Boston Private Financial Holdings, Inc.
Q2 2018 Earnings Call Transcript

Published: 19 Jul 2018

[Operator:]

Good morning and welcome to the Boston Private Financial Holdings Q2 2018 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions]. After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions]. Please note this event is being recorded. And now, I would like to turn the conference over to Adam Bromley. Please go ahead, sir.

[Adam Bromley:]

Thank you, Keith, and good morning, everyone. This is Adam Bromley, Director of Investor Relations at Boston Private Financial Holdings. We welcome you to this conference call to discuss our second quarter 2018 earnings. Our call this morning includes references to an earnings presentation, which can be found in the Investor Relations section of our website bostonprivate.com. Joining me this morning are Clay Deutsch, Chief Executive Officer; and Steve Gaven, Chief Financial Officer. This call contains forward-looking statements regarding strategic objectives and expectations for future results of operations and financial prospects. They are based upon the current belief and expectations of Boston Private’s management and are subject to certain risks and uncertainties. Actual results may differ from those set forth in the forward-looking statements. I refer you also to the forward-looking statements qualifier contained in our earnings release, which identified a number of factors that could cause material differences between actual and anticipated results or other expectations expressed. Additional factors that could cause Boston Private’s results to differ materially from those described in the forward-looking statements can be found in the company’s filings submitted to the SEC. All subsequent written and oral forward-looking statements attributable to Boston Private or any person acting on our behalf are expressly qualified by these cautionary statements. Boston Private does not undertake any obligation to update any forward-looking statements to reflect circumstances or events that occur after the forward-looking statements are made. With that, I will now turn it over to Clay Deutsch.

[Clay Deutsch:]

Thank you, Adam. Thank you for joining the call this morning. In the second quarter our company generated reported GAAP net income of $6.4 million or $0.06 per share. As you saw in the press release, our second quarter GAAP results were heavily influenced by $12.7 million tax charge related to the divestiture of Anchor Capital which we completed in April of 2018. You will recall that we estimated this charge to be $11 million to $12 million during the previous earnings call. Despite this charge, the Anchor divestiture created economic value for our company in the form of an ongoing cash flow stream and capital flexibility. Additionally, we utilized proceeds to help fund the redemption of $50 million of preferred shares in order to benefit common shareholders in future periods. Looking through to our core operating results; our wealth advisory and investment management affiliates turned in solid revenue growth with acceptable margins, with year-over-year revenue growth of 6.5% and expense growth of 3.7%, operating income grew 12.7%. Our Wealth Management and Trust business generated a record $449 million of new business during the quarter which should benefit forward revenue in earnings. Our private bank maintained strong asset quality while increasing loan balances 2% linked quarter and 7% year-over-year. However linked quarter net interest income development was constrained by five basis points of core NIM compression driven by intensifying deposit competition. Consolidated expenses excluding Anchor Capital came down 2% linked quarter and the year over increase of 3% is below our previously stated target of 4% to 5% per year. With those highlights, I would like to turn the call over to Steve and then I’ll come back with some comments.

[Steve Gaven:]

Thanks Clay and good morning. My comments begin on Slide 3 where we show summary of our financial highlights from the second quarter. As Clay mentioned we completed the sale of our equity ownership in Anchor Capital during the second quarter. As a result of the sale, our current GAAP results include income tax expense of $12.7 million or $0.15 per share. On an operating basis excluding the impact of the previously mentioned tax expense, we reported $0.21 of diluted earnings per share and return on average common equity of 10%. The divestiture supported our capital build as Tier 1 common equity increased to 10.9%. Intangible book value per share increased 9% year-over-year to $7.62. Slide 4 shows our second quarter results on a reported basis under GAAP. Anchor’s financial results through the closing date of April 13, 2018 remain consolidated in the company’s reported results during the current period and prior period. To enhance comparability and analyzing financial trends, we have excluded Anchor results from certain financial information in the upcoming slides. A couple quick notes on our financials going forward. As consideration for our equity stake in Anchor, we received $32 million of cash at closing and we will receive a cash flow stream based on Anchor’s future revenue that has a net present value of approximately $15 million. Due to an accounting rule change in 2010, future Anchor payments will reduce a $15 million receivable on our balance sheet instead of running through discontinued operations line on the income statement like prior revenue share you have seen in our financials. Also we redeemed 50 million of preferred shares on June 15; the second quarter includes a full quarter dividend payment which negatively impacts net income attributable to common shareholders by $870,000 in diluted earnings per share by $0.01. This payment will go to zero in future periods now that those are no longer outstanding. Slide 5, shows a consolidated income statement excluding Anchor. Pre-tax, pre-provision income increased 3% linked quarter driven by 2% expense decline as revenue during the quarter was flat. Operating net income decreased 11% as a provision for loan loss swung from $1.8 million credit to $500,000 expense linked quarter. Also there was no Westfield Capital Management revenue share received in the second quarter as that arrangement ended in the first quarter of 2018. Excluding Anchor the effective tax rate in the second quarter was 18.9% lower than last quarter as a result of a tax benefit received for restricted stock vesting during the second quarter. Slide 6 shows consolidated revenue trends. Total operating revenue excluding Anchor for the quarter was $88.5 million. Flat linked quarter and an increase of 2% year-over-year. Our primary source of revenue GAAP net interest income increased 1% year-over-year and was flat linked quarter at $57.5 million. The second quarter of 2017 included $2 million of interest recoveries excluding interest recoveries core net interest income increased 4% year-over-year. Total core fees and income excluding Anchor decreased 1% linked quarter driven by decline in Wealth Management and Trust revenue partially offset by increases in the wealth advisory and investment management segment revenue. The year-over-year increase of 6% was primarily driven by higher levels of AUM in all segments. Excluding the second quarter 2017 interest recoveries total operating revenue increased 4% year-over-year. On Slide 7, we show a detailed breakout of our consolidated expenses on a reported basis. Total expenses declined on a linked quarter in year-over-year basis as a result of the Anchor divestiture. Slide 8 shows a detailed breakout of consolidated expenses removing Anchor from the current and prior periods. Total operating expenses decreased 2% linked quarter primarily driven by seasonal compensation related to payroll taxes in the first quarter partially offset by continued investment in information technology and higher occupancy costs. Slide 9 shows the past five quarters of average loan balances and deposit balances by type. Total average loans during the quarter increased 7% year-over-year to $6.7 billion. Residential mortgage continues to show the strongest growth at 11% year-over-year and 3% linked quarter. E&I loans decreased 1% year-over-year but increased 4% linked quarter primarily driven by increased commercial tax exempt loans and additional line usage. Average total deposits during the quarter decreased 2% year-over-year to $6.3 billion. Deposit outflows were primarily driven by decreased money market accounts partially offset by higher levels of demand accounts and CDs. Slide 10 shows a five quarter trend of net interest income and net interest margin for the consolidated company. Core net interest income which excludes interest recovered on previous nonaccrual loans and FTE adjustments increased 4% year-over-year to $57.5 million. Core net interest margin on a fully taxable equivalent basis decreased to 2.89% from 2.94% in the prior quarter. The decline during the second quarter was primarily driven by increased borrowing volumes used to fund deposit outflows which occurred as a result of seasonal tax payments in increased competition. On a linked quarter basis, the banks cost of interest bearing deposits increased 17 basis points from 59 basis points to 76 basis points. Our total cost of deposits increased 12 basis points from 41 basis points to 53 basis points. And finally the all in cost of funds including DDA increased 15 basis points from 60 basis points to 75 basis points. Slide 11 provides detail on our asset quality. This quarter we booked a $500,000 provision credit which was primarily driven by loan growth partially offset by decline in criticized loans and improved loss rates. The chart below shows further improvement in asset quality during the quarter with criticized loans finishing the quarter at $114 million, a decrease of 8% linked quarter and a 12% year-over-year decreased. ALLL as a percent of total loans finished the quarter at 109 basis points compared to 110 basis points in the previous quarter. On Slide 12, we show the private banking segment excluding the Wealth Management and Trust portion of our bank. Total revenue at the bank increased 1% year-over-year driven by increased levels of swap income in net interest income. Total operating expenses were $39.77 million, flat linked quarter and up 8% year-over-year driven primarily by increased investments in staffing, occupancy, and information technology. I will now turn it back to Clay to discuss our Wealth Management and Trust, Investment Management and Wealth Advisory segments.

[Clay Deutsch:]

Thanks Steve. Slide 13 contains financial information for the Wealth Management and Trust segment which operates under the Boston Private Wealth brand. During the first quarter Boston Private Wealth achieved record levels of new business with $449 million of new AUM introduced. New business showed strength through our bank and COI referral channels, our custody channel and from new client advisory hirers. Net flows during the quarter were negative $77 million primarily driven by outflows associated with the departure of a senior wealth advisor and a large low fee trust client outflow. Slide 14 shows financial results for the wealth management and trust segment. Total revenue decreased 8% linked quarter driven by previously mentioned outflows and one-time trust fees received in the first quarter. Timing of the net flows negatively impact revenue as outflows were weighted toward the beginning of the quarter and new business inflows in quarter occurred near the end of the quarter. Operating expenses decreased 7% year-over-year driven by decreased compensation while increasing linked quarter by 3%. Segment EBITDA for the quarter was $1.3 million and the EBITDA margin was 11%. Margin in the second quarter was negatively affected by revenue dynamics. Our target margin remains in the high teens. Slide 15 shows AUM net flows for all of our wealth business segments. During the second quarter the investment management segment showed net flows of $27 million and the wealth advisory segment at net flows of negative $30 million. On a consolidated basis, the company’s total net flows were negative $76 million. On Slide 16, we show our investment management segment excluding contribution from Anchor Capital. Segment EBITDA margins of 27% are slightly below our corporate EBITDA target of 30%. Moving to Slide 17, our wealth advisors reported total revenue of $13.8 million up 2% linked quarter and 6% year-over-year. Operating expenses decreased 12% linked quarter while increase in 3% year-over-year. The linked quarter decline is driven primarily by a bonus adjustment that was recorded in the first quarter of 2018 as well as seasonal payroll compensation early in the year. Second quarter 2018 segment EBITDA margin of 35% exceeds our corporate target of 30%. That concludes our prepared comments on second quarter 2018 reported results. Before turning to your questions I would like to offer a few concluding comments as we reflect on the quarter and what it says about our performance. First, I’m impressed with the new business potential that we see at Boston Private Wealth. Despite the AUM noise during the quarter we believe Boston Private Wealth will continue to expand its contribution to our overall revenue stream and our earnings profile. Second, I’m pleased with the ongoing development of our loan book. We obviously need to turn our full attention to deposit generation and NIM defense. Third in parallel, we’re pursuing expense conservation initiatives to maintain our operating leverage in the face of intensifying deposit competition. With that, let’s open the line and we’ll be happy to take your questions.

[Operator:]

[Operator Instructions] And this morning’s first question comes from Alex Twerdahl of Sandler O’Neill.

[Alex Twerdahl:]

First off I was wondering if you could maybe update your outlook for the margin for the third and fourth quarter, as you see it today given expected rate hikes for the remainder of the year.

[Steve Gaven:]

Alex, the way - would think about it, think about it in terms of net interest income for the year and given balance sheet dynamics where they are right now, we’re expecting that to top out around mid-single digits. I think you saw some little bit of weakness in the quarter, but we typically have a stronger back half of the year in the deposit build, but rather trying to go through all the imaginations on the margin itself, think about it through the lens of net interest income that would top out mid-single digits for the full year.

[Alex Twerdahl:]

Okay, so we should really be thinking about it. I mean in terms of loan growth being more of a contributor to the growth in NII then any sort of margin stability or margin expansion.

[Steve Gaven:]

Yes, I mean really I think about it deposit growth is going to dictate where margin winds up. If deposit growth comes back you could see flattish to slight up NIM, if that continues to lag a little bit there could be further compression but it’s really - deposits are going to be the regulator for the back half of the year.

[Alex Twerdahl:]

Okay to that point, I think your loan to deposit ratio is now around 104% in the past you said that loan growth will be totally dictated by deposit growth, so are the loan growth target to 8% to 10% for the year, is that still intact?

[Steve Gaven:]

Again that’s all going to be dependent upon where deposit is coming, we’re a little higher as you mentioned on loan deposit ratio, we’d like to see that come down a bit. We’re okay [indiscernible] touch above 100% for a little pivot time but we always to see that kind of working itself back down to 100% as we go throughout the year.

[Alex Twerdahl:]

Okay and then - so are there some new deposit initiatives that are in place to try to ramp up that deposit growth or you just kind of come through realization you got to pay up a little bit for those deposits to kind of make all the rest of the numbers work.

[Clay Deutsch:]

Alex, first off there’s a whole raft of deposit initiatives underway primarily focused on core DDA and core deposits. We’re focused both on private client deposits, using our mortgage instrument as a device and a whole another round of private client introduction initiatives, we have a whole raft of marketing and outreach initiatives teed up as we roll into the second half of the year and as Steve mentioned a moment ago, that’s historically a relatively rich business development period for us. The big driver of deposits is on the private company, private partnership side of the house what we call entity and partnership accounts. We do a lot of operating bank business and we’re very focused there on client outreach, client introduction. We’re preferring core deposits rather than hot money deposits. So it’s fundamentally being driven by client outreach and client work. As you saw last quarter, we’ve been trying not to compete on headline rate and for hot money, hence our 12 basis point increase in funding cost released in deposit driven funding cost, we’re going to continue to evaluate though the whole deposit build pricing trade off as we get into Q3, Q4.

[Alex Twerdahl:]

Okay, great. Thanks for taking my questions.

[Operator:]

Thank you. And the next question comes from Chris McGratty with KBW.

[Chris McGratty:]

Just a quick question, Clay you touched on - you said expense preservation in your remarks, you guys obviously have a good history of going back to the well [ph] when you need to. I guess how should we thinking about magnitude, I think in the past you said ex-banker 4% to 5% expense growth year-on-year and wondering if that’s still good or if we’re going to try to keep them more flattish given the top line pressure on margin. Thanks.

[Clay Deutsch:]

Yes, the linguist in me wants to correct you. I didn’t call it expense preservation, I called it conservation. And I’m half teasing. Preservation isn’t an option right now. I mean you know us, when topline comes down we work on expenses. We’re very obligated to deliver operating leverage after our up spend period last year on staffing and technology. So we view operating leverage as big marker, if as Steve said if revenue development is going to reset into the mid-single digits, our original guide on the 4% to 5% expense growth has to come down. I’m not yet prepared to announce anything specific, but we’re hard at work on expense initiatives in the second half of the year that can defend margins and reset the expense build inline with revenue development.

[Chris McGratty:]

Okay, that’s great. Thanks. Maybe Steve on that point with, what kind of the reset with Anchor out of the numbers now? And how should we be thinking about kind of quarterly expenses in back half and then I guess I can make my assumptions on next year, what the full year might be for the go forward?

[Steve Gaven:]

Yes, I would just take the same approach that we’ve been talking about the first half of the year, looking at the organization ex-Anchor and I would adjust assumptions down to plus 3% to 4% to account for the revenue [indiscernible].

[Chris McGratty:]

Okay and then while have you the tax rate, could you maybe give an outlook for that line?

[Steve Gaven:]

Yes, we expect tax rate in the back half of the year between 21.5%.

[Chris McGratty:]

Okay, all right. Thanks a lot.

[Operator:]

Thank you. [Operator Instructions] and the next question comes from Michael Young with SunTrust.

[Michael Young:]

I wanted to ask you, just given the - maybe the deposit pricing pressures, will that shift kind of wear [ph] your focus for loan growth, are there certain -- loan types that you’re getting relatively better yields on that you’ll need to focus on more to sustain the net interest margin?

[Steve Gaven:]

I think the way we think about loan growth deposit growth and margin is really focusing on those clients that, we’re going to be operating bank floor. So it’s less about we’re going to push towards an asset class because there is more attractive yields. What are the client segments that are deposit rich and that will dictate how we develop the loan portfolio going forward?

[Michael Young:]

Okay and what’s the yields that you’re getting in maybe at least on the jumbo mortgage book at this point, but maybe also you can talk about C&I or CRE?

[Steve Gaven:]

Yes on the jumbo mortgage book those are coming on in kind of high three’s so the stated book yield that we see in the winning tables close to the 3.25, 3.30. I mean they’re starting to come on kind of high three’s now. And then on commercial - you asked about commercial that CRE, C&I.

[Michael Young:]

Yes.

[Steve Gaven:]

Coming around five.

[Operator:]

[Operator Instructions] and we do have a follow-up question from Alex Twerdahl with Sandler O’Neill.

[Alex Twerdahl:]

I figured out, I’d ask a follow-up question on just for the AUM flows at Boston Private Wealth. I saw that you announced some strategic partnerships towards the end of the second quarter. Is that what’s accounted for some of the deposit? I’m sorry the AUM inflows at the end of the quarter or is that something to look forward to in the third quarter?

[Clay Deutsch:]

Kind of two-third answer. First, I’m really pleased that the new business generation strength is pretty widespread. We’ve had strong performance via the private bank referring existing and newly introduced clients to our Boston Private Wealth Partners and that business is significantly outperforming any prior period. Second, our channel partners, our custody partners are contributing very strong referral flow. Third, our COI, our Center of Influence just third party referral business has spiked up and then finally as you observe, we continued to do a lift out in bolt ons and we added a very nice firm down in Florida in the second quarter and all of those have contributed to that very strong new business build. Second part of your question, third quarter despite the downdraft through the AUM departure in the second quarter. I look forward to a strong third and fourth quarter coming out of Boston Private Wealth. So I remain very excited, I thought that business had a very good profile in the first quarter over the year. We had the unfortunate kind of one off in the second quarter that kind of massed over the strong new business performance. But I think we’ll be back on a more appealing, more normal rhythm as we get past Q2.

[Alex Twerdahl:]

Okay and so just kind of a follow-up to sort of the in the past and you’ve had some big PMs leaves [ph] it’s kind of been an issue for several quarters, do you think that there’s more AUM that’s at risk that BP Wealth following the senior person’s departure or do you think it’s we’re not going to talking about this in three months.

[Clay Deutsch:]

I think it’s a one off Alex. Either you’re referring to ‘15, first half of ‘16 we had big negative flows as we worked through post-merger integration of the big acquisition we did in ‘14 and then I think we strung together I’m doing this for memory which is always dangerous, but you know a string of four to five quarters of pretty good new business in accelerating flows, which is still on the second quarter. I’m not glossing over, but it was a one off. It dented the AUM. We do have in a place though a settlement around that departure which will alleviate a substantial part of the P&L impact going forward. I do think that business will always have the odd one off or odd attrition but I don’t view this as anything like the pattern of roll down that we had that back in ‘15 and earlier in ‘16.

[Alex Twerdahl:]

Okay, thanks for taking my follow-up.

[Clay Deutsch:]

Thanks.

[Operator:]

Thank you. And as there are no more questions at the present time, we would like to return the call to Clay Deutsch for any closing comments.

[Clay Deutsch:]

All I’ll say is thank you for your interest in us. We’re looking forward to the second half of the year and as you glean from our comments. Our primary focus will be to continue to build up our success in wealth and we’re paying very, very close attention to loan and deposit development. You all know the industry environment and I think balance sheet development is a major management preoccupation right now. So we’ll be back to you, later as we go out on shareholder visits and then obviously Q3 results.

[Operator:]

Thank you. The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect your lines.