First Republic Bank
Q2 2016 Earnings Call Transcript

Published: 14 Jul 2016

[Operator:]

Greetings and welcome to First Republic Bank’s Second Quarter 2016 Earnings Conference Call. 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 Dianne Snedaker, Executive Vice President and Chief Marketing Officer. Please go ahead.

[Dianne Snedaker:]

Thank you, and welcome to First Republic Bank’s second quarter 2016 conference call. Speaking today will be Jim Herbert, the Bank’s Chairman and Chief Executive Officer; Mike Roffler, Chief Financial Officer; Mike Selfridge, Chief Banking Officer, Jason Bender, Chief Operating Officer; Gaye Erkan, Chief Investment officer and Deposit Officer; Bob Thornton, President of Wealth Management and Mollie Richardson, Chief Administrative 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 and reports, including the Form 8-K furnished today, all available on the Bank’s website. And now I’d like to turn the call over to Jim Herbert.

[James Herbert:]

Thank you, Dianne, and thanks everyone for joining the call today. We’re very pleased with our second quarter results. Both revenues and earnings grew quite nicely. Loan volume was the highest ever at $6.5 billion and very importantly, credit quality remains excellent. We further strengthened our capital basis well during the quarter with a $200 million common stock offering. For the quarter, deposit growth was modest and impacted in part by seasonality related to income tax payments. We are however very pleased with the year-to-date growth of deposits. The fact that the rate paid on deposits remain flat in the quarter is also quite attractive. Wealth management had a very strong quarter and now exceeds $75 billion in total assets. Wealth management revenues grew 27% year-over-year. Our business banking continued to perform very well and is quite a significant contributor to the franchise. Let me briefly cover a couple of key metrics for the quarter. Revenues grew more than 17% year-over-year. Net interest income was up nearly 18% year-over-year. Earnings per share at $0.97, which included $0.08 per share from the adoption of a new accounting standard were strong. Mike Roffler will speak more about this new standard in a moment. For comparison purposes, if this standard had been in effect in the same quarter of last year, earnings per share would have been up 15% year-over-year. Tangible book value per share rose 13.8%. Turning to our geographic markets for a moment, business activity continues to be very strong across the board. Interest rates obviously continue to be a challenge for everyone and the global macroeconomic environment remains a bit uncertain. However, through times of uncertainty and various rates over an extended period of time, we’ve always managed the Bank in accordance with a few key principles, which have served us very well. A total commitment to exceptional client service and unwavering focus on high credit standards, always maintaining a strong capital base and very prudent and active asset liability management. In short, First Republic is a simple business model that has produced consistent positive results throughout a wide range of economic conditions over a very extended period of time. We are also an active partner in the success of our communities and we have numerous programs in place. Mollie Richardson, our Chief Administrative Officer will talk more about these in a moment. Overall we're very pleased with this quarter's results. Now let me turn the call over to Mike Roffler, our Chief Financial Officer.

[Michael Roffler:]

Thanks, Jim. I’d like to focus on capital levels, core net interest margin, the efficiency ratio, the new accounting standard Jim mentioned and its corresponding effect on our tax rate. The $200 million in common equity raised during the quarter helped to further improve our CET1 ratio to 10.74% at quarter end. I note that our Tier 1 leverage ratio was 9.58% at June 30. We are however transitioning our primary focus to the Basel III standard for CET1 now that our de novo period has ended. Our core net interest margin rose two basis points to 3.16% in the second quarter. The increase from the first quarter was largely due to lower average cash balances, which were drawn down to fund lending and investment activities. Loan yields declined three basis points during the quarter due to declining market interest rates. As Jim mentioned earlier, we're very pleased with the growth in net interest income, which importantly was up 17.7% year-over-year. Regarding expenses the efficiency ratio for the second quarter was 59.8%. We’re pleased the efficiency ratio has remained stable as we continue to make significant investments in the franchise. Our efficiency ratio guidance remains unchanged and is expected to be 57% to 61% for the rest of 2016. Let me spend a few minutes on the new accounting standard for stock-based compensation, which we elected to adopt this quarter. The new standard changes were additional tax benefits are recorded in our financial statements. The details were included on a Form 8-K that we filed last week. Importantly, this accounting change does not impact the Bank's total equity, book value per share or regulatory capital ratios. It also does not affect the amount the Bank actually pays in income taxes. The changes from the new standard are reflected in net income, earnings per share and the reported tax rate as noted in our press release this morning. The standard also results in an increase in our diluted share count because future tax benefits are excluded from the dilution calculation. In the second quarter these net tax benefits were $13 million or an $0.08 per share increase to diluted EPS. If the standard were effective in the second quarter last year, there would have been an increase in diluted EPS of $0.04 per share. Going forward our reported tax rate may vary somewhat. That is due to the amount of tax benefits from stock compensation, fluctuating based on one, the Bank’s stock price and also when employees either exercise outstanding options or vest in a stock award. During the quarter, the reported tax rate under GAAP was reduced to 17.8% from 24.5% as a result of the change. In 2016, inclusive of this new standard, we expect the reported tax rate to be in the range of 18% to 20%. Now let me turn the call over to Chief Banking Officer, Mike Selfridge.

[Michael Selfridge:]

Thanks, Mike. Business activity remains very healthy across the enterprise, supported by the continued strength of our geographic markets and our very active client base. California, First Republic’s largest market is now the sixth largest economy in the world and has surpassed Brazil and France. It’s a dynamic economy, diversified economy and its driven by many industries including agriculture, tourism, technology, entertainment and financial and professional services. Looking at the San Francisco Bay Area, overall economic conditions remain good. Though year-over-year job growth has slowed slightly, it continues to outpace both the State and the Nation. We're now seeing a leveling off of real estate values and rents in the area and we believe this is healthy for the market. Los Angeles continues to be a particularly strong market for us due to the strength of its diversified economy in sectors such as entertainment, media, apparel and financial services. Turning to New York, we continue to see cooling at the high end of the housing market, although this is typically not a market segment in which we've been very active. However demand is otherwise strong across other segments of this market. In Boston, business activity is very good and continues to be driven by the health of the technology and financial services sectors. Given the significant appreciation of real estate values across all of our markets over the past few years, we have modestly tightened our credit standards across product lines in recent quarters. We see continued robust demand for lending however that meets our high credit standards. Heading into the third quarter, refinance activity has increased. Overall, our loan pipeline remains strong and is up from this time last year. With respect to business banking, it was a very good quarter. Business loans outstanding grew 16% year-over-year. The increase was the result of growth in capital call lines of credit and robust lending to non-profit organizations. Our overall utilization rate on business lines of credits was 34% at June 30 more in line with historical levels and up from the 31% utilization rate reported at March 31. We continue to see strong activity with respect to banking non-profit organizations of all types focused on serving this market segment through professional expertise and a customized approach has driven growth and it's an extension of our commitment to the community and community engagement. Overall, we are very pleased with activity across the enterprise and the continued strength of our geographic markets. And now I would like to turn the call over to our Chief Operating Officer, Jason Bender.

[Jason Bender:]

Thank you, Mike. Let me touch on overall lending and credit quality, as well as activity in the secondary markets and on balance sheet management. As Jim mentioned, loan origination volume was a record $6.5 billion during the second quarter. Single-family residential lending had a particularly strong quarter up 20% year-over-year. Our median single-family loan originated in the second quarter was $780,000 consistent with past quarters and a relatively modest level given the high housing cost in our urban coastal markets. Of this single-family residential volume, 44% was purchased and 56% was refinanced. Let me comment for a moment on this refinance activity. For First Republic home loan refinance is a terrific opportunity to acquire new clients and to deepen existing relationships. We would note that nearly half of our refinance activity in the second quarter came from First Republic refinancing loans made by other institutions. The majority of these refinanced transactions result in new household acquisition for First Republic and additional opportunities for cross-selling. On average, our loan clients use approximately eight of our products. We view strong refinance activity as yet another opportunity to acquire new clients from other institutions and to increase market share over time. We would also note that despite the volume of business we’ve done over the years, First Republic share of our market still remains relatively small. Credit quality continues to be very strong. Non-performing assets remain extremely low at just nine basis points. During the quarter, net charge-offs were just $1 million or one basis point of average loans. We added over $14 million to our loan loss provision in the quarter to support loan growth. Loan sales totaled $921 million in the second quarter. Secondary market loan sales enable us to operate wide range of loan products to our clients and to manage our balance sheet. We are pleased to have added eight new investors over the past year and half further diversifying demand for loans and increasing liquidity. During that time, we sold approximately $400 million of longer term fixed rate loans to Fannie Mae. We have always taken a long-term perspective relative to asset liability matching and we used a variety of strategies to maintain a balanced position. While largely a deposit funded enterprise, we do for example utilize term FHLB advances in balance sheet management. During the second quarter, we added $1.25 billion of fixed rate intermediate term FHLB advances. These advances have a weighted average maturity of 3.1 years with a weighted average cost of just 1.13%. Such advances equal only 7.8% of total assets as of June 30, which is down from 8.9% a year ago. Looking forward, we had $750 million of term advances maturing in the second half of 2016 that carry a weighted average cost of 1.6%. This may offer an opportunity to further reduce funding cost by replacing such advances with lower rate draws or additional deposit growth. Let me now turn the call to Gaye Erkan, Chief Investment Officer and Chief Deposit Officer.

[Gaye Erkan:]

Thank you, Jason. I will talk about our investment portfolio and deposit franchise. Our total investment portfolio at the end of the second quarter was $11.6 billion up 11% for the first six months of this year and up 49% from a year ago. High quality liquid assets including eligible cash totaled $6.3 billion at June 30 or 10% of total assets. We continue to target HQLA to be at least 12% of total assets by year end. Turning to deposits, total deposits were $51.2 billion, up 7% for the first six months of 2016 and 22% from a year ago. The average rate paid on total deposits during the quarter was only 13 basis points consistent with the prior quarter. Historically, we have experienced some seasonality in deposit activity during the second quarter. For instance, we typically have a build-up in deposits through the end of the first quarter and then see clients make tax payments in April and June. Business banking continues to be an important contributor to our deposit franchise. Business deposits remain at 53% of our total deposits. Deposits from wealth management accounts are also a strong contributor. They now represent 9% of total deposits up from 6% a year ago. These deposits are highly diversified and stable. Finally, we are pleased with our continued growth in checking, which represents 63% of our total deposits in line with the prior quarter. Now I would like to turn the call over to Bob Thornton, President of Private Wealth Management.

[Bob Thornton:]

Thank you, Gaye. Wealth management had an excellent quarter. As Jim noted, assets are $75.8 billion up 5% for the first half of the year. Importantly revenues were up 27% year-over-year. We are pleased with the continued growth in wealth management assets despite market volatility, this growth is primarily from net inflows of client assets. The integration of Constellation Wealth Advisors, which we acquired on October 1, 2015 continues to be successful. We have also realized the expected assets and revenues from the addition of teams from Credit Suisse and elsewhere we announced over the last 12 months. In addition to bring our substantial wealth management assets, fully 100% of those hired over the past year have referred First Republic Banking Products and Services to their clients. This cross-selling effort has resulted in nearly 500 new banking clients. Overall, Private Wealth Management continues to be both a strong source of new banking relationships and through sweep balances, a growing, diversified, and stable source of deposits. And now let me turn the call over to Mollie Richardson, Chief Administrative Officer.

[Mollie Richardson:]

Thanks Bob. I want to spend a few minutes on our commitment to our communities, as well as some employee initiatives. Let me start with our community engagement effort and investment lending and service. Since our divestiture in 2010, the Bank has committed $1.2 billion for the construction of approximately 15,000 affordable low income rental units. Over the same time, we also originated over 1200 low to moderate income community development loans totaling $2.7 billion. The overwhelming majority of these loans are in high minority census tracts. In 2015, of total home loans funded approximately 21% were in low to moderate income census tracts and 15% were too low-to-moderate-income borrowers. First Republic has a strong affirmative outreach to serve low income and minority communities with over 20% of our offices in low-to-moderate income areas. Given the high cost of real estate in our urban coastal markets, we continue to develop innovative ways to serve these communities. For example this past December, we launched a new mortgage initiative the Eagle Community Loan Program, which offers special fixed rate and a dedicated banker to borrowers and unreserved minority census tracts in our market. We're very pleased with the early successes and momentum of this program. Lastly the bank is committed to developing deeper partnerships with non-profit organizations and through philanthropic contribution, supports over 300 non-profits in affordable housing the arts, education and economic development. Our employees receive two paid days per year for volunteer work and during the last 18 months have donated close to 7,000 service hours. We would also note that close to 40% of our business banking loan portfolio is loans to non-profit organizations of all types serving our communities. This cultural commitment to community service has resulted in a consistently satisfactory Community Reinvestment Act rating for 25 years. These efforts and innovative approaches to serving our communities have also been recognized by NASDAQ, which awarded First Republic the 2016 Innovation and Financial Education Award, and the San Francisco Housing Development Corporation who acknowledged the success and dedication of our CRA Program Director. In addition to our communities, we're very focused on taking care of our employees. Effective January 1, of this year, we increased our company-wide minimum wage to $20 per hour in all of our market. This applies to all full-time, part-time and temporary employees, including interns on our payroll. We also have a variety of expanded employee benefits, service and wellness program, which include a mortgage discount program, fitness stipend benefit and expanded parental and family leave. This commitment to our community and employees is both good business for the bank and the right thing to do. And now let me turn the call back to Jim.

[James Herbert:]

Thank you, everyone. Overall it was a very good quarter. We remain prudent in light of microeconomic uncertainties; however, we see many continued opportunities to serve existing clients and acquire new ones as Jason mentioned, regarding refinance activities and unusually good opportunity for new client acquisition. Given recent global events, I would remind everyone that we do no investment banking, no capital markets trading, no proprietary trading, no direct exposure to energy, and have no international lending or other operations. We stick to what we know. We operate in our existing geographic footprint and within business segments that we already serve. First Republic is well positioned with excellent credit, growing in active markets and a strong capital base. We remain as always focused on delivering consistent, stable results. Thank you. Now, I'd like to open the line for questions.

[Operator:]

[Operator Instructions] Our first question comes from the line of Erika Najarian from Bank of America. Your line is now open.

[Erika Najarian:]

Yes, hi good morning.

[James Herbert:]

Good morning, Erika.

[Erika Najarian:]

My first question is looking forward to how we should think about capital management. Now that the de novo status is lifted and you're looking to manage to CET1, how should we think about what you believe is your potential floor relative to the 10.74%? And whether or not given a demand for good credit in your area, despite tightening lending standards, you would feel comfortable growing at a higher rate than the 12% to 15% that we've seen consistently from you.

[Michael Roffler:]

Sure, Erika, I think with respect to capital philosophically we've always believed in very strong capital. You have seen us do periodic, small pieces of capital raising, which really helps support what we see as future business opportunity. And so when we think about the CET1, I think remaining north of 10% is a good boundary for us given the opportunities that we see to continue serving clients and increasing the business.

[James Herbert:]

Let me comment on the growth rate Erika, our growth rate as you know is driven not by a target that we have, but by the availability of good business that we can do in the environment we're operating in say and do it safely. What's happening right now is they have a refinance, refinance is sometimes misunderstood, refinance of course does hit our balance sheet a bit too, but the reality is that the higher refinance is as Jason pointed out earlier the more opportunity we have to take clients away from other banks. That presents us with tremendous opportunity and so we to some extent respond. The control mechanism or the single family growth is of course the secondary market sales and as you saw this quarter, we almost did $1 billion of those.

[Erika Najarian:]

Got it. And my second question, just wanted to make sure I understood all the puts and takes on the core margin. So the contractual yield on your loan portfolio seems to have stabilized at 3.28% despite what's happened to the five and seven year. And I think it was Jason that mentioned an opportunity to lower some $700 million in funding costs. If I loop that in with further HQLA growth, should we expect some net-net stability in the margin despite what's happened to the yield curve? And also, Gaye, thank you for your guidance on HQLA, but is cash as 2% of earning assets an appropriate level going forward, do you think?

[Michael Roffler:]

So on the margin, you're right, that the puts and takes have led us to be pretty stable. Loan yields are relatively stable to a slight tick down, but not significantly in it. The curve has rebounded a little bit most recently, which can be a positive going forward. But we were successful in deploying some of the cash balances this quarter and so we ran a little bit lower. I think a $1.2 billion of average cash is probably a little on the low side, but not much and we could be a little bit more than that, but not a lot.

[Gaye Erkan:]

And just to add, the 12% guidance for the year and that HQLA including cash, eligible cash, which would also guide you going forward on the cash versus [security] [ph].

[Erika Najarian:]

Thank you. And if I could just sneak one more in, Jim, have you -- clearly the actual impact of Brexit hasn't been felt yet. But I'm wondering, in your conversations with your clients, whether or not any investment activity or investments are delayed because of some of the global uncertainty. Or is your client base not really thinking about Brexit much at all as they look forward to either business or personal decisions in the second half of the year?

[James Herbert:]

I think the latter is more the case Erika, they're mostly not -- they're very aware of it of course, but they're not -- their actions are not being driven by it. It's a little more -- the awareness is higher on the East Coast and the West Coast, I would also note. Not so much awareness, but reaction. The VC and private equity activity level is steady now. It bottomed in the first quarter, I would say and has actually picked up a bit and that's been helped by a decline in valuations and thus increased opportunities, particularly in VC area.

[Erika Najarian:]

Got it. Thank you.

[Operator:]

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

[Steven Alexopoulos:]

Hey good morning, everybody.

[James Herbert:]

Hi, Steve.

[Steven Alexopoulos:]

Maybe I could start on the loan growth. So if we look at the first half of 2016, loan growth has been much better than what was originally implied by the low to mid teens full-year guidance. So, Jim, as you think about the balance of the second half of the year, is your intention to maybe sell more loans and slow growth? Or is loan growth for full year now looking to be more mid teens or better?

[James Herbert:]

I would say, well first of all what's happened that was unexpected is the -- was the decline in rates and the very strong refinance, which is a pleasant off guard catch [indiscernible] for us. I know that other banks are having the same experience. We probably will keep our loan sales rather high this year if the opportunities are to sell them, which it does seem to be by the way. I think as we noted we picked up seven or eight new buyers recently over the last 12 months or so. And so I think we would probably pick up our sales if the volume remains at this level. The second quarter is often our strongest quarter and the fourth quarter is usually the second strongest or the strongest. They go back and forth. This quarter tends to be pinned -- our backlog I think as we noted is going into the quarter strong, but the summer does slow it down if not - the backlog the closing rate a little bit, but I think, it's going to be strong. The refinance keeps up, it's going to strong.

[Steven Alexopoulos:]

Okay. So is it safe to assume the low to mid teens guidance is now more mid teens?

[James Herbert:]

I think it probably is slightly more mid teams and single family, that’s where the change is.

[Steven Alexopoulos:]

Well, and to follow up on that, the $2.9 billion of single-family originations, maybe Mike can give color. Was that share gain? Is the market just expanding that quickly? We've never seen this kind of origination level out of you guys.

[Michael Roffler:]

Yeah, I think velocity of activity remains very strong, I think we talked about more than 50% was in refinance. So that may be is little unexpected, but the purchase market also has been healthy and so the spring season is typically our best home loan origination because it’s a very traditional buying market and then the refinance activity was an added benefit to us.

[Steven Alexopoulos:]

Okay. Mike, could you give us a sense of -- just following up on the margin commentary -- where roughly do we stand with that new money NIM? And it sounded like you were expecting more stability on margin. Are you expecting it to be stable or under pressure given what the curve has done recently?

[Michael Roffler:]

So I think a little, a little tick down. I think new money yields are a little over 3%, if you think about the entirety of the portfolio. So home loans are a little less than that and the multifamily and CRE are above, but its only the new business that’s pricing at that. So the existing business is still with the coupon portfolio, which is more 315 and again the growth in the portfolio is generating net interest income, which is really what we are focused on growing over time and if there is a little bit of margin pressure, but we're growing net interest income, that will continue to be well for the franchise.

[Steven Alexopoulos:]

Okay, thanks. And maybe one final one for Bob Thornton on Wealth Management, you had good growth in the investment advisory fees in the quarter. But if I look at the other components of Wealth Management, they are essentially flat to down. Could you give some color on what you're seeing there and what your expectations are? Thanks.

[Bob Thornton:]

Thanks. I think that in the -- as you said advisory fees are up quite a bit, we’ve seen kind of up and down little bit on the securities transaction fees, but I think you will see those start to increase and I think on the trust side there is actually a little bit of a lag between new businesses coming versus the revenue on that. So, I think you’ll see an uptick on that revenue as well.

[Steven Alexopoulos:]

And anything on brokerage, Bob?

[Bob Thornton:]

I’m sorry I was referring to brokerage on that brokerage transaction business.

[Steven Alexopoulos:]

Okay. Got it. Okay, thanks.

[Operator:]

Our next question comes from the line of Joe Morford with RBC Capital Markets. Your line is now open.

[Joe Morford:]

Great. Thanks very much. I was just following up on the deposit growth, a little slower this quarter. Is there really anything driving that besides just the tax payment activity that you talked about? I was wondering perhaps -- anything on the technology or business banking side?

[Gaye Erkan:]

Sure, this is Gaye Erkan. Historically, the average growth in the first half of the year over the past five years for examples has been approximately 7%, which in line with this year's first half growth and we see that new account opening is strong and last thing to add historically average account balances are also higher in the second half compared to the first half and taxes has been the large portion of the seasonality going out in April and June.

[Joe Morford:]

Okay. That's very helpful. I guess the other question is I'd just be curious if you could talk about what your commercial real estate exposure is here in the city of San Francisco, and just how you're currently thinking about trends in the market here.

[James Herbert:]

Our CRE in the city has not changed much from its historical position, the average loan-to-value ratio and the cities probably below 60% and the average unit size in the city is around $2.5 million probably something like that and so there are a fairly substantial number of multifamily buildings, mix used buildings as you know in the city like a lot of cities, there is a lot of mixed used store in the bottom and apartments above. And so I were -- our velocity of new business is about the same as it has been and it hasn’t gone up or down. We are being very cautious. We do underwrite the loan-to-value ratios are going down a little bit, but it's not because we are targeting them to go down. It's because we are underwriting the cash flow based on a fully amortizing higher fixed rate of interest on the underwriting than we in fact are charging, that’s a stable underwriting sort of debt service coverage requirement. What happens is as buildings are being purchased at higher prices, our lending rate, our advanced rates tend to look like they're declining on loan-to-value, but in fact in the same amount based on cash flow coverage and so basically you're getting an apparently increasingly conservative loan-to-value ratio. We actually underwrite pretty much entirely to cash flow coverage.

[Joe Morford:]

Okay. That's great, Jim. Thanks so much.

[Operator:]

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

[Ken Zerbe:]

Great. Thank you. Good morning. So kind of a round-about NIM question here. You mentioned that refi activity is picking up. But if loan growth I'm going to say is broadly unchanged, right, so mid teens -- if you get the refi activity, half of which comes from your own customers, and rates on resi are obviously sub 3%, is the net impact of having more refi activity an actual negative from an NII and NIM perspective? Just that any customer with a higher yielding loan is refing lower?

[James Herbert:]

Well, it's not negative Ken from the NII point of view -- the grow is -- the NII is driven by asset size and volume of business. NIM is impacted as Mike indicated earlier a bit yes, but we’ve been, we’d a nice -- we’d a couple basis point uptick this last quarter that was nice and so I think that when you got a refi move like this, you almost inevitably get a little pressure on NIM, but the net interest income growth far over outweighs the NIM pressure.

[Michael Roffler:]

The other thing I’d add and I think we touched in this briefly is that while you could have a little margin pressure it also client acquisition and further cross-sell of opportunity with that client once they're here really benefits are also as we look out over time.

[James Herbert:]

It really comes back to the same old thing we've talked about almost all the time. If you look at one quarter at a time, yes, you could be right. If you look at it on a three and five year basis, the acquisition decline is the key to the enterprise and this is an extraordinary moment for client acquisition. So, it’s a question of what your horizon is. If it's one quarter yes, if it’s three years it’s a whole month.

[Ken Zerbe:]

Understood. And then just it looks like gain on sale margin went down meaningfully this quarter. Do you guys even think about the gain on sale margin when you consider how much to sell? I know you use the sales to manage balance sheet size. But does there come a point when margin is just too low to -- they may want to retain more loans?

[Jason Bender:]

Hi, Ken its Jason, I’ll take that one. Margin tends to or the gain margin on loan sales tends to fluctuate a bit over time. It's due primarily to market conditions. We don’t take that in as a major factor when we're considering to sell loans. It’s really more a function of balance sheet management.

[Ken Zerbe:]

All right. Thank you.

[Jason Bender:]

And if I could add to that just for, the secondary market, we have a lot of buyers now. We've very nicely expanded our range of buyers. The secondary market in due course catches up with reality just takes little time.

[Ken Zerbe:]

Meaning that ultimately you get higher gain on sale margin?

[Jason Bender:]

Well, higher -- ultimately they drop their prices exactly, and so the good news is we’re never in a hurry to sell. We do it in a very methodical way.

[Ken Zerbe:]

All right. Great. That helps. Thank you.

[Operator:]

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

[Dave Rochester:]

Hey, good morning, guys. I know last quarter you'd mentioned some larger banks have become more competitive on LTVs and that they are actually raising them on resi loan product. I was just wondering if you're continuing to see that competitive dynamic, if that's actually become more widespread, or it hasn't really expanded beyond the large banks you mentioned.

[Michael Roffler:]

Dave, its Mike. No, we’re still seeing competitive pressures and we’re still seeing banks stretch on the credit side. Our markets and as we’ve reiterated in the past, we will not follow them on the credit standard side. We still think there is ample opportunity to go after the type of borrower that we want which is low loan to value liquidity.

[Dave Rochester:]

And can you just talk about what you're limiting your going-in LTVs on resi products these days?

[Michael Roffler:]

I’m sorry.

[James Herbert:]

Our starting LTV on resi products is still about 60%, 62% on the average composite.

[Dave Rochester:]

And then where are you seeing these larger banks come in that are offering higher LTVs?

[James Herbert:]

We’re seeing as high as 80% in extreme sometimes higher.

[Michael Roffler:]

We don’t know they're composite though, but that’s -- they are out -- they are out -- when we lose, we lose, so that kind of advanced level.

[Dave Rochester:]

And are they generally pricing near the same rate that you're using?

[Michael Roffler:]

Yes.

[Dave Rochester:]

Okay. And just switching to deposit growth, I believe you mentioned previously you thought deposit growth might completely fund loan growth this year. Are you still thinking that could be the case? It sounds like you're talking about deposit growth rebounding in 3Q and then loan growth potentially slowing. So I wanted to check on that.

[Gaye Erkan:]

Historically the second half tends to be stronger in deposit growth than the first half. It's one tax seasonality and second, the way that the average account balances tend to be. So from that perspective, we think that the second half would be better than the first half.

[Dave Rochester:]

Okay. And then just one last one on the multifamily side. You had some great growth this quarter. Was just curious if you could possibly give a rough breakdown geographically of what that looked like, or perhaps if you could just talk about any areas of strength.

[James Herbert:]

It’s pretty much across the Board Dave, I’m sorry we don’t have a breakdown by market here. But there wasn’t anything that stood out one way or the other. It was pretty much evenly across the Board.

[Dave Rochester:]

Anything that you guys are seeing of concern in that market, just in the Class A space with supply coming on in certain markets? Any areas of weakness at all, or not really?

[James Herbert:]

Well, we're watching New York carefully because there's a lot of new units coming on. But we don’t tend to do larger buildings in New York anyway but I think we do some and our LTVs in New York are the lowest of anywhere in our marketplace probably the average LTV in New York is possibly -- on multifamily is possibly sub 55. And so I think that, that’s the market that we’re watching the closest. The other markets are harder to build new units and take longer.

[Dave Rochester:]

Okay. Great. Thanks, guys.

[James Herbert:]

Thank you.

[Operator:]

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

[Chris McGratty:]

Good morning. I may have missed it in the prepared remarks. But on the HQLA, can you provide a little color on what you're buying in terms of duration and yield? And I think last quarter you said the new purchases were around 250. I'm wondering if the step-down in rates is effective to what you're buying.

[Gaye Erkan:]

We had some modest impact in terms of in general investment portfolio, additional security purchases given the rally in the rates in the second quarter. It was quite modest and in terms of the type of securities that we're buying, it's similar to what we have been purchasing before, agents with securities in both resi and agents of commercial mortgage by paper as well as agency debt.

[Chris McGratty:]

Okay, but modest pressure on that 250 number that you alluded to last quarter?

[Gaye Erkan:]

Yes I would still take that as a guidance going forward because both the flexibility and timing as well as the mix, the health and mix of the securities that are available in the agency space gives us the optionality to stick with that guidance of 3.5 absent any big changes in the right market.

[Chris McGratty:]

Great. And on the efficiency ratio, Mike, I think you provided some color for the rest of the year. But to the extent Wealth Management drives a big piece of the revenue growth and the curve stays where it is today, do you -- is it possible that we see improvement in the efficiency next year? Or is it in this high end of the range that you provided?

[Michael Roffler:]

Yes, I think we've talked about this a little bit as the wealth management becomes possibly more the revenue base and it’s 13% today that likely keeps us in the higher range of our efficiency ratio and going much lower probably isn’t in the cards and also we are investing quite a bit in the franchise from a client service perspective both with technology improvements, digital and mobile along with investing for our employees to be more effective and be able to be focused more on client service than maybe some of the manual work that goes on.

[Chris McGratty:]

Great. And maybe if I could ask one more, on the PE/VC capital call line that you alluded to in the prepared remarks, any numbers that you could put around the strength that you alluded to in terms of the sequential or year-over-year growth in that business?

[Michael Roffler:]

Not different than what we've talked about in prior quarters. We saw an increase in the utilization rates. So thus maybe a little bit more activity but I would still say there is an overall tone of caution maybe a little bit more favorable than Q1.

[Chris McGratty:]

Great. Thank you.

[Operator:]

Our next question comes from the line of Lana Chan with BMO Capital Markets. Your line is now open.

[Lana Chan:]

Thank you. All my questions have been answered. Thank you.

[Operator:]

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

[Casey Haire:]

Thanks. Good morning. Gaye, a question for you, specifically on the muni position and the securities portfolio, just wondering about $5 billion as of March 31, is there any risk of muni issuers coming back to refinance into a lower rate product?

[Gaye Erkan:]

We don’t anticipate a significant impact due to that and the type of securities that we’re also purchasing. We're making sure that that those type of optionalities are way further out. So in the near to medium term future, we don’t anticipate as a significant risk.

[Casey Haire:]

Okay. And then just a housekeeping question, maybe for Mike, on the prepay penalty this quarter, was that a significant impact?

[Michael Roffler:]

No it’s been pretty modest the last few quarters and it typically averages one to two basis points of our loan yield.

[Casey Haire:]

Okay. Thanks very much.

[Operator:]

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

[John Pancari:]

Good morning.

[Michael Roffler:]

Good morning.

[John Pancari:]

On that, back to the question around Wealth Management, or really the question that was around the efficiency ratio. And I know you just indicated that the continued investment in the Wealth Management business could keep the efficiency ratio elevated. In terms of the corollary benefit that you'll see on ROE, because obviously Wealth Management is less capital intensive, how should we expect that to play out? Right now on an ROE basis, you're around that high 10%s, close to 11% on stated ROE, and 12.5% ballpark for tangible. So where can we expect that to trend as you build out the Wealth Management business?

[Michael Roffler:]

So if wealth management grows as a percentage of total revenue, it should tick the efficiency ratio or sorry the return on equity slightly higher, but while we’re very pleased at 13% to have a big bump in ROE we need to increase meaningfully from that level and so I think it’s a directional increase that you would see as the wealth business grows as a percentage of total.

[John Pancari:]

Okay. And then I guess if you could just talk about the outlook for continued hiring opportunities on that front and acquisition opportunities on the Wealth Management side.

[Bob Thornton:]

Hi this is Bob Thornton. We continue to pursue attractive hire opportunities. We hadn’t announced any hires this past quarter but we’re still talking and interviewing other folks and I think you will see some as we move forward. On the acquisition side, we look at a lot of things but have to be a sort of very strong fit for us to pursue those.

[John Pancari:]

Okay. And then separately, on the -- back to the loan growth side. I know there was a question already about multifamily growth, but on the remainder of CRE -- also put up solid 19% year-over-year growth there. Can you talk to us about the -- what areas, what type of CRE, and then geographically what's driving that? And then separately -- yes; you already gave color on C&I. So really it's around CRE. Thanks.

[Bob Thornton:]

The CRE growth is quite broad from a market point of view and again by type, it's pretty diversified. It's mostly with existing clients either private banking clients or real estate clients. We had a few new clients with very few, renovation the average size in that loan category is probably around $3 million roughly and the LTV in that category would be sub 60% as well. So it's no change from what we've done. There is a fair amount of activity, but nothing that we would particularly call out.

[John Pancari:]

Okay. All right; thanks, Jim. And then my last question is also related to CRE and multifamily, but on the credit quality front. Obviously there's a lot of focus around that right now in terms of certain banks' concentrations in real estate but also their risk controls built around their businesses and everything, and then potential credit issues. Are you seeing anything on the credit quality front or anything from the regulators that's causing you to think about the growth in your real estate portfolios any differently?

[James Herbert:]

The credit -- let me speak to the credit front, the credit front in our portfolio we're not seeing anything that causes us concern. So we're maintaining very high standard and in dealing as I said with mostly clients who we have dealt with for an extended period of time. So we have a lot of history with them.

[Michael Roffler:]

Yeah, the concentration percentages that you see they’re not a concern that we've had to focus on or deal with.

[John Pancari:]

Okay. Great. Thank you.

[Operator:]

Our 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. I guess my first question is a follow-on to what Chris was asking in relation to the PE/VC call lines. Do you have a balance at the end of the quarter for that segment?

[Michael Roffler:]

I don't have it off the top of my head. It's in our new deck and I believe it's about 30% of the business banking outstanding for the quarter.

[James Herbert:]

Which is pretty much our standard?

[Michael Roffler:]

It hasn't had much change.

[James Herbert:]

And up a little bit because it draws.

[Timur Braziler:]

Okay, great. And then switching gears to expenses, I know the first half of this year we were expecting to see some consultants exit the Firm. Maybe just provide an update on where we stand with that and if there's any additional room on the downside there going forward.

[Michael Roffler:]

We're very pleased that the professional fees as we've talked about in the past have continued to come down. This quarter there about $1 million less I think or even last quarter. We don't believe there's probably a lot of room down from here. Much of our consultant and professional fee spend now is around obviously orders and legal fees, but then also consultants who are helping us with various initiatives we have on enhancing client service and internal technologies and so that will continue to make us be more effective at serving clients and working internally. And maybe just on efficiency ratio for a second, 59% to 60% for a growing wealth business and a very high touch business model, we think is a very good place for us to operate and a very good result given the high touch model that we continue to have.

[Timur Braziler:]

Okay, great. And then I just want to make sure I heard something correctly on the call. Did you say the $400 million of longer-term loans were sold to Fannie during the quarter? Did I hear that correctly?

[Michael Selfridge:]

Yeah, that's not just the quarter. That was over a more extended period of time.

[Timur Braziler:]

Okay. And then last question I guess for Mike Selfridge. Can you maybe talk a little bit or give a little bit of detail around the heightened credit standards? Is that across the entire geographical footprint, or is that in any particular area? Just any additional color on that would be great.

[Michael Selfridge:]

No, I would say it's across the enterprise and it's also across all our product lines.

[Timur Braziler:]

Okay. And is that just pertaining to leverage, or what's the details behind it?

[Michael Selfridge:]

Yeah, the detail is generally on the real estate side or as we alluded to, lower loan to values at origination as compared to what we saw maybe five six years ago.

[Timur Braziler:]

Great. Thank you very much.

[Operator:]

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

[Paul Miller:]

Yes, thank you very much. On the origination side, the $6.5 billion, do you guys track or do you disclose how much of that was recapture rate from your own portfolios?

[James Herbert:]

We don't, Paul. We do look at it, we don't disclose it. The fair amount of it, if you look at our -- in our deck our investor deck, about 50% to 52% roughly something like that of our lending each year tends to be with existing clients a lot, but it is in that seller refinance. it could be a second home, it could be another purchase. And then the business of banking heavily with existing clients the CRE and commercials, CRE and multifamily as well. So more than half the business of the bank every year on the deposit side and on the loan side is in fact existing clients, doing more with us, not necessarily refinancing.

[Paul Miller:]

Okay. And then can you remind us again -- because you guys mainly portfolio ARMs and you mostly sell 30-year fixed-rate stuff. Am I correct? And then saying that, will you be selling more ARMs out there? And do the ARMs get a better gain on sale now that you're going to slow down growth a little bit?

[James Herbert:]

Unnecessarily no. We will sell the longer fixed rate, but you want to talk about the next?

[Michael Selfridge:]

Yeah, we sell actually a mix of loans each quarter. You’re right. we do almost always sell most of our longer dated fixed rate loans the 30-year and the 15-year product, but we also sell intermediate ARMs at the same time.

[Paul Miller:]

And is the gain on sale in the ARMs greater than the fixed-rate stuff?

[Michael Roffler:]

That depends on market conditions fluctuate.

[Paul Miller:]

Okay. Hey guys thank you very much.

[Michael Roffler:]

Thank you.

[Operator:]

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

[Matthew Clark:]

Hey, thanks. Can you just update us on what the pretax margin was in the Wealth Management business this quarter, and what your target is longer term, and the time it might take to get there?

[Michael Roffler:]

Sure, so on a on a fee basis, it's pretty consistent with where it's been at around 15% and I think over time a lot of it depends on additions to the team and the pace at which they go because we've been continuing to reinvest in new people and growing the business and that holds down the margin a little bit. And if that were to slow, you'd see the margin tick up a little bit and we're going to balance might tick up to 20%. But we're going to balance that with opportunities we see to continue to add new people.

[Matthew Clark:]

Okay, great. And then do you happen to have the weighted average contractual rate on loans in the month of July so far?

[Michael Roffler:]

No, we don't.

[Matthew Clark:]

Okay. And then on your reserve coverage, I think you talked about in the past being comfortable in that 55 to 65 basis point range; unchanged here at 59 basis points for the last four quarters or so. Just curious whether or not that range of guidance has changed given the environment more recently.

[Michael Roffler:]

With respect to us, no, it has not changed. We think 55 to 65 and being about 59 currently feels about right. It is driven a little bit by mix of portfolio. So if commercial or business became little bit more. you would probably see it tick up a little bit, and with single family being a little bit more it's probably at this level, but we feel very good about it given the quality of the portfolio as it exists today.

[Matthew Clark:]

Okay. And then last one for me. The deposit growth that you anticipate here in the second half, does that contemplate having to raise rates on deposits at all, or not?

[Gaye Erkan:]

Not necessarily taking the past few years into account its again two fold is one. The taxes April and June big season for the taxes and then the second half average account balances historically tend to be higher in the second half both the businesses are resettled and growing with the net earnings as well as the consumer deposit are growing in terms of average balance per account. In addition to that, the new account opening has been continuing at a strong pace that we're very pleased about.

[Matthew Clark:]

Got it. Thank you.

[Operator:]

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

[Aaron Deer:]

Hi, good morning, everyone. Most of my questions have been addressed. Maybe just one on the funding side for Mike or Gaye. You touched on the FHLB borrowings, where there could be some benefit from lower pricing there. Is there anything on the CD side or anything where we've got some large volumes coming due, where there's maybe pricing opportunity there to offset some of the yield pressures?

[Gaye Erkan:]

So in general, on the CD side, it's more of a, it's a good product for our preferred banking offices and it's a good product in general to see these do come in with other types of accounts as well. So we do pay attention that we have good amount of cross sell to the CD clients in that sense. So that's more of an opportunity for us for cross-sell and it’s an insignificant portion of our deposit gathering. So I don’t anticipate a big impact due to that.

[Aaron Deer:]

Okay. Very good. Thank you.

[Operator:]

Our next question comes from the line of Christopher Wheeler with Atlantic Equities. Your line is now open.

[Christopher Wheeler:]

Yes, good morning. A couple of questions. First of all, perhaps on the Wealth Management side, can we talk a little bit about the growth in the assets under management during the period in terms of what actually came in with the people you hired in that particular splurge before Christmas? And also perhaps what's come through obviously market movements and what's come from actually net new money?

[James Herbert:]

So as I mentioned, the majority of our growth over the first half of the year has come from net new client assets and less than a third through market growth. A lot of the overall growth in assets over the last year has come from our overall organic growth along with the Constellation acquisition and the Credit Suisse and other key hires at the end of the year. So I would say overall we have had good organic growth despite these additional ads in over the first half of the year.

[Christopher Wheeler:]

Okay. And so a second question really, and this perhaps relates back to a discussion I think we had when we were in San Francisco back in November, where I think Mike Roffler was talking about when you had a bit of a splurge in terms of hiring relationship managers and how -- the issues of bedding those people into your culture, which is really important, took a little bit longer perhaps than you thought. How are you finding obviously those senior hires that you made at the end of last year and the beginning of this year, in terms of getting them into the culture of First Republic and also feeling that you are ready to take the next step, which you sounded like you were, of starting to pick up some more quite senior hires.

[James Herbert:]

Yes I would say, we really focused on the cultural piece in two ways. I think number one is they sit among our existing bankers and other Wealth professionals, involved in our events and committees and really part of the organization. The other thing that we look at that’s a real acid test of integration is how much business are doing, how much cross-sell and as I mentioned in remarks, every single one of the hires we announced over the last year have all done material banking deposit, cross-sell business with our bankers. So to us that shows, look, people are working all together. They get the value proposition of the bank an important reason of why they came.

[Christopher Wheeler:]

Okay. Thanks very much for that one. And just one final question really, and this is on the growth that you've been seeing in the unsecured loans and lines of credit. I think they were up something like 37% in the quarter, about -- multiply by about three times this time last year. I know what the product is. But could you talk about why there's been the surge in activity around these unsecured lines of credit? And talk a little bit about the tenor of those loans and perhaps the nature of them. Thank you.

[Michael Roffler:]

Thanks Christopher. The growth there first of all is still quite a modest past of the book as you know, but the growth has been mostly the younger, the younger millennial clients that we've been acquiring through our professional loan program at our all in one student loan refinance programs. They have been the quite successful. We’re very pleased, the average FICO score is 775 or so two years in job. So, the average educational level is high over 90% have graduate degrees and the rental markets and we have zero delinquency in the portfolio.

[Christopher Wheeler:]

Okay, that's really clear. Thank you really much. Thank you.

[Michael Roffler:]

Thank you.

[Operator:]

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

[Matthew Keating:]

Thank you. My question is for Mike Roffler. Mike, I appreciate the commentary on the impact of the adoption of the accounting guidance, especially the guidance of the effective tax rate for this year between 18% and 20%. But looking out to 2017, if you look at where the Street consensus tax rate is, it's somewhere between 24% and 25% at the moment. Is there anything unusual about 2016 from a share-based compensation perspective that would impact '17's tax rate vis-à-vis the updated guidance for this year? Thanks.

[Michael Roffler:]

No there is nothing unusual. We’ll continue -- this new accounting guidance will continue to impact our tax rate based upon sort of employee activity which includes when they exercise and also when stock awards vest. The one thing I would say is that the second quarter of this year historically has tended to be when we granted restricted stock awards and so those typically then vest at this time and so if you were to look at on a quarter-to-quarter basis, in the second quarter you may have more activity than you will during the first or third quarter just as an example, but over the year, this guidance I think 18 to 20 right now feels about right even as you look out a little bit.

[Matthew Keating:]

Great. Thanks very much.

[Operator:]

There are no further questions in queue at this time. I’ll turn the call over to Mr. Jim Herbert, Chairman and Chief Executive Officer for closing remarks.

[James Herbert:]

Thank you all very much. Thanks everybody for your attention. We’re very pleased with the quarter. We continue to have excellent results. Credit is strong. Capital is strong, volume of business is very good and the quality is high. So, we look forward to speaking with everybody next quarter. Thank you very much.

[Operator:]

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