Boston Private Financial Holdings, Inc.
Q3 2017 Earnings Call Transcript

Published: 19 Oct 2017

[Operator:]

Good morning, and welcome to the Boston Private Financial Holdings Third 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.

[Adam Bromley:]

Thank you, Carrie, 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 third 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 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 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 all for joining our call this morning. In the third quarter our company generated net income of $19.8 million or $0.22 per share. This compares to $0.27 per share last quarter and $0.22 per share in the third quarter of 2016. Return on average common equity for the quarter was 9.9% and return on average tangible common equity was 13.2%. Despite the linked quarter change from $0.27 to $0.22 this quarter, I am pleased with our company's underlying business performance during the third quarter. You will recall that in the second quarter we had a $6 million provision credit which accounts for the entirety of the EPS decline linked quarter. With this in mind, let me expand upon a few business performance highlights from the quarter. First our private bank delivered very strong year-over-year revenue growth driven by double-digit net interest income growth and core net interest margin expansion. Our balance sheet continues to grow in line with all of our asset and liability goals with especially strong growth in residential lending. Second, our wealth management and trust segment maintained positive momentum recording a fourth consecutive quarter of improvement in net flows and a second consecutive quarter of positive EBITDA, with EBITDA margins now expanding to 9%. Third, our wealth advisory and investment management segments delivered sequential earnings improvement with EBITDA margins in excess of our corporate target of 30%. And business performance issue I see in the quarter, there's an expense level above consensus. Dave and I will have more to say about our expense build later in the call. This quarter's expense levels reflect continued investment in technology and growth linked staff additions as we support stepped up levels of client acquisition and client development. We are very committed to delivering a client appealing, client centric One Boston private growth strategy featuring private banking and wealth management solutions delivered to clients in an appealing and integrated way. With all this said, we will be very focused on expense leverage looking forward. With that I would like to turn the call over to Dave to hit the highlights.

[David Kaye:]

Thanks Clay, and 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 third quarter of 2017 was 9.9% and that compares to 12.1% in the second quarter of ’17 and 10.2% in the third quarter of 2016. Our capital ratios increased as our tier-1 common equity ratio is now up to 10.4% and that's up from 10.3% in the prior quarter. Slide 4 shows our consolidated revenue trends, total revenue was 96.9 million, which is a 2% increase linked quarter and 8% increase year-over-year. Our primary source of revenue, net interest income increased 14% year-over-year and decreased 1% linked quarter to 56.6 million. As Clay said, you may recall we had 2 million of interest recoveries during the second quarter, but absent that linked quarter increase in our core net interest income was 2%. Total core fees and income increased 5% linked quarter and 3% year-over-year. The revenue growth in our market linked fee business was driven by AUM growth with our wealth management and trust business demonstrating a strongest year-over-year revenue growth of 7%. Changes in private banking revenues were primarily driven by changes in swapped fee income. On Slide 5, we showed detailed breakout of our consolidated expenses. Third quarter total operating expenses increased 2% linked quarter to 69.3 million, while increasing 12% year over year. Operating expenses increased year-over-year due to strategic hires, performance-based compensation, and technology initiatives. Slide 6 shows the full consolidated income statement. Pretax pre-provision income was 27.5 million and that's an increase of 1% linked quarter and a decrease of 2% year over year. Driven by the provision credit last quarter, net interest, sorry, net income decreased 15% linked quarter to 19.8 million, while increased 1% year-over-year. Slide 7 provides detail on our asset quality. This quarter we booked a $400,000 provision credit due to net recoveries and improvements in loss factors partially offset by an increase in special mentioned loans and loan growth. The chart below highlights the bank's asset quality for the quarter. Criticized loans finished the quarter at 146 million reflecting a 16 million linked quarter increase. One relationship where we believe the risk of loss is low accounted for 13 million of that increase in the special mentioned category. We continue to maintain strong reserves with our ALLL to loans finishing the quarter at 117 basis points and that's down from 199 basis points in the previous quarter. On slide 8, we show the private banking segment that excludes the wealth management and trust portion of our bank. Total revenue at the bank increased 1% linked quarter and 9% year-over-year and again that was driven by the higher net interest income. Total operating expenses increased on a linked quarter and year-over-year basis to 38.5 five million and that's driven primarily by the revenue related compensation and strategic hires across our markets and also the technology investments that we've made. Slide 9 shows the past five quarters of average loan balances and deposit balances by type. Total average loans during the quarter increased 10% year-over-year to 6.4 billion. Residential mortgage growth continues to show the strongest growth and that’s at 12% year-over-year and 3% linked quarter. The year-over-year growth rates of the individual loan categories on the accompanying slide were affected by reclassifications we made as of 12/31/06. If we could apply the reclassification to prior periods, the CRE growth would have been approximately 11% and C&I growth would have been approximately 8%. Average total deposits during the quarter increased 8% year-over-year to 6.4 billion and that both the non-interest bearing and interest bearing deposits increased by 8% on average. Slide 10 shows core net interest income and core net interest margin at the bank. These measures exclude the impact of interest recovered on previous non-accrual loans. Core net interest income increased 2% linked quarter and 14% year-over-year to 57.2 million, while the core net interest margin increased to 3.06%. That’s an increase of 5 basis points linked quarter and an increase of 16 basis points year-over-year. The increase in net interest margin was driven by increased loan yields partially offset by increased deposit costs. The banks cost of interest bearing deposits increased 5 basis points linked quarter from 43 and 48, while the all-in cost of funds including DDA increased 4 basis points from 41 to 45 basis points. With that I’ll now the call 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 increased 4% linked quarter to 11.7 million due to higher levels of average AUM. Operating expenses declined 2% linked quarter and 5% year-over-year driven by efficiency initiatives, including headcount reduction and custody transition. Segment EBITDA for the quarter was $1 million with EBITDA margins of 9%. On slide 12, we show both new business flows and net flows of Boston Private Wealth for the past five quarters. New business flows for the third quarter of 2017 were 176 million which are in line with our five quarter average. New business flows coupled with strong client retention [indiscernible] resulted in net flows of positive 114 million. This quarter marks our fourth consecutive sequential improvement in net flows and our third consecutive quarter of positive net flows. I will now hand it back to Clay.

[Clay Deutsch:]

Thanks Corey. Let me now address our other wealth businesses. Slide 13 shows AUM net flows by segment. During the third quarter, the investment management segment showed net flows of negative $152 million and the wealth advisory segment had net flows of negative $71 million. On a consolidated basis, the company's net overall flows were negative $109 million. On slide 14 which show the total revenue for the investment management segment increased 2% linked quarter and 5% year-over-year. Operating expenses increased 1% linked quarter and 5% year over year, due to higher compensation expenses. The investment management segment third quarter 2017 EBITDA margin of 32% exceeds our corporate target of 30%. Moving to Slide 15, our wealth advisors reported total revenues of $13.3 million that's up 3% linked quarter and 4% year over year. Operating expenses increased 3% linked quarter and 2% year over year. Third quarter 2017 segment EBITDA margin of 33% for the segment exceeds our corporate target of 30%. That wraps up our prepared comments on the quarter. We’ll now open the line up for your questions.

[Operator:]

[Operator Instructions] The first question will come from Casey Haire of Jefferies. Please go ahead.

[Travis Potts:]

Good morning guys, this is actually Travis Potts on for Casey. Just starting on the expenses, sorry if I’ve missed this in your prepared remarks. But it came in a little bit higher than expected. I'm just wondering is there any kind of like one timers in there, kind of how should we be thinking about the run rate going forward from here.

[Clay Deutsch:]

Yeah, I think as far as one timers, there's probably about $1 million worth of expenses that I wouldn't expect to repeat in the following quarter. Some of those were catch ups on some revenue related accruals. Also we had some new hires during the quarter with guarantees and sign-on bonuses. And if I exclude that we probably have about $1 million savings in the following quarter.

[Travis Potts:]

And then just moving to provision, obviously still on kind of net recovery mode there. But how should we be thinking about provisioning going forward just given the uptick we saw in criticized loans this quarter.

[Clay Deutsch:]

Yeah, the uptick in criticized loans is really isolated to one special mention loan. We're not seeing anything systematic in terms of credit degradation. The provision can be lumpy, because of recoveries that we may or may not have, although we're sort of nearing the end of that. So, I wouldn't expect next year to have credits for the year, but it's difficult to tell quarter by quarter.

[Operator:]

The next question will come from Michael Young of SunTrust. Please go ahead.

[Michael Young:]

Clay, wanted to start with, you mentioned on the expense side that you guys have been doing some robust hiring sort of maybe year-to-date, could you give us a sense of how many net new people you've hired this year and then you mentioned kind of moving towards unlocking the efficiency, maybe at those hires going forward. So does that end kind of at the end of this year and we see the revenue benefit next year? Could you just kind of characterize that for us?

[Clay Deutsch:]

Sure. Michael, if you look at our history, expense discipline has kind of been a signature. So, this is an important issue to talk about. We made a purposeful step-up on staffing and technology spend to drive a higher rate of client acquisition and development. And I think the client side of it is working. I think that’s out in the growth numbers that are pretty significant step up for us. The expense consequences have been the following. We normally hire about 150 people a year, just to go sideways, driven by normal turnover. We added to it this year strategic spending in two areas, expansion of our business development capacity, particularly to support our wealth, mortgage and deposit growth, and second, we are installing a pretty client appealing online mobile platform to better serve our private clients as well as our corporate institutional clients. The specific number, we added above and beyond our normal net hiring year-to-date 36 key positions. Those 36 are in place. Our total goal for the year was in the 40s, but we feel we've pretty substantially accomplished what we set out to do in terms of staffing for the year. So, I hope that's a useful disclosure of how that stepped through. I think what we're going to focus quite a bit on now is levering that investment in client generating capacity. We’d like to continue to travel the growth arc that we're on. I think we're showing very nice revenue leverage. And, we're going to be very focused on getting maximum productivity out of that expense base.

[Michael Young:]

So net-net, you had planned to kind of pass that maybe into next year and see the revenue benefit, is that the right way to think about that or do you plan to continue kind of the hiring trajectory as well?

[Clay Deutsch:]

I don't think the number will be -- we’ll certainly add folks next year, but it won't be a step-up year-over-year.

[Corey Griffin:]

Yeah. Not at this pace.

[Michael Young:]

Okay. Great. And then maybe just switching gears a little bit to kind of the balance sheet management, obviously the deposit growth on a year-over-year basis was 8%, which is pretty good, but sequentially, was a little lighter. Loan to deposit ratio is kind of pushing up a little higher than maybe pure institutions. What's kind of the outlook there and how do you balance the two going forward?

[David Kaye:]

Yeah. We're focused on trying to, over the long term, build liquidity. We'd like to see our loan to deposit ratio, running in the 95% range. I think the average for the quarter was about 97%. We did finish the quarter. It ticked up 100% and that’s not the level that we want to run at. So as Clay mentioned, a lot of the focus on hires is then in the deposit world and we'd like to see that build grow slightly faster than our loan categories.

[Operator:]

The next question will come from Alex Twerdahl of Sandler O'Neill. Please go ahead.

[Alex Twerdahl:]

Hey, just to piggyback on that final question that was asked about deposit growth trends, maybe if you can just talk a little bit more about that we saw some very strong non-interest bearing deposit growth and we have been seeing that, but we also saw some rates on CDs, et cetera tick up a little bit sequentially. So, can you talk about growing that loan to deposit ratio maybe or bringing that loan to deposit ratio back down. Is it through some promotion areas things or do you have to raise rates to do it or is it really hiring people and cultivating relationships and maybe just talk a little bit about kind of how you see the mix of deposits playing into that loan to deposit ratio coming down?

[David Kaye:]

Yeah. I mean, we like our mix of deposits as it currently stands with a heavy emphasis on the non-interest bearing. I think, we’re not trying to compete on rates. We tend to avoid promotional or any sort of special things that attract more of the hot money. And going forward, I would expect to try and be disciplined in our deposit pricing as well and I think we've demonstrated that and we're going to look to continue that in the future. The CD uptick, I mean we had earlier in the year, repriced some of our CDs for some of the clients that are looking to get further yield and I think what you saw there was more of, not necessarily a big migration into CDs, but more of a -- as the other CDs mature rolling into the new higher rates that we had established, but far from any sort of specials or promotional activity.

[Alex Twerdahl:]

Okay. And then just on the expenses, you said there's about 1 million that was accessed in the third quarter that won't occur in the fourth quarter, but just how do we think about that in terms of what the typical fourth quarter would look like with some of the promotion area or non promotion area incentive related accruals that happened in the fourth quarter?

[Clay Deutsch:]

Yeah. I mean, fourth quarter has historically been a little bit lumpy. We think we've got those accruals adjusted appropriately in the third quarter. So hopefully, we won't see that volatility in the fourth quarter. But as I mentioned, I think $1 million of, I’d say, non-recurring stuff that we had in the third quarter, we're hoping that fourth quarter looks a lot like the third quarter, absent that $1 million.

[Alex Twerdahl:]

Okay. That's good. And then, at one point in time, there was a strategy particularly at BP Wealth to try to hire or maybe do lift outs of teams and I think you did actually a couple few years ago where you had to come with the book of business. Is that still part of the strategy or is it really -- has that shifted a little bit?

[Corey Griffin:]

Hi. This is Corey. Yes. Sure. That continues to be absolutely part of our strategy and we continue to look at all sorts of opportunities essential for our strategy. The pipeline is very robust. We've actually made a few hires this year where there will be a lag in terms of assets coming with those individuals that’s absolutely a certain part of our strategy.

[Operator:]

[Operator Instructions] The next question will come from Chris McGratty of KBW. Please go ahead.

[Chris McGratty:]

Clay, I just want to kind of approach the expense question a little bit differently. You guys are A+ in assets. Is any of the spend related to 10 million ultimate possible crossing and then maybe comment about you guys are obviously a couple of years away from it, that’s a strategy you plan to do and number two, have you start to build the expense run rate for that?

[Clay Deutsch:]

Yeah. Chris, great question, I’ll try to be as direct as I can. The expense step up has very little to do with regulatory preparedness. We have been, for the past several years, year over year over year, enhancing our ability to do stress testing, capital planning, balance sheet management, risk management in the broader sense. I feel we're approaching 10 billion in a highly prepared state. There is an expense increment certainly associated with that already present in the company. But that's not what’s at work on our expense development as you see it unfolding this year. The real drivers of it are the already mentioned growth driving staff step ups and staffing costs as well as other vendor consulting glass, et cetera associated with the digital build out.

[Chris McGratty:]

Just if I can go back to the margin, maybe Dave, your deposit betas I think are quite low, relative to peers today. Can you just talk about kind of outlook to sustain the trajectory of the core NIM, given the curve and kind of how flat it is? Is this margin the core margin ex interest reversal? Is that a sustainable number or can you improve upon it in this kind of environment? Any color would be great.

[David Kaye:]

Yeah. I mean I think for this past quarter, where we got the 5 basis points of core margin expansion and we definitely benefited from the June rate hike. Obviously, we didn't have a rate hike in the third quarter, so there won't be that same benefit in the fourth quarter. If there is a December rate hike, it really won't be that material on the margin. So, my expectation is for the fourth quarter, margins are sort of maybe 0 to 1 basis points higher, all other things being equal. And then, I guess, over the long term, it depends on what assumptions you make on the curve as you've said. So, but, in the near term, we think this is a good rate -- run rate.

[Chris McGratty:]

And just maybe you could, I’m not sure if you publicly disclose your assumed betas in your models. I think right now you’re running somewhere around 20%, which is pretty low. What's the long term assumption on the betas?

[David Kaye:]

Well, I think in the K, we had assumed that over the long run, it was sort of in that 50 to 60 depending on the category and it varies. So, that was our assumption over the long term.

[Operator:]

And this concludes our question-and-answer session. I would now like to turn the conference back over to Clay Deutsch for any closing remarks.

[Clay Deutsch:]

Thank you all for your interest in us. I think the key to our future is continuing to push ahead with our client incentive growth strategy. I like the performance feedback we're seeing in terms of client development. I like what we're doing in our wealth business and in our balance sheet linked banking businesses. It has come at a cost. You see, that you see the expense consequences of it. We are now going to be all about margin generation and expense leverage, but I'm pleased that we have moved ourselves to a higher level of client efficacy and I think it's going to bode well for our future in terms of revenue expansion. What we now have to do is translate that into operating leverage. So I feel the way ahead is pretty clear. With that, we look forward to talking with you as we get out and do our shareholder visits and as we move towards the end of the year. Thank you, all.

[Operator:]

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect your lines. Have a great day.