$17B gone: The biggest-ever advisory team exit and the bank that lost it

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It’s a historic week in wealth management. No bank, regardless of size, has ever watched anything close to $17 billion in clients assets walk out the door. Given that this misfortune befell a relatively small one, the blow — at first blush — appears especially severe for First Republic Bank.

Nearly 50 members of its wealth management division have left, following the five top advisers on their team. Those $17 billion in client assets are expected to evaporate with them. If it were classed as a breakaway, which typically refers to brokers who bust out of their wirehouse firms, it would be the largest in history.

Equally extraordinary: the largest breakaway hit not Morgan Stanley with its nearly $2.4 trillion in client assets or Wells Fargo with its $1.6 trillion, but First Republic, a bicoastal firm with $140 billion of assets under management. Additionally, only seven years have elapsed since the bank paid a groundbreaking $125 million to the advisers to acquire the RIA, Luminous Capital.

“It is definitely a case study for a bank-RIA acquisition that went wrong,” says Alois Pirker, research director for Aite Group’s wealth management practice.

David DeVoe, a consultant and investment banker, puts it differently: “The pain index is likely somewhere between excruciating and traumatic.”

That $125 million price tag of 2012 — a jaw-dropping sum at a time before M&A in the RIA space began booming — makes it look like First Republic got a raw deal. But that may not be the case.

Viewed over a longer time horizon, the Luminous purchase helped set First Republic on a path of fast growth that, while helped by its wealth management division, has propelled the bank itself to new heights on Wall Street. It also set the stage for its own subsequent wave of sustained and often-large wealth management acquisitions.

Moreover, industrywide, it served as a bellwether for all RIAs. It did so by galvanizing the then barely four-year-old breakaway movement of wirehouse brokers to independence and by grabbing the attention of outside investors, including private equity money, seeking big kills in the RIA space. In other words, a $100 billion-asset bank with offices in a handful of states now has been involved in two landmark deals, one willingly and the other presumably not, with wide implications for all breakaways.

That's according to industry experts, including insiders who were part of First Republic's Luminous acquisition, and its founders' departure from Merrill Lynch. Constrained by confidentiality agreements, some spoke only on condition of anonymity.

Before going independent, David Hou and Mark Sear, the best known of the five Luminous team members, worked for Merrill — First Republic's former owner — when they joined the vanguard of the first breakaways in 2008. The breakaway movement they joined began that year and the next, during and after the economic downturn. After the market crash and the subsequent draining of their employers' coffers, some wirehouse advisers realized they could make more money on their own.

'The pivotal moment'

Four years later, San Francisco-based First Republic electrified the market with its premium for Luminous, which was managing $5.5 billion in assets under management at the time.

"It was the pivotal moment for the industry to say, 'My god, I could leave this big institution to go build this franchise opportunity,' " says investment banker Liz Nesvold, who represented First Republic's side of the buyout through her investment bank, Silver Lane Advisors, now owned by Raymond James’ investment banking division. "There have been some marquee deals, but there are very few that have gotten so much traction so quickly coming out of a big financial institution."

According to recruiter Louis Diamond, who funnels talent to First Republic and many other firms, "It kind of became the template for the reasons why a big wirehouse team would start an RIA, versus taking a big check from Morgan Stanley: Take it out, build it out and sell it to make a ton of money and, in this case, sell it again down the line."

Hou and Sear have formed their second RIA, Evoke Wealth, based in Los Angeles, while their other three partners have started their own, IEQ Capital in Palo Alto, California, as first reported by RIABiz.

As for First Republic, its acquisition of Luminous transformed the way the Street looked at it. “It has been incredibly synergistic for the bank," Nesvold says.

One of First Republic’s paths to growth has been its focus on high-net-worth clients (though its business in low- and middle-income communities is also growing). It first draws them into the wealth management division, then provides banking service to a demographic that, by definition, comes with a multitude of complex financial needs, she says. (First Republic declined to comment on this characterization.)

"There is a correlation between the two," Nesvold says, referring to the banking and wealth management sides of First Republic. "They have been very successful with their clients, cross- selling. I think the average client has something like nine or 10 services and products with First Republic and, so, it's a lot."

(It’s a practice that’s not without peril, at least when practiced by banks like Wells Fargo, which emphasized the goal of selling eight accounts per retail client, a strategy that gave rise to its notorious fake-accounts fraud.)

A year after First Republic bought Luminous, client assets in its wealth management division stood at $41.6 billion in December 2013. That sum more than tripled to $140 billion in assets under management or administration by March of this year, growing between 11% and 35% a year, according to public filings. The bank's stock rose sharply, too, more than quadrupling from $22.87 on Dec. 1, 2010, to $98.51 on Wednesday, better than the S&P 500 Banks index.

It is quite a track record for a venture founded in 1985 as a small thrift that went on to become part of Merrill Lynch, and then Bank of America, after the latter bought the former in 2007. In 2011, First Republic again went independent and restored the brand when two private equity firms — one of whom was led by the bank's founding CEO, Thomas Barrack — bought out half of its assets.

A newly independent First Republic, guided by its growth-minded PE owners and original founder, then landed Luminous two years later and began moving aggressively into wealth management. From $34 billion at the end of 2013, the bank's own assets crossed the $100 billion threshold by March 31.

Those figures are partly correlated to the bank's wealth management assets, Nesvold says.

The timing for a breakaway was right, according to sources. The advisers' contracts with First Republic expired recently, and First Republic remains in the Broker Protocol, which should allow for an easier exit than if the group were quitting a firm that is no longer a signatory. The protocol facilitates the smooth movement of advisers and clients between firms, but has been eroded lately by the exit of large signatories, such as Morgan Stanley. This ups the ante for some advisers interested in moving, but concerned their own employers could follow Morgan's lead and start fighting departures.

The exit "probably is not even an indictment of First Republic," Diamond says, but an opportunity the advisers just couldn’t pass up.

What happens next


With so many top advisers gone, can First Republic maintain growth in its wealth management division?

If the first three months of this year are any indication, it would seem so. In that time it has added $14 billion in assets in management.

Recent acquisitions include its 2015 purchase of AUM Constellation Advisors ($6 billion in assets under management) for $115 million, a deal Nesvold handled, representing the RIA. In April of last year, the bank brought over adviser James Atwood with nearly $5 billion in client assets from Merrill, Diamond says. And just last month, he adds, the bank announced that it landed Arif Ahmed, a Silicon Valley adviser who managed $4 billion for Merrill.

"Over time, they can replace the $17 billion hole," Diamond says.

As for the Luminous team, "They have the opportunity to break back into being business owners and benefit from the economics there," Diamond says, "and sell again in the future."

This article originally appeared in Financial Planning.
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RIAs Broker Protocol Going independent Wealth management First Republic Merrill Lynch