FIRST REPUBLIC BANK

Greetings and welcome to First Republic Bank's second quarter 2022 earnings conference call. Today's conference is being recorded. During today's call, the lines will be in a listen-only mode. Following the presentation, the conference will be open for questions. To join the queue, please press star 1 on your telephone keypad at any point during the call. I would now like to turn the call over to Mike Ionelli, Vice President and Director of Investor Relations. Please go ahead.

Thank you and welcome to First Republic Bank's second quarter 2022 conference call. Speaking today will be Jim Herbert, Founder and Executive Chairman. Mike Roffler, CEO and President. Mike Selfridge, Chief Banking Officer. Bob Thornton, President, Private Wealth Management. and Olga Sokova, Chief Accounting Officer and Acting Chief Financial Officer. Before I hand the call over to Jim, please note that we may make forward-looking statements during today's call that are subject to risks, uncertainties, and assumptions. 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 8K filed today, all available on the bank's website. And now I'd like to turn the call over to Jim Herbert.

Thank you, Mike, and good morning, everyone. Driven by a steady and intense focus on service, safety, and stability, First Republic has produced consistent growth and results since our founding 37 years ago. This quarter's strong results once again demonstrate the stability and the power of our business model and our culture. Our model is straightforward. Extraordinary service leads to client satisfaction levels that are significantly higher than the banking industry and are even higher than most other leading companies, regardless of industry. This very high client satisfaction level, in turn, drives our organic growth. Our existing, very satisfied clients stay with us, they do more with us, and they refer their friends and their colleagues. At the same time, we maintain a steadfast focus on long-term safety and stability. This focus has produced steady long-term results, strong capital, and exceptional credit quality throughout the bank's history. For example, Since the year 2000, our net charge-offs have been only one-tenth of those of the top 50 banks. Our model and our culture have proven to be very successful long-term through all economic cycles. In fact, during times of broader economic uncertainty, our holistic, client-centric service is even more valued by our clients. During these times, we often see our new client household acquisition rate increase, as it is currently doing. Today, our model is stronger than ever. This has once again driven our excellent performance during this most recent quarter, and we're well positioned to go ahead in the current conditions. Now, let me turn the call over to Mike Roffler, CEO.

Thank you, Jim. It was another terrific quarter of continued strong growth and financial performance. This quarter's results once again demonstrate the strength of our business model and culture and the consistency of our execution. Let me now share a few highlights for the quarter. Year over year, total loans outstanding were up 23%. Total deposits have also grown 23%. Wealth management assets were up 2.5%. despite the S&P 500 being down 12% over the same period. Bob will touch a bit more on this momentarily. Our growth, in turn, led to strong financial performance. Year over year, total revenues have grown 23%. Net interest income has grown 24%. Earnings per share is up 11%. And importantly, tangible book value per share has increased more than 13%. Our focus on safety and stability supports consistent service, growth, and results over time. Maintaining strong capital, credit, and liquidity is a fundamental part of our business model. Our credit remains very strong. Non-performing assets were only seven basis points at quarter end, and net charge-offs were only $1.3 million during the quarter. We remain very well capitalized with a Tier 1 leverage ratio of 8.59% at quarter end. Effective asset liability matching is another important part of our model. We have always focused on delivering a stable net interest margin through all environments as we do more business with clients and grow our earning assets. This drives strong growth in net interest income and total revenues. We continue to make strategic investments in people, technology, and new offices to further strengthen client service and drive future growth. We have invested in people by growing our colleague base by 14% year over year. This supports our growth and differentiated level of client service. Looking ahead, we see great opportunities to acquire new talent in client facing and support roles. Investments in technology also support our differentiated client experience and are critical to our strategy. Earlier this year, we successfully completed our core conversion, and we now remain focused on optimizing its potential. And we also continue to invest in our office footprint, which strengthens our brand and provides an important service point for clients. During the quarter, we opened our first banking office in the Seattle area where we had hired a couple of wealth management teams in the past two years. We are very pleased to now offer full-service banking and wealth management in this very attractive market. We remain focused on deepening our presence in urban, coastal, and highly interconnected markets like Seattle. Over the next year, we expect to open approximately four new offices across our markets. Our success and consistent performance are the result of staying true to our client service model and remaining disciplined in our execution. Overall, it was a great quarter and first half of the year. Now I'll turn the call over to Mike Selfridge, Chief Banking Officer.

Thank you, Mike. Let me provide an update on lending and funding across our business. Loan origination volume for the second quarter was exceptionally strong at $22 billion. Single family residential volume was very robust at $10.6 billion. Purchase activity accounted for 52% of single family residential volume. Financing a home purchase provides a great opportunity for First Republic to demonstrate our differentiated service. as the ability to execute on a home purchase transaction is even more important to the client. Multifamily volume for the quarter was very strong at $2.3 billion. The very robust lending activity during the quarter reflects the strong spring buying season. The continued strengths of our markets and our clients is further reflected in our strong loan pipeline heading into the third quarter. Given our year-to-date growth, we currently expect to achieve high teens loan growth for the full year. Turning to credit, we continue to maintain our conservative underwriting standards. The average loan-to-value ratio for all real estate loans originated during the quarter was just 58%. Business banking also had a strong quarter. business loans and line commitments excluding PPP loans were up 18% year over year. During the quarter, the utilization rate on capital call lines of credit decreased slightly to 38.5%. Now turning to funding, we continue to be in a strong position. We're very pleased that deposits were up 23% year over year and 6% year to date. Our total funding base remained over 90% deposits, which drove an overall funding cost of just 16 basis points. This was up only five basis points from the last quarter. Our deposit base remains well diversified. Checking represented 72% of total deposits at quarter end, up modestly from last quarter. And business deposits represented 64% of total deposits at quarter end. As Mike mentioned, we are very pleased to have expanded our banking and wealth management operations in the Seattle area with the opening of our first preferred banking office in the region. Our preferred banking offices are an important element of our service delivery model and have proven to be a great channel for gathering deposits. Our offices are very productive with deposits of nearly $700 million per office on average at quarter end. Our service model is performing quite well and continues to drive safe, stable, organic growth. And now I'd like to turn the call over to Bob Thornton, President of Private Wealth Management.

Thank you, Mike. Wealth management continues to perform very well despite market volatility. In fact, as Jim mentioned, our high touch, holistic approach to banking and wealth management is even more highly valued by clients during such times. Here to date, assets under management have declined 12% to $247 billion. This compares favorably to the S&P 500, which was down more than 20% over the same period. Despite the broader market volatility, we continue to see strong net client inflows. During the first half of this year, our investment management business had a net client inflow of over $7 billion, consistent with the first half of last year. In addition to investment management, we remain focused on serving our clients with financial planning, brokerage, trust, insurance, and foreign exchange services. Fees from these services help diversify our sources of fee revenue and can provide growth in times of market volatility that can offset the market decline impact on asset-based investment management fees. This diversification helped drive very strong growth in total wealth management fee revenue through the first half of this year. Year to date, wealth management fee revenue is up 32% from the prior year. Our integrated banking and wealth management model makes First Republic an attractive destination for successful wealth professionals. And since our last call, we welcome another new wealth manager team to First Republic. Overall, our wealth management business continues to perform very well. Times like these are a great opportunity to demonstrate our exceptional service, deepen existing relationships, and acquire new households. Now I'd like to turn the call over to Olga Sokova, Acting Chief Financial Officer.

Thank you, Bob. With a consistent focus on credit, capital, and liquidity, we'll continue to operate in a safe and sound manner. Our credit quality remains excellent. Year-to-date, net charge-offs were only $1 million. Our provision for credit losses over the same period was $41 million. This provision reflects our continued strong loan growth and excellent credit performance. Our capital position remains very strong. At quarter end, our Tier 1 leverage ratio was 8.59%. Liquidity also remains very strong. High quality liquid assets were 14.7% of average total assets in the second quarter. In addition to safety and stability, the power of our growth during the quarter was reflected in net interest income. Net interest income for the second quarter was up a very strong 24% year over year. This is due to the robust growth in earning assets as well as a higher net interest margin. Our net interest margin was 2.8% for the second quarter. This quarter's NIEM benefited from a reduced cash level, rising asset yields, and only a modest increase in our funding costs. We currently expect to be in the top half of our net interest margin range of 2.65% to 2.75% for the full year 2022. This assumes a Fed fund rate of 3.75% at year end, which is in line with the market view. Our efficiency ratio was 60.5% for the second quarter. This quarter's efficiency benefited from strong revenue growth, which more than offset continued investment in the business. We currently expect to be near the lower end of our efficiency ratio range of 62% to 64% for the full year 2022. Our effective tax rate was 23% for the second quarter. We now expect the effective tax rate to be in the range of 22% to 24% for the full year 2022. Overall, it has been a great first half of the year, reflecting the stability and consistency of our model. Now I'll turn the call back over to Mike Roessler.

Thank you, Jim, Mike, Bob, and Olga. For over 37 years, First Republic's business model has been grounded in conservative credit, strong capital and liquidity, colleague empowerment, and most importantly, a focus on providing extraordinary client service. This foundation remains unchanged. Our model is as strong as ever, and all of our colleagues remain focused on executing each and every day. Now we'd be happy to take your questions.

Thank you. If you would like to ask a question, please signal by pressing star 1 on your telephone keypad. If you are using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Again, press star 1 to ask a question and we'll pause for just a moment to allow an opportunity to signal for questions. And we'll take our first question from Steven Alexopoulos with JP Morgan. Please go ahead.

Good morning, everyone.

Morning, Steve.

I want to start on the loan side. So there's been this persistent concern in the market that loan growth would slow for you guys, given you have rising rates, right? Negative impact on the mortgage market. And then the lack of housing supply comes up more and more. With that said, you're reporting over $10 billion of single-family originations, a period of long growth that's really strong for single-family. Can you walk through how you're able to deliver such strong single-family growth in the quarter despite both those headwinds? And I'd like for you to drill down specifically to the housing supply issue.

Steve, it's Mike Selfridge. I'll kick it off and hand it over to the others. Well, a couple of thoughts here. First of all, I think we're reverting back to a little bit more of a seasonal pattern that we saw in years past, a strong spring buying season followed by a slower summer, and that's okay. The characteristics of the market, I'd say the growth rate of housing prices is slowing. In some markets, going down a bit, and that's actually healthy. Supply is still constrained. It's come up a little bit, maybe a half-month supply in all of our markets on a cumulative basis, but it's still tight, and there's still a fairly active purchase market. Quite simply, Steve, I think relationship and service are at a premium in markets like this, and we are taking share. Okay.

That's helpful. Now, if we assume loan growth remains strong for the rest of the year, the other concerns for the market is, one, how you're going to fund the growth and the impact on them from that, and, two, whether you'll need to eventually issue more common to support the growth. So maybe on deposits first, so assuming that loan growth remains, now you're saying high teens or higher, Can you walk us through which deposit types do you expect to fund that growth, and how should we think about the incremental cost of those deposits?

Yes, Steve. So along the spring buying season that Mike just talked about, deposits are starting to sort of see that same seasonality we've seen in the past where the first half of the year is a little bit lighter because of the April 15 and June 15 tax dates. that obviously in the pandemic years of 2021 were moved around. And so we're very pleased that the first half of the year, you know, we've continued to grow our deposit and funding base to support the terrific lending activity. And I think you'll continue to see broad base. We probably, you know, CDs have been declining the last two years given zero rates. We'll probably see those start to tick up a little bit because it's a great way to utilize our 80-plus office network to reach out to clients and deepen relationships where not only you do a CD, but you also bring in checking dollars. And so that's a tried and true strategy that we've had, and we're already starting to do a little bit of it. The other thing I'd say is we also declined our FHOB borrowings quite a bit in the last two years, and so there's plenty of room and capacity there to utilize those. And the other thing is we start from a position of great strength because deposits are over 90% of our funding, uh, and had been steadily climbing. And so we feel we're in a good place because of all the things we've done the past few years.

Okay. That's helpful. And then, and then maybe Mike, on the capital side, I know the company you start two years or so of excess capital capital is last raised. It was August, 2021. So does that mean we have about one year's left of additional capital? And are there levers that you might be able to pull? Who knows what the environment will be like a year from now. But are there levers to pull so that maybe you don't need to issue common if it's a pretty tough backdrop for the economy and bank stocks overall? Thank you.

Yeah, I think the two-year capital perspective has served us very well. And I think your date on the August is right on common, but we also did some preferreds. later in the year in November. And so that's sort of your launch point, I would say, for the two years, which means we're at seven or eight months from the last, which means we're in really good shape right now. Similar to the past, we've always been opportunistic and mindful of the markets and the right time when it presents itself. You've seen us probably go early in the past because you don't know when a more uncertain market is going to occur like we've had here the last you know, four to six months. And so we feel really good where we're at now, but we always remain opportunistic and a bit agnostic to the common or preferred market.

Okay. Okay. Thanks for taking my questions.

We'll take our next question from Dave Rochester with Compass Point. Please go ahead.

Hey, good morning, guys. Nice quarter. Thanks, Dave. Just starting on loans, you mentioned the strong loan pipeline heading into 3Q. I was just wondering how that pipeline compares to what you saw going into this quarter, which is obviously a very strong quarter. And can you talk about the dynamics you're seeing in the capital call business as well, just in terms of activity levels in your customer center there, and maybe try to frame the opportunity set, what that looks like for growing that going forward?

Yeah. Dave, thanks, Mike Selfridge. First, your question on the pipeline. The pipeline is strong going into this quarter. It is up significantly year over year. It's down slightly from the last quarter. And again, a bit of that is the seasonality that we're starting to see, particularly in the single family business, but still plenty of market share opportunities, as I mentioned earlier. Cap call utilization rates, you saw those tick down slightly at about 38.5% from 40. And just in terms of characteristic, I'd say the industry overall is slowing. And what I mean by that is it's harder to raise funds. The velocity or pace of investing is slowing. People are being much more methodical and selective about their investment opportunities. And if that slows, that drives down the utilization rate, which historically we've said is tending to sort of gravitate toward a mid-30s to high-30s. So I think we're right within that range. Growth opportunities are still strong for us in terms of acquiring new funds and opportunities.

Perfect. Thanks for the call there. And then can you just talk about where new loan yields are across your major products, especially resi and multifamily and then some of the rest as well? And then for the securities that you're buying today, if you just talk about, you know, on the muni side and outside of that, where you're seeing new securities yield. Thanks.

Sure. Mike Selfridge, I'll start with the loan yields. For the last six weeks, we've been originating single family in about the 3.7 range, multifamily about 4.15, CRE about 4.2%, and then business banking, capital call lending tends to be the larger segment there, and I'd say that's coming in at prime minus 75 to 100 basis points, so call it 375 to 4%. Prime being 4.75. We haven't had the full benefit of the last Fed increases in June.

Perfect.

And then on the securities side. Hi, Dave. This is Olga. And on securities, if we look at the muni purchases during the quarter, the TEY was 5.25. And this compared to the first quarter, the TEY was about 4%. And just subsequent to the quarter end, the TEYs for the munis is about 4.75 to 5%. And then the non-uni HQLA, the purchases during the second quarter were at around 3.4%, and this compared to about 2.5% in the first quarter. And subsequent to quarter end, the TYs are about 4% and 4.25%. Great.

So it sounds like you've seen some nice move up in new loan yields and securities purchase rates, reinvestment rates. I was just curious, on your margin guide, if you average the first two quarters together, you kind of end up at the higher end of that range. So just curious if you're expecting them to sort of stabilize here and, you know, what are the chances that you could actually still continue to see some expansion as we play out the Fed rate hikes you're expecting and your guidance?

Sure.

So, Dave, we believe we will be expected to be at the top half of our range of 2.65% to 2.75%.

Yeah, so, I mean, I guess, go ahead.

Yeah, Dave, let me just maybe comment and maybe just take a step back. You know, we've always focused on stability and consistency across the board. If you think about client service, how we invest in the business and the franchise, which leads to our efficiency, and how we compete in the marketplace for clients, and for business. And what that results in is stability over time. We're really excited about and pleased with the first half of the year results on sort of where we, frankly, if I go back probably three years ago, we've said we would be in these ranges and we've continued to deliver quarter after quarter, further demonstrating that consistency and stability. And I think now, we're sort of towards the high end on margin and low end on efficiency, and we feel really good about that because it allows us to continue serving clients, continue investing in the franchise for future growth, and delivering stable, predictable results that are very safe over time.

Yeah, appreciate that. Maybe just one last one in terms of how you're thinking about the positive data. I know you talked about the 19% you had in the last cycle. You thought maybe you'd be a little bit above that. Has that thought process changed at all, just given what we've seen with inflation numbers and rate hike expectations, that kind of thing? Are you still generally in that range, just above 19%?

Yeah, I would say we're generally in this range. However, every cycle is different, and we expect that this cycle will be slightly higher than 19% in the previous rate cycle. So we'll expect to be slightly above the 19%. Great.

All right. Thanks, guys. Appreciate it.

And we'll take our next question from John Pinkari with Evercore.

Please go ahead.

Good morning. Also on the loan growth side, I wanted to see if, you know, I appreciate the high teens color that you expect for 2022. Could you make a little bit of you know, thought process around how you're thinking about 2023. Is that mid-teen expectation that you've been approximating? Do you think that that's attainable here? Or what type of slowing could we see as capital calls continue to cool and likely see potential slowing in mortgage?

Yeah, John, I think it's a great question. And I think, you know, year after year, the consistency And continued excellent service delivery and serving clients is what has led to that, you know, mid-teens outlook that we have. And we continue to believe that's prudent as we go into, you know, look forward even past today into 2023. You know, if you remember in our presentation materials, more than half our new business comes from existing clients. And those existing clients were continuing to grow households, as we mentioned earlier. And so they continue to do more with us. And if our client satisfaction remains, you know, as high as it's been, and you saw from the net promoter score earlier this year, remains excellent, well, more than 2x the industry, that not only leads to repeat business, but also leads to referrals. And so that service model is what drives and gives us confidence that in varying economic environments, we can continue to grow at a mid-teens pace And this year, I think, is demonstrating that even with macro uncertainty, as Mike Selfridge noted, we've been able to pick up share and continue to grow and serve clients extremely well.

Got it. All right. Thanks, Mike. That's helpful. And then separately on the wealth management side, I know assets down 10% a link quarter. I mean, how should we think about wealth management revenue in the back half of this year in terms of the growth rate? Just given the dynamics that we're seeing in the market as well as asset flows, how should we think about the growth there when we look at the third, fourth quarter?

Yeah, this is Bob. Look, I think we continue to see very strong inflow from clients. I think we'll see some additional team hires. Obviously, market will impact on the business. As you know, we bill at the beginning of each quarter for investment management fees, so For the third quarter, our investment management fees will probably run about $148 to $150 million. But, you know, as I stated in my comments, we continue to see strong growth in households, strong growth in assets. And, again, I want to highlight the other non-investment management revenues we have, which are up 40% the first half of this year versus last year. So we have a lot of things that can – offset the headwinds of the down market. But, you know, the market is something that is something we're just having to counter as we move through the rest of the year.

Okay, great. Thanks for taking my questions.

I'll take our next question from Casey here with Jefferies. Please go ahead.

Yeah, thanks. Good morning, everyone. I had a question on the efficiency ratio, the guide coming in at the low end of 62, 64. It's running year-to-date, it's at 61, and we're used to seeing that, you know, improve in the back half of the year. Obviously, you know, the NIM guide implies a little bit of pressure going forward, but just wondering what What is driving the efficiency ratio so low year to date, and what is the pressure in the back half of the year?

Thanks, Casey. I guess I'd say this. Revenue growth, as you see, has been extremely strong across the business if you look at both net interest income and fee income. because of just the nature, the ratio is a bit lower because revenue growth, frankly, is just outpacing the investments we're making. We are still investing, as I mentioned, in people, technology, offices to serve clients. It just outpaced it a bit this quarter. The deposit beta, as Olga mentioned before, has been low. If that picks up a little bit, that does imply margin at the top half of our range, as we mentioned, and Given the ratio nature, that probably leads to a slight increase. Could we be slightly below? Yeah, maybe, but we're continuing to invest in the franchise to support growth in the bank and continued growth in clients and client activity.

And I would add that some of the COVID benefits that we experienced over the last couple of years – We start picking up those expenses. We've seen them increasing during the first couple of quarters, but they're not at the pre-COVID levels yet. So we can see those ramping up going forward.

Gotcha. Okay. And just following up on the funding side, apologies if I missed this, but the deposit costs, where did they – what was the spot rate at 630 for them? And then just – On the borrowings capacity, I know you guys have a ton of rum, as you referenced, Mike. But I was just wondering, what is sort of a peak level in terms of use of borrowings that would put pressure on your ability to generate the stable NIM that we're used to from First Republic?

I'll start with the spot rate on deposits as of June 30 was 21 basis points.

On the second comment, Casey, I think from a percentage of FHLB as one of our sources of non-deposit funding, we're well below where we've been in the past. And so there is an ability to use that source a bit more while being consistent with our margin guidance, as Olga mentioned. So there is an ability to use a bit more and still remain within sort of our overall NIM and even towards the middle to high end of the range.

Excellent, thank you.

And we'll take our next question from Erica Najarian with UBS.

Please go ahead.

Hi, good morning. Just two questions. You know, it's been well documented how resilient growth can be particularly in single family, even in a recession. So I wanted to ask sort of, you know, especially since one of your peers just mentioned this morning that the results of the stress test is causing him to drive on balance sheet mortgage growth lower. But there's sort of two parts of the balance sheet in this, you know, chunky rate rising environment that I wanted to ask about. You know, the first is on capital call lines. You know, Mike, I fully appreciate that, you know, you've responded in the past that, you know, such an environment would beget significantly more investment opportunities for funds. I'm wondering if there could be sort of a timing hiccup in terms of, you know, some of the, you know, potential mark to markets and, you know, rising funding costs for funds until it's a better investment environment. And for Mike R., You know, as we think about rapidly rising rates, I think you had 375 for the end of the year. You know, can deposit growth at First Republic continue to be positive, even if, let's say, we actually start seeing more negative deposit growth for the industry, particularly given that your deposit exposure is now more skewed away from the consumer?

Erica, Mike Selfridge, I'll start. If I think I understand your question on cap call, it's really from an industry perspective and mark to market, how do they perform? And they do lag. If you think about the private markets, those valuations tend to lag depending on either a quarterly valuation or a next round of financing. So I would expect over the next few quarters that private valuations would come down overall. Having said that, this is an industry that has performed over many cycles, particularly quality funds. So there will still be a level of fundraising. I think the fund manager selectivity and quality will matter. It's going to be a little more difficult and take a little bit longer for certain funds. Others, it'll take longer, but they'll still raise money. And like many of our clients, they're opportunistic. some of the best investment opportunities present themselves in a down market. And whether that's now or a few quarters from now or a year from now, I don't know. But I know they're very opportunistic in terms of opportunities.

And then, Eric, on the deposit side, absolutely, we continue to grow deposits. We're really pleased to view the second quarter historically has been one of our most challenging periods. And to grow you know, over $3.5 billion in spite of, you know, the large tax flows that happen in April and June is a really great resolve and a testament to relationships with clients and the continued dedication to service of our people. As we go forward, the mix of deposit funding, you know, when we go to higher rates, as we note the 375 Fed, you'll see a bit more NCDs and clients will look for incremental yield. But we have no reason to believe, given the deep relationships that we have, we're going to continue to grow deposits as we have in prior rate rise periods.

Eric, as Jim, you know, as you know from following us a long time, the fundamental element is the growth of household and relationships, and that includes business households. And our growth rate, as referred in some of the comments earlier, is at a historic high point.

That ultimately drives deposits.

Great. And, Jim, so good to hear your voice. And just as a follow-up question, Olga, you know, who knows what's going to happen to long rates. But, you know, as we think about, you know, just re-asking the question, as we think about the progression of the net interest margin from here, could we have hit a high point in the second quarter, you know, as we think about, you know, clearly, You know, the outlook for Fed funds is quite robust. You know, should we think that the second quarter is a high point and, you know, for the rest of the year and perhaps into 2023 based on the forward curve, we sort of just, you know, continue to stay in that 265, 275 range on a quarterly NIMH basis.

Hi, Erica. So if we look at our name for the first six months of the year, we were at 2.74%. And the beta early in the year was quite low, and we were able to keep our deposit cost at nine basis points, which is up just four basis points from quarter over quarter. And we expect in the second half of the year the beta will pick up as the Fed fund raises its rates. Again, it's hard to predict, but this is why we provide the guided range of the top half of our 265 to 75%. Okay.

Thank you so much.

We'll take our next question from Bill Korkachi with Wolf Research. Please go ahead.

Good morning. I apologize. There's some construction taking place near us here. You've addressed the appetite of your customer base to continue to engage with you at current activity levels, even in more challenging environments, and your strong growth to date, despite the sharp increase we've seen in rates, is certainly encouraging, but could you speak more specifically to how you think about the point at which negative wealth effects, rising unemployment, and the other things that you see in a recession start to impact your model, or should we really think of just the nature of your model is really being sort of immune to recession.

Bill, Mike Selver, maybe just a couple of thoughts. There's certainly a wealth effect, and macroeconomic factors affect any market. But if you look at what we're going after here in terms of a satisfied client with a net promoter score overall of 79, we think the highest in the industry, Mike alluded to the growth rate, more than half the growth rate coming from existing clients. A lot of these clients have been with us for years. They're active, up cycles, down cycles. And I want to reemphasize relationship and service. Is that a premium in a down market? And market size or market penetration. We have a lot of room to grow in any market. So I'll go back to the consistency that was mentioned, the stability, the room to grow safely and soundly, and we feel optimistic about that.

Maybe it's Jim, maybe just let me add a little historical perspective here since I've been around for a while. The bank generally does very well in these cycles, and the reason is that other competitors tend to get, they pull back, they let go of loan processing, they let go of other people that support the service delivery. And so their delivery times go out. And our ability to compete actually generally increases. And it's based more on service than it is on rate. And we can compete on rate too because our funding costs are better, in fact, than the big banks. But if you look at their total funding costs versus ours. But mostly it's about service and consistency of delivery. Remember that a lot of purchase finance has in the middle of it the intermediary called brokers, real estate brokers. and they know of our service, and they come to us. They bring the deals over to us. So, in fact, it's a very large business. We're in these coastal urban markets. The home lending business is very big, and we do not have dominant share positions, so it's easy enough for us to take an additional share position. That's happening now, and it will happen in probably even greater percentage-wise as through this whatever is coming, probably a downturn. Thanks.

Thanks, Mike and Jim. That's super helpful. So just following up on those final comments, Jim, are you seeing notably less competition among mortgage lenders today who've pulled back amid the increase that we've seen in rates? And is that sort of contributing to more favorable margins?

I would say at this point we're seeing the leading edge of it, but not very much yet. Anyone relying on the secondary market, of course, is out of the market. So it's only the balance sheet lenders still in the markets. But some of their deliveries are not as good as they were. They're still great lenders and they're still great competition, but they're not as good as they were. But mostly it's the degree of certainty that the intermediaries like real estate brokers can count on, and they know they can count on First Republic. And so that competitive advantage will increase as things get more volatile and more dicey as we go forward.

Is it also fair that a unique part of the business model is that as you're extending loans to new clients that there's incentive for them to bring perhaps other deposits over with them? Maybe could you give a sense of what percentage of the clients that you're extending loans to are also bringing deposits over with them?

The model absolutely is that. As you probably know, we do relationship pricing. But still, as Mike Roffer and Mike Selfridge and Roffer both said, most of our business is with existing clients and their direct referrals. The direct referrals go up in this environment. When their friends are having trouble getting something done, they say, you ought to try First Republic. It's pretty simple. This is not a complicated thing. And if you're in the game long-term and steady, you win when things are unsteady.

That's great. Super helpful. If I can follow up on the earlier comments on the funding side, your over-year loan growth and deposit growth were both 23%, but on a sequential basis, some investors are asking about the roughly 60% of your loan growth this quarter that was funded by FHLP Advances. Could you speak to what's happening there and whether, as we look ahead, we should expect your deposit growth to remain in line with that?

So I just maybe harken back. The last two years were absolutely phenomenal from a deposit funding perspective, if you look at the growth. And that allowed us, you know, to continue to reduce non-deposit funding, which we've done. And then as not unexpected, and we may have even talked about this in our last call, as rates start to rise, and you see this through the Federal Reserve data, you know, deposits have grown less than the industry basis. That said, ours have continued to grow to support our lending and investing activities. And if it grows a little bit less than loan growth this year, because of how strong we're coming into that, we're prepared for that. It's considered in our forecasting and, you know, we'll continue to grow. It just may be at a lesser pace than it was the past two, which were outstanding years. But again, just to reiterate, the reason we feel confident in that growth is the service model and how we develop full service relationships via through wealth management, a new lending client, or deepening relationships with clients each and every day.

Thank you all for taking my questions, and thanks for especially the historical context, Jim, that was very helpful.

We'll take our next question from Manan Gosalia with Morgan Stanley. Please go ahead.

Hey, good morning. Just a couple of quick follow-ups from me on the loan growth side. First, I just wanted to ask on multifamily loans. In addition to RESI, you're seeing a lot of strength in multifamily originations as well. I know you said that part of that was seasonality, but there's clearly some strong underlying growth there as well. So can you talk a little bit more about, you know, where that underlying growth is coming from? You know, is that also, you know, some people getting in ahead of rates, or is there a more fundamental share gain story there?

Anand, thanks. Mike Selfridge. Multifamily is not going to follow the seasonal patterns precisely with single family. So that's a little more of – the opportunity from the client. Like our model, more than half of the growth rate in that comes from existing clients, folks that have been in the business for a long time and look for opportunities. I think multifamily has been a solid asset class in general. As housing prices have increased, there's more demand for rents. Rents in general are above pre-pandemic levels, but solid with lower vacancies. So I think it's just been investment opportunities that our clients have spotted and executed on.

Okay, great. And then separately, I know you've mentioned you're investing in themes and ramping up a new market like Florida and Seattle and also some urban areas along the coast. How much do you expect that to contribute to growth in lending this year and maybe offset any slowdown that you may see in mortgages as rates rise? Is that a second half 22-story or do you think that's more of a 2023 story at this stage?

Yeah, it's probably more the latter of what you said. We're really excited with the group of individuals and colleagues that we've hired to serve clients. You specifically mentioned the Seattle area, and we continue to expand our presence in Florida and in the Palm Beach area where we're at. But I think it's probably more of a 23, especially in Seattle, as we get known in the market greater. than a big contributor in 22, but we're very excited about the clients we have there already and the reception we've received in the market thus far.

Great, thanks so much.

We'll take our next question from Andrew Leash with Piper Sandler. Please go ahead.

Hi, good morning, everyone. Hi, good morning, everyone. Just going back to the margin range question here, I'm still thinking you can maybe beat the high end of that. And I understand the deposit beta comments, but I'm just curious, is it also on the yield side? Do you expect the growth in the asset betas to slow? It just seems like with your high-quality service, there's an opportunity for you to charge more, especially as you're able to serve clients better on the mortgage front than the non-balance sheet lenders that have left the markets.

Yeah, maybe I could just step back a little bit. I mean, we're at the top half of the range for the first half of the year. And like I mentioned earlier, for us it's about consistency and stability of the margin over long periods of time. You know, Olga mentioned that we're really pleased where the deposit betas remain low, but we all know as the Fed accelerates, as they have, that will pop up a little bit. And we talked about, you know, sort of the low 20s. And, you know, that's not reflected quite yet. That said, we remain competitive in the marketplace also from a lending standpoint. But, you know, Mike Selfridge talked about the capital calls, for example, the asset yields are adjusting nicely as the Fed raises rates. And if we think about how the business has operated while the Fed has raised, I guess, 150 basis points through June, precisely and consistently as we would have hoped or would have expected because, again, stability of margins, stability of efficiency while continuing to serve clients in deeper relationships, and we're exactly on point with that. And so, you know, could we be at the top end? Feels like, you know, a pretty good spot to be, but also the Fed's going to be pretty aggressive here in the second half of the year as they really try to tame inflation. And so we think that the stable model wins over the long term and continue to be steady over the long term.

Got it. Okay. That's really helpful. And then just on that 3.7% Resilonio that you talked about, can you just talk about the mix of arms and that versus 15 or 30-year fixed rate mortgages?

At KCA's, Mike, I don't have that off the top of my head, but most of our, I'd say a majority of our single-family origination volumes, historically as well, have tended to be hybrids, 5s, 7s, and 10s.

Got it. Okay. And that's still the case. I'm just curious, like, what's the demand for right now, more demand for 5s or 7s or 10s, I guess?

I would say the 7 is probably coming in the best right now, generally. Okay. I mean, it mixes week to week. It just depends on, really, the client. So it's a little bespoke, but sevens, maybe tens.

Okay. Very helpful. Thanks. I'll step back.

We'll take our next question from Jared Shaw with Wells Fargo. Please go ahead. Hi.

Good morning. Thanks. Just following up on a few of the other questions. Mike Selfridge, appreciate the update on the yields that you've seen more recently. Do you have the origination yields for the average for the quarter?

I have, I do, Jared. For all real estate originations is about 318-ish, call it in that range. For all loans, about 320 for the quarter.

And what about single-family residential?

Single-family residential is a little over 3%, and this is an average origination. As I mentioned, I gave you the sort of the six-week average earlier with Steve's question.

Yep, yep, definitely. And then, Olga, on the 21 basis points spot deposit rate, is that interest-bearing or is that for total deposits?

Hi, Jared, this is total deposits.

Okay, thanks. And then, I guess just finally, you know, when we look at slide 29 on the deck for the asset sensitivity, which I guess is based on March 31st, given some of that move, should we assume that that may shift to liability sensitive with the recent rate moves and the expectation going forward?

Not based on our preliminary views. It's still slightly asset sensitive, which is where we've consistently been.

Okay, thank you.

Take our next question from Chris McGrady with KBW.

Please go ahead.

Great. Thanks. Just going back to the funding, you know, last cycle, Mike, you were around 100% loan to deposit. You're 90 today. What's the comfort level to let that drift given the size of the balance sheet today?

We're very comfortable. Obviously, we're coming in 85, 90 where we've been, and we've operated, you know, in the high 90s to 100, and we feel like given our funding sources and the strength of our liquidity profile we could operate in that range again.

And then just a couple of quick ones. The brokerage line popped up, wondering if that was anything unusual there. And then the BOLI line, I'm wondering, you know, kind of a fair run right now. I know there's some seasonality there.

Thanks. I don't think there's anything unusual. Whenever there's quite a bit of market volatility, we tend to see more trading brokerage activity. So I think that's consistent with what we've seen in past volatile markets.

And on the bullish side, Chris, if we look at the income from life insurance contracts, it's impacted, certain contracts impacted by the mark-to-market. And with the market volatility during this second quarter, we've seen decline in the income that was driven by mark-to-market. And just to remind you, there's offsetting corresponding reduction from benefit costs related to those contracts. So you'll see the offset on the other side of the income statement. And if you remove, I'll give you an example. In second quarter, the impact of negative mark-to-market to this line was about $12 million, which compares to about $4 million last quarter. And if you remove the market volatility component, our run rate for life insurance contracts will be around 2021. Great. Thank you.

We'll take our next question from Brian Fran with Autonomous. Please go ahead.

Hey, good morning. Maybe to preface the question, I mean, I think you've shown over and over again you're always going to be pristine and best in class on credit. But on the allowance and where it is today, can you just give us a flavor, you know, any key assumptions? Are you assuming home price declines already in your base case, probability of recession? You know, just any kind of flavor on some of the – I know it's a big process, and, you know, there's no one assumption that drives it, but just helping us gauge, you know, how much of the cycle is already embedded in that allowance.

Yeah, sure. Hi, Brian. The allowance for loan losses were at 48 basis points at our quarter end, and we feel it's appropriate given our outstanding credit track record. And just to remind you, the level of provision is dependent on the loan mix. For example, single-family loans warrant the lower reserve requirement, and more than 70% of our growth during this quarter was coming from single-family. If you think about our charge-offs for the quarter, we were at $1.3 million, and we reserved $31 million. In terms of the assumptions, we used Moody's scenarios, and if we compare them to the previous scenarios, the assumptions did not change. that scenarios didn't change that much. In fact, they got a little slightly better from last time we used them. So I would say the provision was solely driven by the goals in our loan book.

And maybe, Brian, if I could just stand back for a minute. I mean, one of the things that our reserve levels take into account is, you know, the historical performance of the bank. And, you know, over 37 years, the cumulative losses are nine basis points. And so when you layer that in on a cumulative basis and you look at history and also look at 75%, 80% real estate secured at 55% to 60% loan-to-values, projected losses are pretty modest. Even when a Moody's scenario has a home price decline in it, When you're at 55 loan-to-value, there's still not a lot of projected loss. And so I think it speaks to the long-term safety and stability of how we underwrite credit and how we think about being there for clients in all cycles and all environments. And the way you do that is to be safe at all times.

Got it. And one follow-up, this point about some instances of brokers coming to you amidst market turmoil or maybe turmoil is too strong of a word, but in greater periods of uncertainty. I hadn't really thought of that. Is there any sizing you can give? What percentage of loans over a certain period are coming through brokers? And then I'm sure you do a great job cross-selling those customers more broadly through the bank. Does it happen over the same timeline as someone who comes to you directly? Or is there a little bit more of a lag where some of that... broker-referred production turns into deposits and wealth.

It's Jim. Let me respond to that because I made that comment. First of all, let me be extremely clear. We do not do brokered loan business. I'm talking about real estate brokers who are on a sale who refer their client to find a home mortgage. It's all direct lending. The bank is direct lender. But that business picks up as a share of that business. because we're more reliable and more predictable.

Got it. Okay. So it's a different thing. This is a real estate broker who's seeing some deals fall through with other lenders and just starts coming to you guys because their main focus is making sure the house gets sold.

Yes, exactly. And, of course, that has great value long-term because it may be the first time they've ever tried us before. And they're in the business repetitively for a long period, so it's actually very attractive.

And Brian, I'll just address your second question. Is there a lag in cross-selling? Jim mentioned relationship-based pricing. So we want a relationship. We often won't get everything all at once. There's a saying here, just get trial. And that's why once they discover the service and the relationship, half the growth rate or more comes from the existing client who likes what they're experiencing and starts to consolidate more of their banking and wealth management with us. So I would call that a lag.

Appreciate it. Thank you.

And we'll take our next question from Abraham Pumala with Bank of America. Please go ahead. Good morning.

I just had one final question around, as we think about the margin, I think you had a bunch of questions around the outlook for deposit betas and such. I think the struggle, Olga, Mike, is around if we assume that single-family originations are coming around let's call it three to three and a quarter funding costs given how quickly the Fed is moving implies a pretty sharp compression risk in the margin so would I guess one is that a reasonable concern as we think about 2023 in terms of the risk of margin compression and second when you think about the relationship deposit coming on Are the costs materially different relative to your back book on the deposits when we think about pricing?

On the second part of your question, I would say no because typically they're coming from relationships where we're having a new relationship where relationships are being built and you do a loan and you bring deposits and a portion of that's in checking and some of it may be in money market, but I wouldn't see it as a greater pricing than the current portfolio. I'd also highlight, you know, $75 billion of our deposits are non-interest-bearing, relationship-based focus, right? And so, again, that gives us some protection from how fast the Fed looks to be willing to move here the second half of the year. And I'd also, you know, there's a page in our investor deck that talks about the resiliency and the repricing of our loan portfolio. When you combine floating rate assets with, you know, historical repayments, you know, has really offset the rise in funding costs, which continue to be very modest. And the new loan yields that Mike Selfridge talked about, right, that's a portion of the loan portfolio, right? That's not, you don't reprice the whole portfolio. And then if I stand back from all that, you know, I think we had talked about this earlier, it's about consistency and stability over long periods of time, which leads to growing balance sheet, growing net interest income. It's never been about expand the margin and keep growth modest. It's been about serve clients that leads to future growth, keep things consistent and stable over long periods of time.

Got it. And just one quick follow-up on the market share opportunity. I think, Jim, in the past you've talked about the big banks go from hot to cold. It feels like they're getting cooler. I'm just wondering, does that create incrementally better opportunities given the kind of macro environment that we are heading into?

Generally, yes, it does. But the thing to remember is that although we're very proud of the success of the bank, we're still a small market share in most of the markets we're in. So for us to take a bit of share is not that challenging, to be perfectly frank.

Thanks for taking my questions.

The next question comes from John Armstrong with RBC. Please go ahead.

Hey, thanks for letting me in here. I'll make this quick. Mike Selfridge, on the capital call lending loan yields, you mentioned prime minus 75 or 100. Do you think that kind of pricing can hold as prime continues to rise? So if we get 75 or 100 at the end of the month, do you expect that pricing to react by 75 or 100, or is it just too competitive? to make it that linear?

I think it's more of the latter. It's very competitive, and there's, as you know, a couple of key players in that business, and we'll get some benefit to the upside. But I think the range – I feel comfortable in the range I gave you. As Prime goes up, I think we'll benefit from that, maybe not 100% in terms of loan beta, but we'll get some upside. But I think there's a bit of a ceiling just due to competition.

Okay. Okay. And then just one quick one. On your slide deck, you show about half of your loans have repricing timeframes in a year or less, and then another half fixed and hybrid. Can you just talk a little bit about some of the repricing timeframe on that fixed and hybrid portion of the book? Thanks.

Yeah, so the way that slide is built is it's on a historical perspective of how much of those fixed and hybrids repay over a period of time. And so that's what's built into it. It's our floating rate plus a portion of those that prepay over time. And, you know, the hybrid and fixed, you know, has sort of been a four to six year period, typically, if you just were to look at it sort of on a standalone basis. But really what that's getting at is, it shows the power of growth over time, right? As rates are rising, not only it's a dynamic nature of our client base and our loan portfolio and balance sheet, because it's growing, it's repricing to market as new deals are done. And as you see, we had quite a bit of good new business in the quarter. And so, again, that long-term perspective of serving clients allows us to reprice over time. which is offsetting any funding rates or the Fed very well right now.

Okay. All right. Thank you for that.

We'll take our next question from Tim Coffey with Janie. Please go ahead.

Great. Thank you. Good morning, everybody. Given the weakness that we're seeing in office commercial real estate, especially in the San Francisco Bay Area, have you increased your underwriting standards on that product or otherwise become more selective?

We've always been more selective. I would say we've been even more cautious over actually the last few years, but certainly the last six months. And you're probably reading headlines on sort of large high rises with, you know, 30% occupancy. We're not in that business. We're in the small CRE deals, median loan size, $2 million loan to value at origination, typically less than, 55% with recourse, debt service coverage, experienced operators.

Okay, okay. So the vacancy rate in the general San Francisco market of 20%, you don't think that's really going to have much of an impact?

I don't think so for what we do, no. I think people are being very selective in what they purchase, and typically they've been in the business for many cycles. So they know what they're doing, and they know how to make it work.

Okay. And then on the stock secured lending, is the collateral there just highly liquid stocks or could it include restricted stocks?

It's only highly liquid stocks. Okay. All right. Those are my questions. I appreciate the time. Thank you.

We'll take our next question from David Schiberini with Wedbush. Please go ahead.

Hi, thanks. I thought it was impressive to see such a high level of refi in the quarter for SFR at 48%. I was curious, what's the mix of new versus existing clients on the refi side? And then the follow up would be where do you expect that 48% refi level to go going forward?

Dave, the refi, I would just characterize refi as more than majority being another bank's client, so external clients coming to First Republic. And I know we've said historically that it hadn't drifted over the long run down below 40%. We could see refi in terms of mix drop below 40% given the headwinds with rising rates.

Dave, maybe I'd just add on a second. You know, one of the things about and the business we're doing is such a testament to our service model and our colleagues that are serving clients each and every day. As Mike mentioned, you know, the opportunity coming from clients at other banks is a direct result of the great service that those colleagues provide to clients because, you know, as Jim, Mike have mentioned, referrals are very strong, especially in you know, periods of maybe where service isn't as great, right? And so I think it's a real testament to how we focus on service delivery at all times, and our colleagues do a wonderful job of that in any environment. Being there right now for clients is extremely important in this period of volatility, and nobody hides under the desk at First Republic. They pick up the phone and make phone calls and they engage with their clients frequently, and you see that in the results.

Very helpful. Thanks very much.

We'll take our next question from Steven Alexopoulos with JP Morgan. Please go ahead.

Hi again, everyone. Thanks for taking the follow-up. The theme of safety and stability has been emphasized quite a few times on the call today, and I want to ask a follow-up to Jim. I know you're not an economist, but you are one of the longest standing executives in the industry. And like you said, you've seen a few cycles over the past 37 years. Jim, from a big picture view with all the uncertainty out there, what's your assessment of the risk of what lies ahead? And what are you most focused on today? Thanks.

Thanks, Steve. Well, I'm not an economist, but, you know, maybe the scars are better than an education. I'm not sure which. But the... I think we're seeing a kind of a normal but somewhat rapid tightening cycle play out following an excessively long period of cheap money. I started a bank in August of 1980, before this one, and lived through the Volcker years. And they were pretty brutal, but on the other hand, it worked out. Had to have two recessions, but the rest of the 80s were actually quite attractive. So I think what we're seeing is the beginning of the solution. You're watching some prices begin to stabilize, if not come down. Some are coming down. You're watching people pull back, particularly in the Valley and in tech, pull back on employment. If not letting go, they're certainly stopping their hiring. And so it's a normal process. The Fed has to play catch up. They're behind and they're likely to do so pretty quickly. So I think you're likely to see the recession is probably coming of some kind, and it will stabilize a lot of the excesses. I don't think that it's threatening overly to us. We're not naive, and it obviously is a challenge. But I think it'll be fine. The quicker the rates go up, the faster inflation will be resolved. The thing that Volcker did that's so important is he moved really boldly And got ahead of it, but it took two recessions to get there and not that I'm predicting that because I'm not But so I think we're just fairly we're in we're in a maybe the second or third inning of what's going to be required To get inflation under control that would be my personal opinion Okay Thanks so much That concludes today's question-and-answer session

At this time, I will turn the conference back to Mike Roffler for any additional or closing remarks.

I'd just like to say thank you for joining our call today, and we are excited about the service model and our continued excellent delivery for clients and look forward to the future. Thank you.

This concludes today's call. Thank you for your participation. You may now disconnect.