At more than double book value, can First Republic Bank shares continue to climb?


The banking industry has been hammered this year, but you wouldn’t know if you looked Bank of the First Republic (NYSE: FRC). Its stock was trading at around 233% of its book value at Friday’s close, and it is up 11.5% year-to-date. First Republic recently reported a record quarterly profit of over $ 293 million, up nearly 25% from the third quarter of 2019.

The question is: can the bank’s stock continue to climb at such a high valuation? I believe the answer to this question is a definite yes. Here’s why.

Image source: Getty Images.

A formidable franchise

When you watch First Republic, it has all the makings of a strong banking franchise. Like most banks, it has seen deposits pour in over the past year, with total deposits increasing nearly 22% in the third quarter compared to the same period in 2019. About 47% of that gain came from non-interest bearing deposits – the best type of deposits a bank can have as they cost nothing and are generally sticky. Non-interest bearing deposits accounted for nearly 40% of total First Republic deposits, and the cost of bank deposits stood at 0.21% at the end of the third quarter.

But what sets First Republic apart from its peers is that it is actually finding ways to deploy those deposits into assets that generate a decent return in this low rate environment. Its loan-to-deposit ratio (LTD) at the end of the third quarter was around 100%, meaning that its loan growth kept pace with its deposit growth. As a result, the bank saw an increase in net interest income in the third quarter and the bank’s net interest margin (NIM) – the difference between what it pays for interest-bearing liabilities such as deposits and fact on interest-bearing assets such as loans – actually increased by 1 basis point (0.01%) between the second and third quarters. Rising NIMs, net interest income, and high LTD ratios are rare among banks today, as demand for loans has not been as strong as it normally is when rates are low. as low.

This is important because the low interest rate environment has resulted in low returns on securities in which banks could place their excess deposits, such as US Treasuries or mortgage-backed securities. The bulk of First Republic’s loan growth has been in the residential mortgage portfolio, with total residential volume growth of over $ 4 billion in the third quarter and approximately $ 8.7 billion in 2020. The residential portfolio had an annualized return of 2.96% in the third quarter, which is down from the second quarter but remains well above most stock returns at this time.

Lots of banks like to talk about how they deliver the best customer service and loyalty, but First Republic really speaks for itself. Between 2015 and the end of 2019, the bank obtained 88% of its loan arrangements from existing customers and customer referrals. It also loses very few of its check deposit customers, with an annual attrition rate of 2%, compared to an attrition rate of 8% for the industry as a whole.

Superb credit

First Republic also excels in credit quality. Since 2000, the bank has recorded on average only an annual write-off rate of 0.05% (debts unlikely to be collected), against 0.38% on average for the top 50 US banks. Net write-offs at the end of the third quarter accounted for 0.01% of the bank’s total loan portfolio, while non-performing assets, those that have not received payment for an extended period (likely more than 90 days) , were equivalent to only 0.12%. of the total loan portfolio.

First Republic excels in terms of credit quality because it lends to high net worth borrowers who are low risk. The bank defines them as households with at least $ 1 million in assets to invest. With borrowers earning a lot of money, the bank is able to extract large down payments on the loans.

For example, the median loan to value ratio (LTV) of First Republic’s residential portfolio is 60%. LTVs represent the amount borrowed under the loan, which means that the lower the LTV, the safer the loan. A 60% LTV probably means the borrower has made a 40% down payment. The median LTV in First Republic’s multi-family loan portfolio and commercial real estate loan portfolio is 54% and 45%, respectively. So even though First Republic has issued loans in certain sectors and geographies that have been heavily affected by the coronavirus pandemic, these loans are less risky due to all the equity the borrower has already invested in the loan. to start.

Stand out with room to run

While the banking industry has struggled this year, First Republic is one of those niche players that really stands out when you consider its deposit franchise, credit standing, ability to safely grow its business. loan portfolio and its service model, which has resulted in excellent customer retention. and satisfaction.

In addition, the bank still has a lot of room to improve. Among wealthy households in the United States, First Republic estimates that it only controls a 4.21% market share. The bank’s efficiency ratio, a measure of its spending expressed as a percentage of revenue, also sits at the top, with management expecting it to hit around 62.5% for the entire year. If the bank can continue to do what it is doing and improve on these metrics, there is still significant growth for the stock.

This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are heterogeneous! Questioning an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.


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