Boston Private Financial Holdings, Inc.
Q4 2017 Earnings Call Transcript

Published: 18 Jan 2018

[Operator:]

Good morning, and welcome to the Boston Private Financial Holdings Q4 2017 Earnings Conference Call. [Operator Instructions] Please note this call is being recorded. And I would 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, everyone. This is Adam Bromley, Director of Investor Relations of Boston Private Financial Holdings. We welcome you to the conference call to discuss our fourth quarter and full year 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; and Steve Gaven, Chief Financial Officer. This call contains forward-looking statements regarding strategic objectives and expectations for future results of operations and financial prospects. They are based upon the current belief and 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:]

Good morning, everyone. Thank you for joining the call this morning. As you saw in our press release, fourth quarter and full-year financial results include the impact of one-time non-cash charges resulting from two notable items, one, our agreement to divest Anchor Capital Advisors and two, Federal Tax Legislation. While we disclosed both GAAP and operating results in our press release and the earnings presentation, our comments today will primarily focus on the company's operating results which exclude the impact of these one-time non-cash charges. We will provide more detail on these notable items later in the call but we believe both will benefit our company and our shareholders. The Anchor transaction represents a continued simplification of the BPFH business model and allows us to focus attention and resources on our Wealth Management, Trust and Private Banking businesses. This deal creates capital flexibility by transforming goodwill and intangible assets into tangible common equity. Second, we believe the recently enacted federal tax legislation will greatly benefit shareholders in the form of a lower effective tax rate in future periods. Let me now turn to our results. During the fourth quarter, our company recorded a GAAP net loss of $18.3 million. Excluding the notable items, our operating results adjust to $20.6 million of operating net income or $0.22 per share. For the full-year, our company generated GAAP net income of $40.6 million which adjusts to operating net income of $79.5 million or $0.88 per share. In addition during 2017, BPFH distributed $0.44 per share of dividends. Last night we announced a dividend increase to $0.12 per share per quarter. Excluding the impact of notable items, our company generated a 10.2% return on common equity during the fourth quarter and 10.1% for the full year 2017. Highlights for 2017 from my vantage point include revenue generation at the bank which efficiently translated strong loan and deposit growth and a rising rate environment into core net interest margin expansion for the full year of 13 basis points, which allowed us to realize 12% growth in net interest income. Second, Boston Private Wealth continues to demonstrate improvement showing positive net flows every quarter throughout 2017 with EBITDA margins in the high single digits during the second half of the year. Third, we announced a reorganization of our BPFH executive team to structure our company around clients and client development rather than business lines. More integrated delivery of private banking and wealth management services provided a significant lift to all of our Boston Private businesses in 2017. One of the features of our new leadership structure is that Steve Gavin has become our Chief Financial Officer. Steve previously served as Director of Investor Relations and Corporate Finance and more recently as the Chief Financial Officer of Boston Private Wealth. Steve is joining me on the call today and will be walking us through our fourth quarter and full-year results. Steve is familiar to most of our analysts and shareholders and I'm proud to have him here with me today on the call. With that, I’d like to turn the call over to Steve. Steve?

[Steve Gaven:]

Thanks Clay, and good morning everyone. My comments will begin on Slide 3, with a discussion of the notable items impacting this quarter's results followed by an overview of the quarter and the full year. The first notable item is related to our previously announced agreement to divest our equity interest in Anchor Capital Advisors. As a result of this agreement which was announced December 20, we moved Anchor's assets and liabilities to held-for-sale as of December 31, 2017 and we recorded a $1.3 million loss on sale of affiliate which is included in the other income line of revenue, a $24.9 million goodwill impairment charge and $400,000 of legal expense. Results attributed to Anchor's performance during the fourth quarter and in prior periods remain consolidated in the income statement. However, Anchor's AUM is excluded from AUM and net flows. The transaction is expected to close in the first quarter of 2018. In addition to the charge we took this quarter, we have also previously announced that we will be recognizing a tax expense of approximately 10 million to 12 million at the time of closing. At the close of the transaction, we estimate our Tier 1 common capital will increase by approximately 33 million. The second notable item is related to a revaluation of the company's deferred tax asset, deferred tax liability, and low-income housing tax credits following the federal tax legislation that was signed into law during December. As a result of the revaluation, the company incurred $12.9 million of income tax expense during the fourth quarter. We project that our company and shareholders will benefit as our effective tax rate on continuing operations will decrease to 22% in future periods from approximately 30% in 2017. The results shown on the following slides present our results on an operating basis. A full reconciliation of GAAP to operating results can be found in the appendix. Slide 4 shows consolidated revenue trends. Total operating revenue for the quarter was $97.7 million, a 1% linked quarter increase and a 6% increase year-over-year. Total core fees and income increased 3% linked quarter and 4% year-over-year. Linked quarter revenue growth in our market linked businesses was driven by performance fees in the investment management segment, while year-over-year revenue growth was driven by 7% growth in our wealth management and trust, and wealth advisory segments. Private banking fees decreased linked quarter due to lower loan fees while increasing year-over-year due to higher BOLI income. On Slide 5 we show a detailed breakout of our consolidated expenses. Fourth quarter total operating expenses excluding notable items decreased 1% linked quarter to $68.7 million while increasing 10% year-over-year. Operating expenses increased year-over-year due to strategic hires, performance-based compensation, technology initiatives and occupancy expense. Slide 6 shows the consolidated income statement for the quarter. Operating pretax pre-provision income was $29 million, an increase of 5% linked quarter and a decrease of 4% year-over-year. Operating net income of $20.6 million represents a 4% linked quarter increase and a 6% year-over-year decrease. Slide 7 shows the full year consolidated income statement. Excluding previously discussed notable items, the company's pretax pre-provision earnings increased 2% driven by 12% growth in net interest income partially offset by 8% growth in operating expenses. Slide 8 provides detail on our asset quality. This quarter we booked a $900,000 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 $155 million, special mentioned loan have increased $50 million year-over-year coming off a historic low level for the consolidated bank at year-end 2016. The increase in special mentioned loans was driven by two relationships where we believe the risk of loss is low. We continue to maintain strong reserves with ALLL to loans finishing the quarter at 115 basis points down from 117 basis points in the previous quarter. On Slide 9 we show the private banking segment excluding the wealth management and trust portion of our bank. Total revenue at the bank decreased 1% linked quarter and increased 6% year-over-year driven by 11% growth in net interest income. Total operating expenses were $38.6 million, flat linked quarter and an increase of 23% year-over-year driven primarily by revenue related compensation and strategic hires across our markets, increased technology investment and occupancy expense. Slide 10 shows the past five quarters of average loan balances and deposit balances by type. Total average loans during the quarter increased 7% year-over-year to $6.4 billion. Residential mortgage continues to show the strongest growth coming in at 13% year-over-year and plus 3% linked quarter. The year-over-year growth rates of the individual loan categories on the slide were affected by reclassifications we made as of 12/31/16. If these reclassifications were applied to prior periods, CRE growth would have been approximately 4% and C&I growth would have been approximately 2%. Average total deposits during the quarter increased 7% year-over-year to $6.4 billion with money market accounts showing the most significant growth year-over-year. Slide 11 shows core net interest income and core net interest margin at the bank. These measures exclude the impact of interest recovered on previous nonaccrual loans. Core net interest income increased 1% linked quarter while increasing 10% year-over-year to $57.5 million. Core net interest margin was 3.06% flat from the previous quarter and up 17 basis points year-over-year. The net interest margin increase was driven by increased loan yields partially offset by increased deposit costs. The banks cost of interest-bearing deposit increased four basis points linked quarter from 48 to 52 basis points while the all-in cost of funds including DDA increased three basis points from 45 to 48. I will now turn it back to Clay to discuss our Wealth Management and Trust, Investment Management and Wealth Advisory Segments.

[Clay Deutsch:]

Thank you, Steve. Slide 12 contains financial information for the wealth management and trust segment which operates under the Boston Private Wealth brand. Total revenue increased 1% linked quarter to $11.9 million due to the higher levels of average assets under management. Operating expenses were flat linked quarter and are down 13% year-over-year excluding last year's goodwill impairment charge. Segment EBITDA for the quarter was $1.2 million within EBITDA margin of 10%. On Slide 13 we show both new business flows and net flows at Boston Private Wealth for the past five quarters. New business flows in the fourth quarter were $213 million which is above the five quarter average of $181 million. Net flows for the quarter were $79 million. Slide 14 shows AUM net flows for all of our business segments. Reported results from the investment management segment have been restated to exclude Anchor Capital flows during the past five quarters. In the fourth quarter, the investment management segment showed net flows of $20 million and the wealth advisory segment had net flows of $29 million. On a consolidated basis, total company net flows were $128 million. On Slide 15 we show our investment management segment including contributions from Anchor Capital. Total revenue increased 9% linked quarter driven by $900,000 of performance fees realized in the fourth quarter. The 1% year-over-year decline was driven by a decline in performance fees which were $1.4 million in the fourth quarter of 2016. Operating expenses net of the goodwill impairment and transaction-related legal expenses increased 3% linked quarter due to higher compensation expense and declined 4% year-over-year. The investment management segment fourth quarter 2017 EBITDA margin excluding goodwill impairment was 35% exceeding our corporate target of 30%. Moving to Slide 16,our wealth advisors reported total revenues of $13.5 million up 2% linked quarter and 8% year-over-year. Operating expenses decreased 11% linked quarter while increasing 18% year-over-year. The 18% increase is driven primarily by expansion of the partner body in both of the firms in this segment. Fourth quarter 2017 segment EBITDA margin of 41% exceeds our corporate target of 30%. The 41% EBITDA margin includes a revaluation of a long-term incentive plan in one of the firms. A more representative EBITDA for the segment is 34%. This concludes our prepared comments for the fourth quarter. My last comment has to do with BPFH Board composition. Last night we announced via an 8K filing that John Morton, a long time board member has decided to depart from our Board at the upcoming annual shareholder meeting in April. John joined our Board in 2008 and is stepping down in line with our Board guidelines on age limits and length of service. John joined our Board during the depths of the financial crisis and he has been an invaluable Board member and advisor. All of us appreciate his service and I will personally miss his wise counsel and support. We’ll now open up the line for your questions.

[Operator:]

[Operator Instructions] And the first question comes from Casey Haire with Jefferies.

[Casey Haire:]

So wanted to start on the wealth management and trust. You guys have been talking about improving the pretax margins, I think you guys have a long-term goal of 20% in mind. Where are we in that process and what’s the reasonable goal for 2018?

[Clay Deutsch:]

Well we're ending this year more than half way there. So while I gave you the fourth quarter average return, that line has just been steadily rising throughout the year. And that team just continues to make really good progress building the business. And we’re now getting operating leverage through favorable growth dynamics coupled with lot of expense in infrastructure discipline. We have an ambitious plan for 2018 and I'm not going to kind of change the parameters we’ve given you previously. We want that to be a 20% business and then we'll go from there. That business is modeled, is built and modeled to expand very nicely and its going to have we believe favorable operating leverage as they progress. So I think the key numbers to watch are AUM development, revenue build, and how that translates into continued margin progress.

[Casey Haire:]

I mean I guess so in terms - so it has to be revenues from here, there is no more cost cutting from here on now?

[Clay Deutsch:]

I’d call it more cost discipline rather than cost cutting. We like the economic structure that's now built into the business and now we're very, very focused on continued client acquisition and development and building the business from here on.

[Steve Gaven:]

Casey this is Steve, I’ll just add that. There is still some expense relief to be had in the coming year based on actions that we took throughout the year where you didn’t have the full year impact. So you could see - we don’t need to grow expenses I guess to - what I am trying to say we don’t need to grow expenses to keep revenue growth building in that business.

[Casey Haire:]

So just switching to capital management pro forma for the sale of Anchor, you guys will be in a decent capital position I mean above your targets. What you guys see - what are the plans for that excess capital once that deal is done?

[Steve Gaven:]

Casey we have a couple of options, a lot of things [are disposable] [ph] we could do. One of things we’re looking at is how do we reshape the capital stake, we got to deploy that for added loan growth you saw us take the dividend up. We're confident though at the end of the day that we’ll be able to do something with the capital where we make this transaction accretive to earnings based on the capital build we’re going to generate.

[Operator:]

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

[Alex Twerdahl:]

I just wanted to drill on a little bit on a couple of things. One, if you guys could update your expense guidance for 2018 both in the wake of the new tax plan also adjusting for Anchor Capital would be great?

[Steve Gaven:]

Alex the way I would think about, our goal right now is we are going to manage to 4% to 5% expense inflation on a core basis or take Anchor out of it. I think that’s how we’re thinking about it. The only thing I would remind you as it relates to expenses, we typically have the uptick in comp and benefits in the first quarter due to reset of payroll taxes. So that’s typically anywhere from 2 million to 3 million so I’ll just be mindful of that.

[Alex Twerdahl:]

And then also for loans and deposits I think historically your guidance has been somewhere in the neighborhood of 8% to 10% but obviously if you are paying lower taxes you’re able to accrete capital at a faster clip. Does that guidance need to go higher in order to actually put that capital to work?

[Clay Deutsch:]

I would absolutely love to see us perform at the higher end of the range. We’re trying to deploy ourselves to drive something more like 10% balance sheet growth in general. The 8% to 10% interval is something I’ll standby but our plan for 2018 is to try to push our favored loan categories, we love the resi mortgage business. We’re doing a good job in portions of our commercial lending business. I think the key metric for us is deposit build. We want to go up-tempo on growth without diminishing liquidity. So I think deposit growth and capital build become the two real pacing metrics that we’re trying to work within as we manage balance sheet growth.

[Alex Twerdahl:]

And then just a final question from me. I think Clay in your prepared remarks you said that part of the rationale for selling Anchor is the simplification of the business model which we have certainly seen over the last 10 years, a lot of that how much more of this "simplification" perhaps in a way of divesting others subs should we think about in 2018 or in the future?

[Clay Deutsch:]

Alex I wouldn’t read into Anchor moves on our other affiliates not trying to be coy but we evaluate the economics of each one of our affiliates continuously. With Anchor I just came to the view that our company has not been a great owner of autonomous asset management firms. Anchor is a high quality asset, high quality firm but our ability to add a lot of value to that firm as they try to build their own AUM frankly was limited. So I think it’s a good in a world where there are very few win wins I actually think this is a good transaction for Anchor. I believe it’s a good transaction for us and I think we'll be able to redeploy the proceeds into businesses that we more directly control and are much more in line with our wealth and trust and private banking sweet spot. So that’s the logic behind Anchor and we’ll continuously evaluate all the other businesses we’re in.

[Operator:]

And the next question comes from Chris McGratty with KBW.

[Chris McGratty:]

Steve maybe question for you or Clay, you talk about the high end of 8% to 10% I think in the past you said loan growth, the securities portfolio a little bit smaller kind of flat on a sequential basis. Is that going to grow proportionally with loans or is there a bit of a remix story that would suggest and the asset growth might be couple of hundred basis points behind loan growth this year?

[Steve Gaven:]

I mean see I think long-term it will kind of grow in line with the other categories. We’re not looking to make a big strategic shift on the balance sheet mix right now.

[Chris McGratty:]

And then Steve on the margin, I think you said the effective tax rate is 22% is that right effective?

[Steve Gaven:]

Yes, 22% - it might be a little lower in the second quarter Chris depending on stock comp vestings. So there could be some volatility but I think 22 is the right number for the full year.

[Chris McGratty:]

And then with the FTE adjustment, you obviously get the benefit on the tax line. Is my math right, is about 5 to 6 basis point just drag on the NIM just optically begin in the Q1 is that right?

[Steve Gaven:]

Yes, that’s the right way to think about it and as it relates to NIM, we just talk about core NIM for a second, we’re expecting maybe 1 to 2 basis points accretion in the first quarter given the rate hike in December and 30% of the balance sheet that reprices within 30 days kind of getting that lift. So that’s how we’re thinking about the core NIM going into first quarter of 2018.

[Chris McGratty:]

So core NIM up a couple and then optically the hedge with the tax adjustment, okay.

[Steve Gaven:]

Correct.

[Chris McGratty:]

And then maybe a final one on the share count, it came down a bit this quarter is that options related I’m trying to get a sense of is this good share count to use for 2018?

[Steve Gaven:]

Well on a GAAP basis the share count was lower because of anti-dilution.

[Chris McGratty:]

Okay.

[Steve Gaven:]

I think you look back to last quarter share count that’s the pretty good approximation of kind of how share count develop.

[Chris McGratty:]

So you use the average fully diluted from Q3 and kind of this quarter?

[Steve Gaven:]

Yes, it’s a better approximation as you go forward.

[Operator:]

And the next question comes from Michael Young with SunTrust.

[Michael Young:]

Clay, wanted to start off with just kind of big picture, you’ve always guided to 11% ROE and now we’re obviously in a lower tax rate environment. Do you anticipate kind of changing that bogie and what are your thoughts about competing a way that tax benefit over time as it relates to the ROE target?

[Clay Deutsch:]

Kind of two part question, first our targets remain intact and we're just going to adjust. We are going to tax adjust the targets but our - both our goals, as well as our short-term incentives and our long-term incentive plan are very ROE attached and my Board is not going to give us a lot of additional points for tax break which I'm completely aligned with. So we’re just going to adjust our targets for the tax effect in effect, so that’s the first part. Second part, tougher to call longer term I think no question near term I think our capture, our translation of tax benefit into earnings is going to be highly efficient. What happens in the fullness of time I think it’s a little unclear for the entire industry, so we’ll see how that plays out. But I think in the foreseeable future the translation of a tax reset into earnings is going to be pretty direct.

[Michael Young:]

And I guess as a follow up to that I mean does that change sort of the math or the calculus around your valuation some of the other subsidiaries now that they’re effectively dropping more to the bottom line?

[Clay Deutsch:]

Well we continue to like - the affiliates have had appealing ROE enhancement characteristics for us throughout and that math continues to work. So we like the ROE enhancement of our non-Boston Private Bank businesses and that’s unchanged I mean the math changes slightly after tax but that math still works.

[Michael Young:]

And if I could sneak one last one, just have you seen any impacts yet from the changes in the tax while relating to jumbo loans that we seen in early pay down activity to get below the threshold or any other impacts in that book of business?

[Clay Deutsch:]

Not yet. It certainly a perceptive question and something to watch - I think to watch closely is the kind of second order behavioral effects of the tax reset. The first order effects are very straight math you can all do the math on 30 resetting to 22. How it affects borrower behavior? How it affects tax exempt business where we’re active longer-term, we’ve even had shareholders ask how is it going to affect client mobility. Most of our clients are domicile in high state and local tax domains. So far I think our crystal ball always little hazardous but I think our crystal ball suggest that the tax reset is overwhelming positive. I think the client behavioral affects to extent they emerge will be gradual and relatively slow moving with the exception of tax exempt financing. I mean there is a pretty immediate mathematical affect on the calculus between taxable and tax exempt. We’re not a huge tax exempt player but we have facilitated tax exempt borrowings for our business cliental. Obviously that business pretty immediately recalculates under the new tax regime but it’s something we’re going to watch very closely. Again my stands on it that every time we toggle through this, we come up believing that the net effective of the reset as the industry puts all the DTA reval behind, it the ongoing earnings effect at least for us we believe are pretty substantial positive.

[Operator:]

[Operator Instructions] All right, if there is nothing more at the present time, I would like to return the call to Clay Deutsch for any closing comments.

[Clay Deutsch:]

I just thank you all for your interest in us. As I reflect on the year, the thing I'm most heartened by, at the start of the year we telegraphed that we’re going to try to embrace a more ambitious growth formula unifying our wealth and private banking business. I’m really pleased with the progress there it translated very nicely in the revenue build and therefore we look forward to 2018 and awful lot of what we’re going to do in 2018 is informed by our client growth and revenue progress in 2017 and we intend to marry that with operating leverage as we go forward. And we think that formula is going to do good things for us. So it’s only mid-January and hope spring internal but we’re feeling pretty good about what we intend to do this year. So I’ll look forward to updating all of you as the year unfolds. Thank you.

[Operator:]

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