Boston Private Financial Holdings, Inc. (NASDAQ:BPFH)
Q3 2016 Earnings Conference Call
October 21, 2016 8:00 AM ET
Adam Bromley – Vice President, Corporate Finance and Director-Investor Relations
Clayton Deutsch – Chief Executive Officer
David Kaye – Chief Financial and Administrative Officer
Corey Griffin – Chief Executive Officer of Boston Private Wealth
Casey Haire – Jefferies
Chris McGratty – KBW
Alex Twerdahl – Sandler O’Neill
Michael Young – SunTrust Robinson Humphrey
Good morning and welcome to the Boston Private Third Quarter 2016 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded.
I would now like to turn the conference over to Adam Bromley. Mr. Bromley, please go ahead.
Thank you, Keith, and good morning. This is Adam Bromley, Director of Investor Relations at Boston Private Financial Holdings. We welcome you to this conference call to discuss our 2016 third quarter earnings. Joining me this morning are Clayton Deutsch, Chief Executive Officer; David Kaye, Chief Financial and Administrative Officer; and Corey Griffin, Chief Executive Officer of Boston Private Wealth.
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 qualifier contained in our earnings release, which identify 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 Clayton Deutsch.
Good morning everyone. Thank you for joining our call this morning. In the third quarter, our company generated net income of $19.6 million, or $0.22 per share, compared to $0.18 per share last quarter and $0.16 per share in the third quarter of 2015. Return on average tangible common equity was 14.3% for the quarter and return on average common equity was 10.2%. We are pleased with the company’s overall performance during the quarter. Our company demonstrated improved credit quality, capital levels and profitability metrics.
Specific highlights for the quarter include, first our core private banking performance continues to be a valuable source of earnings in 2016. The Private Bank generated top-line revenue growth driven by solid and disciplined balance sheet growth. At the same time, our commitment to risk management remains high as asset quality metrics remain very strong.
Second, in our wealth management and trust business, we continue to build a unique franchise that is integrated with our private banking clientele. Corey Griffin and his team continue to show progress, reducing client attrition, while staffing the business properly for long-term success. Third, our investment management and wealth advisory segments continue to demonstrate healthy margins and profitability, despite environmental pressure on revenue growth.
Finally all of these factors, coupled with ongoing expense discipline translated into improved profitability metrics for the company. Our efficiency ratios improved for the company and for the private bank, while our pretax pre-provision earnings reached our highest level in the last two years. Moving ahead, our focus for the company will continue to be on disciplined growth, balance sheet quality and generating high quality earnings.
With that I’ll turn the call over to Dave for more detail.
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 on bostonprivate.com.
On Slide 3 we showed a summary of our key performance metrics. In the third quarter of 2016, return on average common equity increased to 10.2% and that compares to 8.7% in the second quarter of 2016 and 7.3% in the third quarter of 2015. Increased returns are the result of improvements in both revenue and expenses. Our efficiency ratio improved to 65%, and our Tier 1 common equity is 10.0%. We remained active, repurchasing shares during the quarter, as we have now completed 8 million of our 20 million authorization.
Slide 4 shows the consolidated income statement. On a linked-quarter basis, net interest income increased 1% to $49.9 million, and core fees and income increased 1% to $37.9 million. Other income increased to $2.0 million for the quarter, which drove a 5% increase in total revenues linked quarter. A $1.2 market value adjustment of the derivatives in the private blanking segment was a significant contributor to the total other income line during that quarter.
Total operating expenses for the third quarter of 2016 were $61.7 million and that’s down 5% linked quarter. I will go into a bit more detail on the next slide. Overall, a total revenue increase of 5%, coupled with the 5% decrease in operating expenses resulted in a 20% linked quarter improvement in that income.
On Slide 5, we show a detailed breakout of our consolidated operating expenses. Expenses that drove the decline include decreased legal and consulting fees, other expenses, and occupancy expense. FDIC insurance expense also declined during the quarter due to favorable changes in the FDIC assessment rates.
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, continued recoveries are positively impacting the provision. We recognized a provision credit of $100,000 for the quarter and that was due to net recoveries and a decrease in loss factors, partially offset by an increase in criticized loans of 5% and also loan growth.
The chart below highlights the bank’s asset quality for the quarter. Criticized loans increased 5% for the quarter, and that was driven primarily by the downgrade of a single commercial relationship, totaling $17 million. Outside of this relationship, all other major asset quality metrics demonstrated improvement, and we continued to maintain strong reserves, with ALLL to loans finishing the quarter at 1.32%.
On slide 7, we showed a private banking segment, excluding wealth management and trust portion of our bank. Net interest income increased 1% linked quarter as a larger average balance sheet offset a slightly lower NIM. Total other income includes the previously mentioned market value adjustment on the derivatives. Total operating expenses decreased 5% linked quarter to $30.4 million and that is due to decreases in occupancy expenses, FDIC insurance and other expenses. On a year- the reallocation of the holding company expenses contributes to the increase in expenses in the private banking segment.
Slide 8 shows the past five quarters of average loan balances, and deposit balances by type. Total average loans increased 4% year-over-year with comparable growth rates coming from residential C&I and CRE. Linked quarter residential loans and CRE demonstrated the strongest growth at 2%, while C&I balances declined 2%. On a year-to-date basis average total loans have increased 6%. Average total deposits increased 3% year-over-year to $5.9 billion and that is led by growth in core funding.
Lower cost demand deposit and savings accounts increased year-over-year by 12% and 8% respectively, while the higher cost money market and CDs both decreased year over year by a negative 1% and negative 6% respectively. During the third quarter, non- interest bearing DDA accounts were the primary source of deposit growth at 12% linked. On a year-to-date basis, average total deposits have increased 6%. As you recall, we announced an agreement during the second quarter to divest two southern California offices in Burbank and Granada Hills. We have about a little over $100 million in deposits in the held-for-sale, and that impacts the end-of-period balances, but does not impact the average balances. This transaction is on schedule to close during the fourth quarter of 2016.
Turning to slide 9, core bank NII increased to $50.1 million. Net interest margin at the bank declined 3 basis points linked quarter to 2.92%. Excluding the interest recovered on previous non-accrual loans, core net interest margin decreased linked quarter by two basis points to 2.90%. The banks all in cost of funds including DDA, decreased to 37 basis points, and that’s a result of the mix shift to the demand deposit accounts during the quarter.
With that, I will turn it over to Corey Griffin, CEO of Boston Private Wealth.
Thanks, Dave. Slide 10 contains financial information for the wealth management and trust segment, which operates under the Boston Private Wealth brand. Total revenue decreased 3% linked quarter to $10.9 million. The prior quarter included transactional fees of approximately $150,000 while the current quarter included a revenue adjustment that negatively impacted this quarter’s results by $135,000. Excluding these items, revenue was flat linked quarter, in line with AUM, which was also flat linked quarter.
Total operating expenses decreased 10% linked quarter to $12.3 million, reflecting lower levels of legal and consulting fees, in addition to the impact of previous restructuring charges taking effect. Overall profitability improved sequentially to a net loss of $800,000.
On slide 11, we show both net flows and new business flows for Boston Private Wealth for the last eight quarters. Net flows were a negative $120 million in the quarter, reflecting a slowdown in new business generation from $235 million to $148 million. The drawdown of the short-term liquidity account in excess of $90 million. In addition, we made a business decision to exit a large accommodation for an ongoing client relationship, because it was unprofitable.
Turning the net flows positive remains a priority, and we are encouraged by our team’s continued progress stemming client attrition. During the quarter, lost business as measured by AUM declined 12% linked quarter. We also saw a meaningful slowdown in client attrition, as measured by the number of lost clients. In the quarter the rate was significantly reduced, and reached its healthiest retention level of the last two years. I will now hand it back to Clay.
Thanks, Corey. Let me now address net flows across other wealth businesses. Slide 12 shows AUM net flows by segment. In the investment management segment, we saw net flows of negative $111 million for the quarter. The wealth advisory segment had net flows of negative $105 million during the quarter. On a consolidated basis we had company wide net flow of negative $336 million on 1.2% of our starting AUM of $27.3 billion.
We closed the quarter with AUM of $27.5 billion, driven by positive market action and investment performance. On slide 13, we showed the total revenue for the investment management segment increased 1% linked quarter with a 6% decrease year-over-year. Operating expenses increased 1% linked quarter though they decreased 4% year-over-year representing lower incentive compensation. Third quarter 2016 segment EBITDA of 32% remains above our 30% corporate target.
Moving to slide 14, our wealth advisors reported revenues of $12.8 million up 2% linked quarter and year-over-year operating expenses decreased linked quarter by 2% and 4% year-over-year to $9 million, reflecting a combination of lower performance-related bonuses, and lower amortization. Third quarter 2016 segment EBITDA margins increased to 33%. That concludes our comments on third quarter 2016 performance.
With that, we will open up the line and entertain your questions.
Yes, thank you. We’ll now begin the question-and-answer session. [Operator Instructions] And the first question comes from Casey Haire with Jefferies.
Hi, good morning, guys.
Good morning Casey.
The expense control was pretty good this quarter. Just wondering, the $62 million run rate, was there anything that one time pushed it down, or is this a good run rate going forward?
I think, overall, it was a pretty good run rate. It was perhaps a little bit low. We always have pluses and minuses, and did some accrual adjustments on the compensation side, and so that benefited us a little bit. And marketing is probably a little bit seasonably slow. In that $60 million range is a good range.
Okay, great. And switching gears to credit quality, just two-part question. One, how is the recovery pool shaking up here, looking forward? And the criticized asset uptick, I’m assuming that was mostly the $17 million credit you mentioned, any color there?
No, the only color is, it’s a large commercial relationship, and we are looking at the leases with some of the tenants, and we have made the decision to downgrade that due to timing. But we felt overall pretty good about outside of that one relationship, we felt continued improvement in the overall credit quality.
Okay, and then, Clay, just a big picture question for you. The asset and the bank continues to do very well, mid-single digit growth with clean credit quality. Obviously facing some pretty formidable secular trends, with outflows on the asset management side of the house. You sound pretty committed to turning that tide. At what point, it has been two years since you have had a nice positive flow quarter. I’m just wondering at what point do you, I don’t know, cry uncle?
Yes, why don’t we narrow the frame, Casey, to investment management, which is one of our three pools. The other two, I’m really pleased with the progress in Boston Private Wealth, and I think our two wealth advisory firms are very stable and are doing good things to expand their practices. Within investment management, at the industry level, everything you say is true. The entire sector faces secular headwinds, so there’s no easy solution.
I will tell you, we are pleased with the progress, particularly with Anchor, which is our larger and more significant firm, in the overall picture financially. They have gotten pretty close to flow neutrality with very strong investment performance and strong distribution. In the quarter, we lost one large platform mandate at Dalton Greiner which was obviously a setback, and represents the numbers.
So your assertion that it’s a tough category is true. Our goal is to get those firms as close to net neutral as we can, both firms, we think are high integrity, well-managed firms capable of performance, and we like the profitability.
Okay thank you.
Thank you. And the next question comes from Chris McGratty of KBW.
Good morning everyone.
Dave, maybe for you, the $62 million on expenses, how should we be thinking about that level as you turn the page to 2017, given the transition that the revenues are still going through on the fee side? Is there a level of inflation that is going to take that number up a bit? Or are there other areas you may be able to pull to keep the number in the $62 million range.
Well, I think some of the actions that Boston Private Wealth has already taken, we are going to start seeing further benefits of that. With that said, there is some core inflation in terms of just staffing level increases, to handle some increased volume, and also merit increases. So in terms of a percentage, you can see the compensation lines going up several percentage. So it’s going to put pressure on that $62 million up, but as I said, we will have some relief with the Boston Private Wealth expenses coming down. And then also, we are having the sale of those two offices in southern California, and that will help a little bit.
Sure. Just a couple of housekeeping items, first on the tax rate, how should we be thinking about it near term?
It was a little lower than it has been, we had some provisions to return adjustments. I think we should think about it in the 31% to 31.5% range.
Okay, and if I recall, there’s one more earn-out or there was supposed to be an earn-out with the deal, which was going to affect the share count I believe in the fourth quarter. Is that, can you just remind us if that adjustment will still happen given the flows?
Yes, there won’t be any earnout associated with that.
Okay great, thanks for taking the question.
Thank you. And the next question comes from Alex Twerdahl with Sandler O’Neill.
Hey, good morning, guys.
Good morning, Alex.
I’m just looking at the slide on Boston Private Wealth’s performance. I can’t remember, have you set a target EBITDA margin for that segment?
What we have said to our shareholders, Alex, is we would like to push the business to breakeven in this latter half of 2016, ramping obviously to positive margin territory in the 2017. Our level one operating income margin goal is probably in the 10%-ish range. Long-term, we think the business is capable of much more. We have talked with shareholders about a 15% to 20% operating income interval, as representing pretty good industry performance. You can see some models in the industry doing better than that. There are models like ours, north of 20% operating income.
In the near term, now Alex, I’m being very patient. I know that’s a surprising statement, because we are a very profitability-oriented Company, but our guidance to Corey and his team is build the business right. I believe they are doing that. We have a pretty compelling client proposition. The client value added is extremely satisfying right now, but we are going to push that business above breakeven as we roll into – as we finish the year and roll into 2017. 2017 will be a profit built year. And those are our longer term profit targets.
Is really the only way to sort of get to that 10% margin by the end of 2017 or 2018 or whatever the time frame is, is it really just growing revenues?
No, it’s a mixture – I will turn it over to Corey, but in prior calls, we talked about a mixture of efficiencies, which is why we laid in restructuring charges for the first half of the year. Long-term though, absolutely. The purpose of that business in our portfolio is to be a growth business, no two ways about it.
Okay, and then, just to talk about the flows in that line, again, I think I might have missed your comments, Corey, when you were going over them. But net new business of $150 million in the third quarter is the weakest performance you have had in what looks about a little over a year. Is there anything – I mean is it – can you point to Brexit or can you point to the election, or some other macro trends that are causing people not to give you some of their money, or is there anything we can read into here? Or do you think it’s just a blip?
Alex, we are not commenting on the election, those are house rules, but other than that, anything else is fair game.
We will have to blame it on Vladimir Putin, too, but I’m confident it’s not structural. As I think about, to your point, the last four quarters were normal, in the 200 to 250 range. I’m confident we’ll get back to that. I just think it was this business, as you know as you’re in the business, is sometimes lumpy, and I can’t point to anything else. I would love to take Brexit as an excuse, but I won’t.
Okay, and then the final…
The only thing I would add, Alex is we were encouraged by the client flow in the quarter, and we scratched our head over exactly what you’re raising, why was the new business down? In every quarter, we have had a couple of pieces of very large business that have propelled us. While we had terrific success with target clients this quarter, it was the absence of a really big one or two outliers. It was no more complicated than that. So I don’t think we can point to something systemic.
Well hopefully that turns around, or comes back in the fourth quarter. Final question for me, I was hoping maybe you can give a little more color on that $17 million commercial downgrade. I know it was part of the southern California piece, but geographically where it is, what kind of industry is it in, and maybe just a little more color about that?
It’s a commercial building, and we went through and looked at the tenants, and they were having some issues with timing on the leases and getting those renewed, and so we moved it to classified. It’s still paying as agreed, still cash flowing, and a cautious but appropriate move on our part.
All right, is it an office building, or is it retail, or is it in San Diego or can you give us a little more color on where it may be?
No, it’s right in our market in LA, and it’s an office building.
Okay. All right, thank you very much.
Thank you. [Operator Instructions] And our next question comes from Michael Young with SunTrust Robinson Humphrey.
Hey, good morning.
Good morning, Michael.
I want to ask a big picture question, maybe across the three different business lines. But the ALM outflows that you’re getting, would you characterize those as generally larger accounts that are maybe less profitable, and then you’re adding net new accounts that are smaller but potentially better EBITDA margins? Is that a fair way to characterize it? Maybe we are kind of missing that in the total number?
Yes, so, thank you. I will speak to that at least in regard to Boston Private Wealth. There were two, exactly as you explained departures in the quarter. One was essentially a money market account, and yes, you know how profitable those can be. And the other was an accommodation, the departure of an accommodation we made for a client, where it was an unprofitable business, but we did it as an accommodation for a client we continue to have, where we exited that business, which actually improved our bottom line.
And to the second part of your question, yes. I would say as we are getting into the holistic planning business, we are seeing smaller, more velocity, more touch points, and greater profitability with the clients we are bringing on.
And what about in the other businesses, Clay, maybe the investment managers, et cetera. What’s your thoughts there?
Yes, thanks, Michael. In investment management, it’s a challenging rotation from a pretty barren institutional market, and what I mean by barren, there is just a dearth of high-quality U.S. equity mandates in the institutional space. And our firms in that space, Anchor and Dalton Greiner, have been rotating into the retail platform business. That’s an appropriate ration in our opinion, and yet a challenging one. In the two -- in the wealth advisory space, it is not a, quote, shedding of large clients or anything like that. We continue to serve a very attractive clientele at KLS, and at Bingham Osborn. Bingham in the quarter showed a fair amount of stability, with flows slightly positive. KLS tends to be a little bit more front-loaded firm in the earlier part of the year, because their clientele is very seasonally bonus driven.
In addition, KLS is working through an expansion of the Managing Director group. They have added four new managing directors, which I think bodes very well for the future, but to accommodate that, they are working through client service transitions, and the like. But I’m not overly bothered about anything going on in the wealth advisory segment. Those are two very stable practices, that we think have proven they will perform over the long-term. Probably the greatest sector challenge is in the investment management space. That’s an awfully tough patch right now. Nevertheless, we continue to like the overall profit performance of those firms, so we are working with them.
Okay, great, and one last one, if I could, just on top of the house profitability. Clay, I know in the past, you have targeted maybe like an 11% ROTCE. Just curious where you think that level is going to go in 2017, and maybe what the drivers are to get you to where you want to be next year?
Yes, I mean as you know, our shareholders know that our long-term ROE targets are higher than what we are generating right now. Our cost of equity is 9%. We think anything above that is value added. I was pleased with the 10.2% in the quarter. We did kind of guide our shareholders down in this rate environment. Our long-term house targets of 12% are awfully hard to achieve without a little bit of yield relief. I think we are doing a pretty deft job of managing the balance sheet.
A modicum of rate relief certainly improves the ROE picture, and yet I’m not going to hazard to guess on rates. I think that the jury is still out. I think it’s too early to make a rate call. But we are doing it the hard way, if we can continue to generate quality earnings above the cost of equity, certainly north of 10%, makes us happier as a management team. To push into that 11% to 12% space, we are going to need a little bit of margin help.
Thank you. And as there are no more questions at the present time, I would like to return the call to management for any closing comments.
I just want to thank all of you for your ongoing interest in us. We felt it was a pretty good quarter from a balance sheet management and profitability standpoint, and we maintain an awful lot of confidence in our wealth businesses, and we are going to continue to work hard to generate quality performance. Thank you.
Thank you. The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.
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