Loan growth at First Republic is robust. Can deposits keep up?

First Republic Bank is wondering if deposits, which offer a low-cost way to fund its flagship mortgage business, can keep pace with its meteoric loan growth.

The San Francisco bank reported $22 billion in loans in the second quarter, up 31% from the same period a year ago. Single-family mortgages accounted for almost half of new loans.

Deposits also increased, but at a somewhat slower pace. First Republic reported $165.6 billion in deposits at the end of the quarter, up 23% from the same period a year earlier.

The bank’s results suggest “loans will outpace deposits,” said Terry McEvoy, an analyst at investment bank Stephens.

He said relying more on higher-cost funding sources would lead to lower net interest margins. Still, McEvoy said he expects First Republic revenues to grow at a rate “outpacing that of the banking industry.”

Meanwhile, First Republic CEO Mike Roffler said Thursday certificates of deposit are expected to “rise” after falling for two years amid low interest rates.

He described using CDs to fund loans as a “proven strategy” and said the First Republic had “plenty of room and capacity” to draw more cash from the federal home loan system.

Roffler also explained the discrepancy between loan growth and deposit growth by highlighting seasonal factors. He said the bank tends to have higher loan growth in the first half of the year, even though its deposits are typically staggered around tax season.

First Republic, which has $198 billion in assets, reported accelerating growth in its mortgage business during the second quarter, even as the broader U.S. mortgage market began to show signs of weakness amid the backdrop. interest rate hikes by the Federal Reserve.

The bank’s mortgage customers averaged loans of about $1 million last year, which is higher than the average balance of many other mortgage lenders.

Mortgages are part of the “strength of our business model,” Roffler said during the bank’s quarterly earnings call.

Roffler said he expects filings to pick up later this year as First Republic’s strategy of integrating new borrowers into other parts of its business continues to unfold.

“The fundamental element is the growth of households and relationships,” President James Herbert, who founded the First Republic in 1985, said on the call. “That ultimately results in deposits.”

First Republic leaders told analysts the bank was in a “position of strength”, with deposits currently covering more than 90% of its funding needs.

The bank is on course to end the year in the upper half of its expected net interest margin range of 2.65% to 2.75%, according to chief accounting officer Olga Tsokova. During the second quarter, the bank recorded a net interest margin of 2.8%.

Total revenue jumped 22.6% year-over-year to $1.5 billion, while non-interest expenses climbed 19.7% as First Republic announced the opening of new office in Seattle, new hires and increased compensation.

Net income increased 16% from the second quarter of 2021 to $433 million. Earnings of $2.16 per share beat an average of $2.09 from analysts’ estimates polled by FactSet Research Systems.

Mortgages and customer relationships are the “bread and butter” of how First Republic has done business over the years, said Janney Montgomery Scott analyst Tim Coffey.

But going into an economic downturn “puts the focus on bringing new customers to the bank, if they want to grow their bottom line,” Coffey said in an interview.

“Things happen during recessions,” he said. “Businesses are under unforeseen stress. But on a relative basis to their assets and their loan portfolio, I don’t think it will be significant.

First Republic shares rose 1.78% to $150.98 on Thursday.

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