First Republic Bank (NYSE:FRC) Q4 2022 Earnings Call Transcript

First Republic Bank (NYSE:FRC) Q4 2022 Earnings Call Transcript January 13, 2023

Operator: Greetings and welcome to First Republic Bank’s Fourth Quarter and Full Year 2022 Earnings Conference Call. Today’s conference is being recorded. During today’s call, the lines will be in a listen-only mode. Following the presentation, the conference will be opened for questions. . I would now like to turn the call over to Mike Ioanilli, Vice President and Director of Investor Relations. Please go ahead.

Mike Ioanilli: Thank you and welcome to First Republic Bank’s fourth quarter 2022 conference call. Speaking today will be Jim Herbert, Founder and Executive Chairman; Mike Roffler, CEO and President; Mike Selfridge, Chief Banking Officer; Bob Thornton, President Private Wealth Management; Olga Tsokova, Chief Accounting Officer and Deputy Chief Financial Officer; and Neal Holland Chief Financial 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. We also discuss certain non-GAAP measures of our financial performance which should be considered in addition to not as a substitute for financial measures prepared in accordance with GAAP.

For a more complete discussion of the risks and uncertainties that could cause actual results to differ materially from any forward-looking statements and for reconciliations of the non-GAAP calculation of certain financial measures to the most comparable GAAP financial measure see the bank’s FDIC filings including the Form 8-K filed today, all available on the bank’s website. And now I’d like to turn the call over to Jim Herbert.

Jim Herbert: Thank you, Mike, very much, and good morning, everyone. It was a very strong year for First Republic, our time-tested business model and service culture continued to perform really well. In fact, it was our best year ever in many ways. Our new 2022 Net Promoter Score, which was announced this morning, is our highest ever client satisfaction level is actually extraordinarily strong. Our non-performing assets at year end were just five basis points. This is low even for First Republic. Exceptional client service, and our strong focus lending led to safe organic growth during the year. In 2022, total loans grew $32 billion a record and we had record earnings for the year. In uncertain times like these, and ability to continue to grow safely is quite viable and very rare.

Let me take a moment to provide some perspective on the current rate environment and the Fed tightening cycle as we see it. Since our last call about 90 days ago, the Fed has raised rates another 125 basis points. At the same time, the 10-year Treasury has declined 50 basis points. The resulting increased rate inversion has begun to put some pressure on our net interest margin and net interest income. However, history and experience has shown that this type of inverted yield curve has a limited duration. Cycles are just that they are cycles. During First Republic’s 37-year history, there have been five tightening cycle. We’ve continued to grow and prosper through them and especially after each one. On average, over the last 40 years, the Fed has started to cut rates less than a year after the tenure yield has peaked.

The market currently expects the Fed to start cutting rates during the back half of this year, which will be consistent with prior tightening cycles and is also our current assumption. We’re staying focused on executing our model and we remain very committed to delivering solid results through all market conditions. The bedrock of our performance is providing truly exceptional differentiated service, maintaining very strong credit, delivering safe, organic growth and the results follow. Now let me turn the call over to Mike Roffler, CEO and President.

Mike Roffler: Thanks, Jim. 2022 was a terrific year with record loan growth, record loan origination volume, record revenue and record earnings per share. Let me begin by covering some key results for the year. Total loans outstanding were up 24%, total deposits have grown 13%, wealth management assets were down only 3%, while the S&P 500 was down more than 19% over the same period. This strong growth in turn has led to strong financial performance. Year-over-year, total revenues have grown 17%, net interest income has grown 17%, earnings per share has grown 7%. And importantly, tangible book value per share has increased 11% during the year. As we look to a more challenging year ahead, we remain well positioned to deliver safe, strong growth through the consistent execution of our service focused culture and business model.

We remain very well capitalized as a result of raising capital methodically and opportunistically over time. Our Tier-1 leverage ratio was 851 at quarter end, credit quality remains excellent. Net charge offs for the fourth quarter were less than $1 million. For the entire year, net charge offs were less than 3 million or less than 1/5 of a single basis point of average loans. Non-performing assets ended the year at only five basis points of total assets. As Jim mentioned, this is one of our best levels ever. We do not stretch on credit quality to deliver loan growth. Our growth is driven by consistent execution of exceptional client service, one client at a time each and every day. Today, we released the results of our 2022 Net Promoter Score survey, our client satisfaction scorecard.

We’re pleased to have achieved a record high score of 80. This is an increase from last year’s score, which was also a record at the time. At the same time, client satisfaction is declined for the overall banking industry. In 2022, the net promoter score for the U.S. banking industry declined to only 31. Our service focused model is truly differentiated, even more so during challenging and disruptive environments. During 2022, we also continued to make thoughtful investments that support service excellence and growth. We expanded into the Seattle area by opening our first banking location in the market. We brought on 13 new wealth manager teams, one of our best recruiting years ever. And we successfully upgraded our core banking system, the largest technology project we’ve ever undertaken.

As Jim mentioned, since mid-November, we have been operating with a challenging yield curve. To help us navigate the margin pressure in the near term, we continue to moderate our expense growth. At the same time, we remain focused on the long-term and continue to leverage our reputation of exceptional service to drive new business and grow total households. Our focus on service drives our growth as clients stay with us do more with us and refer their friends and colleagues. In fact, during 2022 and driven by our highest ever level of client satisfaction, total households increased a very strong 15%. This is nearly double the growth rate of the prior year. Over time, this growth compounds continuing to deliver shareholder value and consistent profitability as it has for 37 years since our founding.

Overall, 2022 was a very strong year for First Republic. Now I’d like to turn the call over to Mike Selfridge, Chief Banking Officer.

Mike Selfridge: Thank you, Mike. Let me provide an update on lending and deposits across our business. Loan origination volume was a record for the year at $73 billion. Our real estate secured lending remained well diversified. Both single family residential and multifamily achieved record volumes for the year. Purchase activity accounted for 54% of single-family residential volume during the year and 64% during the fourth quarter. As refinance activity has slowed, so have the repayment rates. This provides a strong base for loan growth. We continue to expect to deliver mid-teens loan growth for 2023. I would note that loan originations have some seasonality with the first quarter typically being somewhat slower. In terms of credit, we continue to maintain our conservative underwriting standards.

The average loan to value ratio for all real estate loans originated during the year was just 57%. Turning to business banking, we continue to deepen our relationships by following clients to the businesses they own or influence. Our relationship-based model also leads to a strong level of referrals to new business clients. In 2022, our business client base grew by 18%. Business loans and line commitments were up 14% year-over-year. The utilization rate on capital call lines of credit increased slightly to approximately 33% during the fourth quarter. Our capital call line commitments grew 16% during the year as we continue to acquire new clients. Turning to deposits, we are pleased that total deposits were up 13% year-over-year, and 2.4% quarter-over-quarter.

We continue to see a shift in deposit product mix as a result of rising rates. Checking represented 59% of total deposits at year end down from 64% in September, and CDs accounted for 14% of total deposits at year end up from 9% in September. Preferred banking offices continue to provide an important service channel for our clients and drive deposit gathering. Over the next year, we expect to selectively open new offices to deepen our presence in our existing footprint. Our programs for acquiring and growing our next generation of client relationships, which began more than a decade ago, continue to deliver strong results. In 2022, millennial households grew 17%. These younger households are the same high-quality clients that we have always attracted and are part of our strategy to see the long-term growth of First Republic.

As Mike and Jim noted, our exceptional Net Promoter Score continues to demonstrate our ability to deliver differentiated client service. Let me take a moment to provide some additional detail. For clients who identify us as lead bank, our net promoter score is 87 even higher than our overall score. And importantly, nearly two thirds of our clients now consider us as lead bank. Remarkably, our net promoter score increased in each of the past three years, as we have dealt with a pandemic, and rising levels of economic uncertainty. And as we implemented a new core banking system in early 2022. And during this time, our consistently high scores also increased across every region, every line of business and every generation of clients. Our high client satisfaction remains the driver of our long-term growth.

Now let me turn the call over to Bob Thornton, President, Private Wealth Management.

Bob Thornton: Thank you, Mike. It was a very successful year for our wealth management business. During the year, total assets under management were down only 3%, while the S&P 500 was down more than 19%. Investment management assets actually increased during the year driven by strong net Client inflow. Wealth management fee revenue was up more than 15% from the prior year. This includes strong growth in fees from brokerage trust, insurance and foreign exchange services. The combined fees from these services increased 29% year-over-year and the strong growth in these products is also further diversified our wealth management fee revenue. As we’ve noted before, our exceptional client service is even more highly valued by clients during times of market volatility.

We take these opportunities to engage our clients and understand their needs as market conditions change. In fact, a key strength of our business model is our holistic approach to meeting our clients banking and wealth management needs. This benefits clients and is driven growth through a strong level of internal referrals, and a deepening of client relationships. In this regard, 2022 was a particularly strong year, our bankers referred over $11.5 billion of AUM to wealth management, and deposit balances from new relationships referred by our wealth management colleagues during the year totaled more than $3 billion. Wealth management referred deposits and sweep balances now represent over 13% of the bank’s total deposits. Our integrated banking and wealth management model also continues to make First Republic a very attractive destination for successful wealth professionals.

In 2022, we welcomed 30 new wealth manager teams to First Republic, and one of our strongest years ever. This included five teams in the fourth quarter alone. So far in 2023, we’ve already welcomed two new wealth management teams to First Republic, reflecting our continued investment in the long-term success of this business. Overall, our team continues to execute very well. I’m excited, these are a great opportunity to demonstrate our exceptional service, deepen existing relationships and acquire new households. Now I’d like to turn the call over to Olga Tsokova, Chief Accounting Officer and Deputy Chief Financial Officer.

Olga Tsokova: Thank you, Bob. I will briefly discuss our strength and stability. Our capital position remains strong. During 2022, we added over $400 million of net new Tier-1 capital through a successful common stock offering. At year end Tier-1 leverage ratio was 8.51%. Liquidity also remains strong, high quality liquid assets for 13% of average total assets in the fourth quarter. Our credit quality remains excellent. Net charges off for the year were only $3 million. Over the same period, our provision for credit losses was $107 million, which was driven by our strong loan growth. This is a multiple of nearly 40x. Heading into 2023, our balance sheet remains strong. And now I’ll turn the call over to Neal Holland, Chief Financial Officer.

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Neal Holland: Thank you, Olga. It was a very strong year. Our exceptional client service and strong credit powered our safe growth. Our 2022 results were in line with or better than the expectations communicated at the start of the year. Let me take a moment to talk about the year ahead. With the rapid rise in rates in the current inverted yield curve, we continue to experience margin pressure. We currently expect the Fed funds rate to peak at 5% and then the gradually decline in the second half of the year. As a result for the full year 2023, our expected net interest margin to be approximately 25 to 30 basis points lower than the fourth quarter. As a growth bank, we create value by consistently compounding our asset base, a direct result of the exceptional service we provide.

Therefore, net interest income is a key metric for our differentiated business model. Despite the current margin pressure, we expect net interest income for the full year of 2023 to be down only 2% to 5% given our continued strong growth in loans, and investments. As we look to 2024, we expect continued strong loan growth in a more normalized rate environment. As a result, we expect to deliver strong double-digit net interest income growth in line with our past performance. As Jim mentioned, the years following tightening cycles have historically been strong for the bank. Turning to expenses for 2023, we expect expense growth in the high single digits. As a reminder, expenses are typically higher in the first quarter due to the seasonal impact of payroll taxes and benefits.

As we discussed at Investor Day, we continued to prioritize our expenses in a way that will not sacrifice client service, growth or safety and soundness. We have identified $150 million and planned expenses that we will not incur in 2023. This is already having a positive impact on our expense base and helped us keep expenses flat from the third to fourth quarter. With respect to income taxes. The full year tax rate is expected to be around 24%. While the current rate environment is challenging, our model is strong. We will continue to deliver exceptional client service, grow new households and provide safe growth in 2023 and beyond. Now, let me turn the call back to Mike Roffler.

Mike Roffler: Thank you, Neal. It was a strong year with record client service levels, record loan growth, and record credit performance. Our time-tested service model remains solid. Our entire team remains focused on executing our client service strategy, one client at a time. Now, we’d be happy to take your questions.

Q&A Session

Operator: Thank you. And we’ll take our first question from Steven Alexopoulos with JPMorgan. Please go ahead.

Steven Alexopoulos: So from a big picture view, if we look at the NIM outlook, it’s a bit worse than what you had guided to it the Investor Day. And before I get into my deeper questions, what’s changed since the Investor Day, which is driving the lower NIM outlook for the year?

Mike Roffler: Yes, Steve. Thanks. I think if you look at Investor Day, what’s happened since then, and I think we highlighted this a bit in the prepared remarks, the tenure has gone down 50, 60 basis points. And so the inversion of the yield curve has a pretty significant impact on just rates in general. And obviously, the macro environment is the thing that we can’t control. The things we can control are our service levels and how we acquire households. And so with that inversion, which, as we noted, won’t last a very long time and we are now partway through it. And so I think that is the biggest driver for the change in outlook relative to about 65 days ago.

Steven Alexopoulos: Got you. Okay. Mike, it sounds like you’re upping the expectations for expense management. And I think you guided to about a 65% efficiency ratio for 2023. Is that still intact when you put these pieces together?

Mike Roffler: Because of the margin outlook, it will be a little bit higher. But we have identified incremental expenses that will be deferred, not planned for the current year.

Steven Alexopoulos: Are you willing to share a new range with us?

Mike Roffler: Yes. I mean, just because of the revenue side of the equation, it’s just doing the math of 2% to 5% decline with net interest income, it’s about 66% to 68%, with that guideposts with high single digit growth rates of expenses.

Steven Alexopoulos: Got you. Okay. And then, just to dive into the deposit side a little deeper. So it’s pretty remarkable to see that with the rate being paid on checking balances more than doubled from the prior quarter, but average balances still came down about 9 billion. Can you take us behind the scenes in the quarter? What’s the typical conversation you had with customers? And maybe underlying the NIM assumptions? Where do you see the rate paid on checking moving to and maybe where does that mix stabilize? Thanks.

Mike Roffler: Well, importantly, I think there’s still about 67 billion I think of zero cost checking, which is operating balances and costs. Obviously, as rates have gone to 4.5%. The conversations between our client facing people and clients have talked about, where might they be able to achieve a bit better yield. And as a service organization, that’s what we continue to focus on is that relationship with our clients to ensure they’re leaving the right balance of in checking for their operating needs, and their other yield alternatives either in wealth management, money market, certificates of deposit, different alternatives. I think we communicated a low 30s data on overall deposits in the past. And we feel like sort of 30 to 35 is about the right range still at this point, and that’s consistent with what we said before at Investor Day.