Interest-only home loans are viewed as somewhat risky by the Consumer Financial Protection Bureau, but that is unlikely to stop First Republic Bank from making them.

The San Francisco bank caters largely to wealthy households — it recently made a home loan to Facebook founder Mark Zuckerberg — and Chairman and Chief Executive James Herbert says many of its clients prefer interest-only loans because much of their income comes from bonuses, not salaries.

Interest-only mortgages make up about 40% of its home loans, and if the $34.4 billion-asset bank were to eliminate them it could risk losing some of that business.

"This is a product of the clients' design," Herbert said at investor conference in Miami Tuesday. "The interest-only loan is a good one for someone who has an unpredictable income stream."

Under new rules proposed by the CFPB, an interest-only loan would not pass muster as a "qualified mortgage" because it has characteristics that the CFPB sees as risky.

Without that government seal of approval, such loans could become less attractive to investors and, in turn, banks could be reluctant to make them. Lenders are also concerned that they could be more susceptible to lawsuits if certain loans they originate fall outside of the qualified-mortgage definition.

Banks claimed for years that many high-net-worth borrowers preferred interest-only payments, but during the housing bubble many banks extended such loans to borrowers who clearly did not demonstrate an ability to repay the loan.

First Republic, though, has suffered few defaults largely because its clients are so affluent. The average size of its mortgage loans is $933,000 and the average net worth of its borrowers is $14.2 million.

In his presentation at the conference hosted by Credit Suisse, Herbert said he believes regulators "made a mistake" by lumping interest-only mortgages in with subprime loans when it drafted the new lending standards.

He added that since the proposal came out last month First Republic has sold interest-only loans on the secondary market and that he noticed no drop-off in pricing.

Looking ahead, he believes that First Republic might be well positioned to pick up more market share because other banks might opt to stop making such loans.

"I'm cautiously optimistic," Herbert said.

During a question-and-answer session with analysts and investors, Herbert seemed more concerned about the impact of California's new tax law on First Republic's wealthy client base. (Nearly 70% of the bank's loans are in California.)

The law that was approved by voters late last year raised the state tax rate on income of more than $1 million from 10.3% to 13.3%, and that hike has raised concerns that some of the state's wealthier residents would flee to more tax-friendly states.

Herbert said that the tax increase is a serious issue but that it is too soon to tell if a 3-percentage-point jump is enough to cause families to leave the state — or if First Republic should follow them. The bulk of the bank's branches are in wealthy, urban markets in California and the Northeast, but Herbert said he would consider setting up shop in other affluent markets if he sees enough demand.

Just last week, First Republic opened its first Florida office, in Palm Beach, because many of its clients have relocated there from higher-tax states.

One area where First Republic is unlikely to open an office is Washington, D.C. Asked why the bank does not have a presence in a region where income levels are among the highest in the country, Herbert said D.C. has too much turnover and too few entrepreneurs for his liking.

"That's not necessarily the best place for us," he said.

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.