Boston Private Financial Holdings, Inc.
Q1 2017 Earnings Call Transcript

Published: 27 Apr 2017

[Operator:]

Good morning and welcome to the Boston Private Financial Holdings, Inc. Q1 2017 Earnings Conference Call and Webcast. 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. I’d now like to turn the conference over to Adam Bromley, Director of Investor Relations. Please go ahead, sir.

[Adam Bromley:]

Thank you, Keith, and good morning. This is Adam Bromley, Director of Investor Relations of Boston Private Financial Holdings. We welcome you to this conference call to discuss our first quarter 2017 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; David Kaye, Chief Financial and Administrative Officer; and Corey Griffin, Chief Executive Officer of Boston Private Wealth. 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 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 identify 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.

[Clayton Deutsch:]

Morning. Thank you all for joining our call this morning. In the first quarter, our company generated net income of $15.7 million, or $0.17 per share. This compares with $0.19 per share last quarter and $0.21 per share in the first quarter of 2016. Return on average tangible common equity was 11.4% for the quarter and return on average common equity was 8.3%. These return levels are below our targets I’d like to briefly touch on the factors influencing the quarter. Starting on the positive side, our primary goal in early 2017 was to frontload the year with strong growth across all of our businesses. To this end, in the quarter, we delivered strong growth in all of our key revenue driving businesses including mortgage loans, commercial loans, deposits and assets under management in all of our segments. Second, we saw expansion of our core net interest margin due to our balance sheet positioning and our core deposit strengths. A combination of strong balance sheet growth and net interest margin expansion translated into 16% annualized growth in net interest income in the quarter. And finally, Boston Private Wealth continues to demonstrate client appeal and stability while posting positive AUM flows, allowing us to now shift our management focus to improving profitability and growth. At the same time, our quarterly profitability was below our long-term target and our shareholders’ expectations. We were short on revenues primarily due to lower levels of swap fee income in the quarter. At the same time, our operating expenses were elevated during the quarter due to the seasonal compensation expenses and by investments we have made in our franchise to increase long-term earnings strength. Specifically, we have added client facing business development staff to increase the growth of our client base across our markets and we have begun spending on a three year technology infrastructure plan to deliver a better client experience, make our client facing professionals more productive and realize cost efficiencies. We expect that these expenditures will help our company improve its competitiveness and drive earnings growth. Despite these expenditures in the quarter, we expect to deliver on our performance targets for the remainder of the year. The Boston Private’s management team and I continue to be excited about opportunities to build growth and earnings strength as the year progresses. With that, I’d like to turn the call over to Dave who’ll walk through the details. Dave?

[David Kaye:]

Thanks, Clay. Good morning everyone. My comments will begin with slide three which provides a summary of our key performance metrics. As Clay mentioned, our return on average common equity for the first quarter of 2017 was 8.3% and that’s declined both on a linked quarter and year-over-year basis. Our Tier I common equity ratio of 10% remains at the top end of our target range, and notably, total AUM is up 4% linked quarter driven by the positive net flows and investment performance; it’s also up 7% on a year-over-year basis. Slide four shows consolidated revenue trends. Our primary source of revenue which is net interest income increased 4% linked quarter and 8% year-over-year to $53.6 million. Total core fees and income decreased 6% linked quarter and 4% year-over-year to $36.3 million. The primary driver of the decreased core fees and income is lower swap fee income that Clay mentioned, that declined 70% linked quarter and more than 80% year-over-year due to lower client demand. Another factor contributing to lower fees and income linked quarter is that we received $1.4 million of performance fees in the fourth quarter of 2016 and that didn’t repeat in the first quarter. Total other income declined primarily due to the positive impact of $5.1 million of items during the fourth quarter of 2016; that included the net gain on sale at a market value adjustment of the derivatives. The net gain on sale was attributable to the divestiture of two offices in Southern California that represented just over $100 million of deposits. On slide five, we show a detailed breakout of our consolidated expenses. First quarter operating expenses decreased 4% linked-quarter to $68.8 million and increased 3% year-over-year. Our first quarter compensation expenses always include seasonal items such as FICA and 401(k), so year-over-year is a more relevant comparison. On a year-over-year basis, our total operating expenses are up 3% or if you exclude the restructuring charge in Q1 ‘16, it was up 5%. Compensation expense is a primary driver of increased expense levels during the quarter. This quarter’s elevated expenses also include staff additions due to strategic hires and we incurred higher expense levels due to a change in our vacation policy which is intended to reduce future expenses. Occupancy and professional services expenses also increased and that was as a result of technology investment we’re making in order to improve the client experience. On slide six, we show the full consolidated income statement. Total net income was $15.7 million, a decrease of 13% from the prior year. However, our pretax pre-provision income was up 1% year-over-year. Slide seven provides details on our asset quality. You can see the top chart shows the relationship between our net charge-offs or recoveries in our provision for loan loss. This quarter’s $200,000 provision credit was driven by net recoveries and declining loss factors, partially offset by an increase in loan volume and an increase in criticized loans. The chart below highlights the bank’s asset quality for the quarter. Criticized Loans increased 14% linked quarter but they remained 19% below last year. We continue to maintain strong reserves with our ALLL[ph] loans finishing the quarter at 125 basis points. On slide eight, we show the private banking segment which excludes the wealth management and trust portion of our bank. Here, net interest income increased 4% linked quarter due to loan and deposit growth, coupled with core NIM expansion. Total other income decreased linked quarter due to the previously mentioned gain on office sale and other items. Our total operating expenses here increased 12% both linked quarter and year-over-year to $35.1 million and that was driven by the compensation expenses noted earlier. Slide nine shows the past five quarters of average loan balances and deposit balances by type. Total average loans for the quarter increased 10% year-over-year. The growth rates of the individual loan categories on the accompanying slide were affected by reclassifications we made at the end of last year. This reclassification moves some tax exempt loans that are primarily multifamily loans from C&I to CRE. If we would have applied the reclassification to prior periods, CRE growth would have been approximately 3% linked quarter and 12% year-over-year while C&I growth would have been approximately 4% linked quarter and 7% year-over-year. Average total deposits for the quarter increased 7% year-over-year to $6.3 billion and that was led by a growth in core funding. Non-interest bearing demand deposit accounts increased 14% year-over-year and that was followed by the savings account and money markets at 5% and CDs at 2%. As you may remember, we divested just over $100 million of deposits as part of the sales the two offices in Southern California, and this is the first full quarter where the divested deposits do not show off any average deposit figures. Turning to slide 10, core bank, net interest income increased to $54.0 million and net interest margin at the bank increased seven basis points linked quarter to 2.98%. Excluding interest recovered on previous non-accrual loans, our core net interest margins increased eight basis points to 2.97%. NIM expansion was primarily driven by increased yield on loans which expanded from 3.51% to 3.61% during the quarter. The bank’s all-in cost of funds increased just two basis points and that’s partially due to some increased brokered CDs that we took to optimize borrowing cost. With that, I’ll turn it over to Corey Griffin, CEO of Boston Private Wealth. Corey?

[Corey Griffin:]

Thanks, Dave. Slide 11 contains financial information for the wealth management trust segment which operates under the Boston Private Wealth brand. Total revenue decreased 2% linked quarter to $10.9 million. Overall AUM increased from $7 billion to $7.3 billion for the quarter. Due to a lag in how we build AUM, higher AUM balances will impact the second quarter core revenues. Adjusted expenses, excluding last quarter’s goodwill impairment charge, increased 3% linked quarter primarily due to seasonal compensation expense. When comparing the first quarter of 2016 to the first quarter of 2017, you’ll see that on an annualized run rate basis, we have already taken out $4 million of operating expenses. As a result, year-over-year, adjusted expenses have decreased 6%. Segment EBITDA, excluding adjustments, decreased $700,000 linked-quarter while it has increased $800,000 year-over-year. Turning to slide 12, we show those new business loans and net flows across the Private Wealth for the past eight quarters. New business flows moderated to $120 million, client attrition reached the lowest levels in the last eight quarters resulting in positive net flows of $34 million. We remain focused on demonstrating continued stability at Boston Private Wealth as we move towards positioning the company for profitability and growth. I’ll now hand it back to, Clay.

[Clayton Deutsch:]

Thanks, Corey. Let me now touch on our other wealth businesses as slide 13 will show AUM net flows by segment. The investment management segment showed net flows of negative $30 million, the wealth advisory segment showed net positive flows of $263 million. On a consolidated basis all-in, the company’s net flows were positive $267 million. On slide 14, we show that total revenue for the investment management segment decreased 13% linked quarter while increasing 2% year-over-year. Excluding fourth quarter 2016 performance fees, linked quarter revenue was down 1%. Operating expenses decreased 7% linked quarter due to compensation expense from fourth quarter. The investment management segment first quarter 2017 segment EBITDA margin of 30% is right in line with our 30% corporate target. Moving to slide 15, our wealth advisors reported revenues of $12.9 million, up 2% linked quarter and 1% year-over-year. The linked quarter operating expenses comparison is affected by the revaluation of a retirement liability in the fourth quarter. On a year-over-year basis, operating expenses are down 3% year-over-year, first quarter 2017 segment EBITDA margins are 29% just below our corporate target of 30%. That concludes our comments on the quarter. We’ll now open the line up for your questions.

[Operator:]

Yes. Thank you. We’ll now begin the question-and-answer session. [Operator Instructions]. And first question comes from Casey Haire with Jefferies.

[Casey Haire:]

Thanks. Good morning, guys.

[Clay Deutsch:]

Good morning, Casey.

[Casey Haire:]

Dave, wanted to dig in on the NIM, the asset sensitivity really I thought surprised nicely this quarter, specifically the loan yields, interesting enough like everything but C&I went up. So can you just give us some help on where the floating rate loans are on the loan side? And the deposit data have been excellent, can you sustain that going forward and just some overall help on the NIM outlook?

[David Kaye:]

Okay. Well, first off on the individual loan categories, you mentioned a declining C&I yield which was odd and it was odd. That was partially influenced by that reclassification that I talked about. So, when we moved some of these industrial revenue bonds from the C&I to the CRE, those were fixed rate obligations and those were generally higher yielding so that caused the decline primarily in the yield for C&I. We have floating rates in both the commercial and industrial and the commercial real-estate I would say is the bulk of the variable rate. Our residential mortgages will adjust over time but those are primarily 5.1 7.1 arms and it will take time for those to reset. On the deposit data, yes it has been great and I think that was unexpected given where we’re at in this point of the rate cycle. I think most banks are really lagging and not showing much increase at this point. That won’t happen if rates continue to rise, we expect there’ll be more pressure on the deposit side. But going forward, we could see further NIM expansion of three or four basis points throughout the rest of the year.

[Casey Haire:]

Okay, great. That’s helpful. And switching to expenses, can you just quantify what the payroll tax impact was and then the vacation policy, I believe you were targeting 3% to 4% expense growth on the tech investments, is that still good for 2017?

[David Kaye:]

Yeah I think in the last call we talked about 2017 having an outlook of 4% core expense growth and I think we’re still on that path. That’s primarily driven due to some increased tech investments and also the strategic hires that Clay mentioned. When it comes to the FICA and 401(k) sort of seasonality, in the past we had seen an impact of about – an uptick about $2 million, this year it was about $2.5 million. So a little bit $500,000 more than we had seen in past years, I think some of the expense was pull forward if you will, and so it’s just a timing issue. On the vacancy policy, it was a change in the policy to sort of avoid or get rid of the growing accruals we have for unused vacations and affected more of the senior officers in the company. But as a result it was sort of a $500,000 one-time charge, we don’t expect that to repeat going forward.

[Casey Haire:]

Okay, great. And just last one for Corey and Clay, on the wealth management obviously finally turned the corner on the flow front. Is this year that we turn the corner on EBITDA margins turning positive?

[Corey Griffin:]

I guess best way to answer that question maybe go backwards a little bit, with the departures in 2015 we lost about $12 million in revenue. Since then, we’ve been balancing rightsizing the cost structure with investing for growth. So we’re building the business for the long-term and our goal is to be profitable this year, but we don’t want to overreach and focus on too much on cost, certainly get off to a good start in the first quarter though.

[Clayton Deutsch:]

The short answer is yes. We intend to generate positive margins this year and Corey and his team are very hard at work on that. Because of the nature of balancing that out, we’re not telegraphing an end of year run rate, but we are committed to positive margins this year in the business.

[Casey Haire:]

Great. Thank you.

[Operator:]

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

[Alex Twerdahl:]

Hey, good morning guys.

[Clayton Deutsch:]

Good morning, Alex.

[Alex Twerdahl:]

First off, just to touch on loan growth for a second here. Historically, you’ve kind of guided towards 6% to 7% total loan growth for the year, off to a pretty good start in 2017. Is that still kind of the right guidance for the full year looking forward? And maybe give us a little commentary on the price and whether or not that growth could be consistent across the year or we should see it somewhat frontloaded or what?

[Clayton Deutsch:]

Yeah, Alex last call we did take it up slightly and we followed that out subsequently in all of our investor presentations. We will never be a reckless willy-nilly growth company, but we are driven by what we think a sustainable balance sheet growth rate is defined by our capital bill. Our capital bill now supports 10% balance sheet growth rather than 8% and in this rate environment, we think putting some of our capital bill to work in balance sheet growth is a good use rather than bad use of capital. So that map has changed in a positive way. So we did want to go slightly and I emphasize slightly up tempo on balance sheet growth without any quality degradation. So we, for example, residential mortgage has come on strong and we like that, that’s by design, that’s a very good asset class for us. Commercial lending will continue to be measured but we’re doing really, really good commercial banking. So I think 8% to 10% is the new 6% to 7% and if we could live comfortably in that 8% to 10% rate, and it will be defined largely by deposit build performing and keeping pace. We like the liquidity and it will be defined by capital keeping pace, while supporting rich dividend. So that, in essence, is the map we’re following. We think it’s the right map for the environment we’re in.

[Alex Twerdahl:]

Great. And then just to touch back on the AUM inflows and outflows, historically, - I shouldn’t say historically, in the past you’ve had a couple of opportunities to hire I don’t know teams or family offices or one-off people that could come over and you bring them on under Boston Private Wealth and they bring over some AUM with them. Was there any of that in the first quarter?

[Corey Griffin:]

No, well considering it’d be a focus of – we’re actively looking for opportunities like that. We feel confident that we could achieve some of those this year but it was none of that this quarter, and that’s in the - of flows.

[Alex Twerdahl:]

Okay. And then just on the other side of it, the outflows, as you kind of given us some sort of figures on different customers that you sort of ring fenced and keeping a sharp eye on to monitor their activity. Has that number of customers -- is that basically down to zero at this point or there’s still couple of customers or big relationship that could still potentially flow out throughout the year?

[Clayton Deutsch:]

Sure I mean that was kind of a point in time in terms of ring fencing certain group of individuals that had gone through, make a lot of turnover and had to have significant changes in their client service team. We do think we’re beyond that. Having said that, we think we have to earn the business every day, so we’re constantly monitoring all of our clients to make sure we’re meeting our service level agreements.

[Alex Twerdahl:]

Great. Thanks for taking my questions.

[Clayton Deutsch:]

Thank you.

[Operator:]

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

[Chris McGratty:]

Hey, good morning everybody.

[Clayton Deutsch:]

Hi, Chris.

[Chris McGratty:]

Hey, Dave maybe just start with you, the margin guide that you projected the three to four basis points is that over the balance of the year or is that each quarter? Just want to make sure I got it right.

[David Kaye:]

Over the balance of the year.

[Chris McGratty:]

Okay. Was there a helper in the security deal from premium I think we’ve seen some banks have little bit slower speeds given the moving rates, but interested if there’s anything that drove the sequential improvement in [indiscernible]?

[David Kaye:]

No that was immaterial impact.

[Chris McGratty:]

Okay. If I could go back just to kind of close the loop on net interest income obviously the growth in the quarter was good, Clay you talked about better growth. Should we expect -- how should we think about the bond portfolio? Should we be assuming you fund incremental loan growth extra couple hundred basis points from reductions in the bond portfolio or should we assume that deposit growth will be able to facilitate that?

[David Kaye:]

No I think we’re looking for deposit growth to facilitate that, Chris.

[Chris McGratty:]

So the security balance is basically flat is what you’re suggesting?

[David Kaye:]

Yeah.

[Clayton Deutsch:]

And Chris we like to keep a pretty similar liquidity profile to what we have baseline year before.

[Chris McGratty:]

Understood. Totally get it. And if could just ask one more based on the growth commentary, Dave you talked about the pipeline recovering slowing, I’m interested if what you see in the next few quarters for recoveries and also, if the growth continues should we be expecting the provision to flow positive?

[David Kaye:]

Yeah Chris that’s always a tough one to predict. We’ll probably see some recoveries in the coming quarters but again, it would be hard for me to project beyond year end and say okay, it’s going to continue into ‘18. But I think over the course of the second half or the remainder of 2017, yeah we’ll see some recoveries.

[Chris McGratty:]

Okay. And anything to make of these – the movement the early stage buckets or any color on resolution?

[David Kaye:]

No I think that when you looked at the early stage buckets, the 30 to 89 test due was up, it was driven primarily there was one $9 million loan that was in negotiation so they had stopped the payment but it subsequently paid off in early April. And in the special mention categories we had two loans probably totaling about $15 million and one in the East Coast, one on the West Coast that were downgraded from past to special mention. It was a result of upcoming lease renewals and I think in one case kind of lacked in there and negotiating with new tenants. So just moved into the watch list. We want to make sure we’re out ahead of things and raising issues where we see that we need attention.

[Chris McGratty:]

Great. Thanks for taking the questions.

[Clayton Deutsch:]

Thanks, Chris.

[Operator:]

Thank you. [Operator Instructions]. And the next question comes from Christopher Marinac with FIG Partners.

[Christopher Marinac:]

Thanks. Good morning. Clay, just wanted to get back on the revenue margin comment you made on the fiduciary side. When we go back to where we were latter part of last year, do you think there would be net improvement above that as this year unfolds?

[Clayton Deutsch:]

Just so I get it Chris, you’re talking about in the affiliates or including the wealth business, or how would you like me to…

[Christopher Marinac:]

Yes, it’s really the three buckets of fees in the overall fiduciary piece, in terms of just looking at those relative to AUM on average basis those percentages seem to come down first quarter or so, so was curious if we go back to where they were or if there’s a net improvement year-over-year?

[Clayton Deutsch:]

Yeah, hard to say. I mean the only thing I have some confidence in Chris, the positive flows in the first quarter will help us a bit with second quarter revenues. There’s usually a following quarter effect because of the way we bill. So there’s a little bit of a draft most likely. Our investment management space pricing pressure in the platform business, yet the pricing drift down has been very measured of late. So I would be hopeful we get some revenue expansion in investment management in that. And I don’t see any weird thing coming on their expense side. So hopefully we’ll get stable to improving margins there. The two wealth advisors doing a really good job, had positive flows in the first quarter. Those businesses tend to have pretty stable economics, they’re enjoying fee stability and again, I don’t see any unusual cost structure thing coming at us. Their cost structure is driven almost wholly by staffing. And then Corey’s already addressed his business, we like where it sits today and we’re working on client attraction, revenue build and margin improvement. So I guess when I net it all out, I sure as heck don’t see margin degradation and I think we’ll go sideways to potentially improving.

[Christopher Marinac:]

Great, Clay, that’s helpful. I appreciate that. And just to follow up I guess on the rest of the business, I mean as you think about growing the balance sheet, is there a scenario where you would go faster than this 8%?

[Clayton Deutsch:]

Well, again, given our small size I don’t think it’s a market limit. We’re serving really deep pools of attractive clients on both coasts. So the mitigants are more self-imposed financial limits driven by maintaining liquidity. So I think our ability to keep pace on deposit build while maintaining our targeted capital levels is how we get to in effect the resulting growth rate, we like balance sheet expansion in this rate environment. And I think the anatomy of our NII development this quarter kind of validates that. So I like what we’re doing. From a risk standpoint though, I don’t think you’ll ever wake up one morning and see us heating up the balance sheet, 15%, 18%, 20% that’s kind of not us. So does that address it clearly? But we think floating from 7% to 8% to more like 8% to 10% is really doing good things for the revenue build.

[Christopher Marinac:]

Got it. That makes sense. And then just the last question is there a -- what would have to happen for the AUM flows not to be positive?

[Clayton Deutsch:]

Corey and I talk a lot and I talk a lot with our affiliates, we’re always to some extent affected by macro shocks and that’s kind of in the ‘who knows’ category. A big macro shock does expose us to market action. Now separately flows, flows are fundamentally about client behavior and about our ability to maintain client appeal. So that’s kind of on us. I do think flows tend to come perhaps a little more readily in a rally, they are a little more dear in a big sell down but that’s kind of how we parse it. We’re always thinking about macro effects, that drives market action, that has big effect on our portfolio and we told you in the past that our portfolios have about a 50% data relative to market actions. So if U.S. equity markets are plus 10, we’re kind of blended towards quite often up five if markets are down five, we’d be down half of that sort of thing. But that’s how we parse it. Macro events, market action and that client behavior and what we’re doing in terms of client attraction and client development.

[Christopher Marinac:]

Sounds good, Clay. Thank you for all the time on this.

[Clayton Deutsch:]

Thank you.

[Operator:]

Thank you. And there are no additional questions, I would now like to turn the call to management for any closing comments.

[Clayton Deutsch:]

We’re excited about the remainder of the year as you glean from my comments, I like the growth profile in the first quarter and not happy with the profitability but we understand the expense dynamics and we’re sticking with what we’re doing and standing by our commitments. Thanks everybody for listening in and we look forward for more conversation.

[Operator:]

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