First Republic Bank: Strong Long Growth Appears To Be Priced In (NYSE:FRC) – Seeking Alpha

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First Republic Bank (NYSE:FRC) reported earnings of $1.40 per share in the second quarter, up 18% from the first quarter of 2020. The earnings increase was attributable to strong loan growth and a drop in provision expense. Earnings in the second half of the year will likely increase on a year-over-year basis due to a strong loan pipeline and low interest rates, which will ensure that loans continue to grow in the year ahead. On the other hand, provision expense will likely be higher than last year due to loan growth and credit impairments. Overall, I’m expecting FRC to report earnings of $5.34 in 2020, up 3% from last year. The one-year ahead target price suggests a low price upside; therefore, I’m adopting a Neutral rating on FRC.
FRC’s loans grew by 4.9% quarter over quarter in the second quarter of the year on the back of high demand for single-family mortgages amid low interest rates. Further, loans under the Paycheck Protection Program, or PPP, increased the loan balance by $2 billion, as mentioned in the second quarter’s earnings release. The management mentioned in the second quarter’s conference call that the loan pipeline is currently quite strong, which will lead to continued loan growth in the second half of the year. Furthermore, the low interest rate environment will encourage refinance activity and boost demand for residential mortgages. Moreover, I had previously expected the PPP loans to get forgiven by the third quarter; however, management now expects the loans to get forgiven next year, as mentioned in the conference call. Consequently, I’m now anticipating the year-end loan balance to reflect the PPP loans. Management expects the loan growth rate to be in the mid-teens for the full year 2020, as mentioned in the conference call. Considering the factors mentioned above and management’s guidance, I’m expecting loans to grow by 14.6% year over year in 2020, as shown in the table below.First Republic bank balance Sheet Forecast
A slight compression in net interest margin, or NIM, is likely to partially offset the loan growth benefit for net interest income. FRC’s NIM was stable in the second quarter, as a plunge in deposit cost countered the pressure on yields following the 150bps federal funds rate cuts in March. The results of a simulation disclosed in July’s investor presentation shows that a 100bps decline in interest rates can reduce net interest income by 0.4% in the first twelve months and by 2.4% in the second year of the interest rate cut. Management mentioned in the conference call that they expect NIM to be between 2.65% and 2.75% in the full year 2020. Considering the factors mentioned above and management’s guidance, I’m expecting FRC’s NIM to decline by 11bps to 2.69% in 2020. The following table shows my estimates for yield, cost, and NIM.
First Republic bank Net Interest Margin
FRC booked provision expense of $31 million in the second quarter of 2020, down from $48 million in the first quarter. The expected growth in loans will likely keep provision expense elevated in the second half of the year. Moreover, FRC primarily operates in California and New York, which have been hit hard by the pandemic. The effects of the pandemic in FRC’s primary markets will likely keep provision expense elevated in the remainder of the year.
On the other hand, FRC has limited exposure to COVID-19-sensitive industries that made up just 2.4% of total loans as of June 30, 2020, as mentioned in the presentation. The limited exposure will likely ease credit losses in the year ahead. Furthermore, FRC modified only 4.3% of total loans until the end of the quarter, which shows that debt servicing troubles are limited. Moreover, FRC has low loan-to-value ratios, or LTV, on its real estate portfolios that will constrain expected credit losses. As mentioned in the presentation, the commercial real estate portfolio had an LTV of only 46%, multifamily had an LTV of 53%, and single-family had an LTV of 60% as of the end of the last quarter. The management mentioned in the conference call that the second quarter’s provision charge should be indicative of the provision expense in the remainder of the year. Considering the factors mentioned above and management’s guidance, I’m expecting FRC to book provision expense of $149 million in 2020, up from $62 million in 2019.
The strong loan growth will likely drive earnings in the second half of the year. Additionally, non-interest income is likely to recover from the second quarter’s decline in the year ahead, which will keep earnings elevated. As mentioned in the conference call, FRC was able to substantially increase its assets under management in the second quarter through the addition of two new wealth management teams as well as stock market appreciation. The fees on assets under management will likely drive non-interest income in the second half of the year.
On the other hand, elevated provision expense will likely pressurize earnings in the remainder of the year. Additionally, the non-interest expense will likely increase due to administrative costs associated with loan growth. The management expects non-interest expense to increase by a high-single to low-double digit rate, as mentioned in the conference call. Based on my estimates for the individual income statement line items, I’m expecting FRC to report earnings of $5.34 per share in 2020, up 3% year over year. The following table shows my income statement estimates.First Republic Bank Income Forecast
Actual earnings may differ materially from estimates due to the uncertainties related to the severity and duration of the COVID-19 pandemic. Although the earnings outlook is much clearer now than it was after the first quarter, there are still some risks and uncertainties that will likely persist until the widespread availability of a vaccine.
I’m using the historical price-to-book-value multiple, or P/B, to value FRC. The stock has traded at an average P/B multiple of 1.95 in the past, as shown below.
First Republic Bank Historical Price to Book
Multiplying this P/B ratio with the June 2021 forecast book value per share of $58.4 gives a target price of $113.8 for the mid of next year. This target price implies an upside of just 1.2% from FRC’s July 16 closing price. The following table shows the sensitivity of the target price to the P/B multiple.First Republic Bank Valuation Sensitivity
The little difference between the target price and the current market price shows that positives, like the expected loan growth, are already priced in. Apart from the small price upside, FRC also offers a low dividend yield of 0.7%, provided the bank maintains its quarterly dividend at the current level of $0.2 per share. Based on the limited upside and unattractive dividend yield, I’m adopting a Neutral rating on FRC.
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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.
Additional disclosure: Disclaimer: This article is not financial advice. Investors are expected to consider their own investment objectives and constraints before considering investing in the stock(s) mentioned in the article.

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