First Republic Bank's (FRC) CEO Jim Herbert on Q4 2016 Results - Earnings Call Transcript

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First Republic Bank (NYSE:FRC) Q4 2016 Earnings Conference Call January 13, 2017 10:00 AM ET

Executives

Dianne Snedaker - Executive Vice President 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 and Chief People Officer

Analysts

Lana Chan - BMO Capital Markets

Steven Alexopoulos - JPMorgan

Dave Rochester - Deutsche Bank

Kyle Peterson - FBR

Casey Haire - Jefferies

Chris McGratty - KBW

Ken Zerbe - Morgan Stanley

Aaron Deer - Sandler O’Neill

Tim Coffey - FIG Partners

Timur Braziler - Wells Fargo

John Moran - Macquarie

Geoffrey Elliott - Autonomous Research

Matthew Keating - Barclays

Operator

Greetings and welcome to First Republic Bank’s Fourth Quarter and Full Year 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 fourth quarter and full year 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 and Chief People Officer.

Before I hand 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 would like to turn the call over to Jim Herbert.

Jim Herbert

Thank you, Diane and thank you everyone for joining our call today. It was a strong fourth quarter and a great year overall. In fact, 2016 was a record in many respects. Revenues were up 20%. Earnings per share were up 24%. We successfully accessed the capital market four different times, raising over $1 billion in new capital. Our total capital will have increased 24% for the year post the upcoming redemption of our Series A 6.7% preferred shares on January 30.

In addition, tangible book value per share was up 17%. Total deposits grew 22% for the year and total loan growth was 18% for the year, while net charge-offs for the year totaled only $1.9 million or less than a single basis point. And our wealth management business continues to grow very nicely total assets were up 16% during the year. Such consistent results are driven by continued focus on strong capital position at all times, excellent credit, and most importantly, continued exceptional client service.

We continue to invest in initiatives that improve the client experience, information security and data analytic capabilities. You will hear more about these in a moment. Our high-touch service model is the key to our success. We regularly measure our client service levels through our net promoter score. We were recently delighted to see that our already high scores have further increased in 2016. More about this in a moment, but it is our key competitive advantage. During the year, the bank significantly enhanced its own balance sheet liquidity, a process begun over 2 years ago. High-quality liquid assets were over 12% of total average assets during the fourth quarter and this was our target.

Let me speak for a moment about the Gradifi acquisition, which we closed near 2016. Gradifi is the leading provider of student debt repayment benefit plans serving companies across the country. While its position is not currently meaningful to earnings, Gradifi has a long-term strategic opportunity to help address the student debt challenge overall. It also offers First Republic a much handed opportunity to acquire new clients through our Eagle Gold All-in-One lending program. You will hear more about this shortly.

Before I turn to the team, let me first put into context our performance over the long-term. We followed three particular metrics that are important from our point of view to the safety, stability and consistent CHIs [ph]. Since our second and national public offering at the end of 2010, our total capital has grown 23% per annum. Tangible book value per share has grown over 15% per annum and credit has remained consistently strong. Net charge-offs have equaled 1 basis point per annum.

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

Mike Roffler

Thanks, Jim. I would like to run through some fourth quarter numbers and then focus on net interest margin, the efficiency ratio, income taxes and our capital structure. In the fourth quarter, earnings per share were $1.03, up 22.6% compared to the fourth quarter a year ago. Revenues grew 21.1% compared to the fourth quarter last year.

Turning to core net interest margin, it decreased slightly to 3.08% from the third quarter. Importantly, net interest income, which represents more than 80% of our revenues, has grown 21% year-over-year. Turning to expenses, the efficiency ratio for the quarter was 60.1%. As we discussed on our last earnings call, we continue to expect our efficiency ratio to be in the low 60s. With regard to income taxes, our effective tax rate was 21.7%, up from 15% in the third quarter of 2016. We can expect to experience some variability from quarter-to-quarter in our effective tax rate due to employee stock option exercise activity, which was lower in the fourth quarter than prior quarter. For all of 2016, our effective tax rate was 18.6%, which is within our previously anticipated range of 17% to 20%.

As Jim mentioned, we opportunistically raised over $1 billion in total new capital during the year at very attractive terms. In the fourth quarter, we were pleased to have issued 325 million in a common stock offering. Earlier in the year, we completed a $400 million, 30-year, 4 3/8 subordinated notes offering, which qualifies as Tier 2 capital. The proceeds from this offering in part will be used to redeem our Series A preferred shares at the end of January. This further optimization of our capital structure will result in a net savings of approximately $2 million per quarter.

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

Mike Selfridge

Thank you, Mike. I will cover economic conditions in our markets, business banking and our multifamily and commercial real estate portfolios. Economic conditions in our geographic markets are very good and our clients are active. In our largest market, the San Francisco Bay Area, as we stated last quarter, residential real estate prices have moderated and current loan demand is strong.

Turning to lending, we continue to focus on the same types of lending in the same geographic markets with the same consistent credit standards. Loan origination volume was $7.9 billion during the fourth quarter, our best quarter ever. Heading into the fourth quarter, we had a very strong pipeline and while our pipeline is currently up compared to this time last year, we do not anticipate the same year-over-year percentage increase in total loan volume in the first quarter.

During the fourth quarter, single-family residential lending volume was 37% purchase and 63% refinance. As interest rates rose in the fourth quarter, there was an acceleration of refinance activity. Once refinance activity subsides, mortgage volume will be driven more by home purchases and in a purchase market, First Republic’s client focused service model is a competitive advantage. Very importantly, credit quality continues to be excellent. Non-performing assets remain low at just 7 basis points. During the quarter and for the full year, net charge-offs were less than 1 basis point of average loans. We added $10.5 million to our loan loss reserves in the fourth quarter and $47.2 million during the year to support loan growth.

Now turning to business banking, it was another strong year. Business banking continues to make a meaningful contribution to First Republic, particularly to the deposit franchise. Business deposits were up 27% compared to a year ago and represent 53% of total deposits. Year-over-year, business loan commitments were up 21% and business loans outstanding were up 11%. Business banking continues to grow because of our ability to offer a comprehensive platform of lending, deposit and wealth management services delivered with exceptional client care.

Turning to multifamily and commercial real estate lending, it was a strong quarter and we continue to apply the same disciplined underwriting standards to multifamily and commercial real estate lending, as we always have. Our multifamily and commercial real estate loans make up less than 25% of our total loan portfolio and are less than 200% of total capital. Overall, we are very pleased with 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 would like to talk about the growth in our investment portfolio and our deposit franchise as well as provide an update on our preferred banking office network. In terms of investments, our total portfolio grew to $15.2 billion. This increase was a strong driver of total asset growth in 2016. High quality liquid assets, including eligible cash totaled $9 billion at December 31, or 12.7% of average total assets in the fourth quarter. We are very pleased to have achieved our long-term objective of growing our HQLA portfolio to over 12% of average total assets. We accomplished this goal with modest impact to our overall yield and we expect to maintain HQLA at around this level of average total assets moving forward.

Turning to deposits, growth was diversified by client types and strong across all channels. Deposits sourced through our business banking, wealth management and private banking activities were all up over 20% from a year ago. Total deposits were $58.6 billion, up 6% from the last quarter and 22% from 1 year ago. Checking deposits represented 64% of our total deposits. The average rate paid on total deposits during the quarter was 15 basis points, consistent with the last quarter.

Let me take a moment to talk about our preferred banking offices, another key channel through which we delivered the fully integrated extraordinary client service experience at First Republic. Our preferred banking office network consists of 69 offices in our geographic footprint. On average our retail offices each holds more than $275 million in deposits. Our focus on extraordinary client service in our office network results in yet another very effectively means of deposit gathering.

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

Bob Thornton

Thank you, Gaye and good morning all. Wealth management had a strong quarter and a good year. Compared to the fourth quarter a year ago, wealth management fee revenues were up 18.8% while assets under management grew 15.6% to $83.6 billion. We would note that these comparisons include the full benefits of the acquisitions of – acquisition of Constellation Wealth Advisors, which we closed on October 1, 2015. Revenue growth from the quarter and year exceeded growth in assets under management principally due to larger – to greater client brokerage activity. During the fourth quarter, wealth management and assets were up 4.2%, 81% of this growth was from net inflows of client assets. And at year end, wealth management sweep accounts represented 8% of the bank’s total deposits.

During the year, private wealth management continued to recruit highly experienced, client facing professionals. In 2016, we brought on seven new portfolio managers and we focused on the integration of our new hires, including the team from Constellation. At the same time, we devoted significant attention and resources to operational and client facing enhancements. For example, we further improved our paperless account opening process, resulting in a more streamlined client experience. We also strengthened our performance reporting capabilities to be able to deliver a more comprehensive view to clients.

Now let me take a moment to speak about the collaborative approach we take at First Republic as we look to fully serve our clients’ financial needs across both wealth management and banking services. Private wealth management continues to be the strong contributor to total deposits through not only wealth management sweep accounts, but also as a source of new deposit clients for the bank. For example, in 2016, more than 1,100 wealth management clients became new deposit relationships due to our team based approach across the entire enterprise. Overall, we are very pleased with the growth in wealth management as well as the continued opportunities ahead to bring in both new clients and talent to First Republic.

And now it’s my pleasure to turn the call over to Jason Bender, Chief Operating Officer.

Jason Bender

Thank you, Bob. Let me take a moment to provide an update on our operations and infrastructure. Our ongoing investments in infrastructure and operational enhancements are designed to deliver excellent client service and support sound risk management. We had a number of operational accomplishments and milestones in 2016. Leveraging our investments in operations and regulatory and compliance infrastructure, we successfully managed higher banking transaction volumes. This included both a record number of wires processed and residential loans funded in 2016, up 17% and 20%, respectively from the prior year. We also managed higher volumes in our wealth management business. First Republic securities company trades for example, were up 30% year-over-year. During 2016, First Republic piloted its first online lending hub, enabling clients to safely and securely provide their mortgage related information and upload required materials while connecting with us digitally in a seamless and integrated experience. And we reengineered our closing process for Eagle Gold All-in-One loans, which can all be processed paperlessly and online from application through funding.

Looking to 2017, we continue to invest in the operations of the franchise moving forward. This includes the continued rollout of our new mortgage loan origination system following a successful initial pilot. This upgraded technology reduces manual data entry, eliminates paper files and incorporates more automated checks and controls. We also continued to make significant progress in redesigning our deposit client on-boarding process. This will create significant time savings for our bankers and ensure even better integration with our compliance and risk management activity. And we look to continually leverage data analytics to provide our bankers with greater insight into client activity and opportunities.

Our continued investment and operational enhancements both enable safety and scalability and ultimately drive our ability to continue to deliver extraordinary service. We measure our client service through Net Promoter Score, a commonly used measurement of client satisfaction and loyalty and one of the most important metrics we follow here at First Republic. In 2016, our new Net Promoter Score, which was just released, increased more than 15% to 72. This is up from an already high level of 62 and more than double the U.S. banking industry average. Our ongoing operational enhancements enabled us in 2016 to support record production and to increase our Net Promoter Score to client satisfaction at the same time.

And now let me turn the call to Mollie Richardson, Chief Administrative Officer and Chief People Officer.

Mollie Richardson

Thank you, Jason. I will cover our community and employee engagement as well as efforts to develop our next generation of clients through the Eagle Gold All-in-One student debt refinance loan. In terms of community engagement, in 2016, we closed over 600 Eagle community home loans. This program, which was launched just over a year ago, is focused on expanding homeownership opportunities for borrowers and underserved minority neighborhood. We also launched our Community Advisory Board comprised of nationally recognized and highly respected experts to help us better serve our communities. These efforts were recognized in 2016 by the National Asian American Coalition for addressing income and wealth and equality and we were also recognized by NASDAQ with an innovation and financial education award.

Attracting and retaining great talent is key to delivering exceptional client service and employee engagement remains an important priority for First Republic. In 2016, we implemented an increase in the bank’s minimum wage to $20 per hour in all of our markets and became one of the first large companies in the nation to do so. We also initiated a company-wide student debt repayment benefit for our employees with Gradifi, the leading provider in this space. Within the first day of making this benefit available, more than 300 employees enrolled. Based on that overwhelmingly positive experience, it was clear that Gradifi shares the same commitment to exceptional client service as First Republic.

Student debt affects not only our employees, but our clients as well. Our Eagle Gold All-in-One loan provides qualified borrowers with the opportunity to refinance student debt at a lower rate and more favorable terms. In 2016, we originated $728 million in loans through this channel while applying our same disciplined credit standards. Though a small percentage of our total loan originations this program is very strong driver of the next generation of clients. In 2016, Eagle Gold All-in-One accounted for more than half of the growth in total lending relationship.

Let me now turn to Gaye to speak about Gradifi and the opportunity with our Eagle Gold All-in-One program.

Gaye Erkan

Thank you, Mollie. We are very pleased with our recent acquisition of Gradifi, the leading provider of student debt repayment benefit plans. Through Gradifi’s secure and easy-to-use platform, companies can make direct regular contributions toward the repayment of their employees student debt. In a competitive labor market, this employee benefit is becoming increasingly popular amongst employers to attract and retain talent. We purchased Gradifi for a couple of key strategic reasons.

First, we completely support Gradifi’s mission to help the 44 million borrowers, with $1.3 trillion in student debt in the United States. Second, there is a great synergy leading to new client acquisition through offering our Eagle Gold All-in-One student debt refinancing service alongside Gradifi’s repayment solution. In addition, our partnership with Gradifi presents a great opportunity to introduce these valuable services to our business banking clients. Offering such innovative solutions to the student debt challenge with Gradifi is good business and the right thing to do.

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

Jim Herbert

Thank you everyone. And let me say, we are really delighted to welcome the Gradifi team to First Republic. In short, 2016 was a great year. It was the result of continued success in executing our unique business model, which is predicated on delivering exceptional client service at every level. [indiscernible] to 2017 for a moment. The franchise is well positioned. We are pleased to have maintained stability in our net interest margin. Business activity and backlogs remained strong with our clients quite active and optimistic. We continue to focus on serving our clients very well, which is the key driver of organic growth. As always, we look forward to delivering consistent results through all macro environments. We are pleased with the results and the year. Thank you very much. We would like to open the line for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Lana Chan with BMO Capital Markets. Your line is now open.

Lana Chan

Hi, good morning.

Mike Roffler

Good morning.

Jim Herbert

Hi, Lana.

Lana Chan

I wanted to first start off, ask about deposit betas in a rising rate environment, what do you assume in terms of the next one or two rate hikes in terms of how your ability to lag deposit rates?

Gaye Erkan

This is Gaye, hi. Over the last six quarters which spent two Fed rate hikes. Our average deposit rate has increased by less than a bp. And also I would like to note that over the same time period, our checking as a percent of total deposits has increased from 61% to 64% now. We expect to lag.

Lana Chan

Okay. And then in terms of any color on expense growth guidance for 2017, I know you – Mike Roffler gave guidance in terms of the efficiency ratio being the low 60% range. But could you talk about relative to the expense growth that you had in 2016, what are the puts and takes in terms of some of this investment spending that you are talking about?

Mike Roffler

Sure. So 2016, we do think about this as a low 60 efficiency ratio because that does also take into the revenue side of the equation, which is also really just as important. One of the big developments I think in 2016 that was important as you saw a reduction in some of our professional fee spending as we completed many of our regulatory initiatives. Some of those dollars were then reinvested back into the business. As Jason and Jim both talked about, the importance of net promoter score and then client service. And so we are really excited to be investing in client service initiatives, which is why we think a low 60s efficiency makes sense and if revenues are growing nicely, expenses on a pure dollar basis are going to grow commensurate.

Lana Chan

Okay. Thank you, Mike.

Operator

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

Steven Alexopoulos

Hi, good morning everybody. I have two questions on originations. So first, you had record business originations in the quarter, but if we look at business loans outstanding, they actually declined. Was this just a function of very short duration loans being originated maybe capital calls or do you actually sell any loans in the quarter?

Mike Selfridge

We sold some single-family loans, Steve, on the business banking side. There was a decrease in the utilization rate, particularly with the capital call lines of credits. So typically, we would see about 33% to 35% utilization on those lines of credits and that dipped down to below 30%. And if you look at the third quarter, it was unusually high at about 41% usage on those capital call lines of credits. So I think the important thing to look at is we are increasing the number of clients in business banking and we are increasing the commitments. So overall, we feel good about the opportunities.

Steven Alexopoulos

Okay, that’s helpful. And then maybe for you, Mike, looking at the very strong refi originations in the quarter, the industry overall is reporting refi activity as being flatter down in 4Q. Why are refis up so much for you guys and is this essentially all share gains?

Mike Roffler

Yes. I think, Steve, I would expect going forward, that refi, if rates continue to rise will subside as I said in my remarks. And with the backup in rates in Q4, there was a bit of a rush to refi that we saw and so that increased the activity. And as I said, we wouldn’t expect origination volume to have the percentage increase year-over-year that we indicated in Q4. But going into the first quarter, the pipeline is strong and we still think that mid-teens loan growth is right for 2017.

Steven Alexopoulos

Okay, that’s helpful. And maybe for Mike Roffler, the core margin declined a few basis points in the quarter, but given what we have seen in the yield curve, how do you think about the trajectory of the core margin here?

Mike Roffler

Yes. So we are pleased actually, the fourth quarter to be stable. As Gaye talked about, we completed our build-out of HQLA and so we are happy in this sort of 3.08 to 3.12 range that we have been. As Mike Selfridge mentioned, the loans we closed really in the fourth quarter really most of them were locked pre move-in rates. And so the move-in rates will start to benefit us probably more towards the latter half of the first quarter as those loans make their way through the pipeline. I think it’s too early to say that it’s definitely up, but it’s trending, the locks are trending better from a rate perspective than what’s on the portfolio today, so we are seeing good direction. On the core NIM, maybe I could just add one technical point. As we did in the first quarter of this year, we reduced our reporting of core metrics given the declining contribution of purchased accounting, we are just going to report the GAAP NIM starting in the first quarter going forward.

Steven Alexopoulos

Okay. Thanks Mike. And I have one final one for Gaye. Can you give color on the strong deposit growth in the quarter, I am curious if there was an initiative given you had such a large HQLA bill required? Thanks.

Gaye Erkan

Sure. Thanks Steve. The second half tends to be always stronger in terms of activity as well as average balance sizes. It was diversified. We are very pleased with the diversification across the industries that span professional services, private equity and other firms.

Steven Alexopoulos

Okay. Thanks guys. I appreciate the color.

Gaye Erkan

Thank you.

Operator

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

Dave Rochester

Hi. Good morning guys. Nice growth this quarter.

Jim Herbert

Good morning Dave.

Dave Rochester

I just want to start with the HQLA, if I could. Now that, that build is done, what’s the investment strategy now with the future growth in the portfolio, I know you will probably continue to buy HQLA to maintain the concentration as Gaye, I think that’s what you had said earlier, but can you just talk about how that investment strategy could change in light of the potential tax policy changes and whatnot, that will be great?

Gaye Erkan

Sure. As you mentioned, we will continue to keep our HQLA at least 12% of average total assets in a given quarter. And we will continue to reevaluate and optimize our investment portfolio purchases in light of any tax or rate movements while ensuring the 12%.

Dave Rochester

Are you thinking to hear upside or news could change depending on the new policies?

Gaye Erkan

It’s early to say. Even a tax rate change of potential decline or slight decline would still make municipal bond portfolios look attractive. Again, it’s early to say, but we will look at the changes and optimize accordingly. The good news is that we also have a lot of opportunity and diversity in our HQLA purchases, so the optimization will give us a lot of alternatives to go as the average.

Dave Rochester

And I am curious, if the $50 billion threshold – $50 billion active threshold were raised sometime this year, would that change how you think about maintaining HQLA and could you possibly shift a decent portion of that portfolio into higher yielding securities?

Gaye Erkan

12% is the result of prudent liquidity risk management and stress testing regardless what the thresholds were to be. We would continue to keep those and to stick to those sound risk management practices.

Dave Rochester

So even if you weren’t subject to the LCR anymore, you would most likely maintain at 12%?

Gaye Erkan

Correct. And let me note that right now, the investment portfolio, despite the tremendous build-out of HQLA in 2016, we ended – we are pleased we ended up close to 4% in yields, which is slight – still attractive compared to the rest of the balance sheet.

Mike Selfridge

And just a clarifying point Dave, as a reminder, because of our new holding company structure, we are not subject to LCR as a liquidity as a matter [ph], as Gaye mentioned, prudent risk management and having appropriate liquidity.

Dave Rochester

Right, yes, got it. Thanks. And Mike, one for you, just on the big number this quarter, I think you guys mentioned a more normalized run rate for that, would be maybe around $10 million or so, just curious if you guys have made any other investments this quarter or anything like that?

Mike Selfridge

No new investments. Our normalized run rate would be about $10.5 million to $11 million. Just once in a while, there are one-offs items that happen during the quarter.

Dave Rochester

And on your tax rate range for ‘17, the 20% for last year or for 2016, does that hold for 2017?

Mike Selfridge

Yes, it does.

Dave Rochester

Okay, great. Thanks guys. I appreciate it.

Operator

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

Kyle Peterson

Hey, good morning guys. It’s actually Kyle Peterson, on for Paul today. Just wanted to touch on the jumbo market a little bit with the up-tick in rates, have you guys noticed much sensitivity in your pipelines with being jumbo kind of versus the more standard conforming mortgages?

Mike Selfridge

I would – no, I would say traditionally if you look at the medium loan side of our single-family mortgage portfolio, that’s about right and that’s a little bit over conforming. And I think your question about refi as I said earlier, the mix, 37% purchase, the remaining being refi, was tilted obviously more towards refi given the back up in rates and the activity that we saw to get people into the pipeline and locked into some mortgages.

Kyle Peterson

Okay, great. And then if I could just get a little bit of update on the student lending business and kind of how Gradifi fits in, when do you guys – do you guys have any timeline as to when you kind of expect to start seeing some of those synergies essentially with the Gold, the Eagle Gold All-in-One product and when do we start seeing kind of more growth off of that from the acquisition?

Gaye Erkan

Yes. In the near-term, we would expect the impact to be material, from the financial results perspective. While that’s the case, there is a great synergy between the student debt refinancing that we have through Eagle Gold All-in-One and Gradifi providing the repayment solutions, that’s a nice fits together. Later in this year, it will be easier to look at the results and expect those to be monetized on.

Dave Rochester

Okay, great. And then I guess just last thing, it doesn’t look like the marketing line item had a little bit of an up-tick this quarter, was there anything unusual in that or it’s just – is that kind of how we should be looking at the run rate moving forward?

Mike Selfridge

It’s probably pretty good for looking at the run rate moving forward. I also think that in the fourth quarter, we tend to have some seasonality in the marketing spend because we do have events, maybe a little bit more loaded towards the end of the year versus the third quarter, which is some of the summer time activity.

Dave Rochester

Okay, great. Thanks. That’s all for me.

Operator

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

Casey Haire

Good morning everyone. Thanks. Just a follow-up Gaye, on the HQLA, I am sorry, if I missed this, but what is the new money yields on HQLA today?

Gaye Erkan

The new money yields today, given the recent rate sell-off, they are actually up across the board. But if you look at the different securities 40 basis points to 50 basis points, so you see securities between 2.5% to 3% and then slightly little over even 3% within the same terms that we have been buying, 3-year to 5-year, most of the 3-year to 4-year type of duration.

Casey Haire

Okay, great. And then with the build now done, if you would continue to have excess deposits versus loans and your HQLA is okay at 12.7 as it is today, I would imagine excess securities would go to munis?

Gaye Erkan

So again as we said, we will continually re-optimize depending on the market development, but in absence of any other changes, yes. And you brought up a great point. It will be less pressure on the funding side given that maintaining HQLA is much less onerous than building it up than we have done in 2016. Thank you.

Casey Haire

Okay, great. And then just on the Bowie line this quarter, obviously a little bit higher, was there an offset on the expense side at all?

Mike Selfridge

No, there would not have been.

Casey Haire

Okay. So if that line were to normalize lower, there would be no offset on the expenses?

Mike Selfridge

Correct

Casey Haire

Okay. Thank you.

Operator

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

Chris McGratty

Hi, good morning. Thanks for taking the question. Mike, on the new provision, on the new loan growth, it dropped considerably quarter-on-quarter, is that just a function of mix that you have alluded to less capital call activity and commercial growth or is there – is it kind of a sustainable growth or level of provisioning rate for ‘17?

Mike Selfridge

So, it will be the former of what you said. Given the decline in the business loans outstanding and that being a little bit less of the total portfolio, the provisioning on that then goes down. So, this is a little bit maybe unusual whereas last quarter, it was almost double at $18 million due to the growth in business loans. The reserve to total loans sort of ranges at about 59 to 60 or 61 basis points and that’s pretty consistent absent any big mix change.

Chris McGratty

Okay, great. And then last on wealth management, you guys continue to have success here. I am interested if there is any opportunities to grow this business again inorganically with teams or producers or whole bank – or whole fee income acquisition?

Bob Thornton

This is Bob. Yes, as I noted in my comments, we made some hires last year, but we had a lot of activity at the end of ‘15, the acquisition of Constellation. But we are still seeing a lot of great hiring activities, and I think you will see some attractive hires as we move through the first half of this year.

Chris McGratty

Great. Thanks a lot.

Operator

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

Ken Zerbe

Great, thank you. Just a quick question on the, let’s call it, taxes/stock options. I mean, what’s the major driver of that? Is it that as the stock options actually vest then they are obviously exercised or is it that they are already vested and it’s just simply a choice among the option holders whether or not they exercise the options?

Mike Selfridge

Sure. So Ken, the large part of it is the latter part of what you said. The bank granted stock options early in our 2010, ‘11 period. Since then, we have moved to restricted stock. So, those have all vested and it is the matter of employees making the decision on their own of when to exercise. They have a life. So by 2020, they pretty much are all exercised, because they have a 10-year life. So, there is some movement that will occur. So, the third quarter was much heavier in activity than the fourth quarter and again, that’s an employee choice. The one thing I would also add, this is obviously different for us right now. But starting in 2017, other companies will also have to adapt this. So, it will be more normal across the board.

Ken Zerbe

Got it. Understood. I mean just mathematically, if I look at the stock price, I would have expected the fourth quarter to be stronger than third quarter from an option exercise standpoint? I mean is that logically correct, I am just trying to get a sense of how to think about the forward exercise? Go ahead.

Mike Roffler

I totally understand your question and it’s really an employee preference and a decision that one makes individually.

Ken Zerbe

Alright. Okay, thank you very much.

Operator

And your next question comes from the line of Aaron Deer with Sandler O’Neill. Your line is now open.

Aaron Deer

Hi, good morning everyone. Mike Roffler, a question on the expenses, you addressed it on the advertising and marketing line. I am wondering too, I know you guys have been investing very heavily in technology, but the IT line ticked up quite a bit this quarter, just wondering there too if this is kind of a run-rate going forward or if there was anything nonrecurring in there?

Mike Roffler

Nothing of significance that would be non-recurring. We are, as Jason talked about in some operational areas, investing quite heavily for the client experience and really that is a driver of being able to deliver extraordinary client service, which then really leads to all the results you see. So that it’s an investment we are making in the franchise and sort of future outlook.

Aaron Deer

Okay. And then a follow-up question for Bob, you had mentioned 1,100 new deposit clients that came over from wealth management during the course of the year. I am curious how many of those might have been Constellation customers versus customers that had been principally in First Republic’s wealth management that then became bank side customers?

Bob Thornton

I would say that there were some material Constellation clients that became bank clients, but the vast majority were just the breadth of referrals from our private wealth and professionals of their clients to the bank.

Aaron Deer

Okay, great. Thanks for taking my questions.

Operator

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

Tim Coffey

Thank you. Good morning, everybody.

Mike Roffler

Good morning, Tim.

Tim Coffey

I have a question – the question about the income statement on the FDIC assessments. What was the rationale for those increasing and what’s a good run rate?

Mike Roffler

So, largely, the FDIC assessment is driven by the bank’s growth in total average assets. I would remind maybe everybody that’s happened last quarter for the first time, the $50 billion plus surcharge from the FDIC went into effect. So, our second half of the year expenses have gone up relative to the assessments, but it’s largely a function of average asset growth as why it’s growing in any given quarter.

Tim Coffey

Okay. Thanks Mike. And then for the other Mike, if you look at the growth in the multifamily loans, two-part question. One, what kind of lead the opportunities to expand that portfolio this quarter, opportunity and geography? And then two, kind of what’s the outlook for growth in that portfolio if rates continue to rise?

Mike Selfridge

I would say in income probably as we characterized by both commercial and multifamily. If we step back, we are doing the same things that we have been doing for many, many years. So, the median loan size on commercial real estate being $2 million and loan to values of 50%. We are still finding opportunities. And if you look at where the growth of the franchise comes, little bit more than half of the growth comes from existing clients, and those clients remained active in our market. So really there is opportunity, but it’s the business as usual as it relates to both multifamily and commercial.

Tim Coffey

Okay. As you look at kind of growing the multifamily or the multifamily piece specifically, do you have an outlook on where NOI goes on those properties?

Mike Selfridge

We don’t have an outlook. We underwrite all of these deals very conservatively, again low loan-to-value, high debt service coverage ratio and following many of our existing clients who are active in our markets. We also don’t set targets. We really – the model of the franchises is centered around the client and what the client wants. I would say, as I mentioned in my remarks, with the moderation of prices and rents as we have said in prior calls, we have tightened up a little bit in multifamily and commercial real estate lending. And then so if you look at our debt that we just filed and look at the loan-to-values at origination for both of those portfolios, we have pulled those back over the last 6 years.

Tim Coffey

Okay. And then in terms of geography this past quarter, was there any specific region where you saw more opportunity for multifamily?

Mike Selfridge

No. I would say, it was geographically dispersed from coast-to-coast for us and the opportunities in all our markets are still quite good.

Tim Coffey

Okay. And then on the opportunities to sell mortgage loans going forward. And I understand selling mortgage loans is a balance sheet management tool for First Republic. But if refi activity is less than it has been in the past going forward, is it reasonable expectation that gain on sale would also decline?

Jason Bender

This is Jason. I think just to remark quickly on the fourth quarter and then talk a little bit about 2017. Fourth quarter, we had kind of an average amount of loan sales. We sold about $800 million at just a little bit over par. I do think that as rates have risen in the fourth quarter, the outlook for early 2017 maybe some pressure on secondary loan pricing as we kind of moved through that part of the rate move. But looking forward, a lot of our loan sales are just tied to overall origination amount. So for instance, about a third of our ongoing loan sales comes from ongoing flow sales.

Tim Coffey

Okay, alright. Thank you. Those are all my questions.

Operator

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

Timur Braziler

Hi, good morning. This is actually Timur Braziler filling in for Jared. Most of the questions have already been answered. I guess, just a couple of follow-ups. The first one maybe for Mike Roffler, in the communication around the efficiency ratio, expectations for 2017, I guess, what’s the assumption for rate hikes that you are embedding in that low-60s guidance?

Mike Roffler

So clearly, the Fed has sort of telegraphed a couple of moves this year. We are not clairvoyant to think much differently than them. However, I would say that even with the potential for a rate hike or two during the year, we are going to continue to invest in the franchise. And so we think that low 60s continues to make sense even in a bit of an environment that’s moving up, because we are making investments to provide continued great client service.

Timur Braziler

Okay, that’s helpful. And then secondly, a bigger picture question, understand on kind of the dynamics when rates go higher, there is a rush to refi, maybe just help us conceptualize what origination activity would look like once the refi environment normalizes and we are stuck with just higher interest rates?

Mike Selfridge

This is Mike Selfridge. I think that’s really a difficult question to answer. I would just go back to what I said earlier going into the first quarter. The pipeline is strong as it relates to the comparison to the same time last year. And we still feel comfortable with our 2017 guidance on mid-teens loan growth.

Mike Roffler

Maybe Mike, I...

Jim Herbert

I would add to that. It’s Jim. Let me add to that, the second. As long as the economies are strong in our markets, the purchase activity is currently strong and it will remain so. I will just remind everybody, we are coming now slowly towards the spring purchase season, which usually picks up quite a lot. So I don’t think we are in a rate – level that will of real estate activity very much at all, except the incremental refinance activity.

Timur Braziler

Okay, that’s great. And then I guess just lastly, looking at the pipeline and some of the production that’s taking place early in the year, has that mix of refi and purchase been fairly consistent to what you saw in the fourth quarter or are you already starting to see that shift more towards the purchase side?

Mike Selfridge

So I think late in the year, if we look at sort of activity, it happened – may have started to switch a little bit. But I would also say as Mike said, there is a bit of a burst that does happen when a rate rise occurs. But it has started to tick up a little bit to a more purchase market than refi.

Timur Braziler

Okay, great. Thank you very much.

Operator

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

John Moran

Hey. Thanks. I have got one follow-up on fees. Just brokerage was particularly strong this quarter, obviously markets probably helped that and there was presumably some kind of a burst of activity, is this a new run rate here or should we be thinking things kind of normalized once folks have repositioned?

Mike Selfridge

I think you will see generally, a little bit higher brokerage activity. Largely because as we have made more hires over the last year and a half, that brokerage activity has been sort of a core part of the business. So I certainly think the fourth quarter up-tick in the market added to a lot of activity and probably won’t see those levels of increases, but I think just continue to see strong growth trajectory in our business.

John Moran

Okay, that’s helpful. And then I have got just a technical one here, the other interest income was up and I assume that, that’s the special on the FHLB stock, is that where that was reflected?

Mike Roffler

Yes, John. That’s correct.

John Moran

Okay, prefect. Thanks very much.

Operator

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

Geoffrey Elliott

Good morning. Thank you for taking the question. More of a conceptual one, in the past, you have discussed how many of your customers don’t necessarily need a loan, but they are taking a loan to benefit from the tax shield and potentially low interest rates, so in an environment where tax rates may go down, that tax shield may become less valuable and interest rates may go up, how should we think about the slice of your clients who fall into that category and your ability to continue lending to them, sort of mortgage lending to continue to be attractive?

Jim Herbert

It’s really difficult to say. In the company’s history, we have gone through a couple of changes in both tax rates and the level of deductibility on the size of a mortgage. It’s worth remembering that back in the ‘80s, there are no limits. And then there were limits put on and then they were tightened. We have seen over the years, the kind of a momentary reaction, but then it kind of goes back to business as usual. And the fundamental driver for that is that at any given time, the cheapest and most stable consumer credit extension source for the consumer user is in fact, a home mortgage. And with the type of clients we have, many of them use the proceeds for investments and other purposes.

Geoffrey Elliott

Thank you.

Operator

Your next question comes from the line of Matthew Keating with Barclays. Your line is open.

Matthew Keating

Great. Thank you. I would like to touch on the bank’s interest rate sensitivity, I guess, in the last 10-Q, obviously the bank talked about a 5% benefit to NII for an immediate 100 basis point increase in interest rate, so obviously, in the fourth quarter, we saw about 85 basis points move in the 10-year, understanding that it’s going to take a lot of flow-through to your loan yields, obviously your loans haven’t moved that much, but do you expect that by the middle part of ‘17, if rates were to stabilize at these levels, that you will start to see the loan yield gradually move higher, is that going to be noticeable? Thanks.

Mike Roffler

I think that now your point is right that in the current quarter, you don’t get any benefit from that rate move. And frankly, the last sort of four weeks in the quarter is when you started to see even new lock activity reflect the rate move up. And I would say also the 3-year and 5-year part of the curve is probably more important to lending than the 10-year would be. And so I think if it stays up like this, loan yields may tick-up slightly. But again, that’s on the new business. You still got the portfolio as it existed today. So we are optimistic that the new locks are coming in a bit higher and we would hope to see the loan yields tick up a little bit as we move into the future.

Gaye Erkan

And just to add on the market side. Just to note, because it was only a year ago but the 10-year treasury was around the same levels at the end of December 2015 and then it dipped around July. So when you are looking at the shock, it’s really since the July that we have seen that increase in the rate, not the full year necessarily that’s taken place.

Matthew Keating

Great. Thank you.

Operator

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

Jim Herbert

Thank you all very much for attending the call today. We appreciate it and have a good day.

Operator

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

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