First Republic Planting The Seeds For A Later Harvest

It may be an exaggeration to say that 2023 is a lost year for First Republic (NYSE:FRC), particularly in mid January, but I don’t think it’s an exaggeration to say that the results this bank will post this year will not be representative of the real long-term earnings power of the business. First Republic is going to take a hit from much higher funding costs, but the bank is willing to pay that short-term cost to reap the long-term benefits of continuing to build a base of high net-worth customers that can continue to support above-average loan growth and profitability over the longer term.

First Republic shares have done pretty well in the brief time since my last update, climbing more than 12% in the last six weeks and outperforming peers (particularly smaller regional banks). The call on this stock is a fair bit more challenging today – while I think the shares are undervalued for investors looking for a long-term buy-and-hold name, I do think there's a better-than-average chance of another chance to buy at more attractive levels this year, particularly if the Fed maintains a harder line on rates through the end of the year.

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First Republic Planting The Seeds For A Later Harvest

First Republic Executing Well And Still Undervalued

There's little question that while banks are clearly benefiting from a combination of healthy loan demand and higher rates, the market is already pricing in the risk of a hard landing (recession) and a swift end to the good times. With First Republic (NYSE:FRC) previously taking a hit on uncertainties related to succession planning and continuing to perform well on a core basis, this fast-growing bank has once again emerged from the pack - solidly outperforming the broader bank sector and slightly outperforming the S&P 500 since my last update.

At this point I continue to like First Republic, but I can't say it's one of the cheaper names out there. There is a risk that First Republic's lower asset sensitivity will lead to underperformance relative to other Main Street banks, but then First Republic could be a way to play a scenario where the Fed is less aggressive on rates, particularly with its strong organic loan growth capabilities. I can't call First Republic my favorite name at this point, but I do see an argument for owning a bank that has a differentiated culture and growth profile at a comparatively reasonable valuation.

 

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First Republic Executing Well And Still Undervalued

A Rare Opportunity At First Republic

 

One of my frequent sayings here on Seeking Alpha is that “buy the dip” is a great strategy complicated by the fact that the best businesses typically only see meaningful dips when something scary is happening. Such is the case with First Republic (FRC) – while the shares of what I believe to be one of the best-run banks out there are typically exceptionally expensive, the stock has pulled back meaningfully on worries related to unexpected management turnover.

I don’t believe the turnover is a sign of anything fundamentally wrong at First Republic, and I believe the board understands the basic idea of “if it’s not broken, don’t break it” when it comes to finding a new co-CEO candidate. Still, the risk of something more significant going on cannot be completely dismissed, and management turnover always carries the risk that new managers will, in fact, “break it”. Growth expectations are hardly low here, but if First Republic can generate double-digit long-term core earnings growth, the shares are definitely worth a look on this pullback.

 

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A Rare Opportunity At First Republic

First Republic Remains A Top-Notch Growth Bank Stock

 

When the biggest bearish argument you can come up with is "I'm not sure how long the bank can continue to grow earnings at a double-digit clip", you know you're looking at a pretty good bank. Such is the case with First Republic (FRC), and I continue to believe this high net worth-focused lender as a long run of exceptional growth ahead of it, as the company continues to benefit from a strong networking effect and very strong underwriting.

Valuation is difficult. By conventional approaches, First Republic looks quite expensive, but then this is not a conventional bank. While metrics like ROTCE can help separate winners and losers when growth rates are similar, First Republic's growth is well beyond "exceptional" and conventional metrics just don't work as well here. Bank investors have historically been willing to pay robust premiums for banks with outsized revenue, earnings, and tangible book growth, and I believe First Republic is well-placed to continue doing just that.

 

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First Republic Remains A Top-Notch Growth Bank Stock

Higher Expectations Make First Republic's Loan Growth Even More Important

Although First Republic (FRC) has reminded a standout performer in the banking sector over the last year, the share price appreciation slowed a bit relative to the broader regional bank space over the last three months as investors became more bullish on the sector's recovery prospects in 2021 and First Republic's growth was less of a standout opportunity.

First Republic's valuation has rarely ever stood out as a bargain, but that hasn't held back the share price appreciation as the bank has continued to post exceptional growth (double-digit CAGR for both loans and pre-provision profits over the past decade). I'm not in the "ignore the valuation and just buy" camp, but I do believe the odds favor First Republic once again beating its initial guidance for the year, and with this bank still poised to be a growth outperformer, I don't think the valuation premium is at immediate risk.

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Higher Expectations Make First Republic's Loan Growth Even More Important

First Republic's Differentiated Model Continues To Stand Out During Challenging Times

Business models matter in banking, and First Republic (FRC) is different in all the right ways. Underpinned by a focus on high-net-worth individuals and disciplined underwriting (low LTVs, long-term customer relationships, et al), First Republic has not only continued to produce far below average credit losses, but also strong spread lending growth in a time of effectively zero rates and weak loan demand.

If you bought in with my April piece on First Republic, you're sitting on a roughly 30% gain that is not only ahead of the banking sector, but comfortably ahead of the S&P 500 as well. With that outperformance, the "easy" undervaluation is gone, but I continue to be impressed by First Republic's loan pipeline growth and the company's methodical approach to gaining share in a still under-penetrated metro-centered HNW market. First Republic's model doesn't require a lot of branches, and its customers tend to come back again and again (to grow their businesses). I don't find the valuation as compelling now as before, but the prospective total return is still in the double-digits (barely), and I wouldn't be in a hurry to sell out of this position.

 

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First Republic's Differentiated Model Continues To Stand Out During Challenging Times

First Republic Once Again Shows It's Different In All The Right Ways

The argument for owning First Republic (FRC), a bank that has often appeared to trade at robust (if not excessive) multiples, has long been that it’s a different sort of bank. Skeptical veteran investors can be forgiven for shaking their head at the “it’s different this time” argument, but First Republic continues to make the case that it really is a different sort of bank – one that can navigate this unexpected pandemic-driven recession better than the vast majority of its peers.

I liked First Republic after first quarter earnings, and the shares have risen about 16% since then – better than the average regional bank, but only a little better than the S&P 500. While that move has shrunk some of the undervaluation I saw, the shares do still look undervalued and I believe the long-term expected return here is pretty attractive, particularly if you believe that multiples can re-inflate somewhere down the road when investors return to the banking sector.

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First Republic Once Again Shows It's Different In All The Right Ways

First Republic Shows How It Really May Be Different

One quarter doesn’t make a story, but First Republic’s (FRC) first quarter results certainly don’t hurt the argument that First Republic’s much higher than normal valuation is underpinned by a differentiated business model that can outperform in all seasons. Again, this is just one quarter and there are certainly plenty of risks in front of First Republic, but it’s hard not be impressed today.

When I last wrote about First Republic, one of my bullet points was that it was going to take a much weaker macro environment to push the shares to a “meaningfully cheap” level … and here we are. First Republic has already rebounded strongly from what may be the point of peak pessimism (the third week of March), but if low-to-mid teens long-term core earnings growth is still a valid assumption, these shares are undervalued now.

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First Republic Shows How It Really May Be Different

Robust Loan Growth Continues To Feed The First Republic Growth Machine

Understanding what a business does well and not messing that up in the pursuit of even more growth is an underappreciated business talent, but First Republic (FRC) has that going for it with its management team. While management often fields questions from investors about building or buying its way into new markets, continuing to drive market share growth within its core high net worth (or HNW) market in California, New York City, and Boston continues to drive exceptional performance for this specialized bank.

The biggest challenge for First Republic may be funding its loan growth, but so long as the market is willing to keep paying a premium for the shares, equity raises make sense. While the HNW market is likely not as bulletproof as the bulls want to believe (let’s see what happens in the next real tech stock washout…), I have no problem assuming that First Republic will generate double-digit loan and core earnings growth for a long time to come (at least on an annualized basis). Valuation isn’t as extreme as relative comparisons may seem (there really aren’t many, if any, truly fair comparables), but if loan growth slows, the multiple will definitely be at risk.

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Robust Loan Growth Continues To Feed The First Republic Growth Machine