First Republic Bank (NYSE:FRC)
Q3 2017 Earnings Conference Call
October 13, 2017 10:00 AM ET
Shannon Houston - Deputy Chief Marketing and Communications Officer
Jim Herbert - Chairman and Chief Executive Officer
Mike Roffler - Chief Financial Officer
Gaye Erkan - President
Mike Selfridge - Chief Banking Officer
Bob Thornton - President of Wealth Management
Jason Bender - Chief Operating Officer
Mollie Richardson - Chief Administrative Officer and Chief People Officer
Steven Alexopoulos - JPMorgan
Chris McGratty - Keefe, Bruyette & Woods
Ken Zerbe - Morgan Stanley
Dave Rochester - Deutsche Bank
Jared Shaw - Wells Fargo
Emlen Harmon - JMP Securities
Aaron Deer - Sandler O’Neill & Partners
Matthew Clark - Piper Jaffray
David Chiaverini - Wedbush Securities
Casey Haire - Jefferies
Tim Coffey - FIG Partners
Greetings and welcome to First Republic Bank’s Third Quarter 2017 Earnings Conference Call. During today’s call, the lines will be in a listen-only mode. Following the presentation, the conference will be open for questions.
I would now like to turn the call over to Shannon Houston, Deputy Chief Marketing and Communications Officer. Please go ahead.
Thank you. And welcome to First Republic Bank’s third quarter 2017 conference call. Speaking today will be Jim Herbert, the Bank’s Chairman and Chief Executive Officer; Mike Roffler, Chief Financial Officer; Gaye Erkan, President; Mike Selfridge, Chief Banking Officer; Bob Thornton, President of Private 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. For a more complete discussion of the risks and uncertainties that could cause actual results to differ materially from any forward-looking statements, see the Bank’s FDIC filings, including the Form 8-K filed today, all available on the Bank’s website.
And now, I’d like to turn the call over to Jim Herbert.
Thank you, Shannon, and thanks to everyone for joining our call today. It was a strong quarter. Year-over-year, our revenues grew 20% and tangible book value per share has increased more than 16% in the last year.
We are very pleased with the continued growth of our Private Wealth Management franchise in particular. Wealth management assets are now over $100 billion, a true milestone.
It’s worth noting that less than seven years ago, the end of 2010, we had only $17 billion in wealth management assets, this is a 31% per annum increase. Importantly, fee income from wealth management, as a percentage of our total revenues has grown from 6% to 13% since then. Growing this part of our franchise continues to be a key strategic priority for the Bank as we go forward. Bob Thornton will speak more about this in a moment.
Let me share a few other highlights from the quarter year-over-year. Total deposits increased 19%, total loans outstanding were up 19%, net interest income increased 20%. This was in fact our best third quarter of loan origination volume in the Bank’s history. And very importantly as always, credit quality remains excellent. Nonperforming assets were only 4 basis points. Our capital levels also remain very strong.
We're pleased to announce that we do plan to open a new office in Jackson, Wyoming likely sometime in 2019. Similar to our Florida office initially, which we opened in ‘13 our Jackson office will provide a service touch point for existing clients from both coast who live or vacation in the area.
The growth of loans, deposits and wealth management assets is the product of our continued focus on exceptional service and building for the long-term, based upon holistic relationships one client household at a time. Overall we're actually quite pleased with the quarter.
Before I turn the call over let me speak about the wildfires in California for a moment. As you’ve undoubtedly seen, fires have been burning throughout the Northern California Wine Country and in several locations in Southern California for the past several days. Our first priority as always is a safety of our colleagues and our clients. We've been fully focused on taking care of those who need our help.
At the same time we continue to assess the situation and we have teams on the ground coordinating our activities in the region. Our two preferred banking offices in Northern California Wine Country are currently open and are serving clients.
Thus far, we have identified 28 single family home properties and two wineries that are of clients of ours that have been damaged by the fires. All are fully insured, although it's a bit too early to make a complete assessment. First Republic has significant experience with natural disasters over the years unfortunately and in the case of fire damage, the standard home mortgage insurance coverage is usually quite specific and comprehensive.
[Indiscernible] perspective the Oakland Hills fire 91 burned more than - 1,200 acres and destroyed 3,200 dwellings we did not experience any direct loan losses.
In terms of the impact to the people and communities that have been affected we remain very actively engaged and will stay so in the weeks and months maybe even years ahead in supporting the recovery and rebuilding efforts for everybody out there.
Now let me turn the call over to Mike Roffler, our Chief Financial Officer.
Thanks, Jim. Let me cover several key metrics including the efficiency ratio, net interest margin, net interest income and the provision for loan losses. We're very pleased with our quarterly results. Revenues have increased 20% and earnings per share grew 14% year-over-year. Our capital remains strong and credit quality excellent.
Turning to expenses, the efficiency ratio for the quarter was 62.4% in line with our recent guidance. We expect the efficiency ratio for the full year to be about the same as this quarter. Our efficiency ratio reflects our ongoing investments in digital and mobile enhancements, the continued delivery of exceptional service and our successful and ongoing efforts to attract the next generation of clients. Gaye and Jason will speak more about this in a moment.
Let me offer some perspective on the interest rate environment, competitive landscape and how we think about net interest margin and net interest income as drivers of our results. We have experienced a modest increase in our deposit rates, despite several increases in the Fed funds rate. Loan pricing in our market however has remained very competitive causing some pressure on our net interest margin.
We value above all maintaining a stable margin through all market conditions, but we look much more closely at growth in net interest income as our key measure of success. Year-over-year growth in net interest income was a very strong 20%.
Growth in net interest income supports strong earnings results and reflects our true earnings power. It also funds the investments that I just mentioned for ongoing franchise development and future growth opportunities.
Next, I would like to touch on our provision for loan losses. The provision totaled $10 million this quarter and was entirely a function of net loan growth. We expect to maintain a total reserve as a percentage of period end total loans of approximately 55 to 60 basis points. At September 30, the allowance to total loans was 58 basis points.
Finally, a brief comment on other non-interest income, which was up $5 million in the quarter this increase relates entirely to the sale of a private investment that was realized in the third quarter.
And now I'd like to turn the call over to Gaye Erkan, President.
Thank you, Mike. I would like to discuss our deposit franchise and investment portfolio along with our efforts in attracting the next generation of clients. At September 30, total deposits increased to $65.4 billion. Checking deposits were 60.5% of our total deposits. Year-over-year deposits have grown 19%.
We are very pleased that our deposit growth has fully funded our loan growth over the past year. Our average deposit rate during the third quarter was 25 basis points, up 7 basis points from prior quarters. Over the past 12 months, our average deposit rate has increased 10 basis points, while the Fed funds target rate has increased 75 basis points.
Turning to investments, our securities portfolio represented 21% of total assets at the end of the quarter. High quality liquid assets including eligible cash were 13% of average total assets. Both are consistent with the last quarter and now it is stable proportion of assets going forward. As Mike mentioned, we are making significant investments in attracting the next generation of clients through student loan refinance and professional loan programs as well as Gradifi.
Let me start with the strong results already produced and then cover why we are even more excited about the opportunities ahead. Three years ago, newer clients acquired through our student loan refinance and professional loan programs accounted for less than 5% of total borrowing households. As of September 30, they accounted for over 20% of such households, a fourfold increase.
Not only have these programs become a meaningful driver of newer and generally younger client relationships, but they've also given us a great opportunity to learn. These clients are helping us further evolve our technology, marketing and the way we think about providing exceptional service.
Gradifi, which we acquired at the end of last year, is yet another initiative focused on the next generation clients. We continue to see more and more employers recognize the value of offering as student loan repayment benefit as a strategy for talent attention and acquisition. While our current focus is on building Gradifi's brand overtime will look to leverage this as a driver of student loan refinance opportunities.
Last month we launched a comprehensive marketing and advertising campaign for Gradifi and we are very pleased with the initial results. Thanks to all these initiatives, our opportunities ahead are significant. The Bank you see today was built on relationships that grew overtime. These relationships that are often begin by serving a single need a home mortgage.
And today, while the initial need maybe slightly different as we look meet clients earlier in their lifecycle, our longer term strategy to build the Bank for the future remains exactly the same. These new clients are creating new opportunities to learn and to grow with them overtime as they purchase homes, grow deposits, build businesses and manage their wealth. These long-term benefits are well worth than the near-term investments.
And now, I would like to turn the call over to Mike Selfridge, Chief Banking Officer.
Thank you, Gaye. Let me talk about credit, overall lending activity, loan sales, business banking and economic conditions in our markets.
It is important to note that we continue to apply the same disciplined underwriting standards across our portfolio, as we have in the past. As Jim mentioned, nonperforming assets were just 4 basis points at the end of the quarter. Year-to-date, we have had less than $2 million in net charge-offs, while at the same time establishing a $43 million reserve.
Loan origination volume was $7.2 billion during the quarter, this was our best third quarter ever. Single family residential lending volume was 47% purchase and 53% refinance during the quarter.
Turning to the secondary market, it was an active third quarter. The Bank has sold loans every quarter since our founding. And we look at the secondary market to manage our asset liability profile, including interest rate risks, while helping to provide a full range of product choices to our clients.
During the third quarter, we sold $822 million in loans. At September 30, we had over $700 million of loans committed for delivery in the fourth quarter more than double our most recent eight quarter held for sale average of $319 million. I would note that we maintain servicing for all of our loans.
Turning to business banking, we had a strong quarter as well. Year-over-year, total business line commitments were up 26%. In the third quarter the utilization rate on business lines of credit was 34%, down a bit from the 37% we reported in the second quarter. Overall loan demand is strong across the board, though pricing as Mike said remains competitive. But we have a robust pipeline going into the fourth quarter.
Turning to our geographic markets, economic conditions remains strong across our footprint, consistent with last quarter and our clients remain quite active. In our markets values for single-family homes under $3 million have remained stable over the past few quarters. Our weighted average loan-to-value for single family loans originated during the quarter was 58%, also consistent with prior quarters.
At the very high end, where we do relatively small amounts of lending, we have seen a softening of prices, which we view as a positive for the market. We continue to benefit from the strength of the economic activity in our regions, which tends to be stronger than the rest of the United States as a whole. Overall, we are very pleased with the quarter and the opportunities ahead.
And now, I’d like to turn the call over to Bob Thornton, President of Private Wealth Management.
Thank you, Mike. We are very pleased with this quarter’s results in private wealth management. As Jim noted, wealth management assets now exceed $100 billion, and now we rank among the largest private wealth managers in the U.S.
Let me discuss the quarter’s results and then offer some additional perspective on our wealth management franchise.
Wealth management fee revenues for the quarter were up 23% compared to a year ago. Wealth management assets were $101 billion at September 30, up 26% year-over-year. The increase in this quarter was evenly balanced between net client inflows and market appreciation, where we were also pleased to have hired another significant wealth management team during the quarter.
As Jim mentioned, the growth of private wealth management has been an area of strategic focus since our divestiture from Bank of America Merrill Lynch in 2010. Since year end 2010 over 80% of our net inflows came from existing clients doing more with us and the acquisition of new clients, both from new and existing wealth advisors. Over the same period we have hired quite a few wealth management teams from many leading investment firms. These new teams have supported our growth, while sharing their experiences from other institutions, which we have further integrated into our best practices.
These additional insides have helped First Republic create a uniquely successful wealth management business. What sets First Republic apart is our ability to provide a breadth of wealth management products and services combined with high touch banking. This fully integrated wealth management and banking model contributes to First Republic's best-in-class overall net promoter score of 72, which measures our industry level of -- industry leading level of client loyalty.
So looking ahead, we continue to see growing opportunities to hire talented wealth managers, deepen client relationships and continue the expansion of our private wealth management business. We are delighted with this quarter's results and to have reached this milestone through our dedication to providing extraordinary client service.
And now let me turn the call over to Jason Bender, Chief Operating Officer.
Thank you, Bob. I'd like to provide an update on two key initiatives discussed last quarter. The rollout of our new online and mobile consumer digital banking experience and the introduction of our new single family loan origination systems. Additionally, I'll touch on efforts we're taking across the franchise to further empower our colleagues and continually streamline our processes.
This June, we began a rollout of our new consumer digital banking platform, which greatly enhances the online client experience, significantly improves our mobile offering and provides the ability to link outside accounts and more easily move funds. To-date we have successfully converted approximately one third of our online clients to the new system. This carefully phased rollout is on track to be completed in early 2018.
Importantly, the benefits of our new consumer banking platform extend beyond improvements to our current system. We have also built the new platform in a way that gives us the ability to make ongoing iterative improvements as our clients' needs evolved overtime.
In May of this year, we began the rollout of our new single family loan origination system. This system is a key component and our plan to safely scale our operations and service model. It provides First Republic with important capabilities such as workflow management, paperless functionality and document preparation along with automated compliance checks and control features. We are currently processing over 60% of our home loans on the new system and we plan to be fully transition by year-end.
While technology investments are very important and essential, service begins with colleagues who are able to focus their efforts on building client relationships and who are empower to take care of their clients' needs. Earlier in the year we launched an internal program designed with a clear mission in mind. How can we better serve our clients in an even more productive way?
Through this program we have identified and implemented numerous solutions to further empower our colleagues and to improve operational processes. Our primary goal is to maintain the speed with which we make decisions and process requests in order to continue to provide the decisive and responsive level of service our clients want.
In short, through efforts such as increasing authority limits, eliminating or reducing unnecessary forms and reengineering key operational processes we are able to continue to reduce the amount of time we spend on administrative matters and increase the amount of time we spend with our clients and prospects. Continued investments in technology and process improvements along with an empowered workforce support our consistent execution of extraordinary client service today and looking ahead as we grow.
And now let me turn the call to Mollie Richardson, Chief Administrative Officer, and Chief People Officer.
Thank you, Jason. I'd like to touch on how we are developing our next generation of relationship managers and provide an update on our corporate social responsibility initiatives. As Gaye noted, our efforts to build the next generation of the Bank's clients have produced meaningful results already with significant opportunities ahead. To serve these clients, this year we expanded our internal training program to develop our next generation of relationship managers.
This comprehensive program is a mix of formal training modules and traditional apprenticeship. We also partner our participant with more senior relationship managers so they can learn from experience and direct mentorship. The 24 participants in our first class have four years of experience at First Republic on average before entering the program already in bodying our client focused culture. Upon program completion, they will join our full team of approximately 175 relationship managers with the same mission of delivering exceptional service to client.
Let me now provide an update on our efforts to care for our communities and colleagues as a thoughtful and responsible corporate citizen. First, we are pleased to have launched a new Green Discount for all residential, commercial and construction lending projects that are lead certified. Caring for the environment is important to us and our clients. This is something we are delighted to encourage through discounted loan pricing.
Next and turning to our responsibility as an employer, we continually look for ways to foster a meritocracy based, inclusive and diverse workplace environment. This has always been a competitive advantage and a key to First Republic's success today and throughout our 32 year history.
Inclusion and diversity starts with leadership. We are pleased to have been recognized as a leader in gender diversity at the Board level. Our diversity at First Republic is reflective of our clients and our vibrant urban coastal markets and it is evident in our workforce at all levels.
Let me share a few statistics as of September 30. 48% of our total workforce and 50% of our senior management team are female. 48% of our total workforce and 21% of our senior management team are minorities. Our very diverse colleagues in fact speak over 50 languages, representative of the many different cultures at First Republic. The power of diversity results in more thoughtful collaboration and team work. A diversity of perspective also helps to drive innovation and gives us greater ability to anticipate our clients' needs.
Last, let me take a moment to cover a few key corporate governance enhancements. Over the past year, we initiated a formal governance outreach program for our shareholders to hear and incorporate feedback in advance of the proxy season. In response and as seen in our proxy statement, we added a net promoter score objective to our named executive officer bonus compensation.
At the start of last year and understanding the ever increasing importance of cyber security, we formed a Board level Information Security and Technology Committee. This committee brings direct and active Board engagement to various aspects of information security including systems, management, employee training and client education. Caring for our communities and colleagues as a thoughtful and responsible corporate citizen is a top priority for First Republic.
And now I'll turn the call back to Jim.
Thank you, Mollie and thank you everyone. We are very excited about our numerous opportunities which are ahead of us. As always we play the long game. Our focus and our key objective is providing exceptional service to our existing clients. These satisfied existing clients drive more than 75% of our growth by growing themselves, by doing more with us overtime and by referring their friends and colleagues. In short, the more satisfied clients we have the more new clients we acquired.
Overall we're very pleased with the quarter, and our ability to deliver stable, consistent results through our continuing simple straightforward business model.
Now I'd like to open the line for questions.
Thank you. At this time we'll be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Steven Alexopoulos with JPMorgan. Please proceed with your question.
Hey, good morning everybody. I wanted to start by diving a bit deeper into the efficiency ratio. So if we look at it there really been three weights on it right. We have margin pressure, we have expense growth in wealth management I guess to a lesser degree. If I start with the margin pressure, it looks like the pressure this quarter really came from the deposit side despite what Mike Roffler talked about with loan competition. It looks likes the money market in savings, deposits went from 18 to 36 bps. Maybe for Gaye was that a one-time adjustment or is this pressure likely to continue?
Sure. It was one-time adjustment. As you know, we have lagged for about a couple of years now. And so we have made an adjustment to our money market savings rate, which at an absolute level was well below the peer median for a $50 billion to $250 billion bank. And I would also note that the larger banks that have reported before us they all have seen just holistic loan-to-deposit increase somewhere between 5 to 9 basis points increase, which is in line with what we have seen about 7 basis points increase which over the past two years it corresponds to a 10% to 15% type of beta.
Okay. So if we think about maybe a modest rise in deposit cost from here maybe for Mike Roffler, how do you think about the trajectory of the overall margin from here given some of the commentary on loan competition?
Yes, I think there is two things as Gaye talked about deposit pricing the competition has ticked up a bit. And the real pressure is you're not getting a great relief on loan yield. Lending is extremely competitive for the type of business that we're doing and in the markets we're in. And as we said before, if you want a quality client, a quality business pricing is extremely competitive because the largest banks want the same client base.
And again it's one of the reasons we focused on our discussion. Net interest income growth is really what drives the bank and drives our ability to continue investing in the franchise. And it is under a little -- the margin might be under pressure, but net interest income is growing very well.
And maybe if I may add the deposit beta impacts NIM. However the healthy growth in the earning assets impacts net interest income, which pays the bills. And the healthy growth in the NII, the net interest income, way overcomes modest NIM pressure as we have seen in this quarter.
So, Mike is that the outlook then modest NIM pressure moving forward is that what you're saying?
Steve, it's Jim. I would -- if I could, if you look back over the last time the rates went up. Our NIM I think bottomed at about 306, 305 somewhere in that range and stayed there for a while. And that wouldn't surprise if it happens again we're close now. And so the model is a little different as Gaye pointed about actually the absolute increase in basis points of the cost to our deposits is in line with the other four larger banks that have reported in the last sort of 48 hours or so, as near as we can tell anyway up sort to 7, 8, 9 basis points.
The real issue is the loan side as Mike said. And on the other hand the loan demand is extraordinary. We actually have raised our rates to slow it down a bit.
Okay. Jim, I want to talk a minute on expenses. If we look at expense growth whereas historically expense growth as a percentage tended to pace about in line with revenue growth. It's starting to outpace revenue growth by a fairly meaningful margin. Do you view that as temporary as you're investing in businesses such as Gradifi and All-in-One. Or is there a new reality that as an $81 billion asset bank growing 20% a year, you need to invest more in this company to drive that growth?
It's probably little of both, but it's more of a former. Gradifi as we're investing heavily in Gradifi it's losing, that company is losing money at its current operating size and we've predicted that for at least a couple of years. But importantly we put forth an advertising campaign that's working very well. But nonetheless it's expensive at this point.
The other investment area you’ve heard a bit from Jason in terms of technologies, we've had two rather meaningful things going on the loan operating system improvements and the new online consumer banking, both are -- will have been rolled out by this time next year and probably in late spring in fact. The LOS, the Loan Operating System will be done by the end of the year.
The other one is the growth in the wealth management relative to the total bank is inflecting the efficiency ratio a bit. And probably that will not reverse. And then I would say the last one is we're building the new generation of clients as Gaye have referred to quite strongly. And that's basically it's not -- it's an upfront expense in the sense of acquisition cost of a rapidly growing cohort on top of a not yet large base. We've added about 5,000 households in the last year on a base of about 6 or 7.
As we going forward that 5,000 add if it stays in that range will be on a base of 10 or 12. So -- and they will be in their second year and that is where they hit profitability for us. So there is expenditure there and there some market in there, but more bonuses and discounts to bring them in. We could not be more delighted with the results however. It's not possible to have better results and we're having I don't think.
So, Jim if we tie this all together with the expense in All-in-One which is clearly a drag we’ll be some lessening of pressure overtime, how should we think about expense growth and the efficiency ratio in 2018?
I think, I'll turn it to Mike, but I think it's probably going to run about the same in this quarter, probably going to be in the 62ish range. The Bank is bigger, but we're improving it very dramatically, wealth management is growing very nicely, but of course the efficiency ratio is different and the young cohort is going to continue to cost us a bit. I'm not too worried about that given the net promoter score results of the Bank for the high touch service that we're delivering the growth rate we're delivering and I would note that most 50 to 250 banks operate kind of in the 65-67 efficiency range.
Perfect, that's all I had. Thanks for the color.
Thank you. Our next question comes from the line of Chris McGratty with Keefe, Bruyette & Woods. Please proceed with your question.
Good morning, thanks for taking the question. Just had a question on the deposit strategy, obviously we're seeing from many banks this quarter pressure on deposit cost recognized through interest expense. I'm interested in any kind of noninterest expense related strategy that might be implemented at the Bank whether it flows through the expense line, more so from the marketing and I know some banks are getting creative in terms of deposit gathering, offering promotions I'm wondering if there is any color you could elaborate there? Thanks.
Sure, we're always focused upon consumer deposits because they are diversified and they’re here given our business model, the client satisfaction and loyalty plays, and the service nature plays an important role. So there is promotions that we have for consumers to just give us a trial, but that business as usual we have had those for several years.
The increase in the deposit rate is really twofold as Steve asked in the question, it's a one time we made an adjustment to the money market savings rates, which has lagged for couple of years now and also the CDs we are keeping them increasing them to be competitive at the relevant benchmarks.
Great, thanks for that. Jim, maybe an update on capital, obviously the second quarter was tremendous you guys come to market a couple of times this quarter slowed a bit. But just remind us where your capital -- comfort with capital is maybe entering the end of the year? Thanks.
We're actually quite comfortable with capital at this point. We have -- we did anticipate pretty good growth in the second half of the year and that's what took as back to the markets in the second quarter I guess it was. And so we're in pretty comfortable shape right now, it seems but as you know we always are focus on the capital markets and we never want to be cough short.
In the positive manner the pressure on the company now is coming from more business than we can do. There is so much demand; there is so much flow of business that we've raised our rates a bit on loans in order to slow it down. That is in a way of course the nicest problem you can have. But we felt that coming and have capitalized for it, but we always try to stay ahead of ourselves too we never want to be short on capital.
And so, we look at the markets all the time as we have forever as you have been following us quite a while and you know that. So, we're likely to be in the market sometime in the next 12 months for sure.
Okay. And then maybe last one for Mike, maybe on the tax rate obviously the first quarter bumps around a bit, but is this about a good rate for the fourth quarter?
Yes so we've been running slightly below 17, this quarter was just above 17. It really is a function of the employees and what exercise activity they have on stock option. So that is what will vary it from the 17 to 20 that we've previously provided. So I could see it been slightly higher in the fourth quarter.
Great, thanks so much.
Thank you. Our next question comes from the line of Ken Zerbe with Morgan Stanley. Please proceed with your question.
Great, thanks. Just want to make sure, I kind of connect all the pieces here. So you had really super strong loan growth this quarter, but you are also saying that the competition for loan yields is really, really strong and that’s kind of keeping a lid on your growth. are you starting on the yields are you getting on the loans, is it -- I mean is it possibly that you guys were just simply too low on loan pricing this quarter and that’s why you felt that pressure on the asset yields where you should have just been a little bit higher, which could have offset some of the NIM compression?
As you know Ken, the answer I suppose technically one loan at a time could be, we could have gotten, we could have pulled back from that loan, but our focus has always been, loans are a means to an end. It’s the acquisition of the household, it’s the acquisition of the client that we focus on and of course the servicing of existing clients. The pressure comes more from the incremental new client than it does from the existing client.
But we -- the demand for loans is strong, however the larger banks have found this asset class to be quite attractive at least for now. And as a result, we have a competition from them, not just on rate but on terms and conditions. We are not following terms and conditions, their loan to value ratios are climbing, ours are not. That’s why Mike put that number in our presentation.
But, if you’re doing 59%, I believe was Mike average, 59% loan-to-value ratio average lending that’s clearly an A loan and it gets A pricing.
Okay. And then just second question on deposits. Maybe just outlook for deposit, pricing for the high net worth client base specifically, because I guess part of the concern is, high net worth mark might be a little more savvy or demanding, in terms of deposit costs and I think if I heard right, this was sort of a one-time adjustment in the money market rates.
But it is, like how confident are we that’s really the one-time versus this is the start of kind of a much more aggressive deposit pricing competition among that high net worth base?
It is actually no different than any other bank. I would note that despite the adjustment that we have made on money market savings and continue adjustment on CDs. Our increase in overall deposit rate was in line with the larger banks who reported so far.
All right, great. Thank you very much.
Thank you. Our next question comes from the line of Dave Rochester with Deutsche Bank. Please proceed with your question.
Hey, good morning guys. Definitely appreciate all the color on the deposit and loan pricing dynamics, was just wondering bigger picture, given all the dynamics we’re seeing at this point. Are you guys thinking you are still modestly asset sensitive with additional rate hikes, or would you just say you are more liabilities sensitive now?
So, we still run and we run asset sensitive, but I think it’s worth talking about in our reported that you saw. It is a net interest income simulation. We actually went back to this 12 months ago. If you looked at the ramp 100, for example we about had that in the last 12 months. Our net interest income actually was 2% higher, the net simulation projected. And so we don’t -- as we mentioned earlier, we don’t think about this in terms of the margin what drives it, it’s what happens to net interest income in that environment and that clearly has outperformed what the projections had been.
So we consider are still -- so long way of saying it, yes we consider to still be slightly asset sensitive reflecting a net interest income growing base.
Got you. So I guess with future rate hikes, I know you’re talking about NII growing, but it sounds like maybe there would be potentially a little bit more NIM pressure incrementally again from future rate hikes, but NII you still expect to grow?
That is a very good way of saying it, yes.
Okay, great. And on the efficiency rate trend you expect from here, appreciated the updated guidance for this year and next year. Historically you've talked about the ratio growing as wealth management grew faster than the Bank. Are you thinking those efficiency ratio or the initiatives that you're talking about will ultimately offset that upward pressure given your outlook for that ratio to remain the same next year versus this year?
I don't think it will offset the pressure from wealth management. And of course in a sort of funny way we would hope it doesn't because that would mean wealth management grows even more. But we do think that the investments that we're making will flatten out. Gradifi is the obvious one that should, as well as the cohort of younger clients as the base grows upon which the incremental growth is a smaller percentage.
Okay, great. And just one last one real quick, I was just wondering what your thoughts were on the impact overall on the deposit market with the Fed balance sheet unwind. Are you thinking that represents a headwind at all to deposit growth, how concerned are you about that at this point?
Well, the recent reports indicate that more to come on the normalizing of Fed's balance sheet. In the near-term perhaps the effect on the mid-to-long end of the curve appears to be somewhat muted given that there is a strong demand on a global level for such security. So while no one really knows I think the business model that we have that is relationship focused and very long-term and half of our deposits close out so our deposits are consumer based that plays a big important role why we have checking stable at a 60.5%, 61% year-over-year at a very stable base.
So you don't sound too concerned about what that overall deposit market kind of look like over the next year. Okay, great. Thanks guys appreciate it.
Thank you. Our next question comes from the line of Jared Shaw with Wells Fargo. Please proceed with your question.
Hi, good morning thanks. Maybe a different take on the deposit side, I understand what you're seeing about pricing and sort of that catch up. But as we look at the deposit composition and the mix shift, should we expect to see that continue over the next few quarters to migrate more towards the interest bearing deposits? And then if we -- where do you ultimately see that flowing through in terms of what component non-interest bearing checking and interest bearing checking could be ultimately?
Yes as of right now, we did not expect a mix shift. There is seasonality in deposits. So I would recommend that we look year-over-year. So for instance, checking as a percentage of total deposits a year ago was at 61% and we're at 60.5% today.
Okay. So you're not expecting a big or continued significant change of migration other than the seasonality.
Given the stability and despite the very competitive pressures in deposit from banks paying for couple of years now higher rates and given increased rate we have been very stable. So we do not expect.
Okay. And then shifting a little bit on the expense side, with the growth on the salaries and benefits line this quarter was how much of that was due to either change in incentive comp versus new team hires?
So a big part of it is going to be increased incentive compensation from all the activities across the franchise. There is probably 25%, 30% of it that’s just new hires to the Bank in general as the franchise grows. And then incentives are probably most of the balance of it. The other thing I would add we talked about this last quarter because it impacts the tax rate. Most of our stock granting occurs in June, May-June timeframe. So the full impact of that expense occurs in the third quarter.
Okay, great. That was it from me. Thank you.
Thank you. Our next question comes from the line of Emlen Harmon with JMP Securities. Please proceed with your question.
Hey, good morning. Just wanted to hit on the, I guess loan growth outlook into the end of the year. So you guys historically have talked about kind of mid-teens for the year. And you're 14% now which I would say you've kind of hit that just given your commentary on strong loan demand we would be thinking about something in kind of high-teens for a full year basis or do you see any potential headwinds there?
It's Mike Selfridge. I would say, going into the fourth quarter our pipeline is strong, but we're sticking to mid-teen.
Got it. Okay, thanks. And then Jim, you mentioned recently at a conference that the Board was going to be reviewing its five year plan shortly, could you maybe just give us a little bit of color kind of what the Board’s focuses when looking out that far and just kind of any changes in terms of the business direction relative to what you’ve been talking to us about?
Actually we do a five year plan review every year and have for almost 30 years we or at least 25 and we run it forward what that does is drive our thinking as to capital primarily obviously systems, et cetera. But we don't see any major changes in the business makeup other than mostly the focus on two things at the wealth management side. We would expect that the opportunities there are considerable.
And on the younger cohort of clients that is picking up a lot of steam and will have considerable impact already is, but we'll have a compoundingly greater impact over the next few years. And particularly as they covert over to first time homebuyers and fully serviced clients, although we're starting with more than four products per client. So, I don't think that there is a lot of change I did mention Jackson Hole where we'll open either in late ‘18 or ‘19. But I think it stays the same steady state, but with technological improvements along the way as needed and in fact many of them were in the works right now.
Got it, thank you.
Thank you. Our next question comes from the line of Aaron Deer with Sandler O’Neill & Partners. Please proceed with your question.
Hey, good morning everyone. Gaye, I just want to -- was hoping your comments with respect to the deposit flows, was there anything outsize in terms of customer activity that drove the decline in the noninterest experience accounts, was that really just entirely a shift in repositioning into rate paying accounts? And I guess partly two if you could elaborate on your comments regarding the seasonality of deposits because if I recall correctly last year the third quarter had very strong inflows in noninterest bearing?
So the first question, there is no particular segment, it still continues to be especially on the business side continues to be very well diversified, no one industry represents any more than 10% of our total deposits. Again having lagged for couple of years now and absolute level was lower than the peer median for $50 billion to $250 billion banks. It was time for us to do a onetime adjustment to the money market saving rates. And again CDs also represents a good portion of our deposits too which are repricing with the markets. So, no one singular aspect to it.
And your second question was on the seasonality, again it was more on the back of the mix, it was pretty much stable 60.5% now versus 61% a year ago in terms of the mix. And the way I look at the deposit growth what really makes us pleased about is the deposit growth fully funding the loan growth.
Okay. And then Mike Selfridge, I was just wondering if you could just give us sense on the line utilization I think you said came down to 34%, it typically runs I think between 30%, 35% somewhere in there. Where -- can you maybe give us a sense of where that is today and what’s driving that is it private equity that's a big component to that that because I know last quarter was particularly outsized in terms of the usage and maybe just directionally where you think that's going from here?
Yes, Ken I think on average if you look historically the rage is sort of in the 27% to 42% range so that's always hard to predict. I think 35% is a good average of the long-term. I would focus more on the business -- so your first question yes, it's driven largely by capital call lines of credits to venture capital and private equity. Two, looking at the business line of credit commitments, which were up 26% year-over-year, that’s the more -- that’s a better indicator of the growth in business banking. And then the utilization will bounce around quarter-to-quarter.
Okay, great. Thanks for taking my question.
Thank you. Our next question comes from the line of Matthew Clark with Piper Jaffray. Please proceed with your question.
Hey, good morning. Curious on the professional expense line, uptick this quarter, wondered if there was anything unusual in that line item.
No, it’s just continued investments that we talked about and the franchise is really driving that and slightly higher legal fees, but nothing unusual.
Okay. And then can you give us your contractual loan yield in the quarter, just relative to last?
So, as we talked about earlier, our new business it’s down about 4 to 5 basis points, it was close to 330 in the second quarter, our new business is 325 our new business this quarter and so the portfolio yields are pretty much flat to where they were.
Okay. And then you guys witnessed some pressure in securities yields down about 10 basis points. I am curious what the drivers there, whether or not there was muni related, maybe you can give us a sense for what you buying in the muni portfolio today and in the rest of the portfolio?
So I’ll take the first part, and then turn it to Gaye. But, we talked about this I think briefly on our last Q&A. The second quarter yield was benefited from a discount security that had some accelerated accretion in it, without that, it was about the same as this quarter. So really this quarter I would call a normal activity, but I will let Gaye talk about the new purchases.
Sure, and to add to Mike’s comments, the average market rate, second quarter average, third quarter average was also flat in line with what we have seen in the investment portfolio yields absence the accretion, the one-time accretion in the second quarter taken out from the impact.
In terms of the muni bond portfolio, same as usual, we have been always focused on AA plus credit, again no changes business as usual.
Great, thank you.
Thank you. Our next question comes from the line of David Chiaverini with Wedbush Securities. Please proceed with your question.
Hi, thanks. So with the increased pace of hiring related to the on boarding of fast-track relationship managers to service the younger the cohort, how long do you expected to take for these new RMs to breakeven?
First of all just to clarify, the fast-track RMs are on the average been here about four years. So we didn’t onboard them specifically. As we move them into that track, we will have to replace them in the positions they were holding previously. But that will take time, that will take place over about a 6 or 12 month period.
So, I don’t think that represents an acceleration of hiring. I would point out that that new cohort represents about a 15% increase in the number of relationship managers we have in the bank.
We -- and we don’t expect them to be the last of that of such a group by the way. What we are doing is transferring over to them or assigning to them the new -- the younger millennial clients that we’re acquiring through the student refinance, as well as the professional loan program. That is going initially quite well, but it still the work-in-progress. So we’re excited about it.
I think our other hiring has been kind of pretty much in line with the growth of the enterprise, nothing unusual here actually.
And you mentioned earlier, about how there is 24 in that class, do you expect similar size classes each year going forward or will that increase or decrease?
Quite frankly we don’t know yet. We like the size of this group, we will see how it works out, it’s going very well, the training is working very well and we will see what -- how they respond when they are in the marketplace full time, and then we will judge from that.
Thanks very much.
Thank you. Our next question comes from the line of Casey Haire with Jefferies. Please proceed with your question.
Yes thanks. Good morning, guys. Want to follow up on the All-in-One, the growth to 9,100 households within three years very strong obviously. What do you guys see as the addressable market? I know there is 44 million student borrowers out there. But how much of that is fits your sort of First Republic niche. And what is capacity per annum in terms of how much you could take on per year?
Let me answer the later first maybe. We think we can do a good job of onboarding and most importantly handling through the new cohort of RMs somewhere in the 5,000 to 6,000 range right at the present time. And that's why we're building out the younger RM cohort the average age in that group by the way our group is about 33 it matches up of course very well with the clients.
The addressable market is substantial probably in the order of at least think in terms of in our market of a loan size above 40 which is currently our minimum loan size and a very high credit standing and also in the job for two years at least those are the standards. We're getting about 760, 770 cycle. That addressable market is at least 200,000 clients.
Okay. And Gaye, a question for you the HQLA looks to be a little over weighted at 13% of assets. I think you had said 12% is the standard. Are you just getting ahead of it or is 13% a new sort of go forward rate?
We strive to keep our HQLA at or above 12%. The volatility that you see in HQLA is primarily due to the changes in cash levels. So if you were to strip out the cash volatility we’re pretty much stable in terms of securities contributing to the HQLA.
Okay, great. Thank you.
Thank you. Our next question comes from the line of Tim Coffey with FIG Partners. Please proceed with your question.
Yes, thank you for taking my questions. I had -- want to talk about the growth in the multifamily and commercial real estate portfolios. You've had very solid growth last several quarters. And I'm wondering if that -- what that as a result of. Is it a specific geography or shift in approach to booking some of those bigger loans?
No, it's Mike there is no shift in approach. Those numbers on multifamily and commercial can move around quarter-to-quarter. So I turn you back to our 8-K filing and look at the profile of commercial and multifamily median amounts less than $2 million low loan-to-value strong debt service coverage. And then just our clients who are active in the market, but waiting for opportunities.
Okay. You're right, they can move around but they've been rather robust about let's say the last seven quarters. So is there a specific geography that you’re finding the most opportunity in?
I can't point to one geography; I'd say it's pretty well diversified across our markets. And again that can move around quarter-to-quarter. Longer term it's good opportunities. Of course our markets are characterized by limited supply so it's just a matter of our clients finding the right opportunities.
Right, absolutely. And then Jim talked earlier about raising prices on certain loans. I'm wondering what those loans were?
We slowed down mostly single family a little bit. And we don't want to do that, but it's a matter of not being able to handle well only so many.
Okay. And then Jim the question about the wildfires. The winery claims that you have up there do those loans require fire insurance?
On the buildings, yes. And we have coverage on we have coverage in place on all of our properties. And just as a matter of lending practice, we have the ability to force place insurance if for any reason that weren’t lapsed. So we keep very close track of this.
What about the business continuity policies?
Generally no, generally no, but of course you have a great deal of winery cases, you have a great deal of land usually as additional value.
Sure, okay. Those are my questions. Thank you very much.
Thank you very much.
Thank you. Mr. Herbert, there are no further questions at this time. I will turn the floor back to you for any final comments.
Great, thank you very much, thanks everyone for taking part in the call today.
Thank you. This concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.
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