March 06, 2015 First Republic Bank Current Recommendation SUMMARY DATA NEUTRAL Prior Recommendation Neutral Date of Last Change 04/14/2011 Current Price (03/05/15) $57.70 Target Price $61.00 52-Week High $57.70 52-Week Low $45.77 One-Year Return (%) 11.32 Beta 1.39 Average Daily Volume (sh) 557,617 Shares Outstanding (mil) 138 Market Capitalization ($mil) $7,963 Short Interest Ratio (days) 4.38 Institutional Ownership (%) 100 Insider Ownership (%) N/A Annual Cash Dividend $0.56 Dividend Yield (%) 0.97 5-Yr. Historical Growth Rates Sales (%) 11.6 Earnings Per Share (%) 4.0 Dividend (%) N/A using TTM EPS 18.8 using 2015 Estimate 18.9 using 2016 Estimate 16.0 Zacks Rank *: Short Term 1 3 months outlook 3 - Hold * Definition / Disclosure on last page SUMMARY Risk Level * (FRC-NYSE) First Republic s fourth-quarter 2014 came in line with the Zacks Consensus Estimate. However it was below the prior-year quarter figure. Results reflected the company s organic growth based on an increase in revenues as well as deposits and loans. However, these positives were offset by a rise in expenses and provision for credit losses. We remain optimistic about the company s prospects as its total assets are expected to reach at least $50 billion by 2015. Further, First Republic s strong fundamentals and earnings strength are expected to drive growth in the coming quarters. However, the unsettled economy, a still low interest rate environment and stringent regulatory issues are matters of concern. Below Avg., Type of Stock Large-Blend Industry Banks-West Zacks Industry Rank * 85 out of 267 ZACKS CONSENSUS ESTIMATES Revenue Estimates (In millions of $) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) 2013 336 A 332 A 331 A 346 A 1,345 A 2014 362 A 389 A 423 A 401 A 1,575 A 2015 432 E 445 E 460 E 474 E 1,811 E 2016 2,025 E Earnings Per Share Estimates (EPS is operating earnings before non-recurring items, but including employee stock options expenses) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) 2013 $0.85 A $0.76 A $0.74 A $0.75 A $3.10 A 2014 $0.73 A $0.76 A $0.86 A $0.72 A $3.07 A 2015 $0.69 E $0.74 E $0.80 E $0.82 E $3.05 E 2016 $3.60 E Projected EPS Growth - Next 5 Years % 13 2015 Zacks Investment Research, All Rights reserved. www.zacks.com 10 S. Riverside Plaza, Chicago IL 60606
OVERVIEW Headquartered in San Francisco, CA, First Republic Bank (FRC) is a commercial bank and trust company and a member of the Federal Deposit Insurance Corporation (FDIC). The company specializes in providing personalized, relationship-based preferred banking, preferred business banking, real-estate lending, trust and wealth management services to customers in metropolitan areas across the United States. On Sep 21, 2007, First Republic Bank was acquired by Merrill Lynch and merged with one of the latter s banking subsidiaries. Under the terms of the acquisition, First Republic operated as a separate division of Merrill Lynch. Further, on Jan 1, 2009, Merrill Lynch was acquired by Bank of America. First Republic continued to operate as a separate division of Merrill Lynch Bank & Trust Company, F.S.B. (MLFSB) a subsidiary of Merrill Lynch until Nov 2, 2009, when Merrill Lynch became a division of Bank of America. After the closure of business on Jun 30, 2010, the current First Republic Bank acquired all the assets and assumed all the liabilities of the First Republic division of Bank of America. First Republic operates through offices including San Francisco, Palo Alto, Los Angeles and Santa Barbara. It provides wealth management as well as trust services through First Republic Investment Management, Inc. and First Republic Trust Company, respectively. First Republic operates two major business segments: REASONS TO BUY The Commercial Banking (accounted for 87% of total revenue of 2014) segment accepts funds from customers, originates loans (principally real estate secured mortgage loans) and invests in investment securities. The chief sources of revenues for this segment are interest earned on loans and investment securities, gains on sales of loans, fees earned from loan and deposit services, and income earned on loans serviced for investors. The Wealth Management (13%) segment consists of First Republic Investment Management, the money market mutual fund activities through third-party providers and the brokerage activities of First Republic Securities Company, LLC as well as operations of First Republic Trust Company, along with foreign exchange activities. Trending toward a $50 billion plus institution, First Republic expects consolidated assets for the trailing four quarters to average at least $50 billion by the end of 2015. Notably, the company is expected to surpass $50 billion in total assets by the end of second-quarter 2015. Though entry into a competitive market with larger players will pose a challenge for the company, we believe that it is well positioned to counter this and will have adequate room for further growth. As an institution with at least $50 billion assets is required to operate in a stricter regulatory environment, the company is making related progress in the infrastructure platform. The company remains committed to fortify on-balance sheet liquidity and will continue to increase high-quality liquid assets (HQLA) portfolio, to comply with regulatory requirement. First Republic s primary source of income from operations is the net interest income. Even amid the low interest rate environment, the bank s net interest income (NII) exhibited a 4-year CAGR (2011-2014) of 15%. We believe continuous growth in loans and rising interest rates will more than offset net interest margin (NIM) compression, while aiding NII growth in the near term. Further company s non-interest income exhibited a 4-year CAGR (2011-2014) of 39.2%. Given such trends in NII and non-interest income growth, we remain optimistic about the company s growth prospects. Equity Research FRC Page 2
REASONS TO SELL First Republic has recorded growth in loan balances, driven by increased loan origination volumes. Notably, originations recorded a 4-year CAGR (2011-2014) of 18%. For full-year 2015, loan growth is expected to be in the range of 11 14%. Further, the company s total deposits have grown at a 6-year CAGR of 17% (2009-2014). A healthy rise in loans and deposits augments organic growth for the company. First Republic has complied with all regulatory ratio requirements since its inception. It has also been able to generate higher cash flow amid an increasingly difficult operating environment. First Republic s de novo status due to its divestiture from Bank of America in Jun 2010, requires the bank to maintain a Tier 1 leverage ratio of at least 8% through the first seven years until Jun 30, 2017. As of Dec 31, 2014, the bank s Tier 1 leverage ratio stood at 9.43%, exceeding the requirement. We believe that a strong capital position will help it grow organically as well as through opportunistic acquisitions in the near future. RECENT NEWS Due to the prolonged low interest rate environment, First Republic s NIM declined to 3.14% in 2014 from 3.26% in 2013, 4.22% in 2012 and 4.63% in 2011. As the interest rate environment is not expected to improve significantly in the near term, we expect continued margin pressure and the positive impact of its loan growth to be somewhat dented. Rising operating expenses have been a concern for First Republic over the past couple of years. Notably, operating expenses increased at a 4-year CAGR (2011-2014) of 19%. Further, the company is working to meet the substantial high regulatory and compliance standards that are necessary for institutions with more than $50 billion assets. This requires infrastructure investments in several areas in the coming quarters. Though the company anticipates such increased costs to be offset by cost containment initiatives that began in third-quarter 2014, we believe higher expenses might limit top-line growth. Further, it is anticipated that quarterly core efficiency ratio will not improve in the near term though it might exhibit improvement in late 2015 or the early part of 2016. The macroeconomic environment is recovering at a slow pace and its prospects are still uncertain. This is compounded by changes within the financial services industry and regulatory actions, which are expected to adversely affect revenues and increase costs of business for First Republic. Moreover, we believe that the company s flexibility with regard to business investments will be somewhat limited in the medium term, given the stricter regulatory capital requirements that the company must adhere to. First Republic Q4 Earnings Meet, Revenues Up Y/Y Jan 15, 2015 First Republic reported fourth-quarter 2014 earnings per share of $0.72, matching the Zacks Consensus Estimate. However, the reported figure compared unfavorably with the prior-year earnings of $0.75 per share. Core earnings per share of $0.67 came a penny above the prior-year core earnings of $0.66 per share. Core earnings exclude the impact of purchase accounting. Equity Research FRC Page 3
Continued growth in revenues, assets and a strong capital position were among the positives in the quarter. On the downside, results reflected higher non-interest expenses and a rise in provisions for loan losses. Core net income available to common shareholders was $94.8 million, up 4.8% from the prior-year quarter. For the year ended 2014, earnings per share of $3.07 beat the Zacks Consensus Estimate of $3.06. However, it came below the prior year figure of $3.10 per share. Core earnings per share came in at $2.83 in 2014, comparing favorably with the prior-year figure of $2.65 per share. Performance in Detail Total revenues were $416.7 million for the fourth quarter, up from $371.0 million in the prior-year quarter. For 2014, revenues stood at $1.6 billion, increasing from $1.5 billion in the prior year. Core revenue in the fourth quarter was $401.3 million, up 16.0% year over year. However, it lagged the Zacks Consensus Estimate of $428.0 million. Core revenues for the year ended 2014 stood at $1.6 billion, up 17.1% year over year, while it was in line with the Zacks Consensus Estimate. First Republic s core net interest income in the fourth quarter increased 1.6% year over year to $325.5 million. However, core net interest margin fell 3 basis points (bps) year over year to 3.06%. The company s non-interest income for the quarter came in at $75.8 million, up 34.9% year over year. The rise was primarily driven by higher investment advisory fees, gain on sale of loans and foreign exchange fees. Non-interest expense for the quarter was $244.2 million, up 2.4% year over year. An increase in salaries and expenses in information systems primarily led to this rise. Core efficiency ratio was 59.9% compared with 58.7% in the prior-year quarter. A rise in efficiency ratio indicates deterioration in profitability. As of Dec 31, 2014, net loans increased 11.1% year over year to $37.6 billion, while total deposits rose 15.7% to $37.1 billion. First Republic s total wealth management assets were $53.4 billion as of Dec 31, 2014, increasing from $41.6 billion as of Dec 31, 2013. Wealth management assets include investment management assets, brokerage assets, money market mutual funds, trust and custody assets. Credit Quality First Republic s credit quality improved partially in the quarter. On a year-over-year basis, total nonperforming assets declined 20.3% to $46.0 million. Further, nonperforming assets to total assets ratio was 0.10%, down from 0.14% in the year-ago quarter. As of Dec 31, 2014, the ratio of net loan recoveries to average total loans was 0.02%, compared with net loan charge offs to average total loans of 0.05% in the prior-year period. However, provision for credit losses increased to $14.1 million compared to $7.8 million in the prior quarter. Equity Research FRC Page 4
Capital Position First Republic s capital ratios improved during the quarter. As of Dec 31, 2014, the company s Tier 1 leverage ratio was 9.43% versus 9.19% as of Dec 31, 2013. Tier 1 risk-based capital ratio was 13.55% compared with 13.34% as of Dec 31, 2013. Further, book value per share increased 14.2% year over to $28.13. Dividend Update First Republic announced a quarterly cash dividend of $0.14 per share for the fourth-quarter 2014. The dividend was paid on Feb 12, 2015 to shareholders of record as of Jan 29, 2015. During 2014, the company paid shareholders $74.5 million as dividend on common stock. Outlook Management remains optimistic about 2015, with its strong growth in loan, wealth management operations and deposits. The company sees opportunities in its footprint across the urban coastal markets. The company remains committed to expense management. Compensation expenses in the first quarter 2015 will include higher payroll tax impact of $6 to $7 million. Excluding the seasonal impact of higher payroll taxes in the first quarter 2015, core efficiency ratio is anticipated to be in the range of 57 61% through the end of 2015. Though management is pleased with the current NIM range, it expects margin pressure going forward. For 2015, loan growth is expected in the range of 11 14%. The company will continue to sell loans in the secondary market in the upcoming quarters. It noted that through loan sales in the secondary market, the company is able to manage balance sheet and interest rate risk better. Equity Research FRC Page 5
VALUATION First Republic s shares on a price-to-earnings () trade at 18.9x the Zacks Consensus Estimate for 2015, which is at a 18.1% premium to the industry average of 16.0x. On price-to-book (P/B) basis trade at 2.1x, which is at a 40% premium to the industry average of 1.5x. The valuation on both and P/B basis looks expensive. First Republic has a trailing 12-month ROE of 13.2%, compared to the industry average of 9.6%. This implies that the company reinvests its earnings more efficiently than its industry peers. Our 6-month target price of $61.00 equates to 20.0x the Zacks Consensus Estimate for 2015. Combined with a quarterly dividend of $0.14 per share, this target price implies an expected return of about 6.2% over that period. This is consistent with our long-term Neutral recommendation on the shares. Currently, First Republic carries a Zacks Rank #3 (Hold). Key Indicators F1 F2 Est. 5-Yr EPS Gr% P/CF 5-Yr High 5-Yr Low First Republic Bank (FRC) 18.9 16.0 13.0 21.4 18.8 20.2 9.0 Industry Average 16.0 13.9 9.5 13.3 17.0 73.7 10.0 S&P 500 16.7 15.6 10.7 14.9 18.3 18.4 12.0 Zions Bancorporation (ZION) 16.9 13.7 7.9 10.4 15.9 24.1 14.0 Malaga Financial Corp. (MLGF) NA NA NA NA 12.0 11.9 6.6 SVB Financial Group (SIVB) 21.1 17.1 9.7 21.9 22.1 33.9 10.5 SVB Financial Group (SIVB) 20.3 17.8 10.3 16.7 21.0 NA 12.1 TTM is trailing 12 months; F1 is 2015 and F2 is 2016, CF is operating cash flow P/B Last Qtr. P/B 5-Yr High P/B 5-Yr Low ROE D/E Last Qtr. Div Yield Last Qtr. EV/EBITDA First Republic Bank (FRC) 2.1 2.1 1.2 13.2 1.5 1.0 17.9 Industry Average 1.5 1.5 1.5 9.6 0.3 1.6 8.9 S&P 500 6.2 9.8 3.2 25.4 NA 2.0 NA Equity Research FRC Page 6
Earnings Surprise and Estimate Revision History Equity Research FRC Page 7
DISCLOSURES & DEFINITIONS The analysts contributing to this report do not hold any shares of FRC. The EPS and revenue forecasts are the Zacks Consensus estimates. Additionally, the analysts contributing to this report certify that the views expressed herein accurately reflect the analysts personal views as to the subject securities and issuers. Zacks certifies that no part of the analysts compensation was, is, or will be, directly or indirectly, related to the specific recommendation or views expressed by the analyst in the report. Additional information on the securities mentioned in this report is available upon request. This report is based on data obtained from sources we believe to be reliable, but is not guaranteed as to accuracy and does not purport to be complete. Because of individual objectives, the report should not be construed as advice designed to meet the particular investment needs of any investor. Any opinions expressed herein are subject to change. This report is not to be construed as an offer or the solicitation of an offer to buy or sell the securities herein mentioned. Zacks or its officers, employees or customers may have a position long or short in the securities mentioned and buy or sell the securities from time to time. Zacks uses the following rating system for the securities it covers. Outperform- Zacks expects that the subject company will outperform the broader U.S. equity market over the next six to twelve months. Neutral- Zacks expects that the company will perform in line with the broader U.S. equity market over the next six to twelve months. Underperform- Zacks expects the company will under perform the broader U.S. Equity market over the next six to twelve months. The current distribution of Zacks Ratings is as follows on the 1128 companies covered: Outperform - 15.5%, Neutral - 75.4%, Underperform 8.3%. Data is as of midnight on the business day immediately prior to this publication. Our recommendation for each stock is closely linked to the Zacks Rank, which results from a proprietary quantitative model using trends in earnings estimate revisions. This model is proven most effective for judging the timeliness of a stock over the next 1 to 3 months. The model assigns each stock a rank from 1 through 5. Zacks Rank 1 = Strong Buy. Zacks Rank 2 = Buy. Zacks Rank 3 = Hold. Zacks Rank 4 = Sell. Zacks Rank 5 = Strong Sell. We also provide a Zacks Industry Rank for each company which provides an idea of the near-term attractiveness of a company s industry group. We have 264 industry groups in total. Thus, the Zacks Industry Rank is a number between 1 and 264. In terms of investment attractiveness, the higher the rank the better. Historically, the top half of the industries has outperformed the general market. In determining Risk Level, we rely on a proprietary quantitative model that divides the entire universe of stocks into five groups, based on each stock s historical price volatility. The first group has stocks with the lowest values and are deemed Low Risk, while the 5 th group has the highest values and are designated High Risk. Designations of Below-Average Risk, Average Risk, and Above-Average Risk correspond to the second, third, and fourth groups of stocks, respectively. Coverage Team QCA Lead Analyst Analyst Copy Editor Content Ed. 11B Kalyan Nandy Priti Dhanuka Anindita Chaudhury Ishani Mukherjee Priti Dhanuka Equity Research FRC Page 8