a little bit when you look at this slide because we’ve had such fabulous growth. The key thing I think is 97% of these deposits are core deposits and one area that I don’t think we get credit for right now is I continually hear people talk about how banks have these low cost deposits. Most banks have relatively low cost deposits now, deposit rates are low. But really, go back and look at what their cost of deposits were four years ago when our deposit cost was very, very low and the rest of the industry was much higher.
I mean part of that is having such a high amount of core deposits but I think when rates eventually go up, whenever that’s going to be – Steve tells me it’s going to be next year, I think – we’re going to get the benefit that we’re not getting out of these low cost deposits. But we’re still happy that we have it, we’re still growing these deposits and we do think it’s a key part of the franchise value of our company that isn’t totally recognized right now.
Loan growth: you can really see it started to pick up last year and continued in Q1. We had $440 million of net loan growth in Q1 which is on an annualized basis almost 14%. It was pretty broad based. I’m not telling you we can do that every quarter but it was a solid quarter – there’s always some lumpiness in our quarter-to-quarter growth. But we feel good about it.
Our loan production numbers were very strong and have been for the last three quarters so we’re optimistic, and we are still not seeing any line utilization. And I think that’s a barometer that the economy is still, at 2% to 2.5% GDP growth, we have a lot of our particularly middle market small business clients that are not drawing down on their lines of credit and they’re just waiting. I think that’s the same at most banks, and probably in our case whenever the economy really turns around another $1 billion plus of loan growth that will happen without us really doing anything. But that is not happening at the moment and we’re still getting half decent growth.
Asset quality: the story here is the same. It’s been improving rapidly for two years and we had a great year last year and it’s continuing this year. As we said in our Q1 conference call we still expect classified loans to continue to trend down this year and PAs will trend down. While we had no provision in Q1 we expect to have provisions this year, but it’s a very good story and we’re not quite at the bottom yet in terms of how low these things can go. Certainly probably this year or early next year we’ll get to that point so there’s still more improvement to come here.
This is a newer chart and it just shows are net charge off average over ten years, and it’s highlighted by the construction in my mind where we [had a 194 basis points]. We’ve made a strategic shift to kind of keep that portfolio lower; we let it get to 10% during the downturn. And although we made money through the downturn it certainly impacted our profits, and sooner or later there will be another downturn. Nobody wants to think about that right now, but we think we will perform even that much better.
The other kind of interesting note on the chart is our mortgage portfolio which has a 2 basis point loss through the cycle. I’m sure that’s going to be very hard to get the regulators to appreciate that when we go do the stress test because I think in the stress test the large banks were using 500 basis points to 1000 basis points, which wouldn’t seem to make sense for our portfolio.
Almost every good regional bank is very well capitalized and we are too, but part of what we thought would make sense is to compare some things from where they are in a credit standpoint – in this case, our credit is better than a lot of regional banks. So the green, it probably should be blue but the green is City National in this case, and in this case the green is lower. So this is just showing that relative to our credit and our peers we look pretty good from a capital standpoint.
Another big part of our story is our asset sensitivity and we certainly are probably the most asset sensitive bank of the top 50 banks. This is just focusing on net interest income but we also roughly lost $35 million to $40 million in our money market funds. So we do benefit a lot when rates go up; we do think they are eventually going to go up, and this is just depicting it to you all. And we put the same information on our 10(q) and 10(k) with all the assumptions that there is a lot of earnings power here when rates go up, and I think our stock price will naturally follow.
It’s hard to have one of these discussions without at least talking about the regulatory area and what’s going on there. We’re happy that most of what has happened there is not targeted at us and has very, very little impact. The regulatory forum, we have low risk and there’s really been very little that’s impacted us there. On the consumer side we don’t have any kind of mortgage problems at all – I think we had five foreclosures last year in our $4 billion portfolio – and we have no direct or indirect exposure in our money market funds or in any other place in our bank to the [picks]. So we feel pretty good about that, that we don’t have to be in the headlines on any of those things.
So let’s move into a little bit more of the future. So those that follow us we did a couple weeks ago announce two smaller acquisitions, one in our wealth business – Rockdale Investment Management that we will be merging in with our bank business, and I’m going to talk a little bit about the wealth business later so I’ll come back to it and show where that fits in; and then we also bought a fabulous leasing company called First American Equipment Finance. It’s headquartered in Rochester, New York; it actually just a week ago got the award for companies with employees less than 250, the #1 Place to Work in the State of New York. But it’s a fabulous company, very, very high quality. I don’t think there’s a leasing company that is a better fit with City National.
We certainly did a lot of work in this whole space, we’re already in this business, so both of these acquisitions we think are great fits for our company. They both produce very nice IRRs and we’re optimistic with this. They’re small, and that’s our style to kind of do smaller deals, but we think they’re going to be good for the franchise and good for shareholder value. And then in previous years we did a number of FDIC deals. We actually bought two banking branch offices in San Jose and last year we bought an asset-based lending portfolio.
Okay, the wealth business. So here’s the kind of four focal points in our wealth business: our bank business and some small affiliates there, our ultra-high net worth business, Convergent which is a national open-architecture advisory business, and our institutional business that’s headquartered in Boston. And then lastly we own 20% of Matthews International which is the largest US-based Asian mutual fund advisor, which has fabulous performing numbers and has had great growth. And again, we own 20% of that – the rest of that we mostly own 100%.
Rockdale fits in the blue box – that’s going to get merged in with our bank business. And we think it is going to help us from a scale and a competitive standpoint. It gives us a broader product set and it really should be a one plus one equals three kind of thing. So we have a very comprehensive platform here. We feel the future is really bright for these businesses. We’re still looking to make acquisitions in sort of all of the boxes but the green and the yellow. It’s tough to find things that really fit for us so I’m not committing that we’ll get anything done but we’re still looking to buy something, and I’d say [Leem Undergroup] has been focused on it. They did a very small acquisition at the beginning of this year but they’re still trying to build up some scale.
Preferred banking, which I touched on briefly: so we started an initiative in 2007 where we went sort of that segment below the high net worth, and we did a study and there I think was 900,000 preferred banking clients within five miles of our branch. And we define them as individuals that have $150,000 of income and $250,000 investable assets. So long and short, we did two things. One, we revised our products at targeting that group: no ATM fees – and we looked at what other banks, you have to study your competitors, and I think what we feel we’re doing is different.
Most of the large banks we compete against have a special product for this segment group. What we didn’t see was that there was any real differentiated service, so we are providing a differentiated service. We feel pretty good about the numbers; probably the operative number to look at on this chart is the 1067 – that’s what we call new money, and that’s about $880 million in deposits, the rest in loans. So we’ve had so much deposit growth over the time it sort of didn’t get noticed that much, but it’s a very nice initiative that’s helping our deposit growth and we think it’s something that we’ve really just kind of scratched the surface, so a good new initiative that will continue.
So last year we set a record and opened six new offices, we’re not going to probably do that this year, by the way – our second in New York, our second office we bought in San Jose; one in Brentwood in the Pacific Palisades on the west side of Los Angeles; and then in Nashville and Atlanta. So as I said right at the start, we are investing in the franchise. I mean there’s always a cost to carry when you do this but we really started the effort of doing a lot of investing in 2010. We’re seeing those benefits and we would expect those benefits to carry into 2012, which they are, and into 2013 and beyond.
International trade service – another area where we decided we had to build out a platform here. We brought in experienced people from other larger banks that had significant experience and also are adding technology. So some of the results of that showed up in our Q1 in some of the lending that we’re doing, and we think we’re still early in that and we’re perfectly positioned where we’re located and where our client base is to benefit from what’s going on in this space. You can see here world trade volumes grew 5.8% in 2011. The two biggest ports in our country are in California, so there’s a lot of activity here and we expect this to be a nice source for us to help us grow in the future.
Okay, I’m not going to go any further here. I don’t know where my time thing is here, I don’t see it but I’m probably close to running out. Let’s go the economy in California which I know you’re all eager to hear about. California, I mean the short story is California is kind of doing what it normally does – in a weak economy it does worse, in a good economy it does better. So we are creating jobs, housing looks like it’s bottoming out. We’ve got four industries that are actually doing really well: tech, healthcare, ag, and entertainment. I mean I’m sure most of you went and saw the Avengers movie. It’s already done $200 million, a new record to the box office. But the entertainment business has actually done very well through the downturn, but probably the hottest business in California is tech.
So there’s a lot going on in California; unfortunately unemployment is still high. In two of our major markets, San Francisco and Orange County, it’s about 8% which is not bad, but you’ve got in LA County it’s still just a shade under 12%. So there’s still some work to be done here, and you’ll see the next slide which actually talks about that. So I mean this is a good news slide; I think you’ve got to be careful looking at some of the numbers, particularly construction is up 12% there but it’s coming off the floor.
And I mean you can see the big contraction that’s been going on for a while is in the government. There isn’t enough money, although I’m sure they’re going to pass this tax for the wealthy that they have on the ballot, but there isn’t enough money to pay for all the government employees. So that’s a steady cutback and it’s tough on those government employees and it’s still tough on our unemployment numbers. But if you look at the rest of the charts there there’s a lot of job activity going on here. So I think it will take a little bit longer but California is steadily pulling out of the downturn.
One of the things we look at, if you look at states that are adding jobs there’s five or six states that are ahead of California. Every single one of them has something to do with oil. When you get past oil we are adding more jobs than anything else. So these are just a couple more slides that show positive things going on: sales and income tax. And with that I’ll turn to the end here, I think.
So we feel great about the way we’re positioned. We think that the regulatory forum isn’t targeted at us. The rogue players are mostly gone from the industry and landscape and we have big opportunities. The only thing that’s really holding us back, frankly, is the interest rate environment. These low rates, our business model is built around gathering a lot of low cost deposits and in this rate environment I mean we do an estimate that if we shocked our balance sheet to a normal rate environment tomorrow we’d right away make $150 million more pre-tax. So there’s a lot of earnings power in our company and it’s just not going to be realized until the rate environment goes up.
Until that happens we still think we can grow our company steadily and continue to improve our returns, but our returns won’t get back to the normal levels until rates are a little bit higher. So that concludes my comments and with that I’d be glad to answer any questions that anybody has.
Stephen Scinicariello – UBS Securities
Great, I’ll kick it off. One core competency as you laid out, Chris, is City National is always making timely investments for the long term and for the future; and just like we’ve seen recently with the equipment lease operation, First American, and the wealth management at Rockdale. As you look out in terms of dislocation in the marketplace given your strong level of capital, are there more of these types of bolt-on opportunities as you look ahead for 2012 and 2013?
Yeah, I think there are. We’re not planning to do a leasing company roll-up strategy so it’s not likely that we would right away go out and buy another leasing company. I think if we found something that we thought was a perfect fit would we look at it? Sure. But I think there’s other specialty business in the commercial finance arena that could lend, I mean we certainly have the liquidity. So there’s other things besides banks.
We are spending a lot of time looking at banks. We haven’t been successful this year in finding something that fits and at the right price, and most of that time is really spent looking at things in California. But we would certainly entertain something if we found something in Manhattan. We’ve never really found anything that fit for us here. And then wealth management, we really do hope we get some of the things done there this year but again, no commitments but we’re spending a lot of time on the whole area there. We still think it’s a good time and we should be out there looking to deploy capital in all these different areas, and we have some needs that are more strategic to get some more scale in some of our business so it makes sense.
Can you talk a little bit about how you’re protecting your margin in this environment, and your response to prepayments and things like that?
Did you say talk about the impact of the margin? Sure. Well, in this kind of environment, it’s tough to protect it too much. We did lengthen our securities portfolio a little bit but we had it awfully short, so in the short run that improved our margin a little bit. You know, we’re trying to monitor pricing and how all things are going there but it’s a competitive market. It always is in California. We have, I think, even though we have a low cost deposit base we’ve been bringing down the cost of deposits, and I guess in the last year or two we refinanced out some more expensive debt but we don’t have too much more opportunity there.
So we’ve tried to kind of do most of the things you can do, and we’re kind of running out of things to do there. And we’re a little bit wary of taking too much duration risk. We don’t pretend that we can predict when rates are going to go back up so you know, what I try to tell people is we still expect some modest compression in our margin throughout the rest of this year. I think that for most banks, I mean some have a few different things going on than us but that’s probably what’s going to happen. So there’s some limits on what you can do if you’re really growing your balance sheet, and we are growing our balance sheet. And if you’re growing your balance sheet I think you’re still going to see some compression, and I don’t think it should be too bad this year for us and a lot of banks but you’re still going to have it.
Can you talk about the competitive and demand dynamics in C&I in the markets that you’re in?
Yeah, I think that they are varied. So we have a lot of specialty businesses, so the sort of bread and butter middle market, $10 million to $100 million in sales company, the vanilla company that you don’t need a specialty to lend to is the most competitive space and the pricing is tough. I think you can still get an acceptable return but it’s very competitive. But those companies need other services from banks and for example, if you were just a real estate lender it’s hard to quickly go into that business because they would expect you to have a complete suite of cash management products and other services, but I would say that’s where it’s the most competitive.
When you go into some of the specialty businesses, some of healthcare for example can be more about the technology solutions you’re going to bring to bear, for whether it’s a practice of 20 doctors, than about the exact pricing on the loan because there’s a lot of technology solutions for that sector to make their jobs easier, in the whole of healthcare. And a lot of them are cash management-oriented. So we have a combination. We have businesses that are in the pure middle market; we have some specialty lending businesses like franchise finance, entertainment, legal services and there’s different dynamics in those different segments.
Overall, though, it’s competitive and it’s what’s been putting pressure on our loan yields and most of the industry’s loan yields.
And how about in terms of the wealth management business right now, probably about 15% of revenues but like you showed us up there on the slides, you’ve made a lot of investments for the future, it looks like creating a lot of earnings torque for a better environment. As you kind of look at that franchise and some of the things you’re bolting on there, what are some of the things that you guys get excited about in terms of potential upside and in a better environment for pieces of the wealth management franchise?
Well, I think there’s two things, and one we don’t really have any control over. But we obviously get very excited in our company when people really think rates are going to go up, and that’s a big benefit to our wealth business. But we also think that our wealth businesses are at a point where the additional revenue that we bring into them, they’re big enough that a significant portion of that falls to the bottom line. So where we can make an acquisition it just really adds to that, but even as we just grow the business the marginal profit on that is higher. So while we’d always like more scale in a lot of our businesses, I think our bank business, particularly with Rockdale is a part of it now. I think it’s pretty powerful in what it can offer to our clients, and then the revenue that comes in, we’ll get a bigger margin on that. And I think that’s what we’re trying to drive in all those businesses, and a lot of it, acquisitions can help but we do have good sales efforts in all the businesses, so part of that will help over the next couple years because the margin should go up.
Stephen Scinicariello – UBS Securities
Alright, with that there’s no further questions. Please help me in thanking Chris Carey from City National for joining us, and if you have further questions feel free to come to the Louis XVI East room on the 4th floor. Thank you.
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