Boston Private Financial Holdings, Inc.
Q2 2015 Earnings Call Transcript

Published: 16 Jul 2015

[Operator:]

Hello and welcome to the Boston Private Financial Holdings Second Quarter 2015 Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions]. Please note this event is being recorded. I would now like to turn the conference over to Clay Deutsch, please go ahead sir.

[Clayton G. Deutsch:]

Good morning everyone. This is Clay Deutsch, Chief Executive Officer of Boston Private Financial Holdings. Welcome to our second quarter 2015 earnings conference call. Joining me this morning are David Kaye, our Chief Financial and Administrative Officer; Mark Thompson, President of Boston Private; and Steve Gaven, our Vice President for Investor Relations. At this time I’ll ask Steve to read the Safe Harbor Provisions before we make additional comments.

[Steven Gaven:]

Good morning. 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 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 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.

[Clayton G. Deutsch:]

Thank you all for joining the call this morning. In the second quarter, our company generated net income of $17.6 million or $0.20 per share compared to $0.21 per share last quarter and $0.25 per share in the second quarter of 2014. Return on average tangible common equity was 15% for the quarter, and return on average common equity was 10%. Particular highlights for the quarter include

[David J. Kaye:]

Thanks Clay, and good morning everyone. My comments will begin with slide 3 of the earnings presentation and that can be found in the Investor Relations section of our website, bostonprivatefinancial.com. On slide 3, we provide a summary of our key performance metrics. In the second quarter of 2015, return on average common equity was just about 10%, which is in line with our expectations down from 11% in the first quarter of 2015 and 14% in the second quarter of 2014. As you’ll recall, the second quarter last year included several unusual items such as a $5 million provision credit, 2.5 million of interest recoveries, and $1.6 million gain on some commercial loans. This quarter, the company’s tier 1 common equity ratio was down just about 6 basis points linked quarter and that reflects strong loan growth in the quarter. On slide 4, we walk through the consolidated income statement. Core fees and income were flat linked quarter, and they are up 18% year-over-year to 40 million. The year-over-year increase includes fees from the Banyan acquisition as well as organic growth. Other income was 2.3 million in the second quarter this year, and that’s compared to 1.1 million in the first quarter of this year. Second quarter this year included 1.1 million related to the market value adjustment for the Banyan Partners acquisition earn out and 600,000 in gains on partnership investments. The first quarter this year included a $400,000 market value adjustment for the earn out and about 200,000 in gains on partnership investments. Total operating expenses for the second quarter this year were 62.4 million, that’s down 2% linked quarter. Total operating expenses increased 15% year-over-year, and that’s primarily due to the acquisition of Banyan. Overall, the company’s efficiency ratio declined quarter-over-quarter to 67%, and that’s in line with our goal. The company recorded no provision for loan loss due to net recoveries of 1 million in the quarter and that was offset by a fairly strong loan growth. On slide 5, we show a detailed breakout of our consolidated operating expenses. Salaries and employee benefits drove the overall linked quarter decline during the first -- as the first quarter of 2015 included seasonal expenses of approximately 1.5 million. Marketing and business development expenses increased during this quarter about 27%, and that’s up to 1.7 million and reflects the timing of marketing campaigns at both Boston Private Bank and Boston Private Wealth. We expect the marketing and business development expense to increase a little bit in the second half of the year. Finally, other expenses were around 4.3 million in the second quarter of 2015, and that’s compared to 3.8 million last quarter and 3.1 million in last year. The linked quarter increase represents a number of miscellaneous and in frequent expenses most significant of which were two settlements totaling $300,000 combined. Moving to slide 6, the top chart shows the relationship between our net charge offs or recoveries and our provision for loan loss. As you can see, these measures are pretty highly correlated. Absent the strong loan growth in the quarter, the company probably would have booked a small provision credit given the continued recoveries. The chart below demonstrates the continued improvement in asset quality, with criticized loans down 11% year-over-year. We continued to maintain strong reserves with the ALLL to loans finishing the quarter at about 143 basis points. That concludes my prepared comments for this morning and I’ll now turn it over to Mark for a discussion on the Private Banking and Wealth management and trust segments. Mark.

[Mark D. Thompson:]

Thanks Dave and good morning. My comments will begin on slide 7, which shows the Private Banking segment, excluding wealth management portion of our bank. In the second quarter, net interest income decreased 2% linked quarter to $46 million. The current quarter includes 69,000 of interest recovered on previous non-accrual loans, while the first quarter of 2015 and the second quarter of 2014 includes recoveries of 1.7 million and 2.5 million respectively. Excluding interest recovered on previous non-accrual loans, net interest income increased 2% linked quarter and 4% year-over-year. Total operating expenses decreased 2% linked quarter to 28.3 million. On a year-over-year basis, total operating expenses increased 2%. The efficiency ratio was 54% in the current quarter compared to 55% last quarter and 53% last year demonstrating our ability to effectively manage expenses while at the same time funding our growth initiatives in both New England and on the West Coast. The bank's average loan to deposit ratio was 98% in the second quarter of 2015, down from 101% last year. We continue to grow core funding and build liquidity to better position the balance sheet for potential changes in interest rates. Slide 8 shows the past five quarters of average load balances and deposit balances by type. Total average loans increased 4% year-over-year led by C&I up 18% and Residential up 6%. Average CRE loans are down 7% year-over-year due in part to the loan sales we executed in the second quarter of 2014 and the timing of new loans originated in the second quarter of 2015 which were weighted towards the end of the reporting period. End of period CRE loans increased 4% linked quarter led by New England up 6% and San Francisco Bay up 5%. We have maintained strong momentum in building our private clients franchise in Southern California. In the second quarter of 2015, end of period C&I loans increased $120 million or 14% year-over-year. Southern California accounted for $40 million or 33% of the total growth. Average total deposits increased 6% year-over-year to 5.4 billion led by growth in our core funding, demand deposits, and money market deposits increased 8% and 10% respectively while CDs continued to trend lower down 1% linked quarter and 3% year-over-year. Slide 9, shows end of period deposits by region. Total deposits increased 10% year-over-year led by San Francisco Bay up 17% and Southern California up 14%. In the second quarter of 2015 the West Coast markets accounted for than 50% of the total deposit growth once again showing that our Private Bank franchise is taking hold outside of New England. In addition New England continues to pose solid growth with deposits up 7% year-over-year. On the right side of the slide we show the progress we have made in remixing our client base in the sense we integrated the West Coast banks with Boston Private Bank and Trust in 2011. CDs as a percent of total deposits had fallen from 31% to 11% in San Francisco Bay and 44% to 15% in Southern California. Now turning to slide 10, net interest margin was 2.9% in the second quarter of 2015 down 10 basis points linked quarter and down 24 basis points year-over-year. Excluding interest recovery on previous non-accrual loans, net interest margin was up one basis point linked quarter and down seven basis points year-over-year to 2.90. Slide 11 contains the financial information for the wealth management and trust segments which operates under the Boston Private Wealth brand. The second quarter of 2014 data represent pre-acquisition bank wealth management business while the first and second quarter of 2015 shows the results for the newly combined Boston Private Wealth. Revenue increased 5% on a linked quarter basis to 14.6 million. The second quarter of 2015 revenue included 1.1 million related to the market value adjustment for the Banyan Partners earn out while first quarter included 400,000 market value adjustment. Excluding these adjustments revenue was flat linked quarter. Total operating expenses increased 4% linked quarter to 12.8 million. The current quarter includes $220,000 restructuring charge related to employee severance. Excluding this charge operating expenses increased 2% linked quarter Net flows were negative 243 million for the quarter as new business of 176 million was offset by client draw downs of 190 million in closed accounts of 229 million. In the quarter we experienced a higher than normal client attrition rate due to portfolio manager role transitions and departures which explains 50% of AUM loss in the quarter. We anticipated an elevated level of staff turnover as we implemented our new client advisory model during integration. While we do not anticipate additional AUM -- while we do anticipate additional AUM loss, we believe that the bulk of staff departures is now behind us and we look forward to a more normal AUM development profile in the second half of the year. Now I’ll turn it back to Clay.

[Clayton G. Deutsch:]

Thanks Mark, let’s go to slide 12, total revenue for the investment management segment was flat on both a linked quarter and year-over-year basis. Operating expenses decreased 6% year-over-year. The second quarter of 2014 included a onetime charge related to the elimination of referral arrangement. Second quarter of 2015 segment EBITDA margin was 34% compared to 33% in the first quarter of 2015 and 29% in the second quarter of 2014. The EBITDA margin of 34% remains above our 30% corporate target. The segment overall reported net inflows of $97 million for the quarter, assets under management end of the second quarter at $10.7 billion down less than 0.5% in the quarter. Moving to slide 13, our wealth advisors reported a 6% year-over-year increase in revenue for the second quarter of 2015 to $12.7 million. Total revenue was flat linked quarter due to lower levels of assets under management. Operating expenses increased 7% year-over-year reflecting investment in personnel and facilities. On a linked quarter basis operating expenses fell 5% due mainly to seasonally high compensation expense in the first quarter of the year. As a result, EBITDA margin was up 300 basis points linked quarter to 35% well above our 30% target. More information on AUM net flows can be found on slide 14. In the second quarter consolidated net flows were negative $193 million. As previously mentioned Boston Private Wealth experienced net outflows of $243 million due in part to client draw downs and loss accounts. The wealth advisory segment experienced net outflows of $47 million while the investment management segment saw net inflows of $97 million. That concludes our comments on second quarter 2015 performance. I will now open up the line for your questions. Thank you.

[Operator:]

[Operator Instructions]. And the first question comes from Alex Twerdahl with Sandler O'Neill.

[Alexander Twerdahl:]

Hey, good morning guys.

[Clayton G. Deutsch:]

Hey Alex, good morning.

[Alexander Twerdahl:]

Hey, first off, could you just remind us of the size of your variable rate loan portfolio that will reprice immediately when rates rise?

[David J. Kaye:]

Probably of about 50% of our commercial loans are variable rate that will reprice pretty quickly. The residential mortgage portfolio as you know is mostly 3

[Alexander Twerdahl:]

Okay, and of the commercial stuff, is any of that sitting on floors right now?

[Clayton G. Deutsch:]

Very little of that is on floors.

[Alexander Twerdahl:]

Okay, and so just as it relates to the margin, I know you have talked in the past Dave about seeing stabilization in the margin and in the current rate environment maybe that is the case, but if we get 25 basis points in September, in the fourth quarter would you say the margin would expand all things being equal given the size of the portfolio that will reprise fairly quickly?

[David J. Kaye:]

Well, that is going to be on our ability to lag on deposits but it is conceivable that that could happen, yeah.

[Alexander Twerdahl:]

Okay, thanks. That's all my questions for now.

[Clayton G. Deutsch:]

Thanks Alex.

[Operator:]

Thank you and the next question comes from Casey Haire with Jefferies.

[Casey Haire:]

Hey, good morning guys.

[Clayton G. Deutsch:]

Hi Casey.

[Casey Haire:]

Thanks for all the color on the wealth management and trust flows, just wanted to dive in a little deeper. Of the 243 million, can you break down how much of that was from Banyan and how much was from legacy Boston Private? And then appreciate your comments that you feel like you have got the team on the court and the turnover will be less, but what have you done to sort of preempt any further turnover and what makes you feel comfortable that you won't have any more lost accounts?

[David J. Kaye:]

I will take that, I will take the first part of the question that -- it is difficult right now, we really are an integrated -- so saying this was legacy versus -- legacy wealth management versus legacy Banyan, a lot of these are getting blended right now. I would say that we had some outflows, and particularly on the legacy Banyan side, there is AUA outflows. So these are -- there might have been about 50 million of net outflows that really have not much of an impact on our revenues. So, as I said, that was about 50 million in the quarter. But to break it out further between legacy Banyan and legacy Boston Private as we have combined is getting a little bit more difficult.

[Mark D. Thompson:]

Yeah, and I will take the second half of the question. We have had a very active client outreach program and touched the top 300 clients in Boston Private Wealth. And what we found in many cases which we expected, many of those clients have strong private banking relationships across multiple business lines which we feel and the clients have affirmed made the business much stickier. So, we feel pretty confident in the situation. While we are prepared for additional client outflows, we believe our motto will deliver superior client experience and performance.

[Casey Haire:]

Okay, and just following up on the expenses, I think last quarter you were at one third of your $3 million goal, it sounds like you guys are ahead of schedule with the balance coming in the third quarter here, how much was achieved in the second quarter and is there an opportunity to do better than that 3 million?

[David J. Kaye:]

I think there is an opportunity to do better. Some of that will come with some further systems consolidation that will expect to achieve some of those savings over the second half. I would say the other piece on that, you asked how much was achieved during the second quarter, I mean I think that we’ll get the bulk of the remainder. We didn’t see it realized, I mean by the end of the quarter it was out. So you should start seeing that in the third quarter.

[Casey Haire:]

Okay so we didn’t see there was really no -- because of the severance, there was no help from the severance expense knocked out or neutralized the cost saves?

[David J. Kaye:]

The previous cost, yes. So, there probably had been about 250 that would have been actually in the quarter, but that was offset by the 220 severance and then we think we’ll get another on a quarterly basis, 500 going forward in the second half for the year.

[Casey Haire:]

Okay, so still 2 million left in the third quarter per annum?

[David J. Kaye:]

No, you will start seeing that. Again on a quarterly basis if you think about the 3 million it should be 750 a quarter roughly. We had 250, although it was kind of masked by the severance charge and then you’ll see another 500 which we will start in the third quarter.

[Casey Haire:]

Okay, alright. And this last one from me, on the name outlook, it looks like your loan yields ex the recoveries came in pretty flat, and the securities book obviously with the remix and some high yielding MBS that came in pretty, that was an improvement. Can we expect that going forward and where is the new money yield on loan production today?

[David J. Kaye:]

The new yield on loan production is, overall it’s pretty close to the book. We still might see some further degradation on the commercial side. It depends on the mix that we were putting on there. So, in the second quarter, we put on more variable rate commercial loans and those generally come in at a lower rate. But we expect net interest margin absent a change in the rates to be fairly stable. We might see a basis point or two pressure, but we are pretty happy with the development there.

[Casey Haire:]

Okay, thanks for taking the questions.

[Clayton G. Deutsch:]

Thank you.

[Operator:]

Thank you and the next question comes from Jennifer Demba with SunTrust.

[Jennifer Demba:]

Good morning.

[Clayton G. Deutsch:]

Good morning, hi.

[Jennifer Demba:]

Question on the turnover in your wealth management personnel to date since the Banyan acquisition, how many people have you lost and what is that as a percentage of your relationship personnel?

[Clayton G. Deutsch:]

The total compliment in the combined business is around 160 to 170 professionals. The departure rate, I think that most matters is that departure of client facing advisors that are portfolio managers. The number there has been 5ish, well below 10 and those people have affected over 10% of the base business. So therein lies the heart of our client retention effort. As Mark said earlier we have a full court press on client retention. We anticipated departures Jen as you know from our prior conversations about this. I was absolutely prepared to withstand departures to transition to a much more organized, much more disciplined model. So we’ve flushed out of the system some people who just weren’t going to buy into the new model of the new structure. So that’s about as candid as I can get on it. I am not surprised by the transitional issues and I remain pleased with where we are going with this.

[Jennifer Demba:]

Great thanks a lot.

[Operator:]

Thank you. [Operator Instructions]. And we do have a question from Christopher Marinac with FIG Partners.

[Christopher Marinac:]

Thanks good morning. Clay and Dave and others, I want to sort of dig back down on the expense line question from before. Really I guess the bigger picture question for me is do you still feel that there is ample room for a positive operating leverage within the model, whether that’s a near term next couple of quarters or just looking out the next few years?

[Clayton G. Deutsch:]

Chris are you talking the company overall or Boston Private Wealth?

[Christopher Marinac:]

Yes, really company overall.

[Clayton G. Deutsch:]

Well I guess the short answer for me is yes and then obviously I’ll defer to Dave and when I say that, I think our cost disciplines are strong and remain intact. I have said for many quarters now, I think given our wealth management weight, the company should view an efficiency ratio in the high 60s, mid to high 60s as a healthy level. Those wealth businesses at high performance levels generate about 30% EBITDA margins, so 30 gets you 70. So, our mix is a little expense savvy. Anything below 70 I think reflects well run businesses at the overall company level. The bank of course aims even higher. That's a higher margin business, tough ROE business but a higher margin business. And Mark and his team have done a great job there. We have said our goal was to be in the mid to high 50s and we are in the mid 50s. With that said as Dave said earlier we are going to perform or outperform on Boston Private Wealth from an expense standpoint. That's coming home I think in a very nice way. And you can see that really begin to take bite the second half of the year. The only thing I would add though, I am going to stop short of course of -- we are not announcing any "expense programs". It has been a long time since we had an overall reduction in force or any kind of broad structural program. I believe our company is lean and productive. We are going to continue to maintain a core expense inflator cap of about 2%, that's our goal and then we will continue to look for opportunities to get efficiencies beyond that. So sorry for the long ramble but I think our cost disciplines are good but yes, I see remaining opportunities there and we are very focused on it.

[Christopher Marinac:]

Great, so I guess at the end of day Clay and this is very helpful that there is an upward bias to your returns whether it’s on assets equity or what have you?

[Clayton G. Deutsch:]

Well absolutely. I think what’s going to drive the upward return bias and that’s why we are so fixated on wealth management overall is primarily mix. As you know there is substantial operating leverage and return leverage built into the wealth businesses. We run a really efficient, a really productive private bank. I think our return progression has a lot to do with continuing to improve the mix of the company overall.

[Christopher Marinac:]

Great and one last question for Dave, Dave is there any additional interest income coming in from accruals from prior non-performers, will that all be an impact second half of the year?

[David J. Kaye:]

Yes that’s a real tough one to gauge. I think we could get recoveries from non-accruals paying off, its just tough to see when that will take place. The number of our non-performing loans are paying as agreed so those are the types of loans that when they pay off fully you get the interest recapture. It is just tough to say when the timing of that going to be.

[Christopher Marinac:]

Okay, no problem. Thanks for all the color guys.

[Clayton G. Deutsch:]

Thanks.

[Operator:]

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

[Christopher McGratty:]

Hey, good morning everybody.

[Clayton G. Deutsch:]

Hey good morning.

[Christopher McGratty:]

Hey Clay on capital, you are sitting with almost 10% tier 1 comment. You obviously allocate the capitals to wealth business over the past couple of years, can you talk about use of capital over the next 12 to 24 months, is the wealth business other opportunities to expand that further or is it really organic growth and potentially adjusted the dividend?

[Clayton G. Deutsch:]

Chris I am having flashbacks that you are asking me about the dividend. Let me give you a straight answer though, we have gone a couple of quarters now focusing on capital replenishment following the Banyan acquisition. I think we had about an 80, what was it Dave 80 or a 100 basis point burn down when we bought Banyan. As you know Chris, I think given on how clean and healthy and de-risked our company is that we can run with a very efficient capital stack and still have a really strong kind of fortress balance sheet. We’re in my mind headed into an excess capital, capital build kind of a mode from this quarter forward. My favored destinations for capital would be subsequent additions to our wealth business and return of capital via an escalating dividend. So that’s how I view it. I’d like to demonstrate to our shareholder following that as we continue our progression toward wealth management we can become an increasingly cash flow rich capital efficient company. And that frees us up to do some very interesting things with respect to return of capital.

[Christopher McGratty:]

Okay, thank you for that. Clay just a follow up, your ROA days roughly 90 basis points. You’ve guys have discussed the challenges of the asset management business but overtime if you look out over the next 12 to 24 months you do have a situation – in the industry where credit costs will begin to move away from zero and as per your balance sheet the key question is what the margin do as higher rates. Can we maybe flush out the source of the earnings growth that you believe are possible because it’s kind of factoring these variables together, you certainly see a situation where earnings growth [inaudible] a bit, thanks?

[David J. Kaye:]

I’d say this is sort of a compliment to what Clay said before though. When you look at the source of earnings growth and the operating leverage opportunities that we have, the biggest source is in the Boston Private Wealth. So we talked about operating margins that our target is around 30% EBITDA margins. You can see that the business today is at 18%, 19% EBITDA margins. So we feel that there is room there and that’s going to be achieved through a combination of revenue growth and also realization of some expense saves that we have slated for there. We still think that we will be helped in a rising rate environment overtime but we’re going to try and fund growth initiatives in all of our areas and develop and grow the revenues there so I think there is opportunities but particularly the opportunities on the Boston Private Wealth side for the margin expansion and improvement in earnings.

[Clayton G. Deutsch:]

Chris the only tag on, more macro and longer term I think of three broad sources of earnings progression. None of this will surprise you but I think of three pools of earnings progression. One, expansion of our wealth management businesses overall, we are at or above target margins, we like the operating leverage in those businesses, expansion translates into earnings growth pretty handsomely. Second, I like to amplify something Mark said in the prepared comments, franchise expansion in our core private banking businesses I really like as I reflect on the quarter, I really like what I see in our client expansion loan growth, deposit growth across all of our banking markets. Nice growth in Boston and I am especially proud of what our teams are doing in Southern California and Northern California. And as we start to hit on all three cylinders with our private banking model that’s a very nice source of revenue and earnings growth. And then third, if and when the [inaudible] rate expansion ever comes we are well positioned for margin expansion in our core balance sheet business. The only offset I see coming, we will someday return to a more normal provision environment whatever that means. I think our disciplined loan growth and our underwriting standards will keep us on the healthy side of provisioning. But that will be a counter account. So, I see three pluses, one minus and we are now I think to a pretty positive place as we progress.

[Christopher McGratty:]

Alright, thank you that's helpful.

[Operator:]

Thank you. And as there are no more questions at the present time, I would like to turn the call back over to management for any closing comments.

[Clayton G. Deutsch:]

Well, I just want to thank you all for your ongoing interest in us. As we look forward to the second half of the year we are excited about continuing to advance this agenda. The things to watch with us are wealth management progression and continued expansion of our private banking franchise. And it is our focus and we look forward to reporting back to you how we are doing. Thanks all.

[Operator:]

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