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Thursday, June 18, 2015 5:42 PM ET
Finally over $50B, First Republic grows wealth management through deal
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First Republic Bank's latest wealth management acquisition offers the company a more attractive and higher-earning asset base in the wake of the bank's first quarter above $50 billion in assets.

First Republic's First Republic Investment Management Inc. announced it would acquire Constellation Wealth Advisors LLC for approximately $115 million. Constellation had wealth management assets of $6.1 billion as of March 31. The six partners at the firm signed long-term employment contracts as part of the deal. The acquisition is expected to be modestly accretive to earnings in 2015 and close in the third quarter.

The deal is a "win-win" for First Republic, which can grow the steady fee income from the wealth management stream and take advantage of cross-selling opportunities to Constellation's existing customer base, said FBR Capital Markets managing director Paul Miller. The transaction was valued at 25.4x earnings and had a price to assets under management of 2.68%. Although Miller said the valuation seemed "a little bit expensive," the bank has excess amounts of capital and a stock that he pointed out trades at 227.0% of tangible book.

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In addition to the fee income, wealth management acquisitions are attractive to banks because they feature low-risk weightings and loyal clients. First Republic is in an opportunistic position to make acquisitions, but has also been successful at growing the business line organically, said Sean Stannard-Stockton, president and CIO of Ensemble Capital Management. Ensemble Capital had about 257,000 shares in First Republic, valued around $16.3 million, according to SNL's institutional ownership data. He said while there were scant disclosures around Constellation's financials, the price seemed reasonable. He added that Constellation has offices in Menlo Park, where many of First Republic's customers reside. The Constellation deal is the bank's second since 2012, when it purchased Luminous Capital Holdings LLC, which had an announced price to assets under management of 2.27%.

Wealth management remains an attractive business line for many banks. The noninterest income streams have only grown in importance in the wake of muted demand for loans, although Miller pointed out that First Republic competitors such as money centers Wells Fargo & Co. and JPMorgan Chase & Co. have also tried to grow their wealth management arms in recent years. The success and reception of this deal, as well as its strategic fit into the company, means there could be more in store.

"[First Republic is] a good bank … and I wouldn't be shocked if you see them do something very similar in the next couple of months," Miller said.

The deal is in line with First Republic's desire to gain scale in the wealth management space, wrote Evercore analyst John Pancari in a June 18 report. The business line is "still a relatively small" contributor to the top line at the bank, accounting for about 9% of First Republic's revenue in 2014. He believes the Constellation deal could push wealth management revenue up to 11% to 12%, underlining the importance of acquisitions in increasing scale.

The fact that First Republic is doing deals also dampens industry rumors that the bank could be in play, he added. First Republic had been the target of speculation following the City National Corp./Royal Bank of Canada deal. The Wall Street Journal reported that RBC had expressed interest in First Republic, and it was rumored that other Canadian banks could have similar intentions. Pancari noted that the bank's stock has outperformed peers by 640 basis points since the announcement, but this deal could indicate management's commitment to remaining independent.

"In our view, the Constellation acquisition represents First Republic's continued efforts to refine its business model, and more important, likely removes speculation that [First Republic] is a seller" in the near term, he wrote.

The acquisition comes as First Republic closes its first quarter above $50 billion in assets, making it subject to heightened regulatory scrutiny. The bank announced in the second quarter of 2014 that it would book unexpectedly high expenses associated with the regulatory build, which would increase its efficiency ratio to a range of 59% to 62%. Since then, management has worked to control costs and bring the ratio down.

"The market in our opinion dramatically overacted to the downside. The stock was down toward $47 and it's $64 today. We thought it was a tremendous bargain at that time," Stannard-Stockton said. "And we think that the company is doing all the right things to grow. The regulatory costs going along with that is part of the cost of being a large bank. They are the first bank to cross the $50 billion threshold organically, and we think they have a tremendous long-term growth runway."

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Salman KHAN contributed to this article.

Article amended at 2:24 p.m. ET on June 19, 2015, to add a chart displaying acquisitions of wealth management firms by banks.
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