Republic National Bank/HSBC: A US stepping stone for HSBC

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Two months ago, Stephen Saali had plans. The bank of which he is president, Republic New York Corporation, had been through a rough six months. Republic, which is ultra-conservative in its approach and proud of it, had tarnished its image with a $200 million loss betting on Russian treasury GKOs during the Russian crisis, and reported a third-quarter loss as a result.

According to Saali, who is 34, there were two main reasons for getting into Russia. "We've always been primarily a private-banking institution, but we have over the years added businesses to diversify somewhat, as well as to improve returns. Getting into the Russian GKO market was part of that."

But by April that painful episode was history. Republic's share price had soared into the $60-plus range, way above its low of $36 last September, a new management team was in place, and a restructuring plan to focus on its core businesses and increase returns had been announced two months before. The bank had announced the closure of its section 20 securities and derivatives trading arm. Plans were announced to reduce expenses by $67 million, 560 jobs (7% of the workforce) would be cut, and a greater integration of domestic and international private banking activities with a more streamlined management structure would bring in more savings.

Two weeks later the bank announced it was to be bought by HSBC for $72 a share. Its sister arm in Europe, Safra Private Bank, is included in the sale (Republic owned 49% already), making the total price $10.3 billion, the most ever paid for a US bank by a non-US institution. "We had talked with them over a period of two months or so beforehand," says Saali. "But the idea died down. Then it took off again, and was concluded within three weeks." The advisers for each party - Merrill Lynch and JP Morgan for HSBC, Goldman Sachs for Republic - offered little more than fair-value assessments. Although he won't say who the other bidders were, Saali admits that he and fellow executives discussed a merger or a sale with several institutions. But the rapid sale will have caused some disappointment and internal investigations at other potential acquirers, such as UBS.

What exactly has HSBC bought? After its strategic review, Republic decided to concentrate on four areas. The first is private banking, its core business since being founded in 1966, with $56 billion of assets under management (Safra manages $33 billion, Republic $23 billion) which is growing around 15% a year. Republic is the third-largest retail bank in New York, behind Chase and Citibank. Saali describes the growth of this part of the business as "somewhat opportunistic, but it fitted in well with our aim to diversify". It has expanded over the years mainly by acquisition, has 750,000 customers, but not much growth potential on its own. Making this operation efficient has been management's focus - Republic has acquired over 160 branches since 1987, yet has just 83 open now. Added to Marine Midland's branches, the combined entity will have 450 branches, with only 20 earmarked for closing.

Republic has a strong lending business, specializing in apparel electronics and real estate (it has over $4 billion in loans for the latter), as well as providing revolving credit to major corporates, and liquidity to major Wall Street firms. A strong treasury operation and a presence in precious metals as a market-maker, in foreign exchange and banknotes completes the major businesses that Republic pursues. On a net income basis, last year private banking and retail banking each contributed 25%, lending and treasury 20%, and most of the rest came from global markets (precious metals, foreign exchange and banknotes).

But analysts criticize Republic for excessive conservatism: "Management seemed to believe that clients were best served by the ultimate in security," writes Brad Ball, money centre bank analyst at CSFB. "[That is] exemplified by an above-average tier one capital ratio (14% versus an industry average of 8%)." Over a five-year period, Republic has an average return on equity of 13% (below that of its peers), average earnings per share growth of under 10%, and investment returns of just one-third of the S&P500. Before the merger, Saali was sanguine on this point. "We think that the capital ratio is important to our private-banking clients. Wall Street probably wants to see that decrease, but there's been no big push to get us to do so." As for the return on equity, last year's strategic review puts the onus on each business unit. "All have been given the same ROE hurdle of 15%. Banking simply can't yield 20% or more ROE on a sustainable basis. It's too much of a commoditized business."

Republic has also put a lot of effort into serving its customers. "You won't get voicemail, or a 1-800 number here," says Saali. "If you phone in, you'll get someone who will help you to deal with your enquiry. We pride ourselves on spending more time on, and charging that little bit extra for, customer service. We've benefited from all the other mergers, as people don't always like to be part of a huge machine."

But isn't that what will happen at HSBC, one of the world's largest banks? Not according to Saali. "The overlap on revenues isn't that great, and we saw in this a great deal for our clients as well as our shareholders. For us, client service and client focus is foremost. I doubt we'll have total autonomy, but HSBC recognizes our strengths. That's why they bought us."

Nonetheless, the relatively poor share-price performance helps explain the price HSBC paid. The price of $10.3 billion values Republic at 2.5 times book, while many of its peers are trading between three and four times book. Yet it still surprised some, no doubt because they are more accustomed to seeing HSBC buy troubled banks on the cheap, But HSBC has been muttering recently about its relatively meagre US presence and is planning to list on the New York Stock Exchange later this year. A quick injection of US earnings from a well-known and respected name could help that. But it hardly gives it a major foothold in the US - most of the private banking assets Republic manages are sourced outside the US ($10 billion).

For HSBC the acquisition of Republic National Bank can be little more than a stepping stone if it truly has ambitions to grow in the US. For Republic, the deal secures a greater degree of independence than it might have enjoyed in other link-ups (the four main executives are to stay in their present roles), and access to a much larger network. "They have offices in 79 countries, we have clients in 80, so we'll be able to offer them a much broader array of services and products," says Saali.

Whether that will fit in well with Republic's conservative tradition remains to be seen. The first test will no doubt revolve around the brand name. Once the deal is completed - probably by the end of the year - Republic will be one of the few HSBC units not to carry the company name, after recent re-branding.

A senior HSBC executive admits the bank must tread carefully with Republic. "There is a big difference between re-branding a bank that has failed and changing the name of a bank that has been as successful as Republic New York Corp. If it becomes clear that the Republic name is very important to its customers then you might see HSBC Republic."

The Republic acquisition doubles the size of HSBC's private banking around the world, a department it has acknowledged to be weak.

The question now is whether HSBC can lead its wealthier retail clients from around Asia, Middle East and Latin America to entrust their wealth to Republic. Analysts at Salomon Smith Barney point out: "When HSBC acquired Midland Bank in 1992, the claim that Midland would benefit from HSBC's global network was met with scepticism. Seven years later, it is apparent that Midland has benefited enormously from HSBC's network and scale, most obviously in the commercial and wholesale banking markets." Private banking is a different business, but HSBC has at least pulled the trick off once.

At $10.3 billion, the deal marks the largest acquisition of an American bank by a foreign group, but there has been no hint of any regulatory obstacle so far. And HSBC sounded out the US authorities early in the process. Financing for the deal was also smooth. HSBC completed an equity placement inside eight hours on the day the acquisition was announced, raising $3 billion without denting its stock price.

But it will take a little longer for the deal to be declared a success. HSBC aims to take out $450 million of annual pre-tax costs, mainly through back-office integration and by the introduction of HSBC benchmarks. Republic New York Corp's cost-income ratio has risen form 58% in 1996 to 70% last year, while HSBC Americas saw its cost income ratio fall from 52% in 1996 to 50% last year.Antony Currie