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This Under-the-Radar Bank Stock Is a Hidden Buy in Today's Stock Market

By Dave Kovaleski – Apr 18, 2020 at 8:00AM

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First Republic Bank had a solid first quarter and has good long-term returns.

Given the disruption caused by the coronavirus pandemic, figuring out which companies to invest in may carry an even higher degree of difficulty these days, particularly with the likelihood of a recession in the near future.

There are many large blue chips with solid fundamentals that have weathered corrections in the past and are built for the long haul. But if you're looking for an under-the-radar stock that is outperforming now and also looks good for the future, consider First Republic Bank (FRC -1.70%).

Outperforming in the sell-off -- and beyond

First Republic, based in San Francisco, is a bank and wealth management firm with 79 branch locations, most of them in California. In addition to consumer banking, it offers business banking, and private wealth management through its subsidiaries First Republic Investment Management, First Republic Trust, and First Republic Securities. The company has $123.9 billion in banking assets and $137.9 billion in private wealth assets. 

A hawk flying low

Image source: Getty Images.

This has been a difficult period for banks, but First Republic has weathered it well and has posted great long-term returns. The stock is down about 18% this year through April 15. That trails the S&P 500 -- but it outperforms the financial sector, which is down 26% through April 15, and the banking industry, which is down 36% year to date. 

Through April 15, First Republic has a five-year annualized return of around 11%, which beats the S&P 500 -- up 6% on an annualized basis -- as well as the overall financial sector.

Beat earnings estimates in Q1

A testimony to First Republic's strength is the fact that it easily beat earnings estimates in the first quarter. The company had net income of $218.7 million, down 3.5% from the first quarter of 2019. Earnings per share was $1.20, down 4.8% year over year but well ahead of the $0.92 consensus estimates by Wall Street analysts.

Net interest income -- including $48 million for provision of credit losses related to the COVID-19 pandemic, which was up from $14 million a year ago -- was still was up about 6.5% year over year to $704 million. The company had strong gains in both loans and deposits. 

"Credit quality, capital strength, and liquidity remained strong," First Republic CFO Mike Roffler said in a statement. "Loans and deposits grew nicely, and we're pleased with 11.4% growth in net interest income and a stable net interest margin."

Overall, noninterest expenses rose 13.6% to $596 million for the quarter, resulting in a drag on earnings. The expense hike came from increases in salaries and benefits and occupancy expenses related to expansion of the franchise and unfunded loan commitments. The efficiency ratio, a key operational metric (lower is better), remained flat at 65.1% for the quarter, nearly identical to the 65% ratio after the first quarter of 2019. The common equity tier 1 ratio, which shows us a bank's capital strength, was 9.87%, down slightly from 10.5% the previous year.

Investors will also be glad to know that First Republic increased its dividend for the seventh straight year, raising the quarterly cash dividend to $0.20 per share from $0.19.

Why this stock will continue to beat the market

While the next couple of quarters may be bumpy, First Republic is in a stronger position than most banks and should continue to be a good long-term investment -- as it has been. One reason is its high credit quality and low loan-to-value (LTV) ratio. The weighted loan-to-value ratio is 58% percent for single-family residential loans, 52% for multi-family loans, and 48% for commercial real estate loans. The higher the LTV, the more risk to the lender. 

"We have very limited exposure to many of the areas directly impacted by the pandemic, such as retail and hotels. These areas collectively represent less than 2.5% of our portfolio," founder, Chairman, and CEO James Herbert said on the first-quarter earnings call. "We do not have automobile loans, credit card loans. We do not lend to oil and gas companies, casinos, airlines, or most other travel-related businesses." This should result in lower estimated credit losses -- as was evidenced in Q1.

Another reason is its customer service, which scored twice the industry average in 2019. "In times like these, exceptional client service is even more important and creates stronger bonds with our clients. I would also note that knowing our clients very well, for an extended period of time in many cases, improves credit quality and reduces risk," Herbert said.

The company also recently completed major upgrades to its technology and operations, which allows it to provide customers with a better digital banking experience to keep up with the high volume of loan applications.

The stock price has come down and is trading at about 18 times trailing earnings and 1.9 times tangible book value per share. This is one bank stock that should be on your radar as the market begins to recover from the effects of the coronavirus.

Dave Kovaleski has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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