First Republic Bank
Q4 2017 Earnings Call Transcript

Published: 16 Jan 2018

[Operator:]

Greetings and welcome to First Republic Bank’s Fourth Quarter and Full-Year 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, Senior Vice President and Chief Marketing and Communications Officer. Please go ahead.

[Shannon Houston:]

Thank you and welcome to First Republic Bank’s fourth 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 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.

[Jim Herbert:]

Thank you, Shannon, and thanks to everyone for joining our call today. It was a particularly good year for First Republic across our entire franchise. We continued to be successful in executing our very stable, client centric business model, growing households very consistently. 2017 was a good year on a number of fronts. We'll go through a few. Total loans grew by over $10 billion with no change in the loan mix or credit quality. Total deposits also grew by $10 billion up 18%. Wealth management grew to over $107 billion in assets up fully 28%. As always and very key, our credit quality remained excellent. Nonperforming assets were only 4 basis points. Net charge-offs for the year were only $650, 000 on a portfolio of over $62 billion. Importantly, our capital levels remained quite strong. A couple of additional metrics. During the year, total revenues rose 18%. Net income was up 13% and our tangible book value was up over 14%. Let me take one moment to talk about the business model and our acquisition of client households which is the key metric which we focus on. Each year we typically grow our total client households in the mid teens percentage. In 2017, household growth was even higher than this already strong rate, driven largely by our success in consumer deposit gathering and our millennial strategies. Overall, client growth at First Republic is always direct and continuing result of exceptional client service delivery. Our high touch model leads to uniquely strong client satisfaction levels that far exceed our competition. This service quality is why we have in our promoters' score that's twice the industry average. It's also why we have a client attrition rate of only 2% compared to the industry's 8% and this is why our home loan clients have an average of 8 products with us. Our urban coastal well-educated professional clients tend to have an intrinsically high economic growth rate, which benefits First Republic. With their high levels of client satisfaction and their growth over time they do much more with us and they happily refer their friends and colleagues. Now let me turn the call over to Mike Roffler, Chief Financial Officer.

[Mike Roffler:]

Thanks Jim. I'll cover the new tax law, our net interest margin, net interest income and efficiency ratio. Let me start with the impact of the tax law and the fourth quarter results. As noted in our two recent 8-K filings, some of our employees chose to exercise an unusually large portion of their remaining stock option during the quarter. Also during the fourth quarter we revalued our deferred tax assets due to the new federal corporate tax rate. The net effect of these two activities was a reduction to earnings of approximately $0.02 per share for the quarter. Our effective tax rate for the full year 2017 was 17%. As we look ahead to 2018 we currently expect the bank's effective tax rate to be approximately 19%. Turning to net interest margin, beginning in the first quarter of 2018, the bank will use the reduced federal corporate tax rate of 21% to compute the tax-equivalent yields on our tax-exempt municipal securities and loans. The newly reduced rate lowers the tax-equivalent yield of these holdings which has a negative impact on our reported net interest margin. As a result of this change in tax rate calculation and assuming the continued competitive lending environment, coupled with flatter yield curve, we currently expect the bank's net interest margin to be in the range of 285 to 295 in 2018. Importantly however, the tax rate change does not affect the contractual interest income of these investments and it will have no impact on either our reported net interest income or our efficiency ratio. With the nature of our growing business we look closely at net interest income as the most meaningful reflection of the growing earnings power of the enterprise. Growth in interest income was up a very strong 18% in 2017. Turning to expenses, the efficiency ratio for the quarter was 63.7% and for the full year of 2017 was 62.8%. Looking ahead we currently expect the bank's efficiency ratio to be in the range of 63% to 64% for the full year 2018. This excludes the seasonal impact of higher payroll taxes and employee benefits that occur each year in the first quarter. And now I'd like to turn the call over to Gaye Erkan, President.

[Hafize Gaye Erkan:]

Thank you, Mike. I would like to talk about our investment portfolio, deposit franchise, and Gradifi. In terms of investments, our total portfolio grew to $18.6 billion at year end. High-quality liquid assets, including eligible cash totaled $10.5 billion at December 31, or 12.4% of average total assets in the fourth quarter. Turning to deposits, we are very pleased with the diversified and strong deposit growth across all channels and geographies. Total deposits were $68.9 billion up 5% from the last quarter and up 18% for 2017 a very successful year. Growth in checking deposits remained strong and checking represented 63% of our total deposits at year end. The average rate paid on total deposits during the fourth quarter was 28 basis points up only 3 basis points from the third quarter. Let me provide some perspective on our deposit franchise. Our mission every day is to fully serve our client's personal banking, business banking, and wealth management needs. Through exceptional service our clients favor us over time. This leads to deep, stable relationship driven banking not just transactional. Rate matters when selling a product. However, service matters when building growth, long-lasting relationships and that is the reason our home loan clients use 8 products on average. We source and service our consumer deposit relationships through a variety of diverse channels. These include private banking, our preferred banking office network, relationship managers, business bankers and private wealth management. At year-end consumer deposits represented 46% of total deposits with an average consumer checking account of approximately $80,000 which is not particularly large. We are very pleased that total consumer deposit households grew 20% during the year. It's likely our consumer relationships that drive growth in business banking. By providing extraordinary service our individual clients introduce us to the businesses and nonprofits they lead and influence. Mike Selfridge will speak to this in a moment. Turning to private wealth management, sweep accounts represented 6% of total deposits at year-end. Private wealth management has been an increasingly important source of deposits not only through the sweep accounts but also the direct referral of wealth management clients through personal banking. As seen with those business banking and private wealth management, our deposit franchise realizes great benefit from the holistic, personal, client focused relationship model of First Republic. One channel often serves as a referral source to another. And our deposit results speak for themselves. Over the past nine quarters, the fed funds rate has increased 125 basis points and over the same time period our deposit rate has increased 14 basis points. This reflects our relationship-based banking model. Let me now discuss Gradifi for a moment. We are pleased with the continued momentum of Gradifi which we acquired a year ago. At year-end 2017, Gradifi had over 300 companies on its platform an eightfold increase during the year. Increasingly, more companies are helping their employees replay their student debt by offering this innovative benefit. Employers recognize this benefit as a very effective way to attract and retain talent. Overall, it was a terrific year across the franchise and now I would like to turn the call over to Mike Selfridge, Chief Banking Officer.

[Mike Selfridge:]

Thank you, Gaye. Let me start with economic conditions in our markets. We continue to operate in some of the most dynamic geographic markets in the country. The strength of our markets is demonstrated in the loan origination volume in 2017 which was $28 billion. This was our best year ever. Two thirds of our loan growth in 2017 was real estate collateralized housing, both single-family and multifamily. For the full-year single-family residential lending volume was about half purchase and half refinance. Our medium loan size was about $650,000 with an average loan-to-value of only 58%. Multifamily and commercial real estate also grew nicely this year. The average loan-to-value ratio at origination was 50% for our multifamily originations and 47% for commercial real estate. Very importantly, credit quality remains excellent. We continue to make high quality loans based on our consistent conservative underwriting standards. During 2017 we added fully $60 million to our loan loss reserves. For perspective, the total loan loss reserve is now $366 million or almost 10 times our year-end nonperforming assets. Turning to business banking, it was another great year. Business deposits were up 21% compared to a year ago. At year-end business deposits represented 54% of total deposits with an average business checking account size of approximately $299,000 not particularly large at all. Over 60% of these business deposit balances are operational or working capital in nature. These are very relationship driven accounts and tend to be less rate sensitive. Year-over-year business loan commitments were up 16% and business loans outstanding were up 21%. I would note that loans to nonprofits are the largest segment of business loans outstanding and represent 37% of our total business banking loan portfolio. Over the past five years we've made significant investments in our business banking franchise, which have yielded the results you see today. Total business deposits five years ago were $11.4 billion. Today they are $37.4 billion up 27% per annum. We served 20,000 business clients five years ago. Today we have doubled that number. The investments in our business banking franchise continue to deliver meaningful results. Looking forward to 2018, our overall loan pipeline is strong up modestly compared to a year ago. And now I'd like to turn the call over to Bob Thornton, President of Private Wealth Management.

[Bob Thornton:]

Thank you, Mike. Wealth Management had a record year. We continue to be very successful in growing wealth management assets by winning a greater share of our existing clients' assets, generating new business from word-of-mouth referrals and recruiting new advisors. Now let me share some key results. Wealth management assets totaled $107 billion at year end 2017 up $23 billion compared to a year ago. Client inflows represented nearly half of that growth. Wealth management revenue totaled $356 million for the year up 22% compared to the prior year. Let me also touch further on how private wealth management contributes, continues to drive deposits. As Gaye mentioned, private wealth management sweep accounts represented 6% of total assets at year end. Sweep accounts represent a strong, stable source of consumer deposits for the bank. In addition these deposits are highly diversified with an average account size of only 116,000 and during the year many wealth management clients also became new deposit relationships. The growth in individual deposit relationships sourced to private wealth management highlights our highly integrated team based approach and our ability to holistically serve our client's financial needs. In terms of recruiting experienced wealth professionals, 2017 was another very good year. During the year we brought on seven new wealth management teams and we also successfully integrated some of our more recent hires. Our reputation in the advisor community continues to grow as our client centric service focused firm that provides exceptional banking. We're also quite pleased with the investments we've made in the wealth management franchise which have supported our very strong growth. For example, five years ago wealth management revenues were 7% of our total enterprise revenues. Today they are 14%. Over the same period, the number of wealth management households with banking relationships at First Republic has more than doubled. We are very happy with the success and continued growth of wealth management and the opportunities that lie ahead. And now it's my pleasure to turn the call over to Jason Bender, Chief Operating Officer.

[Jason Bender:]

Thank you, Bob. I'd like to comment on our business model, its scalability and some significant operational initiatives that we completed in 2017. As Jim said, our business model begins and ends with extraordinary client satisfaction and loyalty, that's demonstrated by First Republic's net promoter score which is more than double that of the U.S. banking industry. A highly differentiated level of client satisfaction produces a more stable client base and allows us to do more with our existing clients. It also leads to strong word of mouth referrals. As a result, half of our growth in any given year comes from doing more business with existing clients with another one fourth of our growth from their direct referrals. Our stable client base, coupled with growth largely driven by existing clients, allows us an advantage in operational scale. This further supports our efforts to provide exceptional client service. Let me tie our operational scale to Jim's description of our business model. For contacts looking at banks of a similar asset size, First Republic has far fewer the number of employees, branches and deposit accounts just to list a few metrics. This relatively modest operational scale supports key tenets of our client service focused business model as well as its scalability. Fewer employees on average, means fewer layers of management and faster decision making. Your accounts on average, means more time spent on each relationship which in turn has further benefits. More time per loan leads to better credit, more time per transaction leads to lower execution risk, and more time per client leads to greater client knowledge and differentiated service. Maintaining that differentiated level of client satisfaction and ensuring the scalability of our client service focused business model, underscores all that we do, and drives our investments in technology and operations. To that end, we completed three major investments in technology in operations during 2017. We completed the rollout of our new single family loan origination system with almost all of our new single family mortgages now being originated on this system at year end. Approximately 60% of all loans we originate going forward will be originated on this new system. We completed development on our new consumer digital banking platform, the largest technology project for First Republic today. We have successfully and smoothly converted two thirds of our online clients to the new system and will have converted nearly all remaining clients by the end of the first quarter. Finally, we completed development of our new deposit client onboarding system and have migrated all of our bankers and offices to the new system at year end. This new technology reduces the number of systems necessary to opening new account from eight to one and enables bankers to now open new deposit accounts up to 50% faster than before. Together, these three initiatives represent a big upgrade in some of our most important systems allowing for improved usability, streamlined workflows and paperless functionality. With the completion of these investments in 2017 First Republic has further scaled its capacity to continue to deliver consistent, exceptional client service well into the future. Let me now turn the call over to Mollie Richardson, Chief People Officer and Chief Administrative Officer.

[Mollie Richardson:]

Thank you, Jason. The diversity of perspective, experience and background of our people is key to our culture as is exceptional client service. We invest in our people in order to ensure that our culture and high service levels remain consistent. In 2017, we launched a new management development program which brings together colleagues from across departments and regions to learn best practices in identifying and growing talent. We also introduced a new relationship manager development program mostly recruiting from within First Republic, this program develops our next generation of bankers to support the growth of our new younger clients. We would note that we have been paying a $20 per hour minimum wage for two years now in support of our people. Our meritocracy based inclusive and diverse workplace environment has been fundamental to First Republic's success throughout our 32-year history. 48% of our total workforce and 52% of senior management are female and 48% of our total workforce represents minorities. Additionally, approximately one third of our Board of Directors is female and has historically been so. In fact, collectively, we speak over 50 languages at First Republic. In addition to investing in our people and culture, we also invest to fully serve our diverse and dynamic communities. In 2016, we launched our Eagle Community Home Loan program which provides attractive rates for home loans in underserved areas or communities. In 2017, we closed 3.5 times more Eagle Community Home Loans than the prior year with a total portfolio of almost $1 billion and median loan amount of $377,000. We also support our diverse market through community development lending. Since 2011, First Republic has originated over 1900 community development loans with a total portfolio of over $4.4 billion. Our community lending and engagement efforts are guided by our community advisory board. This independent and diverse group of community leaders offers strategic guidance on the banks' affordable housing, small business and economic development and financial empowerment initiatives. A continued focus on culture, diversity and our communities continues to be a foundation of our First Republic values and success. And now let me turn the call back to Jim.

[Jim Herbert:]

Thank you all very much. The Bank remains steadfastly committed to our key pillars, highest possible credit quality, capital strength and exceptional differentiated client service. We've always focused on the longer term and remained steady in our approach to that. In this regard, we're continuing to invest in our systems, our people and our client services. 2017 was a very strong year marked by safe and solid growth, substantial systems improvements and successful capital raises. We're looking forward to 2018 very much and expect it to be a good year. Now we'd like to open the line for questions.

[Operator:]

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Thank you. Our first question comes from the line of Steven Alexopoulos with JPMorgan. Please proceed with your questions.

[Steven Alexopoulos:]

Hey, good morning everybody.

[Jim Herbert:]

Good morning, Steve.

[Steven Alexopoulos:]

I wanted to start with the tax rate. I know you guys have had several moving pieces in tax rate in 2017 particularly around all the stock option exercising, hear from Mike Roffler, from a very high level, why is the effective tax rate not expected to move lower in 2018 given the lower federal tax rate now?

[Mike Roffler:]

Steve, it’s actually leads into what you just said. So in the fourth quarter we had a sort of a pull forward or an acceleration of employees exercising their options given the changes to the personal tax code also. When we had projected taxes before you had assumed a more, what I'd call normal distribution or level exercise pattern, but in essence those got exercised in the fourth quarter, so you have less benefits in future periods. So it’s sort of an offset where you won't see the benefit from the federal rate cut because this offsets it.

[Steven Alexopoulos:]

Okay, okay that makes sense. And regarding expenses following up on the efficiency ratio guidance you gave for 2018, given all the puts and takes around the efficiency ratio, can you help us think about a reasonable range for expense growth in 2018 particularly as the spend for Gradifi subsides?

[Mike Roffler:]

Yes, so in 2017, on Gradifi that's a good point, we spent about $17 million and so that was a $17 million increase off of the base and that was about $0.07 or $0.08 per share. Probably also impacted our efficiency ratio by a negative 70 basis points. If we think about, we've been a consistent revenue growth of mid to high teens. And so you'd look at expense growth, you know probably in that same range. We've been running a bit higher because of all the investments we've made in the franchise including Gradifi going from 0 to $70 million, but I think we look at sort of mid to high teens for hopefully both revenues and expenses as we look out which keeps efficiency kind of where it is.

[Steven Alexopoulos:]

Thank you. Maybe if I could squeeze one more in just on the new margin guidance you gave the 285 to 295, what is the new money margin currently running at under the new tax rate? Thank you.

[Jim Herbert:]

Yes, so loan yields in the quarter were around 3.25 on new business. And that it was really reflective probably of pricing from the third quarter as they sort of pull through into the fourth quarter, that doesn't change a lot because there's not a bunch of tax exempt lending in our current production.

[Steven Alexopoulos:]

Okay. Thanks for taking my questions.

[Operator:]

Our next question comes from the line of David Long with Raymond James. Please proceed with your question.

[David Long:]

Good morning everyone.

[Jim Herbert:]

Good morning, David.

[David Long:]

In the past you guys have talked about mid teen loan growth, is that still your expectations here going forward?

[Jim Herbert:]

That feels about right to us, we don't set targets I should note that and at the same time we see a lot of good credit opportunities in our markets, so that drove a little bit higher volume in 2017, but looking forward we think mid teens feels about right.

[David Long:]

Got it, thanks. And then as a follow up, I think Jason you mentioned the three platform upgrades that were completed or are close to being completed, does that have any positive impact on your operating expenses that you can talk about?

[Jason Bender:]

Sure. We think we continue to invest in the infrastructure of the bank and what we think is that that really allows us to scale our overall business model and to continue to offer differentiated levels of client service particularly as we grow. I think in terms of efficiency ratio, I'd refer you back to Mike's earlier comments on our expectations for ’18.

[David Long:]

Got it, thanks for taking my questions.

[Operator:]

Our next question comes from the line of John Pancari with Evercore. Please proceed with your question.

[John Pancari:]

Good morning.

[Jim Herbert:]

Good morning, John.

[John Pancari:]

Regarding the loan yields in the quarter, I know heard your margin commentary and some of the factors influencing, but the loan yields were essentially flat linked quarter despite the upside move in rates on the short end. I know you pointed to the flatter curve as being a factor to a degree, but can you give us a little bit of color, is there anything going on in terms of pricing or you're adopting a bit more of a competitive posture that is eating into the spreads over the benchmark rates? Thanks.

[Jim Herbert:]

No not really. We are always competitive on pricing as need be. We don't compete on terms as you know in terms of credit issues, but the market is just holding at a very competitive level on mortgages. They've begun to move up a little bit recently and so we're getting some additional pricing power but not much. So, but I don't think our margins - our margins that as Mike indicated, reflect a pretty steady-state situation.

[Mike Roffler:]

The other thing I'd add is, your comment about the rate hike obviously it happened mid December and so there's a very modest benefit in December and you'll see that helix [ph] in other adjustable rate have a little bit of a move in the first quarter, but we have just a little benefit in Q4.

[John Pancari:]

Okay, great. And then my follow up is around expenses. I just want to get your latest take on what was the would you say is the biggest driver of the reason why the efficiency ratio expectation was dialed higher through the year and now we're at 63% to 64%, what was the greatest driver of the upside pressure? And then separately, are you starting to see higher than expected cost of hiring in your wealth management business just given that some of your peer brokers are exiting the broker protocol and its possibly making FA hiring more expensive? Thanks.

[Mike Roffler:]

So, on the first really continued investment in the franchise around the couple things we mentioned specifically, Gradifi and systems and sort of operational improvements we're making at a pretty rapid pace to support the household acquisition that Jim talked about during the prepared remarks. And so those investments really support the bank's overall differentiated service and are important to make. Second on the wealth management, I don’t think we've really seen a change in the sort of the way we are negotiating or the packages that come through when we hire advisors.

[Jim Herbert:]

Let me just on this expense issue for a second. We passed $50 billion officially in terms of completion of all the programs only about a year and a half ago. And all of the map I would say it was about 2.5 years ago in fact all the systems we needed for that were only signed off on or about a year and a half ago. That expense build up has leveled. It's not going down but it has leveled. We then shifted to investing in this entire systems of the enterprise, service delivery, efficiency. You've heard Jason go through several of them. So we've been focused on building out the improvement of our systems delivery and our clients service delivery for only about a year and a half. That has a ways to go, but the benefits are now beginning to show, particularly the online banking system, particularly the improved loan booking system as well as many other benefits throughout. We will be at that in ’18 for sure. On the other hand the growth of households and the growth of client base in the bank has never in 33 years of history been stronger. It is absolutely extraordinary what is happening and that has some upfront costs. It will have enormous short, intermediate and longer term benefits.

[John Pancari:]

All right Jim, thanks.

[Operator:]

Our next question comes from line of Aaron Deer with Sandler O'Neill. Please proceed with your question.

[Aaron Deer:]

Hi good morning, gentlemen.

[Jim Herbert:]

Good morning.

[Aaron Deer:]

I guess sort of looking at the gratify investment that's been made over the over the past year, I'm just curious where we should expect to see that starting to pull through on the revenue lines? Is there something we can be watching for to see when that starts to really deliver?

[Mike Roffler:]

So, we're continuing to make investments in the platform and as Gaye mentioned, companies are signing up at an increasing pace. I think the revenues probably start to grow in sort of 2019 and thereafter.

[Jim Herbert:]

Actually, that right it's very interesting task. Right at this moment if you think about it, you're hearing a lot of companies very appropriately so, increased the compensation of their employees as a result of the tax cut. As Mollie said, we've been at $20 minimum wage for a couple of years. But what I wonder full time for companies to take on a student loan repayment activity. And so the ramping up of Gradifi, the timing on Gradifi is virtually perfect. If companies want to help their younger employees who may be struggling a bit economically, helping them to repay their student loans as a additionally benefit is central casting for exactly what they're trying to do right now.

[Aaron Deer:]

Sure, that's a good point. And then on the deposit cost Gaye mentioned that the - they're up 14 basis points since the Fed started raising rates, there's a little bit of catch-up it seemed back in the third quarter, and this quarter it did seem like they were still pretty benign. What is, is it kind of look out and kind of what consumer and business expectations are now for deposit rates, what kind of pressure do you see on that going forward?

[Mollie Richardson:]

Sure. As we said we are very pleased to have grown 18% year-over-year in terms of ending balances and only 13 basis points up in rate and in the entire year with 7 to 5 bps increase over the last 12 months. We’re extremely pleased with that the checking growth. Obviously that doesn't have rate associated with it. It is therefore service. Just going back to the business model we tend to do a lot with the clients. We have 50% of our growth on deposit side comes from existing clients and 25% comes from referrals. And our coordinated focus on the holistic relationship has resulted great growth if you look at the fourth quarter in consumer checking which we are very pleased about. So it has been a great quarter and year from a deposit perspective.

[Aaron Deer:]

It is in terms of, given that the loan growth that you're looking to fund this year, what would you expect in terms of deposit pricing at this point? Obviously it's hard to know, where exactly that goes, but just based on what expectations are now from your customers are you seeing much deposit pricing pressure here than in 2018.

[Mollie Richardson:]

Nothing any different than the banking sector. The beta has been in line with the banking sector and lower than the historical betas. If I could bifurcate on the consumer side, obviously those are the lowest betas given the relationship nature and there is a lot of healthy activity on the businesses that they are banking that are led by the individuals who we have the personal banking relationship with as well. So we - looking at 2017 as a trend we would expect to fund the loan growth with deposits and have the loan deposit ratio in the low 90s.

[Aaron Deer:]

Okay, great. Thanks for taking my question.

[Mollie Richardson:]

Thank you.

[Operator:]

Our next question comes from the line of Ken Zerbe with Morgan Stanley. Please proceed with your question.

[Ken Zerbe:]

Right, thanks. Good morning.

[Jim Herbert:]

Hi, Ken.

[Ken Zerbe:]

I guess the first question just on the tax rate, I definitely appreciate the guidance for the 19% next year, but I guess what, I'm trying to just get a sense of like how much more of this, I guess this sort of a stock option exercise impact is out there. Right, I know it's kind of a vague question, but as I think about say 2019 or 2020 like should the tax rate only move higher from the 19 or is there still big chunks of one of the exercises that could meaningfully reduce that?

[Jim Herbert:]

So, yes so it's a good question Ken. So the stock options which are sort of the biggest variable on this, they will - they have a ten-year life and so there are through the middle of 2020. And maybe just for a little bit of perspective to give we've put this in our filings 8-Ks that we did at the start of September, October first we had just over 4 million options outstanding, we're down to 2.4 million. So you had about what’s that 40% of them in one quarter when there were 11 quarters left, that's unusual. And so, think of the $1.7 million being sort of or the 2.4 that are left being done over the next eight to ten quarters on a pretty normal basis and so after that you won't have this sort of volatility in the tax rate I’ll call it.

[Ken Zerbe:]

Got it, understand that your 19% assumes that $2.4 million is spread evenly over the quarters?

[Jim Herbert:]

That's correct.

[Ken Zerbe:]

Got it, okay. And then just really quickly on expenses. Did I hear you right there, you said 63 to 64 excluding the higher costs in first quarter and if that's right, just give us a magnitude of what it will be on all in basis?

[Jim Herbert:]

Sorry, if I misspoke. So 63 to 64 was the annual efficiency range. The first quarter will naturally be higher than 64, but that higher first quarter is included in the annual range guidance.

[Ken Zerbe:]

Perfect, okay my mistake All right, great. Thank you very much.

[Operator:]

Our next question comes from the line of Dave Rochester with Deutsche Bank. Please proceed with your question.

[Dave Rochester:]

Hey, good morning guys.

[Jim Herbert:]

Hi Dave. Q - Dave Rochester Switching to the NIM guide again, does your guide factor in today's curve with no additional rate hikes beyond the December hike at this point, is that right?

[Mike Roffler:]

No, we would have rate hikes in the forecasts for 2018 pretty similar to market expectations. It's a function of, one obviously we make the adjustment for the tax calculation and second is competitive lending environment and the curve is relatively flat obviously it’s steepened a little bit lately, but competition is the biggest part of that sort of outlook.

[Dave Rochester:]

Got it. And then how many hikes are you assuming at this point, or are you’re just going with the forward curves, is that basically what you said the expectation in the market right now?

[Mike Roffler:]

Three hikes, three hikes.

[Dave Rochester:]

Three hikes, okay. Great and then just on expenses, I was curious how much would you say is discretionary spending you're doing right now that's in the run rate, like marketing expense for Gradifi or other items you could choose to slow or reduce over time following the ramp up and Gradifi?

[Mike Roffler:]

There’s several million dollars in there and you're right, the fourth quarter had the completion of our advertising campaign that ran the television campaign. We also had some Millennial strategy that we were doing marketing wise in the fourth quarter. So there are some dollars we could pull back on. From an investment infrastructure standpoint, Jason mentioned the big things that were largely completed and will now be mostly in our run rate going forward and we do have other things that we're looking to do as we continue to build out and improve our infrastructure and operations again in the name of client service.

[Dave Rochester:]

Okay, great. Just one offline on the income side, it's on investment management fee growth was pretty substantial this quarter, especially versus the AUM growth which is also strong, were there any performance fees or anything like that else that are one time or anything like that in there?

[Mike Roffler:]

It’s a good question, Dave. There actually is one item, it's a legacy performance item from an acquisition that was about $7 million that would only occur in the fourth quarter if it does occur, so the run rate I would pull that out when you project forward, but there's also of course income [ph] compensation, relatively close compensation increase also as a result of that fee.

[Dave Rochester:]

So a compensation item that was roughly $7 million as well or maybe a little less?

[Mike Roffler:]

A little bit less, call it $5 million.

[Dave Rochester:]

Okay. And one last one on credits, any uptick in LTVs or increasing competitors cutting corners on credit that you guys are seeing or is it just pretty much similar standards that you are seeing from last quarter?

[Jim Herbert:]

I would say from our perspective we're very consistent in our LTVs. Well, competitors may go higher we as you know don't chase on credit and we do price to win based on relationship.

[Dave Rochester:]

From that are you basically saying that you haven't seen any uptick in competitive pressures on the credit side?

[Jim Herbert:]

They are about the same.

[Dave Rochester:]

Okay. Great, all right, thank you, guys.

[Operator:]

Our next question comes from the line of Jared Shaw with Wells Fargo. Please proceed with your question.

[Jared Shaw:]

Hi, good morning.

[Mike Roffler:]

Good morning, Jared.

[Jared Shaw:]

Just circling back on the taxes of that 19% guidance, what are your assumptions for that for tax credits going forward? And can you share with us what the expense - the noninterest expense for tax credits in fourth quarter was and then I guess what your expectation is for 2018 to get that 19% level?

[Mike Roffler:]

Sure, so on the tax credit investment obviously with the market the syndicators and developers will be adjusting for the new federal tax code. We invested last year, but we do continue to make investments. It is part of our CRA activities and we will continue to make probably more moderately amount of credits going forward. This might be a little bit different than your other banks, I'm not sure, but our expense associated with low income housing, the amortization of investment actually goes into our tax expense under accounting that was issued probably two or three years ago. Some banks may not follow that, I'm not sure. And so that amortization included in our tax rate every quarter has been sort of $25 million to $30 million per quarter in terms of a run rate on amortization of the low income housing investment and that's embedded in the 19% that you see in our forward projection.

[Jared Shaw:]

Okay, thanks. And then on the muni side, any change in the expectation of sort of purchase level of munis going forward or ultimately you would like to see munis as a percentage of securities?

[Mollie Richardson:]

Yes, on the muni side we'll be more opportunistic. We will continue to be opportunistic in the purchases looking forward into 2018. At the current levels from a yield to duration perspective, we would expect to slow down on the muni purchases and maintain the age KLA about 12% as previously guided.

[Jared Shaw:]

Thank you.

[Mollie Richardson:]

Thanks.

[Operator:]

Our next question comes from the line of Casey Haire with Jefferies. Please proceed with your question.

[Casey Heire:]

Thanks, good morning. More of a big picture question I guess on the operating leverage dynamics, it looks like this is going to be another year of negative operating leverage. I know you guys are growing very well and investing in some of your - the wealth management and millennial strategies, but as we look forward to 2019, do you need the yield curve to be steeper to get a positive operating leverage or can you get there by maybe striking a better balance with your longer term investment strategies and profitability, near term profitability?

[Jim Herbert:]

Actually very good question Casey. I think we can get there in the latter way, we don't need a steeper yield curve and our projections don't necessarily assume it. We assume kind of where we are now on the yield curve which is obviously a very challenging yield curve. So we don't expect to get any benefit from the market. Obviously we will be delighted if we did, so our expense growth should fall more into line with our expansion. The big variables are systems investment, Gradifi and some of the flow of our millennial strategies and other fronts. But generally speaking, we're really, we're quite pleased. We realized we get a lot of grief on the expense ratio, but the quality of what we're doing with the clients, the net promoter scores and the referrals rate at which they're operating is such that we really can't complain. We don't expect negative operating leverage next year though, I wouldn't characterize it that way at all.

[Casey Heire:]

Okay, great. And just switching, I guess to Capital Management, the you guys redeemed some preferreds earlier on in the year, the Tier 1 leverage at 885, how low are you willing to take that because you do have an opportunity to redeem more of the preferreds and get some earnings back given that Tier 1 common is the gating ratio for you?

[Mike Roffler:]

We're actually quite happy with our capital ratios at this point. The leverage ratio is one of the ratios obviously that we could - that could run a little tighter, but we don't, at this point our common equity seems to be quite adequate.

[Casey Heire:]

Okay, great. Thank you.

[Operator:]

Our next question comes from the line of Erika Najarian with Wedbush, please proceed, I’m sorry with Bank of America Merrill Lynch. Please proceed with your question.

[Brandon Berman:]

Hi this is Brandon Berman on for Erika. We just wanted to ask a question, a clarifying question on the net interest guidance, net interest margin guidance, the 285, 295 range is that off of the 280 basis points in 4Q, so you’re implying margin expansion? And I guess another way of asking is, what is the pro forma securities yield and assumptions for FTE going forward? Thank you.

[Mike Roffler:]

So let me walk through this maybe briefly. So the fourth quarter was 308 and we have to make the tax equivalent adjustments that I talked about to the go forward yield, that puts us at about 293, 294. And so that guidance reflects the tax adjustment being made and after that it's reflective of sort of what we view the competitive landscape to be to stay in that 285 to 295 range.

[Operator:]

Does that complete your question? Our next question comes from the line of David Chiaverini with Wedbush. Please proceed with your question.

[David Chiaverini:]

Hi thanks. So, a follow up on the net interest margin. So when we look at the increase in the 10-year Treasury yield which has been pronounced over the last few weeks, I would think that should help loan pricing for First Republic. Could you talk about how leveraged First Republic is to a rising 10-year yield as it relates to the net interest margin or do the benefits of that get completely competed away and on the deposit pricing front?

[Jim Herbert:]

No it’s not competed away, it’s really a case of - it obviously is positive because we are in our real estate activities at least mostly an intermediate term lender pricing a lot of our loans priced off to five and 10-year. And so, when I commented earlier that we are thinking forward for the first, for next year is assuming that current yield curve, it did not take into account the recent tick up and 10-year rates. It remains to be seen whether it holds, whether it goes further and whether the yield continues to steepen. If the yield curve continues to steepen, we would get some benefit.

[David Chiaverini:]

Great, thanks and as a follow up, to what extent if any is the student refi product pressuring the NIM?

[Jim Herbert:]

It’s not pressuring the NIM. The incremental margin on that product is probably right in the high 2s. At this point, the size of the loans and the marketing to bring them on puts some pressure on it in the early years of the relationship, actually in the early year of the relationship, and so the fact that we have a fairly large growth rate in the number of relationships relative to what we already have, it's kind of a how many new to how many old do you have kind of analysis. That business is in its early stages and as a result, the magnitude of the new which is considerable is weighing on the profitability over, as each year goes by the base grows larger and the profitability increases actually rather rapidly.

[David Chiaverini:]

Thanks very much.

[Operator:]

Our next question comes from the line of Chris McGratty with KBW. Please proceed with your question.

[Chris McGratty:]

Hi good morning, thanks for taking the question. Maybe Gaye on the HQLA 12% comment, I'm interested number one in why 12% is the right number. I thought maybe in the deregulatory world that we live in, hopefully that number could potentially go a bit lower in the remix of that piece of the securities book could have an upward bias any color would be great? Thanks.

[Hafize Gaye Erkan:]

Sure. Similar to the conservatism we have in capital and credit we applied the same conservatism on liquidity risk management as well. We according to our own liquid stress test I think deemed 12% as a good guidance looking into 2018 and will continue to maintain absent any changes we continue to maintain that in 2018.

[Chris McGratty:]

Okay, great. And what was the, what’s the yield on that portfolio there and were new money purchases are being done?

[Mollie Richardson:]

I'm glad you asked because I was going to -- I remembered, but I forgot to mention that. The HQLA has picked up nicely in yields. The marginal approach, the additional approach that we're making is now in the low 3 to 3.3% with four to five year duration. So compared to the rest of the banks NIM, it's actually a while being liquid it is still a good investment.

[Chris McGratty:]

Okay, great thank you.

[Mollie Richardson:]

Thanks.

[Operator:]

Our next question comes from the line of Geoffrey Elliott with Autonomous Research. Please proceed with your question.

[Geoffrey Elliott:]

Good morning. Thank you for taking the question. When you look at originations in 4Q do you think that was much impact from activity getting pulled forward ahead of the changes in deductibility limits on mortgage.

[Jim Herbert:]

I think perhaps a little bit yes and also when you compare it to Q4, '16 remember that was our best, that was a record quarter for us and there was also a little bit of pull forward that was the second Fed rate hike little bit of rush to refi. So quarter-over-quarter it's a little noisy but if you look at year-over-year we're quite pleased.

[Geoffrey Elliott:]

And then it seems like prepayments have down a bit is that just a function of rates or is there anything else going on there?

[Jim Herbert:]

Yes, that's a function of rates a little bit it happens pretty much every time rates go up. There's a reset on refinance is primarily slow down for a bit.

[Geoffrey Elliott:]

Great, thank you very much.

[Operator:]

Our next question comes from the line of Matthew Clark with Piper Jaffrey. Please proceed with your questions.

[Matthew Clark:]

Hi, good morning.

[Jim Herbert:]

Good morning.

[Matthew Clark:]

On the tax credit related discussion, assuming you do maybe less of it again in 2019, I mean is it fair to assume you can hold that 19% tax rate or should be assumed some upward creep?

[Jim Herbert:]

So again, it largely is on the timing of when employees were exercise but for the next couple of years that feels like a good place for us to be.

[Matthew Clark:]

Okay and then on reserve coverage, you guys were unchanged with the strong - you’re providing for the stronger growth keeping the reserve ratio at 58 basis points. Again how should we think about that ratio with CECL on the horizon should be assumed some upward bias there, you think you can kind of hold the same level even when that rule goes into.

[Jim Herbert:]

So it is too early to say we're two years away we are actively working on the project and going through the portfolios but given the banks credit quality from a historical perspective when you look at our losses over 33 years, that should tell us we should be less impacted than probably others when we go to the new methodology in 2020.

[Matthew Clark:]

Okay. Thank you.

[Operator:]

Our next question comes from the line of Emlen Harmon with JMP Securities. Please proceed with your question.

[Emlen Harmon:]

Good morning, just a quick one left from me. Here's the [incentive] markets, kind of most meaningfully impacted by personal self provisions and mortgage deductibility. Are you guys starting to see any impact of the housing market from tax reform, yes just be interested on your views there?

[Jim Herbert:]

No, it's a good question and we're paying close attention to that. We're in touch with a number of brokers, our clients' prospects, and our bankers and right now to be honest it's too soon to tell. I would also note our vibrant markets strong economies, low unemployments and there still is a lot of activity but again too soon to tell.

[Emlen Harmon:]

All right, great that was it for me. Thanks.

[Operator:]

Our next question comes from the line of Lana Chan with BMO. Please proceed with your question.

[Lana Chan:]

Thanks. Good morning. Just one quick question about the average cash position. It seems like an average balances have come down over the last couple of quarters in the period end only down slightly from September 30, how should we think about that? It seems that that helped your margin recently.

[Jim Herbert:]

If you look in the fourth quarter it was down a bit, it has helped the margin. I think we've been running around a billion in the last couple of quarters which feels about right in order to meet sort of the strong loan demand that we've obviously had coupled with the investments we've been making. We've been able to run at this level and it is a comfort level for us to be at on the average.

[Hafize Gaye Erkan:]

And just to add it also is a function of the liquidity portfolio growing as well as the deposit, strength of the deposit activity in those quarters the second half tends to be much better. Deposits our seasonal, so the second half tends to be much better have the increased activity in deposits.

[Lana Chan:]

Okay, thank you and just one more, do you have where your cost of deposits ended the year end?

[Hafize Gaye Erkan:]

So we ended at 28 basis points in total deposit rate.

[Lana Chan:]

The average was 28 basis points and the end of period was also 28 basis points?

[Hafize Gaye Erkan:]

The ending period was around 29 type of level if I'm not mistaken.

[Lana Chan:]

Okay, thanks Gaye.

[Hafize Gaye Erkan:]

Thank you.

[Operator:]

Thank you. Mr. Herbert we have no further questions at this time. I would now like to turn the floor back over to you for closing comments.

[Jim Herbert:]

Thank you all very much. Sorry about the glitch at the beginning of the call. Thanks for your attention. Bye-bye. Have a good day.

[Operator:]

Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at the time. Thank you for your participation and have a wonderful day.