Boston Private Financial Holdings, Inc.
Q3 2018 Earnings Call Transcript

Published: 19 Oct 2018

[Operator:]

Good morning, and welcome to the Boston Private Financial Holdings Third Quarter 2018 Earnings Call. All participants will be 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. I’d now like to turn the conference over to your host today, Adam Bromley. Please go ahead.

[Adam Bromley:]

Thank you, Keith, and good morning, everyone. This is Adam Bromley, Director of Investor Relations of Boston Private Financial Holdings. We welcome you to this conference call to discuss our third 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’re based upon the current beliefs 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, good morning, everyone. Thanks for joining our call this morning. In addition to reporting quarterly earnings, we made a number of announcements last night that will improve our return profile, simplify our business, and create flexibility to return capital to shareholders, while reinvesting in our core business. First I would like to start with our third quarter operating results highlights. In the third quarter, our company generated GAAP net income of $18 million or $0.20 per share. These results included a $5.8 million restructuring charge, related to an efficiency initiative recently launched. Excluding this restructuring charge, third quarter diluted EPS was $0.25 per share, return on average common equity was 12.1%, and return on average tangible common equity was 14.2%. Before turning to the main body of our call, I would like to briefly discuss third quarter results, the impact of a significant cost reduction effort, the divestiture of a Wealth Advisory affiliate and capital redeployment. First, we believe core operating performance improved in the third quarter. The company’s financial performance, on an operating basis, reflects positive operating leverage of 410 basis points and pre-tax, pre-provision growth of 16% linked quarter. Second, deposit volumes built with average balances increasing 6% linked quarter. We reduced our loan-to-deposit ratio from 105% to 100%. Third, new business trends at Boston Private Wealth remain quite robust with $394 million of new business and a new record-high positive $315 million of net flows. New business generation was balanced across regions and distribution channels. Boston Private Wealth posted an EBITDA margin of 20%, up from 11% last quarter. While working hard on third quarter performance, we, in parallel, designed and implemented a substantial cost restructuring effort. Actions already taken in early October drove a $5.8 million restructuring charge and will result in a simplified management structure and streamline staff that will deliver operational efficiencies and expense reductions. We expect full-year annual cost savings of approximately $11 million from these moves. In a separate release last night, we announced our intention to divest Bingham Osborn & Scarborough, one of our Wealth Advisory affiliates. The divestiture of BOS together with Anchor Capital in the previous quarter have provided the company with the flexibility to accelerate share repurchase activity in the fourth quarter through our already approved $20 million authorization, while stepping up organic and inorganic investment across our integrated Wealth Management and Private Banking platform. We remain committed to managing our common equity Tier one capital ratio to a range of 9.5% to 10.5%. With these highlights, I’d like to turn the call over to Steve, for more detail and then I’ll come back. Steve?

[Steve Gaven:]

Thanks, Clay, and good morning, everyone. My comments begin on Slide 3, where we show you summary of our financial highlights from the third quarter. This quarter, we reported GAAP net income of $18 million or $0.20 per share. Our operating results, which exclude the restructuring expense, net of tax, show operating net income of $22.5 million, or $0.25 per share. And an operating return on average common equity of 12.1%. Slide 4 shows our third quarter results on a reported basis under GAAP. As you will recall, we close on our agreement to sell ownership in Anchor on April 13, 2018. Anchor’s results remain consolidated in the company’s reported results through the closing date of April 13, 2018 and prior periods. Overall GAAP results improved during the quarter, primarily due to a $12.7 million income tax expense during the second quarter results associated with the divestiture of Anchor, partially offset by the restructuring expense in the current quarter results. The company’s effective tax rate during the quarter was 22.4%, we estimate the tax rate to be closer to 22%, going forward. To enhance comparability and analyzing financial trends, we have excluded Anchor results from certain financial information in the upcoming slides. Slide 5 shows a consolidated income statement excluding Anchor. Pretax, pre-provisioned income increased 14% year-over-year, driven by 410 basis points of positive operating leverage. Operating net income increased 20% year-over-year due to a larger provision credit and a lower tax expense. This was partially offset by the loss of Westfield Capital Management revenue share. Slide 6 shows consolidated revenue trends. Total operating revenue, excluding Anchor for the quarter, was $92 million, a 4% increase both linked quarter and year-over-year. Net interest income increased 5% year-over-year and 4% linked quarter to $59.6 million. The current quarter included $1 million of interest recoveries. Excluding the interest recoveries, core net interest income increased 4% year-over-year and 2% linked quarter. On Slide 7, we show a detailed breakout of our consolidated expenses on a GAAP basis. Total expenses declined on a year-over-year basis as a result of the Anchor divestiture. While linked quarter, the increase was driven by the third quarter restructuring expense. Slide 8 shows a detailed breakout of consolidated expenses, excluding the restructuring charge in the third quarter and Anchor in prior periods. Total adjusted operating expense decreased 1% linked quarter, primarily driven by a decline in the information technology investment. Expenses remained flat year-over-year due to lower compensation, offset by higher levels of information technology investment and occupancy and equipment. The current quarter includes approximately $700,000 of bonus unwinds from the efficiency program. As Clay mentioned earlier, the restructuring charge is related to a company-wide efficiency initiative and consists primarily of severance and other compensation-related expenses. We believe our actions associated with this charge will result in approximately $11 million of savings annually. The go-forward expense savings will be fully realized in 2019. We have included financials for BOS on a year-to-date and last 12-month-basis at the end of the slide deck to assist in reconciling the impact of the transaction to your models. Slide 9 shows the past five quarters of average loan balances and deposit balances by type. Total average loans during the quarter increased 6% year-over-year to $6.7 billion. Residential lending showed continued strength, increasing 11% year-over-year. Average total deposits during the quarter increased 5% year-over-year and 6% linked quarter to $6.7 billion. The linked quarter increase in deposits was driven by growth in money market accounts and demand deposit accounts as the average loan-to-deposit ratio for the quarter returned to 100%. 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 $58.7 million. Core net interest margin on a fully taxable equivalent basis decreased one basis point linked quarter to 288 basis points. The decline during the third quarter was primarily driven by increased funding costs, partially offset by increasing yields on interest earning assets and lower borrowing volumes. On a linked quarter basis, our total cost to deposits increased 15 basis points from 53 to 68 basis points. The banks cost of interest-bearing deposits increased 22 basis points from 76 to 98 basis points and our all-in cost of funds including DDA and wholesale borrowing increased 11 basis points from 75 basis points to 86 basis points. Slide 11 provides detail on our asset quality. This quarter, we booked a $900,000 provision credit, which was driven primarily by loan recoveries and loan balance declines, partially offset by an increase in criticized and classified loans. The chart below shows asset quality metrics during the quarter with criticized loans finishing the quarter at $135 million. Criticized Loans are 8% lower compared to the third quarter of 2017. The 18% linked quarter increase was driven by an increase in Southern California Special Mention loans, and San Francisco Bay Area accruing substandard loans. ALLL as a percent of total loans remained flat at 109 basis points compared to the previous quarter. On Slide 12, we show the Private Banking segment, excluding the Wealth Management & Trust portion of our bank. Total revenue at the bank increased 5% year-over-year, driven by net interest income. Excluding restructuring, operating net income increased 15% linked quarter and 21% year-over-year. I will now turn it back to Clay, to discuss our Wealth Management & Trust, Investment Management, and Wealth Advisory segments.

[Clay Deutsch:]

Thank you, Steve. Slide 13 contains financial information for the Wealth Management & Trust segment, which operates under the Boston Private Wealth brand. During the third quarter, Boston Private Wealth demonstrated continued strength in new business generation with $394 million of new assets under management. Net flows during the quarter were positive $315 million as a result of strong new business offset by very low client attrition. Slide 14 shows financial results for the Wealth Management & Trust segment. Total revenue increased 3% linked quarter, driven primarily by higher levels of assets under management and the full revenue realization of strong second quarter inflows. Adjusting operating expenses – adjusted operating expenses, excuse me, which include – which exclude restructuring, decreased 6% linked quarter and 12% year-over-year, driven by decreased compensation. Segment EBITDA, on an operating basis, was 20%, an improvement from 11% last quarter. Slide 15 shows AUM net flows for all of our business segments. During the third quarter, the Investment Management segment showed net flows of positive $45 million, and the Wealth Advisory segment had net flows of negative $18 million. On a consolidated basis, overall company net flows were positive $342 million. On Slide 16, we show our Investment Management segment excluding contributions from Anchor Capital. Segment EBITDA margins of 32% are above our corporate EBITDA target of 30%. Moving to Slide 17. Our Wealth Advisors reported net income of $2.6 million, up 2% linked quarter, and 33% year-over-year. Third quarter 2018 segment EBITDA margin of 34% exceeds our corporate target of 30%. This concludes our prepared commentary on our third quarter of 2018 reported results. Let’s open up the line and we will entertain your questions.

[Operator:]

[Operator Instructions]. And this morning’s first question comes from Christopher McGratty with KBW.

[Steve Gaven:]

Good morning, Chris.

[Christopher McGratty:]

Good morning, everybody.

[Clay Deutsch:]

Hey Chris.

[Christopher McGratty:]

Hey Clay. Quick question, maybe just start with the implications of the actions on BOS. I think, Clay said, you have 20 of buyback authorized previously. Could you help us maybe see what the pro forma capital ratio is? Not sure if there is any goodwill adjustments to the – that would run to the P&L. But I think, you said 10% – 9.5%, 10.5% is a Tier one common target. Do you have the pro forma for that in TCE and TA and kind of how you’re thinking about buybacks above and beyond the 20 that you have?

[Steve Gaven:]

Yes, Chris, I’ll take the question on, kind of, target capital ratios. Really, what we managed to is a CET one ratio, right? So we printed 11.14% in the quarter and when you adjust for BOS that gets you about to 11.7%. And as Clay mentioned in the prepared remarks, we’re still committed to managing to that 9.5% to 10.5%. In terms of share repurchases, Clay, I don’t know, if you – if there’s anything you want to add, but, like we said, we have the $20 million authorization. We’re going to continue to look at all our options, but we haven’t really said anything more than that to this point.

[Christopher McGratty:]

Okay. I mean, there are, I guess, a couple of million dollars of lost earnings from the sale. And I think, what you did last time with Anchor, as you took the TruPS out, is it fair to assume – or I guess, how would you steer the street towards managing the capital aside from, we’re not going to put in acquisitions into the model, we can talk about that. But managing the capital levels with a share buyback, I mean, your stocks have been pressured like most banks this year, and I’m just wondering at this level that you think the buyback is a great use of capital?

[Clay Deutsch:]

Yes, Chris, there are two destinations that we are very interested in for capital. We do think at these levels – as you know, I’ve been not a big fan of share repurchase historically as a return of capital device. We’ve achieved that through an escalating dividend. I will say at these levels in the sector and with our own stock price, I think, share repurchase is a shareholder appealing way to reset the share count. The second destination, the success of our wealth franchise is publicly visible. And we are becoming a pretty attractive destination for inbound inquiries from attractive firms and wealth practices, who would be very interested in coming our way and joining our model. And that’s not a new theme I’ve been saying to our following for several years that we’re committed to building a really high-quality wealth and private banking franchise and as we do that, we’re very attracted to organic investment, but also M&A-enabled expansion of the reach of our wealth business and our private banking and trust capabilities. So to your point, you can’t model nonspecific acquisitions, but those two broad areas are pretty appealing to us. So there’ll be – we’ll have more to say about our share repurchase intentions and we will also have more to say about how we’re thinking about M&A as a reinvestment opportunity.

[Christopher McGratty:]

Okay. That’s great color. Is there – just a quick modeling follow-up. Is there any below-the-line adjustment from the sale like you did with Westfield years back? Like an earn-out – is there anything – or is that all just, kind of, a clean cut?

[Clay Deutsch:]

Yes. Now – Steve, why don’t you just walk through the economic highlight now?

[Steve Gaven:]

Yes. The last two divestitures we’ve done, Chris, that’s just – there’ll be some adjustments. We book everything upfront and then, to the extent, there’s differences versus what we booked at the time of sale, it will get adjusted through other income. But it’s not going to be like the Westfield transaction, where there’s a specific discrete line item accreting over the revenue share period. We’ve booked all that upfront the same we did with Anchor.

[Christopher McGratty:]

Okay. And Steve, is there an adjustment to your intangibles? Just, kind of, a quick one there on – given the sale. Is there anything that goes away with the sale?

[Steve Gaven:]

Yes, there’s about $18 million of goodwill and intangibles that will be consolidated.

[Operator:]

And the next question comes from Alex Twerdahl with Sandler O’Neill.

[Alex Twerdahl:]

And just a, kind of, follow-up on this discussion about the divestiture, Bingham Osborn, and sort of based on what we can determine from the – from what you guys have provided, it’s going to cost about $0.04 of earnings next year. That’s what I’m coming up with. But how should we really think about, sort of, the lost earnings in context of, one, how much will we get back from that earn out over the next, I guess, on an annual basis? And then secondly, is the intention really to use the tools that you mentioned, the repurchase and possibly some acquisitions to get this transaction back to earnings neutral as quickly as possible?

[Steve Gaven:]

Yes, Alex, this is Steve. So you won’t see earnings accrete the way you did with the Westfield transaction on an ongoing basis. So that loss of $0.04 that you are referring to that’s what it will be on a go-forward basis. But you’re right, I mean, through looking the share repurchase opportunities and then M&A opportunities, that’s really – along with organic investment opportunities – that’s what will be the earnings replacement. Unlike Anchor where we had, kind of, equal trade in retiring the TruPS, there’s not that opportunity right now. So it’s really about investing in the core business and opportunistically buying back shares to get EPS back to where we want it to be.

[Alex Twerdahl:]

Okay. And then, Clay, on last quarter’s call, you discussed the possibility of an expense initiative, but, I believe, you said that it would be to defend margins in a case of a lower reset of revenue development. So in what context should we really take the expense reduction initiatives? I mean, should we now be thinking about loan and deposit growth at a lower pace in the future? Or can you maybe just talk about that a little bit?

[Clay Deutsch:]

Well a two-part question. First, the primary motives for the expense reduction was simply to better equip us to generate target returns in an increasingly competitive environment. You all are reading the sector prints that I’m reading. Every participant in our sector is experiencing a deposit-driven, rate-driven NIM squeeze. I’m pleased that this quarter, we’ve showed an ability to make real headway on the deposit build. And we did it with, I think, a fair amount of demonstrated pricing discipline and that’s reflected in NIM. Nevertheless, this isn’t a one quarter war. And we’re trying very hard to gird ourselves to generate operating leverage and toe the line much closer to target returns than what you saw on the second quarter. Our return performance in the second quarter was unacceptable. So we worked very hard on the expense side of the ledger. Long term, the advance as a company is going to be driven by expansion of the Wealth business and disciplined growth of the balance sheet on both the loan and deposit side of the ledger. So of all the good things happening in the third quarter, I think, the most fundamental thing I’m watching is our now demonstrated progress advancing high-quality deposit build. That’s the fuel upon which we’ll continue to expand the revenue strength of the company.

[Alex Twerdahl:]

Okay. So some of the targets that you’ve put out in the past for a loan generation, for example, the 8% to 10%, are you going to stick to those targets? Or do you think that they need to be dialed back just a little bit given the competition that you just sighted?

[Clay Deutsch:]

We still like those targets. The gating factor is going to be deposit build. I mean as you saw in the quarter, we will not tolerate the loan-to-deposit ratio of 105%, that’s just – that’s not a good number. So our loan book development in the third quarter does reflect a slight rollback by us, self-restraint by us to better match asset build what we’re demonstrating on the deposit side. So our targets remain our targets, but the gating factor for you all to watch and for our shareholders to watch is how we are doing on deposit development.

[Alex Twerdahl:]

Great. Thank you for taking my questions.

[Clay Deutsch:]

Thank you.

[Operator:]

[Operator Instructions]. And the next question comes from Michael Young with SunTrust.

[Michael Young:]

Hey, good morning.

[Clay Deutsch:]

Hi Michael.

[Michael Young:]

Just wanted to ask a quick follow-up on the last question regarding loan growth and deposit build. You guys have a good bit of seasonality in that throughout the year related to tax payments. I assume that view is, kind of, over an annual period versus on a quarter-to-quarter basis? And if deposits flow out in the second quarter, we shouldn’t expect softer loan growth, you’d just, kind of, backfill with higher cost deposits for a period of time.

[Steve Gaven:]

And that depends, Michael, I mean, yes, typically, we have the back half where it starts to build at a more rapid rate. I think, what you’re seeing just in this environment, there’s growth challenges and I think everyone is facing them. You did see the loan growth dialed back, kind of, in line with deposit growth. What we have done in the second half of 2018 with an eye towards 2019, we launched a raft of deposit initiatives both across the personal client base and the business client base to hopefully drive us back towards those high single-digit growth rate that we want to achieve. So yes, you did see a little bit of a slowdown in near-term just given the amount of seasonality we had, which was a little more severe than typical in the first half and then, like I said, we’ve launched a bunch of initiatives to, kind of, keep the momentum that we’ve built in the third quarter going.

[Michael Young:]

Okay. And Clay, just on the efficiency initiative or the expense reduction, I guess, in – just trying to zoom out a little bit in 2017, you, kind of, made a larger reinvestment into the business that I think increased the expense run rate by about $5 million to $6 million coming into this year to drive operating leverage, and now we’re pulling a significant amount of cost out going into 2019. So just trying to understand is that a pivoting of, kind of, the staffing levels towards more revenue production? Or is this, kind of, an unwind of what was invested that maybe hasn’t materialized in the better revenue?

[Clay Deutsch:]

Yes, I’d say – I’d frame it not as the pivot or an unwind in the sense that we did step-up our investment in client-facing, business-developing, revenue-producing staff. And we have not unwound those investments, and we also stepped up our investment in our technology and operating platform. And we have not unwound those investments. The offset is we have taken a very hard look at corporate structure, top to bottom, end-to-end, and what you see in the just announced restructuring and the associated $11 million, is not an unwind of our business building or technology investments. It’s taking a very fresh look at the staffing intensity of our management team, of our functions, of our business model and a streamlining of all of that. So while I appreciate from the outside, it’s all one cost base. But I view it as a very different pool of spending that we’ve taken a very hard look at this time around. But I want to emphasize, it’s not an unwind of our client-generating, revenue-generating investments. We’re pretty happy with the growth tempo we’ve established from those moves.

[Michael Young:]

And one last one if I can. Just on the Wealth Management & Trust net flows. Can you give a little more color around the string to last two quarters, if there’s been any change and any pricing that’s helped drive that? Or there is just, kind of, hitting the streets with more feet, more advertising and getting more in the door?

[Steve Gaven:]

Yes. Michael, I’ll take that and then Clay will add. But I think what you’re seeing is, in the Wealth business, just really strong performance across all our distribution channels, all our regions, kind of, clicking on all cylinders at this point. So this is something we’ve set out and did the Banyan acquisition. This is what we envision from the growth profile for being able to do $800 billion, $900 billion of gross new business a year on a repeatable basis. And what you’re seeing is, across the franchise, just really good pipeline activity coming from the bank, coming from our custody referral partners and that momentum has continued, and we feel really good about keeping that momentum going forward. We did see some pricing – lower pricing in the past two quarters. It wasn’t – the volume wasn’t price-driven, it’s more of the nature of the relationship and with larger relationships, that just generally price at lower rates. So it’s not that we are out there cutting pricing to get AUM. That was just, kind of, idiosyncratic attributes in the last two quarters. But pricing has been pretty steady for that business. And we expect that to continue.

[Clay Deutsch:]

The only thing that I’d add to that, I agree with all that. Those of you, who have been in the company, I’m speaking out to shareholders, for a while, know that one of the most persistent work efforts in the company has been our intention to build a really high-quality Wealth Management business that would become a very appealing destination for clients and prospects. That’s been an enduring theme. We’ve been very hard at work on that, really going all the way back to late 2014 and early 2015. And I think what you’re seeing in new business generation is just the realization of all that effort. Happily, it’s not pricing, what’s really driving new business at these, kind of, unprecedented levels is all of our channel-facing efforts are now performing in terms of prospect flow and client flow, both new clients as well as client development. So we’re seeing really, really good client attraction through our custody channel partners, through our direct sales efforts, through our center of influence referral programs and importantly, through our own Boston Private Bank channel. So, I’m really pleased with the AUM development and new business profile and client profile that we’re now presenting as we’ve reported quarter-to-quarter. I think it’s fundamental and I think it’s going to do very good things for us.

[Operator:]

Okay. Thank you. And as there are no more questions at the present time, I would like to return the floor to Clayton Deutsch for any closing comments.

[Clay Deutsch:]

I want to thank all of you for dialing in. A lot to talk about this quarter, but I’m pretty pleased with our progress on multiple fronts. And we’re going to stay hard at it. These themes will persist as we go into the fourth quarter. Thank you all for your interest.

[Operator:]

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