Mortgage development at First Republic is powerful. Can deposits maintain tempo?

First Republic Bank is facing questions about whether deposits, which offer a low-cost way to fund its flagship mortgage business, can keep pace with its torrid loan growth.

The San Francisco bank reported $22 billion in loan originations during the second quarter, a 31% increase from the same period a year ago. Single-family mortgages accounted for nearly half of the 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 that “loans will outpace deposits,” said Terry McEvoy, an analyst at the investment bank Stephens.

He said that relying more heavily on higher-cost sources of funding will lead to lower net interest margins. Still, McEvoy said that he expects First Republic’s revenue to climb at a rate “in excess of the banking industry.”

Meanwhile, First Republic CEO Mike Roffler said Thursday that certificates of deposits are likely to “tick up” after declining for two years amid low interest rates.

He described using CDs to fund loans as a “tried-and-true strategy,” and said First Republic has “plenty of room and capacity” to draw more liquidity from the Federal Home Loan Bank System.

Roffler also explained the gap between loan growth and deposit growth by pointing to seasonal factors. He said the bank tends to have higher loan growth in the first half of the year, even as its deposits typically lag around tax season.

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

The bank’s mortgage clients averaged loans of around $1 million last year, which is larger than the average balance at many other mortgage lenders.

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

Roffler said he expects deposits to pick up later this year as First Republic’s strategy of wrapping new borrowers into other parts of its business continues to play out.

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

First Republic executives told analysts that the bank is in a “position of strength,” with deposits currently supporting over 90% of its funding needs.

The bank is on pace to finish the year in the top half of its forecasted net interest margin range of 2.65% to 2.75%, according to Chief Accounting Officer Olga Tsokova. During the second quarter, the bank reported a net interest margin of 2.8%.

Total revenue jumped 22.6% year over year to $1.5 billion, while noninterest expenses climbed 19.7% as First Republic reported the opening of a new Seattle office, new hires and increased compensation.

Net income rose by 16% from the second quarter of 2021 to $433 million. Earnings per share of $2.16 exceeded a $2.09 average of estimates from analysts surveyed by FactSet Research Systems.

Mortgage lending and client relationships are the “bread and butter” of how First Republic has done business over the years, said Tim Coffey, an analyst at Janney Montgomery Scott.

But entering an economic downturn “puts an emphasis on bringing new clients to the bank, if they want to increase their bottom line,” Coffey said in an interview.

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

Shares in First Republic rose Thursday by 1.78% to $150.98.

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