The banking sector has been hammered this year, but you wouldn't know it if you looked at First Republic Bank (NYSE:FRC). Its stock was trading at roughly 233% of book value at Friday's close, and it's up 11.5% year to date. First Republic recently reported record quarterly earnings of more than $293 million, up close to 25% from the third quarter of 2019.

The question is: Can the bank's stock keep climbing at such a high valuation? I believe the answer to that question is a resounding yes. Here's why.

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A terrific franchise

When you look at First Republic, it has all of the makings of a strong bank franchise. Like most banks, it has seen deposits flood in over the past year, with total deposits up nearly 22% in the third quarter over the same period in 2019. Roughly 47% of that gain came from non-interest bearing deposits -- the best type of deposits a bank can have because they don't cost anything and are usually sticky. Noninterest-bearing deposits made up nearly 40% of First Republic's total deposits, and the bank's cost of deposits sat at 0.21% at the end of the third quarter.

But what has set First Republic apart from its peers is that it is actually finding ways to deploy these deposits into assets that earn some decent yield in this low-rate environment. Its loan-to-deposit (LTD) ratio at the end of third quarter was about 100%, meaning its loan growth has kept up with its deposit growth. As a result, the bank saw higher net interest income in the third quarter, and the bank's net interest margin (NIM) -- the difference between what it pays for interest-bearing liabilities such as deposits and makes on interest-earning assets such as loans -- actually grew by 1 basis point (0.01%) between the second and third quarters. Rising NIMs, net interest income, and high LTD ratios are rare among banks right now, as loan demand has not been nearly as strong as it normally is when rates are this low.

That's important because the low-rate environment has resulted in low yields on securities that banks might put their excess deposits into, such as U.S. Treasury bills or mortgage-backed securities. Most of First Republic's loan growth has been in the residential real estate loan portfolio, growing total residential volume more than $4 billion in the third quarter and about $8.7 billion in 2020. The residential portfolio had an annualized yield of 2.96% in the third quarter, which is down from the second quarter but still a good deal higher than most yields on securities right now.

A lot of banks like to talk about how they have the best customer service and retention, but First Republic's really speaks for itself. Between 2015 and the end of 2019, the bank sourced 88% of its loan originations from existing customers and client referrals. It also loses very few of its checking deposit customers, with a 2% annual attrition rate, compared to an 8% attrition rate for the industry as a whole.

Superb credit

First Republic also excels when it comes to credit quality. Since 2000, the bank has averaged a mere 0.05% annual rate of charge-offs (debt unlikely to be collected), compared to 0.38% on average at the top 50 U.S. banks. Net charge-offs at the end of the third quarter represented 0.01% of the bank's total loan book, while nonperforming assets, those that have not received payments for an extended period of time (likely 90-plus days), equated to only 0.12% of the total loan book.

First Republic excels in credit quality because it lends to high-net-worth borrowers who carry little risk. The bank defines those as households with at least $1 million in investable assets. With borrowers that make lots of money, the bank is able to extract large down payments on loans.

For instance, the median loan-to-value (LTV) ratio in First Republic's residential portfolio is 60%. LTVs represent the amount being borrowed in the loan, meaning the lower the LTV, the safer the loan. A 60% LTV likely means the borrower put down a 40% downpayment. The median LTV in First Republic's multifamily loan book and commercial real estate loan book is 54% and 45%, respectively. So, even though First Republic has originated loans in some sectors and some geographies that have been heavily impacted by the coronavirus pandemic, these loans are less risky because of all the equity the borrower has already put into the loan to begin with. 

Standing out with room to run

While the banking sector has struggled this year, First Republic is one of those niche players that really stand out when you consider its deposit franchise, credit quality, ability to safely grow its loan book, and service model, which has resulted in excellent customer retention and satisfaction.

Furthermore, there is plenty of room for the bank to improve. Of high-net-worth households in the U.S., First Republic estimates that it only controls a 4.21% market share. The bank's efficiency ratio, a measure of its expenses expressed as a percentage of revenue, is also toward the higher end, with management expecting it to come in around 62.5% for the full year. If the bank can keep doing what it's doing and improve on these metrics, there is significant growth left for the stock.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.