First Republic Bank: Great Bank, But A Little Rich For My Blood (NYSE:FRC) – Seeking Alpha

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When I first came across First Republic Bank (NYSE:FRC), I was blown away by the explosive growth of both deposits and loans, which at first look appears to be helping the bank overcome the NIM pressure it is starting to see. The bank has arguably one of the best customer experiences in the banking business which allows them to build those relationships that have helped grow both loans and deposits.
There is a lot to like with First Republic, but as we will see all this great growth, the price has been driven up to the point where it is expensive.
Let’s take a look.
First Republic Bank, based out of San Francisco, with a current market cap of $18.5B had in the words of Jim Hebert, CEO “was a very good quarter. Growth continues to be strong across our franchise. In fact, in terms of loan originations, this was by far our best quarter ever.”
Total revenues were $837.2 million for the quarter, up 8.9% compared to the third quarter a year ago. Net interest income was $695.0 million for the quarter, up 9.5% compared to the third quarter a year ago. The increase in net interest income resulted primarily from growth in average earning assets.
The net interest margin was 2.80% for the third quarter, compared to 2.85% for the prior quarter. The decline was primarily due to a more rapid decrease in the average yield on loans compared to the offsetting decrease in total funding costs.
Noninterest income was $142.2 million for the quarter, up 5.8% compared to the third quarter a year ago. The increase was primarily from growth in brokerage and investment fees and foreign exchange fee income, partially offset by a decline in investment management fees attributable to the departure of wealth managers in the second quarter.
Noninterest expense was $534.0 million for the quarter, up 10.3% compared to the third quarter a year ago. The increase was primarily due to increased salaries and benefits, occupancy, and information systems expenses from the continued investments in the expansion of the franchise.
The efficiency ratio was 63.8% for the quarter, compared to 63.0% for the third quarter a year ago. For the first nine months of 2019, the efficiency ratio was 64.4%.
On the investment banking front, total investment securities on September 30, 2019, were $17.4 billion, up 7.7% compared to the prior quarter and up 6.8% compared to a year ago.
High-quality liquid assets, including eligible cash, totaled $13.6 billion on September 30, 2019, and represented 12.7% of average total assets.
First Republic reported earnings per share of $1.31, up 10.1% YOY, and an increase of 7 basis points from the previous quarter.
Common Equity Tier 1 ratio was 9.91%, compared to 10.47% a year ago, which is well above the required 5% by the Fed and shows continued strength in capital reserves.
First Republic has remarkably low nonperforming assets, which remained at a low 12 basis points of total assets, and net charge-offs were only $4.3 million, or two basis points of average loans. All while adding $16.7 million to its allowance for loan losses due to continued loan growth.
Finally, First Republic has high-quality liquid assets, including eligible cash, totaled $13.6 billion on September 30, 2019, and represented 12.7% of average total assets.
All in all, this was a very good quarter for First Republic and very encouraging considering the current interest rate environment. As First Republic continues to leverage its superior customer service, I expect the revenue growth and loan growth to continue.
First Republic is in the business of selling superior customer service to high net worth individuals. Lots of businesses say that they are in customer service, and banks generally have a horrible reputation for customer service.
First Republic is different, and this sets them apart from their competitors. According to Gaye Erkan, President:
“Our success in household acquisition and our low household attrition rates are the result of our ability to consistently deliver exceptional client service. Our client satisfaction level, as measured by the net promoter score, remains more than double the banking industry average.”
The net promoter score is an internationally recognized measure of how likely your customers are to recommend you to friends and family. It takes how many people would recommend you and subtracts the people who would not and get a net promoter score.
The banking industry overall has one of the worst net promoter scores of any major business industry, whereas First Republic’s net promotor scores are on par with Nordstrom, Apple, Ritz Carlton, the top tier across all industries. They tend to be two times the rest of the scores of the rest of the banking industry.
Many banks have a monopoly because they have trapped their customers by integrating them into services such as bill pay, automatic payments, and so on. First Republic is different in that its customers delight in banking here, and this attention to customer service contributes greatly to their growth.
Because of this attention to customer service First Republic has been able to grow its deposit base from organic growth as opposed to using acquisitions to grow.

Chart courtesy of Intrinsic Value Formula
Deposits are the fuel for growth for any bank. At First Republic, we have seen continual growth in the deposits over the last five years, to the tune of 17.88% CAGR. Total deposits increased to $85.7 billion, up 14.7% compared to a year ago.
Checking deposits remains strong and represented 58.5% of total deposits at quarter-end. Business deposits represented 58% of total deposits consistent with the prior quarter.
Wealth management assets were $140.2 billion, up 7.1% compared to the prior quarter, and up 6.8% compared to the year-ago which has led to wealth management revenues were $114.8 million, up 4.7%.

Chart courtesy of Intrinsic Value Formula
Loans, excluding loans held for sale, totaled $86.3 billion, up 19.3%, and this trend has continued for years, specifically over the last five years, despite having the highest credit quality in the banking industry. Only six basis points of their loans are written off each year; this is at 1/6th the level of the overall banking industry because the bank is lending to a much more creditworthy clientele.
Single-family residential volume was a record at $4.9 billion for the quarter. I would note that the average loan-to-value ratio for single-family residential originations during the quarter was a conservative 58%. The decline in interest rate has shifted to a mix of home loan originations towards refinancing. Refinance activity accounted for 63% of single-family originations in the third quarter. The focus on a lower loan-to-value customer helps create a much more stable loan portfolio in the event; there is a downturn in the economy and offers a greater margin of safety.
First Republic had a dividend payout of 0.76, which is up 5.63% over the previous year, and a dividend growth rate of 6.4% over the last three years. First Republic also has a yield of 0.68%, and the dividend is extremely safe, with a lowly 15% payout ratio. All in all, this is not a great dividend, especially compared to First Republic’s peers, but a growing dividend with a huge margin of safety tied to it is always a bonus.
As with all banks in the current interest rate environment, First Republic is in danger of shrinking net interest margin. In fact, First Republic has seen a gradual decline in its net interest margin over the last five years from 3.01% in 2015 to the current 2.83% TTM.
First Republic is guiding to a net interest margin of 2.75% for the fourth quarter, and they expect the full year 2019 to be approximately 2.82%.
In the near term, I would expect that there will continue to be pressure on the NIM as the fed continues to consider more rate decreases despite possible good news in regards to the economy.
Despite the pressure on their NIM, First Republic has continued to show growth in their net interest income, which was up 10% YOY and continues to grow powered by their strong growth.
The biggest risk to First Republic at the current time is the rising interest rates and the pressure it puts on the NIM, but First Republic has done an incredible job leveraging their superior customer service to grow their deposits and loans. Which, in turn, helps offset the increased pressure on its NIM, helping to lead to growing profitability.
At first blush, it appears that First Republic could be overvalued. Based on just the PE, which is currently 21.53 versus the bank sector of 12.49 and the historical average of 18.67.
But when we dig a little deeper, we see that First Republic has an ROA of 0.82%, which has seen a gradual decline over the last five years from 1.08% in 2014 to the current 0.82% TTM. The decline coincides with the decrease in the NIM as pressure from the interest rate increases continues.
Also, ROE remains neutral with a ratio of 9.56%.
The tangible book value per share was $48.84, up 11.0%. Since the bank was purchased back in 2010 has tangible book value has compounded 15% annually.
However, when I run the company through both DCF, based on the free cash flow, I come up with a fair value of $108.38, which is right about the current price of $108.74.
The multiples I used to calculate the DCF were:
Based on all the above, I think that First Republic is overvalued, and there is absolutely no margin of safety if I am wrong. I think this is an absolutely fantastic bank and they are very well run. To buy into the bank, I would be looking more for a price in the low $90s.
I think based on all the above information that First Republic is a first-rate bank and extremely well run. They have done a fantastic job of creating a superior customer service culture and are reaping the benefits of this advantage.
We all bank somewhere and most of us tolerate our banks, to put it mildly. They are a necessary evil, but First Republic has taken that customer service model and used it to drive their success.
The growth in both loans and deposits is impressive and has enabled them to grow the bank’s profitability over the last five years.
Because of how the bank is operated and the loan portfolio they have built, I believe that First Republic will withstand any downturn in the economy that might be coming this way. I feel that, currently, the success the bank has achieved is priced into their current price and the bank is overvalued, once it drops into the low $90s, I will be all over it.
This article was written by
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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