Boston Private Financial Holdings, Inc.
Q2 2013 Earnings Call Transcript

Published: 18 Jul 2013

[Operator:]

Good morning, and welcome to the Boston Private Financial Holdings, Inc. Second Quarter 2013 Earnings Conference Call and Webcast. [Operator Instructions] Please also note this event is being recorded. I would now like to turn the conference over to Mr. Clayton Deutsch, CEO and President. Please go ahead, sir.

[Clayton G. Deutsch:]

Good morning. This is Clay Deutsch, Chief Executive Officer and President of Boston Private Financial Holdings. Welcome to our second quarter 2013 earnings conference call. Joining me this morning are Dave Kaye, our Chief Financial Officer; Mark Thompson, Chief Executive Officer of Boston Private Bank & Trust Company; and Jeanne Hess, our Vice President for Investor Relations. At this time, I'll ask Jeanne to read the Safe Harbor provisions before we make additional comments.

[Jeanne Hess:]

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 identify the 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.

[Clayton G. Deutsch:]

Thanks, Jeanne. Thank you for joining the call this morning. I'd like to begin the call by discussing 2 important transactions we completed in the second quarter, both of which had a significant impact on our reported financial results. First, we closed the sale of our Pacific Northwest Private Banking offices in May, which resulted in a onetime, after-tax gain of $6.3 million. Second, we repurchased all Boston Private Financial Holdings preferred stock held by an affiliate of The Carlyle Group. The transaction did not impact our net income but the accounting effects reduced earnings per share by $0.14 in the quarter, or $11.7 million. While both of these transactions created noise in our second quarter financial results, we believe that these transactions strengthened the company. Our capital base is now more efficient and we have managed the unwind of Carlyle's ownership position without punishing our other common shareholders. Absent these transaction effects, our company generated core net income of $15.1 million in the quarter, or $0.18 per share. Our reported return on common equity for the quarter, including transaction effects, is 14%. Our core business return on common equity, excluding these transaction effects, is around 10%. Our core return on tangible common equity is now 13%. As we look at our core businesses, we believe that our Wealth Advisory and Investment Management segments are producing strong results. Fees from the Investment Management segment increased 8%, while Wealth Advisory segment fees increased 2% quarter-to-quarter. Our Investment Management and Wealth Advisory segments are producing attractive operating margins and earnings, with EBITDA margins of 31% and 36%, respectively. Our Private Bank realized 1% quarter-to-quarter growth in loans and deposits. Net interest margin actually increased slightly in the quarter to 3.14%. Nevertheless, quarter-to-quarter revenue, overall, declined due to the loss of net interest income associated with the Pacific Northwest franchise and a decline in gains on sale of loans within our mortgage business. We remain very focused on loan and deposit growth with disciplined pricing and fee generation opportunities across our Private Banking businesses and markets. Overall, our Private Bank is extremely healthy and strong from a portfolio and balance sheet perspective, and we are focused on client acquisition and development to drive more satisfactory revenue growth. At this point, I'd like to turn it over to Dave and Mark for more detail on the quarter, and then I'll return for some concluding comments. Dave?

[David J. Kaye:]

Thanks, Clay. 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, bostonprivate.com. On Slide 3, we show the linked quarter consolidated P&L highlights. Net interest income declined by 1% in the quarter; however, core fees increased 1%. Note that our NII was reduced by about $1.4 million due to the Pacific Northwest sale. So absent that, we would have shown a small increase. Within our Core Fee line, we did have increases in the Investment Management and Wealth Advisory segments. Other income increased during -- in the quarter due to the gain on the sale of the Pacific Northwest Private Banking offices that Clay mentioned earlier. Our total expenses were flat during the quarter despite a $3 million decline in compensation expense. You'll recall that Q1 was elevated due to seasonality and a SERP charge. The non-compensation increase that we had during Q2 was attributed to an accelerated marketing spend of about $1.3 million and also $2.4 million in our other expense line, and that was driven by a liability restructuring charge and a tax-related reserve. On Slide 4, we show the spread in fee-based revenues from a core revenue profile for the quarter, as this excludes the gain on sale of the Pacific Northwest offices. Our core fees were up 1% in the quarter, as a 3% growth in overall Wealth Management fees was partially offset by a reduction in banking and loan sale fees. However, our overall core fees are still up by 14% on a year-over-year basis. Slide 5 shows our net interest margin. The reported NIM increased by 4 basis points in the quarter to 3.14%. Loan yields were relatively flat overall and both deposit and borrowing costs dropped to drive the rise in our net interest margin. On Slide 6 we show the provision for loan losses. We did record a provision credit of $2 million in the second quarter and that's due to recoveries of previously charged-off loans, a 14% decline in our overall criticized loans and continued improvement in our overall credit quality. The $500,000 in net recoveries during the quarter helped lower our year-to-date annualized net charge-off rate to just 10 basis point. You'll note that, despite the $2 million credit to our allowance, our allowance to non-accrual ratio actually increased during the quarter from 113% coverage ratio to 155% coverage ratio at the end of Q2. Slide 7 highlights our capital position. In the quarter, our TCE to TA and TCE to risk-weighted asset ratios declined by 60 basis points and 70 basis points, respectively, and that's a result of the Carlyle preferred stock repurchase that Clay spoke about earlier. However, on a year-over-year basis, both of these ratios have increased by about 20 basis points. In the quarter, our Tier 1 common is at right about 9.9%. And we're very comfortable with that level, especially given the finalization of the Basel III rules. With that, I'll turn it over to Mark.

[Mark D. Thompson:]

Okay. Thanks, Dave. My comments will begin on Slide 8, where I will highlight the performance of our Private Bank. In the first quarter, total revenue at the Private Bank increased by 17%. This increase reflects 3 factors

[Clayton G. Deutsch:]

Thanks, Mark. Let's goes to Slide 11. Our investment management fees increased 8% on a linked-quarter basis. Remember that Anchor capital, our largest investment manager, bills on a 1 quarter lag. As a result, the Investment Management segment fees and revenues shown here reflect assets-under-management balances as of March 31, '13. Expenses increased 7% to $8.3 million in the quarter. The EBITDA margin was strong and stable at 31% for the quarter, while our pretax margins improved by 1 point to 24%. The investments -- the Investment Management segment, overall, reported net outflows of $233 million for the quarter, driven primarily by the loss of 3 large institutional mandates. On Slide 12, we show our linked-quarter Wealth Advisory performance highlights. Our Wealth Advisory revenue increased by 2% quarter-to-quarter to $2.3 million. Operating expenses decreased 9% to $6.9 million. As a result, the segment's second quarter EBITDA and pretax margins both strengthened to 36% and 33%, respectively, reflecting positive operating leverage. Segment assets under management was flat on a linked-quarter basis at $8.5 billion. Wealth Advisory net inflows were $41 million in the quarter. More information on AUM net flows can be found on Slide 13. In the second quarter, net outflows were $228 million. Net flows at our Private Bank and Investment Managers were down compared to the first quarter. Our Private Bank continues to experience a high rate of new client and new AUM introduction. However, in the second quarter, we saw an elevated level of current client drawdowns, resulting in net outflows. As mentioned earlier, our Investment Managers suffered several large institutional client losses. We do see acceptable new business pipelines in place for our Investment Management firms. On Slide 14, we show holding company costs. Operating expenses at the holding company decreased 25% in the quarter, due primarily to the decline in seasonal compensation charges we incurred in the first quarter. Discontinued operations increased 62% in the quarter to $2.8 million, which includes the ongoing Westfield revenue share and payments from previous -- previously divested affiliates. Looking ahead, we're pleased to have successfully executed important transactions in the quarter. We're now fixated on strengthening our core business performance. Our strategy for the company remains rooted in revenue mix management, expense discipline and efficient management of our capital base. We are encouraged that our company is sustaining solid, fee-based revenue growth. Fee-derived revenue now represents 41% of total company revenue and continuing to expand this component of revenue mix remains a very important company priority. On the expense side, we have now completed the final steps in our $10 million cost-reduction effort, full realization of cost benefits will be reflected in our third quarter expense run rate. Finally, we remain focused on capital efficiency and return-of-capital strategies. We are least to announce an increase of our quarterly dividend from $0.05 per share to $0.07 per share. With clear evidence of our portfolio derisking success, disciplined balance sheet growth, earnings stability and comfort with our capital position vis-à-vis Basel III, we believe that we are an increasingly powerful capital generator. We have a very precise and efficient capital plan and we will be managing to it. The just-announced dividend increase is another step towards capital efficiency. With that, I'd like to open the call and invite your questions.

[Operator:]

[Operator Instructions] Our first question comes from Jennifer Demba of SunTrust Robinson Humphrey.

[Jennifer H. Demba:]

If we could just talk about your quarterly expense targets for a moment and when you envision getting to there? And what's sort of left to accomplish here?

[David J. Kaye:]

So we did mention that we had a couple of things in our current expenses that I wouldn't project forward in a run rate, the $2.4 million that's in the other expense and also the elevated marketing expense. I think if you look at the marketing and look at what we project to spend for the full year, if you were to divide that by 4 and say that's a good quarterly run rate, we're about $800,000 high this quarter. So I would expect there's a little bit over $3 million there that would be coming out of our expenses. And then in terms of our overall $10 million cost save, we mentioned last quarter that we had achieved about half of that. We had the other half remaining. I would say during this quarter, we probably are up to about a 75% to 80% realization that's in our run rate. So maybe a little bit more. I mean, on a quarterly basis, that's only another $400,000 or $500,000 that we expect to come out. So we're pretty close given those one-timers, and then the additional expense reduction.

[Operator:]

Our next question comes from Casey Haire of Jefferies.

[Casey Haire:]

So I'd like to start off on the NIM. The loan yield compression slowed down pretty good this quarter. I was just curious, have we reached the bottom here? And then on the funding side, obviously there were -- sounds like there were some restructuring that'll bleed forward positively. Are there more opportunities there and what kind of impact can we expect on the funding side?

[David J. Kaye:]

Well, let me take it on the loan yield side. I think we did benefit a couple basis points this quarter. You saw the reduction in the non-accrual loans. So we did recapture some interest expense there. We've been getting that every quarter but I would say this quarter was probably 1 or 2 basis points of additional elevation. And then, have we seen the bottom on loan yields? Well, I think the steepening of the curve definitely helps in terms of the new loans that are coming on, that should help our yields going forward. But it will be affected by prepayment speeds on additional stuff. If that slows down, again, we will -- it will help our NIM going forward. In terms of the liability restructuring, is there more there? I would say there's a little bit in terms of the trust prefers. We've been repurchasing those, looking at doing some additional repurchases of our trust-preferred securities and those should help bring down our overall liability cost. But nothing in terms of -- on the horizon in terms of additional restructuring charges going forward.

[Casey Haire:]

Okay. And then switching gears to capital. The up dividend, obviously boost the payout ratios. I was just curious what your target payout ratio is? And then on the capital efficiency front, how willing are you -- how much lower are you willing to go on the TCE ratio?

[David J. Kaye:]

Well, let me just start on the latter and I'll turn it over to Clay on the payout ratio. The -- on capital efficiency, we're really focused on the Tier 1 common primarily. Right now, we're at about 9.9%. I mean, we think a good range for us is in that 9.5% to 10% range. So we're very comfortable with our capital levels as they are now. Clay, just on the payout ratio.

[Clayton G. Deutsch:]

Yes. I'd just say -- we're not trying to be evasive, but we really don't have a target payout ratio. We clearly have a target capital structure. And we think we're good. We're very focused on Tier 1, as Dave mentioned, not that we're disregarding TCE but we like the way Basel III shook out and we like where we stand, vis-à-vis the now-clarified rules, in terms of our capital structure. So we're going to manage pretty tightly to a target capital structure and let the payout ratio kind of shake out wherever that leads us. But we feel very good about where we stand and we're going to keep working hard on capital efficiency.

[Casey Haire:]

Okay. And then just one more for me on the -- Clay, just big picture. The ROE expansion target in the Q previously shooting for 11% by the end of the year. It sounds like we're at 10% core but with some decent help on the credit provision. I'm just curious, are you still shooting for -- do you still think 11% is doable by this year? And yes, just some updated thoughts on that front.

[Clayton G. Deutsch:]

Yes. 11% remains the house target. I will point out -- I think one important milestone is our return on equity in the company now exceeds our cost of equity. And I've been very vocal about that as a very important goal for us to deliver to our investors. Cost of equity is imprecise, as you know, but we think it's somewhere in the 8.5% to 9% range. Our core ROE is around 10%. We're unsatisfied with 10%. 11% is the house target. There is some uncertainty, I think, around NIM and rates, which could help us. I'm unprepared to make a rate prediction but we like what's happened with the steepening of the yield curve and, should that persist, that's good for us. Second, Dave pointed out, we have a strong reserve position. We have equity in reserves and our reserves are actually going up, not down. A bit of a question mark around, where does that go? The controllables, we remain fixated on fee growth and fee bill, expense discipline and tighter and tighter capital management. And that's the pathway, we believe, to an enhanced ROE.

[Operator:]

Our next question comes from Chris McGratty of KBW.

[Christopher McGratty:]

Clay, let me ask the capital question a little bit differently. The -- you guys were obviously active with Carlyle in the second quarter with the preferreds. You're sitting at 7.5% tangible common, you just took up the dividend. And the 60-day lockup for Carlyle, if they so choose to sell the last stake of the stock, comes up in the next few weeks. What's your appetite today to consider repurchasing all or a portion of that?

[Clayton G. Deutsch:]

Well, I'm not going to comment on our intentions with Carlyle. I mean, they are an important common shareholder but they're no longer a special or privileged shareholder and I think where they choose to go from here is absolutely up to them.

[Christopher McGratty:]

Okay. But I guess maybe putting Carlyle aside, I think you do have a buyback authorization, or you did, at 7.5%. I know you've historically said you wanted to be in the lower quartile of capital because of the derisked balance sheet. Is that -- would you take 7.5% TCE down under the right scenario?

[David J. Kaye:]

Well, I think your original question was would we consider purchasing all of that? That's a big reduction in our capital ratios and so I would say that, no, we wouldn't do the entire amount. I mean, there could be some scenario where we would do a partial but, as Clay said, I think we're focused on managing our capital position and using the dividend payout ratio primarily as the tool there. We're not ruling it out. We certainly have the share buyback as a tool that we can use. But we're comfortable with our capital position right now and I don't think we'd like to see any material degradation to that.

[Christopher McGratty:]

Understood. One more, Dave. On the size of the securities book and the cash levels, I think right now it's about 15% of earning assets. Can you help us on the outlook going forward for, I guess, earning assets? We can make our assumptions on loan growth but, on the securities and the cash position, will it drift lower or is this -- will it grow from here?

[David J. Kaye:]

No, I don't think it will drift lower. I mean, it could drift higher or stay the same. That's really our intention. It's not going to get much lower than this.

[Clayton G. Deutsch:]

Loans to assets, we actually have it, Chris, at about 17%. I think you said 15%. I mean, at 83% rather, 17% of liquidity. We're around our comfort zone.

[Operator:]

[Operator Instructions] Our next question comes from Brad Rinschler of FIG Partners.

[Brad Rinschler:]

One of my questions has been answered but just really quick on the assets under management outflows. Would you guys still see the full year 2013 still be net positive?

[Clayton G. Deutsch:]

Well, we're sure working on it. I mean, obviously, our goal is positive flows. We see great, positive stability coming from our 2 large Wealth Advisory firms. As I said earlier, we like the new business generation in Boston Private Bank and we're working hard on the client drawdowns. We believe some of that may have been seasonal. And then on the Investment Managers, there was kind of consultant and client pressure resulting in a couple of large mandates going against us. We don't think that's systemic. So we're very focused on the new business pipeline and very focused on AUM build.

[Operator:]

Our next question comes from Jake Civiello of RBC Capital Markets.

[Jake Civiello:]

I think Clay touched upon this but I'll kind of ask it in a different way, that it's been 4 consecutive quarters with either a negative or 0 loan-loss provision and with the reserve ratio at, call it, 1.7%-ish and assuming charge-offs remain low, or negative as they were this quarter, can you continue to sustain the provision at basically a negligible level?

[Clayton G. Deutsch:]

Well, Jake, I'm not allowed to predict the provision but let me just tell you how we think about it and point out a few facts. Our credit quality continues to improve dramatically. So while we're strong and healthy and no one really asks us much about portfolio quality anymore, it continues to improve, and the quarter-to-quarter-to-quarter decline in criticized and classified credits continues to evolve very favorably. Our reserves remain ample and elevated relative to any industry benchmark and we're very confident in our portfolio quality, loan-review processes. The kind of X factor, if you will, is provision set aside for new loan growth, portfolio development. We've been very, very disciplined about loan growth thus far and have had, overall, a pretty modest rate of loan growth. So I think the major factor in the provision will be kind of the opposing forces of continued de-risking and portfolio quality improvement on the one hand and whatever we do with new loan trajectory on the other hand. So far the intersection of those 2 has been a continued negligible provision or even a contra account.

[Jake Civiello:]

Okay. And then just a question for you, Dave. How are you thinking about investment securities portfolio runoff reinvestment given the volatility that we've seen in the long end of the curve?

[David J. Kaye:]

Well, we've remained very short. I mean, it did -- we did see some lengthening of the duration but our duration, looking at last quarter, was probably 2.5 years. It's maybe ticked up to 3. And we're going to continue to maintain that very short.

[Operator:]

Our next question comes from Tom Alonso of Macquarie.

[Thomas Alonso:]

I just wanted to clarify something that I think you mentioned. You said that the discontinued ops line was impacted by payments from previously divested affiliates. So that wasn't all Westfield in that line?

[David J. Kaye:]

That's correct, Tom. We had the second of our third DTC, Davidson, contingent payments. And then we had -- actually we had a contingent payment from Sand Hill, which we divested back in 2009. But that was their one and only sort of future contingent payment.

[Thomas Alonso:]

Okay. And you said this is the second of the third for Davidson. Is that every second quarter annually? Or is that every...

[David J. Kaye:]

It's every other quarter. So the fourth quarter would be our last contingent payment. This one, as was the previous one, was about a $500,000 after-tax impact on our discontinued ops line.

[Thomas Alonso:]

And that was just Davidson or that was the both of them together?

[David J. Kaye:]

No, just -- Davidson was just the $500,000. And then Sand Hill was another -- a little bit more than that.

[Operator:]

This concludes our question-and-answer session. I'd like to turn the conference back over to Mr. Deutsch for any final remarks.

[Clayton G. Deutsch:]

And I'd just say thanks for participating and, as always, we appreciate your interest in our company.

[Operator:]

Thank you, sir. And we thank you, all, for attending. The conference has now concluded. You may disconnect your lines and have a wonderful day.

[Clayton G. Deutsch:]

Thank you.

[Mark D. Thompson:]

Thank you.

[David J. Kaye:]

Thank you.