First Republic Bank (FRC): Benefiting from the Secular Trend of Increasing High-Net-Worth Households and a Growing Wealth Management Business

Based in San Francisco, California, First Republic Bank is one of the fastest growing banks in the U.S. small-cap banks universe. It has a strong management team, an attractive high-net worth client base, and it has built a solid reputation for customer service. I expect FRC shares to outperform its peers as it is one of the few banks in the current environment that can meaningfully grow its core earnings.

FRC is well positioned to capitalize on the secular trend of increasing income inequality. The bank has been increasingly successful in growing its wealthy customer base. The number of its high-net-worth households (at least $1.0 million of investable assets) clients increased at an 8-year CAGR of 13% through 2011, and its loans and deposits have each increased at a 10.75 year CAGR of 22% through 3Q13. Moreover, the attractive operating environment for FRC also provides the bank a great opportunity for future growth.

FRC’s attractive business model attracts and retains high-net-worth business clients and cross-sells them its wealth management and banking products and services. While it may sound very simple in theory, in practice, it’s not. In fact, the company’s high levels of client service and strong employee retention trends have proven quite difficult to replicate and effectively differentiate it from its peers. The growth in its business is driven by a number of factors including the above-average growth rate of its high-net-worth clients and positive reviews and referrals from its existing clients. FRC has built a robust wealth management platform and its hiring of additional portfolio managers and relationship managers has also contributed to growth. Finally, opening new locations is also contributing to its growth. FRC is targeting a consistent core ROE in the range of 10-13% and plans to remain a rapidly growing and highly consistent business. Furthermore, I think returns are likely to grow in a higher interest rate environment.

Strong Wealth Management Platform Driving Growth

I think the market doesn’t fully appreciate the growth potential of FRC’s wealth management business. While the bank has long planned to grow its wealth management, it has only recently started expanding it by doubling the number of wealth advisors, hiring portfolio managers, acquiring Luminous Capital to provide access to alternative asset classes, and improving its ability to cross-sell wealth products to existing customers.

Inflows in the company’s wealth management business have been stronger than expected. From 2010 through the 3Q13, net asset inflows totaled $21.3 billion, including approximately $6.0 billion of assets acquired through the Luminous acquisition. Nearly half the growth in assets has come from hiring portfolio managers who have brought over their clients. FRC has a team of roughly 60 portfolio managers that provide customized portfolio management to its wealth management clients. However, now that the platform is largely built, most of the growth should come from cross-selling existing bank clients. As of the 3Q13, wealth management asset balances totaled $38.2 billion.

Now that the company has built a robust wealth management platform, its team of experienced portfolio managers should help sustain the growth. FRC’s recent acquisition of Luminous also provides it with both alternative asset classes as well as more institutionalized knowledge of how to run a successful asset management platform. Helped by the growth from its wealth advisors, who act as facilitators between the relationship managers and portfolio managers, FRC has also substantially improved its ability to cross-sell its wealth management products to its banking clients.

Now that there are fewer distractions from mortgage lending, relationship managers can focus more on the entire client relationship including wealth management. This point is very significant, as previously, due to fall in rates, focus shifted more towards refinancing mortgages than deposit gathering and cross-selling other products. The refinancing volumes are lower now, which allows FRC to focus on other cross-selling opportunities.

Finally, while most of the future growth should come from cross-selling existing bank clients; an increase in new clients should also contribute to the growth. It is important to note that FRC is one of the best growth stories in the banking industry, driving growth through mortgage lending to high-net-worth individuals. Now that FRC has a much stronger wealth management platform and as this growth in new clients continues, cross-selling at the time of client acquisition will be a meaningful driver of new client asset inflows.

Conclusion

First Republic is one of the fastest growing banks among its peers with an attractive high-net-worth client base, strong management team, and a reputation for excellent customer service. It is well positioned to capitalize on the secular growth in high-net-worth households in the U.S. Its coastal, urban, and wealthy markets provide it with ample runway to continue growing its loans at a healthy rate. FRC provides its private banking and wealth management services in markets with high concentrations of wealthy individuals that are growing at a faster pace than the overall economy. I expect FRC to outperform its peers, as it is one of the few banks in the current environment that has the ability to grow its core earnings meaningfully.

FRC’s strong brand and market reputation are key drivers of its growth. The company’s consistent client service has helped it successfully develop a robust banking and wealth management businesses. The majority of its new clients are referred to it by satisfied existing clients. Going forward, FRC’s service culture, strong brand, and customer loyalty should allow it to continue expanding its client base at a high rate. This customer growth will allow FRC to cross-sell its services, and attract and retain high quality employees. I think the market is not fully appreciating the potential of FRC’s wealth management business. The company has been actively building its wealth management platform by hiring experienced professionals the acquisition of Luminous Capital, which provides it with both alternative asset classes as well as more institutionalized knowledge of how to run a successful asset management platform.

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