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At First Republic, loan yields driving margin pressure


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According to Market Intelligence, April 2023

At First Republic, loan yields driving margin pressure

Although First Republic Bank adjusted some of its deposit pricing in the quarter, management said competitive loan pricing and high demand created most of the pressure around the bank's net interest margin.

The net interest margin, or NIM, ticked up slightly to 3.16% during the third quarter from the previous one, and the margin is at 3.12% year-to-date. However, CFO Michael Roffler said management prefers to look at loan growth and net interest income as "key" measures of success, and he focused instead on loans outstanding that increased 19% annually and net interest income that expanded 20.5% year over year.

Still, First Republic was not immune to deposit price increases, even as executives argued that lending put the most pressure on the NIM. The bank paid an average deposit rate of 25 basis points during the quarter, up 7 basis points sequentially. President Hafize Gaye Erkan said average deposits rates have increased 10 basis points over the last year, lagging the federal funds target rate increase of 75 basis points. But one analyst pointed out that money market savings rate increased from 18 basis points to 36 basis points as well. Erkan said this was a one-time adjustment and that the money market rate was well below the peer median. Roffler added that this came at a time when there was little relief on loan yields for high-quality clients in such a competitive lending environment.

"Lending is extremely competitive for the type of business that we're doing and in the markets that we're in. And as I said before, if you want a quality client, a quality business, pricing is extremely competitive because the largest banks want the same client base," he said. "The margin might be under pressure, but net interest income is going very well."

First Republic continued investing in initiatives to increase digital offerings and attract millennial clients, keeping its efficiency ratio at 62.4% for the quarter. But the investments pose a large opportunity for the bank to capture a younger client base through student loan repayments, Erkan said. Three years ago, new and younger clients accounted for less than 5% of total borrowing households; they now account for more than 20%, she said. The growing base has led the bank to improve its technology, marketing and service channels.

One driver of those efforts will be Gradifi, a student loan repayment platform that the bank acquired in 2016. In September, the bank launched a marketing campaign around the platform. Gradifi is losing money at its current operating size and is predicted to do so for a couple of years, said CEO James Herbert II. But he added that many of the clients Gradifi brings in will be profitable in the second year of the banking relationship, and he said he "could not be more delighted" at the client acquisition rates.

Management also provided an update on the California wildfires and their impact on some lending relationships. First Republic's branch in the northern California wine country remains open, but the bank has identified 28 single-family home properties and two wineries that are clients who have sustained fire damage. All are fully insured but have yet to receive complete damage assessments. The loans to winery clients are required to carry fire insurance and the bank has the ability to force-place insurance should it lapse; however, clients are not required to carry a business-continuity policy. Herbert said the bank has "significant experience" when it comes to natural disasters and that standard homeowners' insurance usually offers "quite specific and comprehensive" fire damage coverage.

Shares were under pressure around midday, sinking 5.01% to $97.05 as of 12:41 p.m. ET.

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