Boston Private Financial Holdings, Inc.
Q3 2014 Earnings Call Transcript

Published: 16 Oct 2014

[Operator:]

Good morning and welcome to the Boston Private Financial Holdings Third Quarter 2014 Earnings Conference Call. All participants will be in listen-only mode. (Operator Instructions) Please note this event is being recorded. Now, I’ll turn the conference over to Clayton Deutsch. Mr. Deutsch, please go ahead.

[Clayton Deutsch:]

Thank you. Good morning. This is Clay Deutsch, Chief Executive Officer and President of Boston Private Financial Holdings. Welcome to our third quarter 2014 earnings conference call. Joining me this morning are David Kaye, our Chief Financial Officer; Mark Thompson, Chief Executive Officer of Boston Private Bank; 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. Steve?

[Steve Gaven:]

Good morning. This call contains forward-looking statements regarding strategic objectives and expectations for future results of operations and financial prospects. They’re based upon the current belief 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 Deutsch:]

Well, thank you all for joining our call this morning. In the third quarter, our Company generated net income of $18.3 million or $0.22 per share. Return on average common equity remains within our strike zone of 11% to 12%, coming in at a 11.2% for the third quarter and 11.9% year-to-date. Return on average tangible common equity was 14.1% for the quarter and 15.1% year-to-date. Total revenue increased 8% year-over-year, while total operating expenses increased 4% for the same period, driving positive operating leverage of around 400 basis points. In the private bank, we continue to deliver on our stated balance sheet growth objectives. Average total deposits increased 9% year-over-year, outpacing average loan growth which was up 5% for the same period. As a result, by design our loan-to-deposit ratio fell to 98%. At the same time, our non-bank wealth management affiliates delivered 15% year-over-year revenue growth with 26% year-over-year pre-tax income growth. Our affiliates had an aggregate third quarter 2014 EBITDA margin of 34%. At this point, I’d like to turn it over to Dave and Mark for more detail on our financial performance. And then I'll come back to discuss the wealth management affiliates.

[Dave 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 Web site, bostonprivate.com. On the consolidated P&L highlights, we show core fees increasing 13% year-over-year and all of the wealth management business lines posted double-digit growth. On a linked-quarter basis, core fees were down 2% due primarily to lower gain on sale of loans. You recall that in the second quarter of 2014, we had $1.6 million gain on the sale of commercial loans. Excluding that gain, core fees increased 3% on a linked-quarter basis. Total expenses increased 4% year-over-year to $54 million. On a linked-quarter basis, total expenses were down 1% due to seasonally lower marketing expenses and lower professional fees. Pre-tax pre-provision income was up 19% year-over-year to $24.6 million. Slide 4 is our spread and fee-based revenues and that shows the progress we've made in growing our fee-based revenue. Total revenue increased 8% over the third quarter of 2013, that's driven by a 13% increase in core fees and a 6% increase in NII for the same period. Within core fees, total Wealth Management fees increased 14% on a year-over-year basis. For the quarter, fee-based revenue represents 43% of total revenue. Slide 5 shows our net interest margin. Our reported net interest margin decreased 21 basis points to 2.93% from the 2Q ’14 and that’s due primarily to lower levels of interest recovered from previous non-accrual loans that we had in the second quarter. Also we had some seasonally high cash balances and slightly lower yields on commercial loans. Slide 6 shows that we recorded a provision credit this quarter of $2.6 million and that was due primarily to $3.3 million in net recoveries and also a decrease in our criticized loans on a linked-quarter basis, partially offset by provision for newly originated loans. Slide 7 shows our Tier 1 common equity capital and that remains flat at about 10.6%. We expect the goodwill and intangibles created in the Banyan transaction to reduce our Tier 1 common ratio by about 100 basis points in the fourth quarter. That concludes my prepared remarks for this morning. And I'll turn it over to Mark for a discussion on the Private Banking segment. Mark?

[Mark Thompson:]

Thanks, Dave. My comments will begin on Slide 8. In the third quarter, pre-tax pre-provision income at the Private Bank increased 15% year-over-year due to a 5% increase in revenue to $55.2 million and a 1% decline in total expenses. Slide 9 shows the past five quarters of average loan balances by type. Total average loans increased 5% year-over-year in line with our previously stated growth objectives. The strong year-over-year performance was driven by a 7% increase in commercial loans and a 4% increase in residential. Within commercial, end of period is C&I loans increased 18%, while at the end of period CRE loans were up 5% for the same period. On a linked-quarter basis, average loans were flat as a result of the commercial loan sale that was completed late in the second quarter of 2014. At the individual market level, loans grow 6% year-over-year in both New England and the West Coast. On a linked-quarter basis, total loans were up 5% in Southern California, up 2% in New England and down 1% in the San Francisco Bay Area. Now turning to Slide 10. In the third quarter, we saw a continued strength in the development of our deposit and franchise. The average deposits increased 9% year-over-year led by money market and demand deposits which were up $250 million and $128 million respectively. On a linked-quarter basis, average deposits increased 3%. On the West Coast we’ve continued to see positive changes in the composition of the deposit base. On a year-over-year basis, demand deposits and NOW accounts are up 13% and CDs are down 24%. We are pleased with the success of our private banking model on the West Coast and the strategic focus of our market segments resulting in attracting core deposits. Now, I’ll turn it back to Clay.

[Clayton Deutsch:]

Thanks, Mark. Turning to Slide 11, Investment Management pre-tax income from continuing operations increased 46% year-over-year to $3.1 million in the third quarter. This was driven by strong top line growth with revenue up 14%, coupled with disciplined expense management. Third quarter 2014 segment EBITDA margin increased to 33%. On a linked-quarter basis, Investment Management fees increased 2% and pre-tax income grew 18%. The segment overall reported net outflows of $265 million for the quarter, reflecting ongoing pressure on active domestic equity strategies. Over 70% of these net outflows were the result of client rebalancing. Segment assets under management was up 7% year-over-year, while on a linked-quarter basis AUM declined 5%. Slide 12, our Wealth Advisors had another very strong quarter. Reported a 14% increase in pre-tax income on a year-over-year basis. Total revenue increased 14% to $12.2 million with expenses also increasing by 14% over the same period. On a linked-quarter basis, Wealth Advisory fees increased 2%, expenses were up 3%. The segment's third quarter EBITDA margin of 34% remains above our target of 30%. Segment assets under management increased 10% on a year-over-year basis. Linked-quarter AUM was flat at $9.7 billion. Wealth Advisory net inflows were $40 million as compared to net outflows of $37 million in the prior quarter and net inflows of $16 million in the third quarter of 2013. More information on AUM net flows can be found on Slide 13. In the third quarter, the Wealth Advisors and the Private Bank posted net inflows of $40 million and $14 million respectively. Both the Wealth Advisors and the Private Bank have generated positive net flows in seven of the last eight quarters. Finally, we’re very pleased to announce that on October 2nd, we closed the acquisition of Banyan Partners on schedule and as planned. Slide 14 outlines the closing payment and summary financial highlights for Banyan Partners. The total upfront payment was $65 million with $44 million or 68% payable in cash and $21 million or 32% payable in Boston Private Financial Holding stock. Post closing, Banyan Partners adds $25 million of revenue, $7 million of EBITDA and $4.5 billion of assets under advisement to Boston Private Wealth Management. Together, Boston Private Financial Holdings now manages $29 billion of client assets. With this addition, fee-based revenue will represent 47% of our total company revenue. Going forward, we’re very excited about building from here and fully integrating Banyan into the Boston Private Wealth Management business. This concludes our comments on third quarter earnings. And with that, we will open it up for your questions.

[Operator:]

Yes, thank you. We will now begin the question-and-answer session. (Operator Instructions) And the first question comes from Jennifer Demba with SunTrust Robinson Humphrey.

[Michael Young:]

Hello, this is Michael Young on for Jennifer.

[Dave Kaye:]

Good morning, Michael.

[Clayton Deutsch:]

Hi, Michael.

[Michael Young:]

Good morning. Just wanted to see if we could an update, you gave us sort of the acquisition summary on the Banyan acquisition, but if you could just give us an early update on sort of integration and anything on this materially different or better, worse than your original expectations?

[Clayton Deutsch:]

Everything is in line. Nothing better, nothing worse. We’ve been hard at work on pre-close integration planning since about July. That work continues. We anticipate spending most of the first half of 2015 putting the businesses together and we expect the business to really start to show accelerated performance into the second half of the year. So, so far so good. Everything is unfolding as we envisioned.

[Michael Young:]

Okay. And just one follow-up on that. You mentioned when you originally acquired Banyan that they were a scalable platform and had experience in integrating deals, given your sort of second half of ’15 to be fully integrated. Is that when you would potentially look -- begin looking at other deals or will you be looking the whole time?

[Clayton Deutsch:]

Well, we won’t comment on timetable. We are consistently looking around the outside world. So we will continue to do that. The first half of your question, I’ll just affirm the Banyan Partners experience suggests to us, it’s about six months to proficiently integrate Wealth Management managers. So we’re pretty confident in our timetable to put the business together. As you know, though meanwhile you can’t stop the world. So we will kind of parallel process and while we’re building out the joint business, we will continue to look for opportunities.

[Michael Young:]

Okay. Thanks.

[Operator:]

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

[Alex Twerdahl:]

Hey, good morning.

[Dave Kaye:]

Good morning.

[Clayton Deutsch:]

Hi, Alex.

[Alex Twerdahl:]

I just wanted to ask about -- it looks like the upfront payment for the Banyan deal went from $60 million to $65 million, I just wanted to know why that happened and if it affects the contingent payment as well?

[Dave Kaye:]

It really doesn’t affect the contingent payment, it was based on just their run rate EBITDA coming in a little bit higher than we had initially projected.

[Alex Twerdahl:]

Okay. And then also because the Banyan deal does add I think you said like 230 basis points return on tangible common equity. How does that affect your targets for 2015 in terms of ROTCE?

[Dave Kaye:]

Yes, that would -- it would increase our overall targets. I mean we had said that our long-term targets for ROE just the stated ROE 11% to 12%, and then on the return on tangible common equity that would translate into 14% to 15%. This would up that and we expect this to be accretive to those targets.

[Alex Twerdahl:]

Okay. But you’re not going to formally put out some target numbers right now?

[Dave Kaye:]

We haven’t reset anything yet. Our targets Alex are largely driven by our sense of our cost of equity and what we think we need to do to generate a very attractive positive spread. This deal does not alter our cost of equity. We feel very comfortable that this is return enhancing. I think as we digest this and get it under our belt the whole question of as we become more and more of a wealth management and private banking firm, should we have higher return expectations? I think it’s a rich topic. A big part of what we’re talking to investors about is how we put ourselves in a position to have a shot at more open ended higher range ROE. And we think continuing to re-wait in this direction is a very positive direction for us. But no real guidance yet, we’ll work that trough.

[Alex Twerdahl:]

Okay. And then just final question is just on the margin, probably maybe 5 or 6 basis points of the margin compression was maybe due to the higher liquidity. Just talk about given the interest rate environment is that higher liquidity planned or is that something that would go back to work in the fourth quarter or just sort of maybe just as we model our margin, give us a little bit more guidance there?

[Dave Kaye:]

Yes, I would say that it’s a little bit higher than we had anticipated. I think there is some timing with loans coming on and also being able to deploy that into the securities book. We had obviously the Banyan payment early in the fourth quarter, so that will -- it will eat up some of the cash. But yes we -- the average balance was higher than normal and we do intend to get some of that into working earning assets.

[Alex Twerdahl:]

Great. Thank you very much for taking my questions.

[Clayton Deutsch:]

Thanks.

[Dave Kaye:]

Thank you.

[Operator:]

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

[Casey Haire:]

Hi, good morning guys.

[Dave Kaye:]

Good morning.

[Clayton Deutsch:]

Hi, Casey.

[Casey Haire:]

Just as a follow up to the margin question, I guess focusing on the loan yields, actually the non-accrual versus last quarter held pretty stable at 380, I was just wondering is that still a reasonable target just given the recent curve flattening we’ve seen?

[Clayton Deutsch:]

Well should we ignore yesterday?

[Dave Kaye:]

This is a pretty dynamic environment, so it’s a little soft. But in a normal environment I think that what we’ve seen, the residential yields as you’ve seen held pretty steady. We do see some of the newer commercial loans coming on a little bit lower than our stated book. So perhaps there’s a little bit of pressure there, but we’re doing what we can to mitigate that.

[Clayton Deutsch:]

The only thing I would add Casey, and Mark may want to comment as well. We constantly go through our pipeline. For the foreseeable further which admittedly is kind of near term, our pipeline looks good. We like what we’re seeing on the lending side of the balance sheet. As Dave said though, it’s certainly an interesting environment right now but we like what we see in terms of the development of the loan book.

[Casey Haire:]

Okay. And then just switching the credit obviously another good recovery quarter here. What were gross charge-offs this quarter and then, so what is the outlook in terms of -- how does the recovery pipeline look going forward?

[Dave Kaye:]

Yes, you’re just talking about for the quarter or for the year to date? For the quarter we had gross charge-offs of $1 million and then recoveries of $4.3 million -- $4.4 million, $1.1 million in gross charge-offs. I think that’s been the difference this year very low sort of charge-offs. The recoveries had been strong almost $10 million on a year-to-date basis. We can get, I would still expect in the near term to get some additional recoveries, but in terms of how long that will last is difficult to gauge.

[Casey Haire:]

Got you. And then Clay, last one for you. In terms of the wealth management businesses, obviously the investment managers continue to kind of net outflow. I’m just curious, any guess as to where we are in terms of how long that you guys are battling that sort of -- that secular headwind and at what point do you, I mean I know you have a 5% net flow target, do you still feel like that’s attainable with the investment management segment under pressure?

[Clayton Deutsch:]

Well, two part question Casey. I guess I’ll start with the backend. To hit the 5% overall, clearly we can't have the kind of investment management outflows that we’ve had. We’ve got to get to net neutral to maybe even slightly positive with Banyan now we will be across our roughly $30 billion of AUM, it $10 billion in the Wealth Advisory Channel, its $10 billion in the now unified bank, Boston Private Wealth Management and Trust Business and another $10 billion in the Investment Managers. So if you just kind of mix weighted our wealth advisory firms in a market normal environment are chugging along at 4%, 5%, 6% net positive flows. The bank has actually raised its game in terms of new business generation and with the addition of Banyan we’re hoping can go from 1%, 2%, 3% to more like 4% to 5% if now 5% and above. And then you come to your question, what are the investment managers going to do? So let me turn to that. I certainly, I’m not going to make a near term market call. Longer term I think U.S. equities remains a preferred destination for global capital. In the near term, I think what you’re seeing this year is largely environmental. What we see in the U.S. is flows -- discretionary flows into investment classes of all types is actually ramped down the last several quarters. It’s been specifically difficult for active U.S. equity managers to generate positive flows. What has particularly affected us in addition to that macro -- just that macro pressure this year is a lot of client rebalancing. We’ve seen a lot of clients after several years of very positive U.S. equity performance re-wait and take money off the table and reallocate to other asset classes. So it’s almost a triple cocktail of pressure on discretionary funds available for investment flowing into active U.S. equities. Longer term, I’d like U.S. equities as a destination for capital. So what we’re doing in the interim, we’re working really hard to try to create marketing and sales opportunities on additional platforms, broader platforms but in the meantime I think we have to just tough it out. The history of these kinds of businesses is ebbs and flows, and we’ll just have to -- we’ll have to work through it.

[Casey Haire:]

Understood. Thank you.

[Operator:]

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

[Chris McGratty:]

Hi, good morning guys.

[Clayton Deutsch:]

Good morning.

[Dave Kaye:]

Hi, Chris.

[Chris McGratty:]

Dave or Clay, in your prepared remark you said the loan to deposit ratio move in the quarter was by design, obviously deposit growth is trumping the loan growth right now. At 98%, I guess what's the outlook for the balance sheet strategy from here into the next year or so and presumably rates may or may not go up. I guess what's your -- are you guys managing to a specific loan to deposit ratio, help us with that in terms of kind of how you manage the margin?

[Dave Kaye:]

Yes, I mean I think at this point in this cycle we’re looking at trying to build a little bit more liquidity. We had, at one point we were up, our loan to deposit ratio was up 103, 105. It’s moved down as we built some liquidity. We have seen some nice deposit growth particularly on the west coast in the last couple of quarters; they have done a nice job. And there’s not a specific ratio, I mean if we could move to that down a little bit, lets say get in the range of 95%, 96% over the next year or so that might be appealing to us. But we’re looking and we’re working hard at trying to generate good quality loans. We’re certainly not pulling back on that. It’s just looking for the right types of strategic clients that’s going to enhance our overall franchise.

[Chris McGratty:]

Okay, great. And maybe on this Dave, the expense outlook has been pretty flattish. Can you help us with the next few quarters? Is there any material investments you guys need to make or is this kind of 54, 55 quarterly run rate kind of fair?

[Dave Kaye:]

Well, absent the Banyan …

[Chris McGratty:]

Assuming that -- yes, excluding the deal.

[Dave Kaye:]

… acquisition, I don’t think we have any major investments. What we’ll try and continue to generate positive operating leverage and so trying to maintain an expense growth that’s reasonable, but nothing – no major investments planned.

[Chris McGratty:]

All right. Thanks a lot.

[Operator:]

Thank you. And the next question comes from Christopher Marinac with FIG Partners.

[Christopher Marinac:]

Thanks. Good morning. Just want to take on the last question coming from new customers or from existing, I’m sure its both. But to what extent are new customers driving this growth? Are you at a point where you’re almost willing to back off existing customers throwing more liquidity to you?

[Mark Thompson:]

Sure, Chris its Mark. First, I guess I would comment for the West Coast in particular. We’re quite pleased with the progress we’ve made with the Wealth Management Private Banking Model. We’ve really exported that model to a largely community based franchise prior to the integration and consolidation. If you take a look at the growth year-over-year it’s really been strategically focused with private partnerships, privately held businesses and select non-profit organizations. And I guess if I had to look at the mix between new client relations coming over its ransom in enrichment to existing clients, its probably about a 60-40 split for new account generation and that includes a healthy enrichment from existing clients that are growing their businesses which is important to sustain long-term growth which we feel pretty confident we can continue to do.

[Christopher Marinac:]

Great, Mark that’s helpful. And I guess just another question perhaps for you Clay. When you look at the sort of fees within investment management business is there any sort of outlook for that changing up or down in the next year or two?

[Clayton Deutsch:]

I don’t think so Chris, I mean well there are two things at work. There is obviously the question of external fee pressure and how were fees resetting over time. Our fee profile looks very stable and I think that’s reassuring. The second thing is, some of our managers have performance fees that typically come home to roost in the fourth quarter of the year. This year those fees will be relatively modest. Last year we had a Q4 up tick that was performance fee driven. But those are really the two factors that tend to move fees around. I would call the performance fee factor, not a big factor and thus far at least fee realization looks healthy and stable. So, I don’t see anything coming down the pipe that could tilt that one way or the other.

[Christopher Marinac:]

Okay, great. Thanks very much guys.

[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 Deutsch:]

Well I’d just like to thank you all for your interest in our Company. We’re excited about where we are. I think especially gratifying for us has been the progress of our private bank in all of our private banking markets. Really nice job by the team out on the West Coast and that’s reflected in the loan and deposit growth. We’re very excited about the future for Boston Private Wealth Management. So we’re working hard towards the end of the year and we’re excited about how our overall business is developing. Thank you.

[Operator:]

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