Boston Private Financial Holdings, Inc.
Q2 2017 Earnings Call Transcript

Published: 27 Jul 2017

[Operator:]

Good morning, and welcome to the Boston Private Financial Holdings Second Quarter 2017 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. I would now like to turn the conference over to Adam Bromley, Director of Investor Relations. Please go ahead, sir.

[Adam Bromley:]

Thank you, Amy, 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 second 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, at 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 belief and expectation 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:]

Good morning, everyone. Thank you all for joining our call this morning. In the second quarter, our company generated net income of $23.4 million, or $0.27 per share, compared with $0.17 per share last quarter and $0.18 per share in the second quarter of 2016. Return on average tangible common equity improved to 16.3% for the quarter and return on average common equity improved to 12.1%. Our company delivered strong earnings during the second quarter, with revenue growth and margin expansion in all of our business segments on a linked-quarter basis. I would like to expand upon a few segment highlights from the quarter. Overall, private bank earnings increased 33% year-over-year. The private bank showed robust net interest income growth as our balance sheet positioning and core deposit strength drove expansion of our net interest margin. In addition, recoveries assisted earnings, and our loan portfolio continues to exhibit strong credit quality and a favorable risk profile. Second, we are pleased with the AUM development, revenue build and improving financial performance of our Boston Private Wealth business. Our team has worked very hard to build a client-appealing business for the long term, while focusing on profitability and investing for growth. Third, our Wealth Advisory and Investment Management segments demonstrated operating leverage, translating revenue growth into improved profitability. Overall, we believe these results demonstrate the progress we are making, investing in our franchise, building a franchise with distinctive appeal for high-caliber private clients across all of our markets. I am especially pleased with our client acquisition and client development strength in the first half of this year. We will continue to invest in technology and staff to support a client-centric, One Boston Private strategy, providing excellent client service, while delivering complete wealth management and private banking solutions for our clients. With that, I’d like to turn the call over to Dave, who’ll go more deeply through our results. Dave?

[David Kaye:]

Thanks, Clay. Good morning, everyone. My comments will begin with Slide 3, which provides a summary of our key performance metrics. Return on average common equity for the second quarter improved to 12.1% and that’s up from 8.3% in the first quarter of 2017 and 8.7% in the second quarter of 2016. Despite what the slide says, our efficiency ratio on an FTE basis is 68% for the current quarter. We’ll post the corrected version after the call. Finally, our quarterly EPS of $0.27 represents the company’s highest earnings per share since the fourth quarter of 2009. Slide 4 shows consolidated revenue trends. Total revenue was $95.2 million. That’s a 6% increased linked quarter and 11% increase year-over-year. Our primary source of revenue, which is net interest income, increased 7% linked quarter and 16% year-over-year to $57.1 million. Total core fees and income increased 2% linked quarter due to sequential revenue growth in all of our businesses segments. Total core fees and income decreased 1% year-over-year due to lower swap fee income, which remains lower than previous quarter’s. Moving on to Slide 5, we show a detailed breakdown of our consolidated expenses. Second quarter total operating expenses decreased 1% linked quarter to $67.8 million, while increasing 5% year-over-year. Operating expenses decreased linked quarter primarily due to seasonal compensation expense that resulted in elevated expenses during the first quarter. Operating expenses increased year-over-year due to strategic hires, performance-based compensation and technology initiatives. Excluding restructuring, operating expenses have increased $4 million or 6% year-over-year. Of that 6% increase, 2% is related to the performance and revenue-driven compensation, and the remaining 4% is the split between the technology initiative and just normal salary increases and staff additions. On Slide 6, we show the full consolidated income statement. Pretax preprovision income was $27.3 million, an increase of 28% linked quarter and 29% year-over-year, while net income was $23.4 million, an increase of 49% from the prior year and 43% -- from the prior quarter, excuse me, and 43% year-over-year. Slide 7 provides detail on our asset quality. We continue to show improved asset quality, which coupled with the net recoveries drove this quarter's $6.1 million provision credit. The chart on the bottom highlights the bank's asset quality for the quarter. Criticized loans decreased 4% linked quarter and decreased 14% year-over-year to $130 million. We continue to maintain strong reserves with our ALLL for loans finishing the quarter 119 basis points, and that's down from a 125 basis points in the previous quarter. On Slide 8, we show the Private Banking segment, excluding wealth management and trust portion of our bank. Here, net interest income increased 7% linked quarter with loans and deposit growth, interest recoveries and core NIM expansion during the quarter. Core fees were $2 million, a decrease year-over-year due to lower swap fee income. Total operating expenses increased 5% linked quarter and 15% year-over-year to $36.9 million. That's driven primarily by the performance-related compensation and increased technology investment. Slide 9 shows the past 5 quarters of average loan balances and deposit balances by type. Total average loans for the quarter increased 10% year-over-year to $6.3 billion. Linked quarter, growth was strongest in residential mortgages at 3%, followed by CRE growth at 2%. The year-over-year growth rates of individual loan categories on the accompanying slide were affected by the reclassifications that we made at the end of 2016. If we could apply the reclassification to prior periods, CRE growth would have down approximately 12% and C&I growth would have down approximately 7% year-over-year. Average total deposits for the quarter increased 13% year-over-year to $6.5 billion, with all major deposit categories exhibiting double-digit growth year-over-year. Linked-quarter growth was $152 million or 2%. The second quarter is typically slower for deposit growth due to client tax payments; but those weren't as prevalent this quarter, and that aided our year-over-year growth. Turning to Slide 10, core bank NII increased to $55.8 million. Net interest margin at the bank increased 14 basis points linked quarter to 312 basis points, and that's aided by $2 million of interest recovered on previous non-accrual loans. Excluding the interest on previous non-accrual loans, the core net interest margin increased 4 basis points to 301. NIM expansion was driven by low deposit beta, coupled with increased loan yields. The bank's cost of interest-bearing deposits increased 2 basis points linked quarter from 41 to 43 basis points, while the all-in cost of funds, including DDA, increased 3 basis points from 38 to 41. And now I’ll turn it over to Corey Griffin, CEO of Boston Private Wealth. Corey?

[Corey Griffin:]

Thanks, Dave. Good morning, everyone. Slide 11 contains financial information for the Wealth Management and Trust segments, which operates under the Boston Private Wealth brand. Total revenue increased 3% linked quarter to $11.3 million due to higher levels of average AUM. Operating expenses declined 14% linked quarter and 13% year-over-year, resulting in segment EBITDA of $400,000. Achieving positive EBITDA is an important milestone is especially notable given that we have been adding client-facing professionals in all of our markets as we balance returning the business to profitability with positioning for the long-term growth. On Slide 12, we show both new business flows and net flows of Boston Private Wealth for the past five quarters. New business flows improved to $195 million. With strong client retention this quarter, we showed our second consecutive quarter of positive flows and the third consecutive sequential net flows. I will now hand it back to Clay.

[Clayton Deutsch:]

Thanks, Corey. Let me quickly cover our other wealth businesses. Slide 13 shows AUM net flows by segment. During the second quarter, the Investment Management segment showed net flows of negative $176 million and the Wealth Advisory segment had net flows of negative $67 million. On a consolidated basis, the company’s net flows were negative $180 million. On Slide 14, we show the total revenue for the Investment Management segment increased 2% linked quarter and 4% year-over-year. Operating expenses were flat linked quarter but up 6% year-over-year due to higher compensation expense. The Investment Management segment second quarter 2017 segment EBITDA margin of 31% remains in line with our 30% corporate target. Moving to Slide 15. Our wealth advisors reported revenues of $13 million, up 1% linked quarter and 3% year-over-year. Operating expenses decreased 5% linked quarter and 3% year-over-year. First quarter 2017 segment EBITDA margins of 30% are in line with our corporate target of 30%. That includes our comments on the quarter. Now we’ll open up the line for your questions.

[Operator:]

Thank you. [Operator Instructions] The first question is from Casey Haire at Jefferies.

[Casey Haire:]

Thanks. Good morning, guys. I wanted to focus on the credit recovery, obviously continues to be very strong. I guess, first on the provision. What kind of reserve pool do you have against the special mention and the substandard-accruing population? I’m assuming that’s the opportunity, just what kind of reserve is allocated against them?

[David Kaye:]

It’s about $10 million, Casey.

[Casey Haire:]

Okay. And obviously feeling pretty good about capturing a large portion of that?

[David Kaye:]

Look, there is always going to be a portion of our loan book that’s in the special mention and the substandard cell. It’s definitely come down, but we could see further reductions in that. It’s never going to go to zero, though

[Casey Haire:]

Okay, understood. And then on the - on the NPL reversals, of that NPL population, what percentage is paying as agreed?

[David Kaye:]

It’s about 30% now.

[Casey Haire:]

Okay, great. And just switching to expenses, Dave, obviously coming a little bit higher than what you guys have talked about last quarter. So what is sort of the - what is the new expense growth target going forward? Just in sounds like package driving a lot of that, is that abating, or just sort of some updated thoughts on the expense outlook?

[David Kaye:]

Yeah. I think, look, for the second half of the year, I think it looks like that that 6% growth year-over-year is going to hold largely, as I said, due to the performance-based comp and also some of the tax spend. We have expected some of our technology costs to be -- more of that technology cost to capitalize in then expensed in future periods turns out it’s being expensed upfront. So for this year we probably expect a full year sort of 6% growth. Now, that doesn’t mean that carries into next year. Next year, we feel comfortable that we probably return more in line with our 3% historic expense growth versus this year’s elevated expense growth.

[Casey Haire:]

Okay, great. Thanks for taking the questions.

[Clayton Deutsch:]

Thanks, Casey.

[Operator:]

The next question is from Michael Young at SunTrust.

[Michael Young:]

Hi. Good morning.

[David Kaye:]

Good morning.

[Clayton Deutsch:]

Hi.

[Michael Young:]

First, I wanted to follow-up maybe on Casey’s question on the provision. Just as we think about new loan production, what rate are you kind of reserving against maybe both the commercial and residential new loan production? And how is that compared to the existing reserve at this point?

[David Kaye:]

Yeah. I mean, I think our residential loans are generally in a 40 basis point range, and that’s been fairly steady over time. Commercial, the new loans are coming and the past rated loans, CREs, is more in a 175 range. And C&I is a little bit lower than that. That’s probably 125.

[Michael Young:]

And then maybe just shifting gears kind of over to the Wealth Management and Trust segments, obviously a pretty good expansion in the EBITDA margin there to get that back to positive but pretty meaningful decline in the operating expenses, is that sustainable at this new lower run rate? And any color you can -- any additional color you can provide on what drove the decline?

[David Kaye:]

Well, I think that the decline in expenses had to do with some of the restructuring we’ve taken in the past, and you’re starting to see that bear fruit in the reduced expenses. So I think, yes, it’s sustainable.

[Michael Young:]

Okay, great. And maybe just lastly, Clay, just kind of a big-picture outlook on overall net flows. Obviously, the new business flows that you called out this quarter were good, but still kind of the big draw down in Investment Management. Do you think we’re going to kind of find some more stability in the back half essentially?

[Clayton Deutsch:]

Yeah, if I think of it as a three-legged stool, very excited about the progress we are now seeing in Boston Private Wealth. We think the underlying client acquisition and development fundamentals are pretty good, and we think that business is on its way now to a good place after a lot of hard work over the last year or year and a half. If anything, I'm looking to that business to accelerate and we think margins will continue to widen. So we feel pretty good about where we're going there. The investment managers are doing a very good job of P&L management and margin maintenance, even a little bit of margin expansion, despite ongoing headwinds against nichy, active U.S. equity strategies. Our investment managers are doing a lot to try to hold serve, despite category compression in active U.S. equity management. I think having those firms stay as close to flow neutral as possible with strong P&L management is the recipe where we're following there, and I think both firms are below our AUM and revenue growth targets, but hanging in there from a margin generation and kind of value to the enterprise standpoint. And then third, our wealth advisory segments, we're disappointed the flows were negative. Those firms historically have had more stability. We also know, though, their track record is pretty lumpy from a new business and AUM standpoint. Those are pretty nichy, pretty book boutiquy firms. In an any given quarter, they tend to hop around a bit from an AUM and flow standpoint. We're pleased with the revenue and margin stability those firms have generating. And when I say those firms, I'm referring to KLS and [indiscernible]. Both firms continue to invest in marketing and business development efforts, and they're doing a great job on client service, good job on client retention. So we would hope going forward that the wealth advisory firms, which show steadier growth not in any one quarter, but if you draw a line through multiple quarters, we think that's a stable segment probably with better growth prospects than the hardcore investment management, equity management business. Sorry for ramble, but is that an adequate treatment or do you want to more deeply into any of them?

[Michael Young:]

No, that's helpful. I appreciate it.

[Operator:]

The next question is from Chris McGratty at KBW.

[Chris McGratty:]

Hey, good morning, everyone.

[Clayton Deutsch:]

Good morning.

[David Kaye:]

Hi, Chris.

[Chris McGratty:]

Dave, maybe on the margin. I think in the remarks you talked about interest reversals, but you also talked about betas been quite low. I’m interest, number one, in the mix of your deposit base, retail versus commercial, any color there, and then expectations for the margin based on the renewed flattening of the curve but also discipline on the deposits. Thanks.

[David Kaye:]

So, I'll take the retail versus commercial. It's probably about 60% commercial in terms of balances. In terms of looking forward on the margin, I'd be pleased with another couple of basis points of expansion for the later half of the year. We'll get a little bit more from the last rate hike that we saw in June, and hopefully our deposit base will continue to be…

[Chris McGratty:]

Just as a follow-up, the expansion, are you adjusting for the interest reversal or are you doing off reported number? Just to be clear.

[David Kaye:]

No. Yeah, sorry, just that the core number I'm really talking about.

[Chris McGratty:]

Okay, and that was around 300 if you take out the…

[David Kaye:]

I think it’s -- yeah, for the bank, it’s like 301 or something like that.

[Chris McGratty:]

Okay, great. And then maybe, Clay, for you. Can you update us on kind of the expectations for ROE maybe the next year, year and a half, given the dynamics of the company -- the challenges with flows but also the opportunities you guys -- the success you had with credit and balance sheet growth will be a little bit more meaningful? Thanks.

[Clayton Deutsch:]

Yeah, Chris. If I, I fact, back the provision out and try to get to a core ROE number, so even though I’m thrilled our stated was 12.1, there was, what Dave, 60 basis points or so just the provision growth in there. So let’s call the core ROE this quarter more like in a 11-ish. I think 11 is a good number in the core. I think the fulcrum for the whole discussion, Chris, is can we maintain margin expansion. And all I say about that, I am encouraged I’m spending a tremendous amount of time with our bank and with our private bankers and what I see going on in terms of upsurge in client acquisition rate and client development rate across our markets excites me. So I look at it as a two-part story. We have margin expansion potential in our Boston Private Wealth business, and the bank is doing a tremendous job. We don’t disclose client metrics or client statistics, but I am comfortable talking to shareholders about what we’re doing on business building. Big uptick this year, bigger than our financials reveal, big uptick in client acquisition success in all of our wealth and banking markets, and a big upsurge in client development activity. I think the metric you most see that around is deposit build. We’re doing an exceptional job on deposit build, which I think is a great parameter of client acquisition and development success. There is gold in that liquidity. There is absolute gold in that liquidity. So I’ll stop there. But I think the go-forward for us hinges tremendously on how you feel about the client/development fundamentals, the client acquisition and development fundamentals, because that to me is the fulcrum for margin expansion. If we can keep this margin expansion be going, I think we can meet or exceed the 11-ish that I’ve been in search of. So I’ll just stop there, but that’s how I think about it.

[Chris McGratty:]

Alright, that’s great color. Thank you for that. Maybe last one, David, on the tax rate. Can you help us with kind of the expectations over the next couple of quarters?

[David Kaye:]

Yeah, I go back to sort of the 31% guidance that we had. We had a little bit of benefit from the new tax rules regarding when stock vests [ph], and so we get a little bit of credit on the tax for this quarter stove it down, but other than that, I go back to the 31%.

[Chris McGratty:]

Okay, thanks a lot.

[Clayton Deutsch:]

Thanks, Chris.

[Operator:]

[Operator Instructions] The next question is from Alex Twerdahl with Sandler O’Neill.

[Alex Twerdahl:]

Hey, good morning, guys.

[David Kaye:]

Good morning.

[Clayton Deutsch:]

Hi, Alex.

[Alex Twerdahl:]

First off, Dave. Dave, I was wondering if you can just, with respect those interest recoveries in the margin, which loan buckets are those mostly allocated to? Can you give us the breakdown, and maybe for last quarter as well, just so we can see how the loan yields in each category has been trending?

[David Kaye:]

Yeah. A lot of those recoveries are really in the CRE bucket. Those are sort of the historic source of -- if go back in five year, it’s -- we had some problems in the CRE bucket, and so the recoveries are really coming from that.

[Alex Twerdahl:]

Okay. So as you look forward for kind of the loan outlook on the margin, residential stuff seem to stabilized, is maybe moving a little bit higher in terms of those yields. The home equity obviously is moving higher with short end of the curve. And then is there some stability in the commercial side as well given the shape of the curve right now?

[David Kaye:]

Yeah, there is. So just - again, don’t -- I wouldn’t take the 2Q yields and look at that, because those were aided by the recoveries.

[Alex Twerdahl:]

Got it. And then I want to drill on a little bit more on the performance-related expenses particularly this quarter, which I think maybe accounted for a little bit of the higher guidance. But if you look at the segments, you look at the - at Boston Private Wealth, these expenses going down; and if you look at the investment managers, they’re up but only modestly; in the wealth advisors, expense going down. So I’m assuming that the bulk of those performance expenses are allocated to the banking segment. So what exactly can we look at - or we do you recommend we look at in the banking segment as we re kind of try to project forward the variability in those types of expenses

[David Kaye:]

Well, I think it was a little bit of a combination of all those things. We had very strong deposit growth and loan growth particularly in the residential, and so commissions associated with the residential book, with the deposit book, influence those numbers. And then kind of just the revenue growth on the banking side I think as well, we have targets for the senior management in terms of revenue growth, and we’ve seen just a little bit of a catch-up this quarter. Those are maybe the things that are driving it.

[Alex Twerdahl:]

Okay, great. Thanks for taking my questions.

[Clayton Deutsch:]

Yeah, thanks, Alex.

[Operator:]

The next question is from Christopher Marinac with FIG Partners.

[Christopher Marinac:]

Thanks. Good morning, guys. Clay, if we go back in time, we’ve had a fair amount of market list, yet you’ve had several quarters and years of sort of negative outflows, but I’m sure the business has grown even with the outflows. So I guess I’m wondering is there a point in time where we’re putting too much emphasis on the outflows. And then if we look at the general business and the progress that you’re making across all four areas on EBITDA, would that be maybe a better way of thinking about the business? Or should we still be putting a lot of weight on these flows?

[Clayton Deutsch:]

Yeah, I would never - Chris, I would never say ignore flows because flows to me say a lot about long-term earnings power of an AUM-driven business particularly in investment management. In the wealth advisory arena and even to some extent in our Boston Private Wealth business, pricing is not explicitly linked to AUM. It’s loosely linked to AUM. But certainly in the investment management business, and to some extent in all of our market-related businesses, a growing body of AUM obviously is an important foundation for sustainable revenue growth. So I never say ignore flows. Having said that, you make an insightful point. We are at the end of the day a margin-driven, margin-preoccupied company. So as we look at the portfolio and as we make decisions about the portfolio, we pay a lot of attention to what we think is underlying earnings power. So in these businesses, we're always working in fact on two things. We are always working on underlying business development, but we pay a whole lot of attention to margin management. And one the things I'd like about our fee-driven businesses is in the hands of good management, which I believe we have, there is a fair amount of latitude in how you manage the margins of those businesses. So I spend a lot of time, I spent as much time on comp to revenue and things like that as I do to the underlying AUM build. So my answer would be both matter, but at the end of the day, we're a margin-driven, long-term margin potential company. That's that we're trying to look at the portfolio.

[Christopher Marinac:]

Great. That's very helpful. I appreciate that. And I guess, as you look out the next year, you may have mentioned this also earlier, but is there opportunity do you think in the big picture to kind of expand these margins in general?

[Clayton Deutsch:]

I think we kind a touched on this a bit, but just to analyze on it, the -- just in absolute terms, the biggest margin expansion potential in company is probably in two areas. Kudos to Corey and the Boston Private Wealth management team, they are now EBITDA positive. $400,000 in the quarter is not a Hall of Fame achievement, but when you were running massively negative for the last better part of 2 years, it's a big achievement. And we've said to our shareholders, and I'll stand by this, that we're committed to driving that business to mid to high single-digit EBITDA margins this year, and we believe long-term that the business is capable of high teens, 20% kind of operating margins. And we stand by that expansion potential. There continues to be margin expansion opportunities in the bank. They’re growth- and development-driven, for my answering Chris McGratty five minutes ago. The more boutiqy investment management and wealth advisory businesses today are operating very close to what we think is an optimal target margin. 30%-ish, anything over to 30% margins in those businesses we think is - margin is in good standing, if you will. So I’ll pause there, but that’s it. I see two big areas of margin expansion potential for us, Boston Private Wealth and our core private banking business, which is very client-driven.

[Christopher Marinac:]

Sounds good, Clay. Thank you for following background here. Really appreciate it.

[Clayton Deutsch:]

Thank you.

[Operator:]

As there are no further questions, this concludes our question-and-answer session. I would like to turn the conference back over to Clay Deutsch for any closing remarks.

[Clayton Deutsch:]

Well, thanks for your interest in us. As pleased as I am with the financials in the quarter, which overall look pretty good, I try to look through it and look at the underlying fundamentals. I feel good about what I see underlying the financials with respect to client acquisitions, client development, expansion of our business, and we remain very fixated on that as the year unfolds into next year. I feel we’re on the march on the client side. And if we could say up tempo on client acquisition and client development, I believe good things are going to happen for us. Thank you.

[Operator:]

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