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Is First Republic Bank (FRC) a Smart Long-term Buy?

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Alex Smith
·7 min read
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Wedgewood Partners recently released its Q3 2020 Investor Letter, a copy of which you can download here. The Fund returned 10.77% for the third quarter of 2020. Meanwhile, the benchmark S&P 500 Index and the Russell 1000 Value Index gained 8.93% and 5.59%, respectively. You should check out Wedgewood Partners' top 5 stock picks for investors to buy right now, which could be the biggest winners of this year.

In the said letter, Wedgewood Partners highlighted a few stocks and First Republic Bank (NYSE:FRC) is one of them. First Republic Bank (NYSE:FRC) is a bank and wealth management company. Year-to-date, First Republic Bank (NYSE:FRC) stock gained 7.2% and on October 19th it had a closing price of $125.92. Here is what Wedgewood Partners said:

"First Republic Bank was founded in 1985 on the idea that a culture of exceptional, concierge client service brought to bear on commodity banking and wealth management would lead to an exceptional business model. The founders were right. First Republic Bank is an exceptional growth company that happens to be in the lackluster banking industry. Starting in 1985 with $8.8 million de novo capitalization, the virtuous circle of high-touch, empowered client service coupled with low-turnover, experienced client-facing employees has led to equally low-turnover, referral-rich, satisfied clients. With just 78 banking offices (just 10 more since 2014) clustered in wealthy zip codes primarily in San Francisco, Palo Alto, Los Angeles, Santa Barbara, Newport Beach, and San Diego, California; Portland, Oregon; Jackson, Wyoming; Palm Beach, Florida; Boston, Massachusetts; Greenwich, Connecticut; and New York, New York, the Company has organically grown its deposit base to $99 billion and wealth management assets of $156 billion. Wealth management generates about 14% of overall Company revenues.

Over the past five years (2014—2019), the Company has generated compound growth of loans, deposits, Tier-1 capital, and wealth management assets of +19%, +19%, +16%, and +23%, respectively. In addition, over the same five years, the Company has compounded revenue growth at +15% per annum, tangible book value at +14% per annum, and earnings per share at +11% per annum. We believe that the Company has more than a few years of double-digit runway growth ahead of it.

In addition, the Company has long exhibited a parallel culture of extremely conservative lending, conservatively funded by a stable deposit base (84% of liabilities). Knowing its client well and knowing their respective loans well is exemplified by the fact that 90% of the Company’s real estate loans are within just 20 miles of a Company office. In addition, 90% of loans since the Company’s founding were originated by bankers still employed by the Company. Consistent across the Company’s loan portfolio are conservative loan-to-value ratios; high customer liquidity; and for individuals, high average FICO scores of 774. Consider this amazing statistic: since the Company’s founding in 1985, the Company has originated $288 billion in loans, yet cumulative loan losses have been just 0.12% ($289 million). Indeed, in the last reported quarter, the Company reported that nonperforming assets remained at a very low level – 13 basis points of total assets – and net charge-offs were just $1.1 million, or less than 1 basis point of average loans.

First Republic Bank views its culture of concierge service as its brand. All clients (not customers) enjoy a single point of contact. Happy clients refer their family, friends, business associations, and the boards and charities they may serve on – the list goes on. The Company estimates that at least 50% of its growth comes from existing clients, plus another 25% from referrals. Specifically, client referrals account for 32% of checking deposit account growth and 29% for new loan origination growth. Relatedly, the Company boasts that its annual checking deposit attrition rate of 2% is significantly lower than industry’s attrition rate of +8%. It is no surprise the Company’s Net Promoter Score is off the charts for a client service focused company.

We expect households banked by the Company to continue to increase at least at a high single-digit pace given the Company’s still-low market penetration. These expectations may be conservative given the turmoil in most of the U.S. banking industry. The majority of U.S. banks are starved for growth – particularly in the high-net-worth sector. Employee turnover in senior client-facing positions has plagued the banking industry for years. Couple that with the current shrinkage in branches across the industry and its easy to assume that client service levels are poorer still. The current environment is ripe for First Republic to gain even greater household penetration.

Despite First Republic’s differentiated banking business model, like all lending institutions it too must manage an interest rate-spread environment that continues to tighten, hindering net earnings growth. The offset to tightening lending spreads is top-line revenue growth – where the Company excels. The Company’s latest reported quarter put an exclamation point on its ability to grow loan originations unlike any industry peer. During the second quarter, the Company’s loan originations totaled $1.4 billion, an annual increase of +19% – its best quarter ever of loan originations.

Just as First Republic’s business model and its long history of growth are unique in the banking industry, the stock’s valuation has been at a premium to its so-called banking peers. Despite the stock’s long history of premium valuation, the Company’s growth has long been rewarded as a premium performer versus both its banking peers and the stock market. If the Company continues to execute as we expect over the next years, we expect that the stock will be duly rewarded in kind."

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Last month, we published an article revealing that Ensemble Capital is bullish on First Republic Bank (NYSE:FRC) stock. The bank is witnessing strong growth in new deposits and loans.

In Q2 2020, the number of bullish hedge fund positions on First Republic Bank (NYSE:FRC) stock increased by about 32% from the previous quarter (see the chart here), so a number of other hedge fund managers believe in FRC's growth potential. Our calculations showed that First Republic Bank (NYSE:FRC) isn't ranked among the 30 most popular stocks among hedge funds.

The top 10 stocks among hedge funds returned 185% since the end of 2014 and outperformed the S&P 500 Index ETFs by more than 109 percentage points. We know it sounds unbelievable. You have been dismissing our articles about top hedge fund stocks mostly because you were fed biased information by other media outlets about hedge funds' poor performance. You could have doubled the size of your nest egg by investing in the top hedge fund stocks instead of dumb S&P 500 ETFs. Below you can watch our video about the top 5 hedge fund stocks right now. All of these stocks had positive returns in 2020.

Video: Top 5 Stocks Among Hedge Funds

At Insider Monkey we scour multiple sources to uncover the next great investment idea. For example, Federal Reserve has been creating trillions of dollars electronically to keep the interest rates near zero. We believe this will lead to inflation and boost real estate prices. So, we recommended this real estate stock to our monthly premium newsletter subscribers. We go through lists like the 10 most profitable companies in the world to pick the best large-cap stocks to buy. Even though we recommend positions in only a tiny fraction of the companies we analyze, we check out as many stocks as we can. We read hedge fund investor letters and listen to stock pitches at hedge fund conferences. You can subscribe to our free enewsletter below to receive our stories in your inbox:

Disclosure: None. This article is originally published at Insider Monkey.