Boston Private: The Tide Is Turning

| About: Boston Private (BPFH)

Among the bank stocks that have gotten walloped as a result of the Great Credit Crunch—and there are plenty—one of our favorites is Boston Private Financial Holdings (NASDAQ:BPFH). In fact, the stock is one of our largest positions.

Boston Private, with $5.9 billion in assets, provides private banking and asset management services via five subsidiaries, in California, Florida, Massachusetts, New York, Washington State, and (until recently) Florida. On the one hand, private banking is one of the true growth niches in the banking industry in recent years, and Boston Private in particular is a very successful player. Before the credit hurricane hit in earnest in 2008, the company generated average annual earnings per share growth of nearly 10% going back to 2000.

But on the other hand, Boston Private has not been immune to the credit problems that have afflicted so many other lenders its size. It has been hurt in particular by residential construction loans at its Florida unit, as well as commercial real estate credits in California and the Pacific Northwest. Over the past nine quarters, the company has charged off $240 million of its $4 billion-ish loan portfolio, with more yet to come. At the end of the third quarter, non-performers came to 2.31% of total loans, compared to 1.97% at the end of the second quarter and 1.02% back at the end of 2007.

Not surprisingly, the company’s earnings have gotten walloped as credit has deteriorated—and so has its stock price. Boston Private has lost money for the past six straight quarters, and is likely to keep on losing money through the end of this year. From an all-time high of $35 in mid-2006, the stock lately trades $6.20 per share.

But while credit problems have laid Boston Private low, the company is well-positioned to deal with them, and then come out of the credit slump in a very strong competitive position. It’s has taken a number of steps in the past few months to clean up its balance sheet and strengthen its finances. The first is the sale of its Florida subsidiary, Gibraltar Private Bank & Trust, announced on September 17, for $93 million in cash. Not only will the sale enhance the company’s liquidity, it will rid Boston Private of $50 million in non-performing assets and another $91 million in classified assets. (The bulk of the problem assets are residential construction loans.) Overall, the sale will reduce problem assets by roughly one-third.

Then on October 9, the company announced it will accelerate to yearend the closing of the previously announced sale of its Westfield Capital management unit. Boston Private will receive $59 million in cash at the closing and, thereafter, will receive 12.5% of Westfield’s revenues for the next eight years.

The effect of these moves will be to add to the company’s liquidity and boost its capital ratios.

In the meantime, evidence is accumulating that the worst of Boston Private’s credit problems may be past. Net chargeoffs came to $7.1 million in the third quarter, compared to $15.8 million in the second quarter and $12.8 million in the first. Similarly, the company added just $2 million to its loan loss reserve last quarter, down from $8.3 million in the second quarter and $3.9 million in the quarter before that.

With the company’s Florida exposure now contained with the sale of Gibraltar, investor concern has shifted to the company’s commercial real estate loans on the West Coast. CRE makes up 31% of Boston Private’s loan portfolio; half of that is in Northern California. At the end of the third quarter, nonperformers in Northern California came to 3.58% of loans (1.62% are reserved for). But the company’s exposure should be limited. The company says that almost 90% of its loans in Northern California have loan-to-appraised-value ratios of 70% or less.

Through it all (and with the help of those asset dispositions) the company’s capital ratios have stayed strong. Tier 1 Risk-Based Capital came to 17% at the end of the third quarter, while total equity made up 10.55% of total assets.

In the meantime, Boston Private’s stock trades as if its survival is a touch and go proposition. At $6 per share, the stock trades at 125% of tangible book value. (Historically Boston Private trades at around 3 times book.) In addition, it trades at 2.3 times the $2.80 per share in earnings power we think the company will achieve once the cycle turns. Before the recession, the stock typically traded around 20 times earnings.

And when the cycle does turn, Boston Private will still be well-positioned in one of the most attractive niches in the banking business. Even as the company has dealt with problems on the asset side of its balance sheet, its deposits have continued to grow nicely. They were up 17% at the end of the third quarter from a year ago.

As the economy and credit cycle finally begin to turn, there’s no shortage of opportunities among beaten-up bank stocks. Boston Private is one of the most attractive, in our view.