Boston Private Financial Holdings, Inc. (NASDAQ:BPFH)
Q2 2016 Earnings Conference Call
July 21, 2016, 08:00 AM ET
Adam Bromley - VP, Corporate Finance and Director of IR
Clayton Deutsch - CEO
David Kaye - Chief Financial and Administrative Officer
Corey Griffin - CEO of Boston Private Wealth
Casey Haire - Jefferies
Alex Twerdahl - Sandler O’Neill
Chris McGratty - KBW
Good morning and welcome to the BPFH Second 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, Pete, 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 second quarter earnings. Thank you for your patience with us this morning. If you are joining us via webcast, we encourage you to reload your browser so you can get the updated slides showing this quarter’s results.
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.
Thank you, Adam. Good morning everyone. Thank you for joining our call this morning.
In the second quarter, our company generated net income of $16.4 million or $0.18 per share, compared to $0.21 per share last quarter and $0.20 per share in the second quarter of 2015.
Return on average tangible common equity was 12.4% for the quarter and return on average common equity was 8.7%. In the quarter all of our businesses demonstrated resiliency while confronting a turbulent macro environment that posed challenges for revenue generation across the industry and across our businesses. Despite the environment we're encouraged by our client attraction and client development success across our wealth management trust and private banking businesses.
Particular highlights for the quarter include: First, our Private Bank continued to demonstrate steady performance with disciplined growth, careful management of the balance sheet and very strong asset quality. Net interest income for the quarter was up 8% year over year while recoveries continued to assist earnings.
Second, our market-linked affiliates demonstrated healthy margins and profitability despite negative net flows putting pressure on revenue growth.
Third, our Boston Private Wealth business showed strong new business performance while demonstrating considerable improvement in client stability. I'm encouraged by our progress on AUM development, the demonstrated 2% revenue growth quarter to quarter and successful client retention efforts at Boston Private Wealth.
In addition, we continue to invest in and reshape and upgrade our private banking office network. This quarter we announced the divestiture of two older Southern California offices while also announcing the opening of a new downtown Los Angeles private banking office. We will continue to invest in our office footprint to more effectively acquire, develop and serve private clients in all of our markets.
Our West Coast markets in particular continue to be a source of strength for client attraction and new business generation. I am excited about our recent client acquisition and development performance. We have deepened our client analytic capability which helps us better understand client sentiment and to drive future new business. Data from the first half of this year shows a greater than 20% step-up year over year in our target client acquisition rate as a result of marketing, branding and client outreach initiatives across our markets.
We are also delivering outstanding client service as measured by very high levels of client satisfaction. We are determined to prove that Boston Private Bank is a highly effective multi-market client expansion vehicle. We believe that a high performing wealth management offering when married with a strong private bank holds distinctive client appeal and will deliver attractive long term performance.
With that, I'd like to turn the call over to Dave. Dave?
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 on bostonprivate.com.
Slide 3 provides a summary of our key performance metrics. In the second quarter of 2016 return on average common equity was 8.7%. That compares to 9.8% in the first quarter of ’16 and 9.9% in the second quarter of 2015.
Our tier 1 common ratio increased to 10%. We continue to optimize our capital structure as our share repurchase program remains underway and we've now completed approximately $5 million of the $20 million program.
Slide 4 shows the consolidated income statement. Net interest income declined to $49.2 million linked quarter. Core fees and income were flat linked quarter at $37.6 million. Other income was negative this quarter due to market value adjustments of derivatives in the private banking segment.
Total operating expenses for the second quarter of 2016 were $64.7 million and that's down 3% linked quarter. I'll go into a little bit more detail in the next slide.
And on Slide 5 we show a detailed breakout of our consolidated operating expenses. Expenses that drove the decline include compensation, professional services and marketing and business development. You'll recall that expenses were elevated in the first quarter and that's due to the seasonal compensation charges for FICA and also some increases in the 401(k) match. Notable expense increases during the quarter included one-time expenses related to FHLB debt prepayment costs and that's categorized in the other expense line.
Moving on 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 continue to be correlated. We recognized a provision credit of $2.5 million for the quarter and that's primarily attributable to net recoveries of $1.9 million.
The chart below demonstrates continued improvement in asset quality with total criticized loans down 10% year over year. We continue to maintain strong reserves and our ALLL for loan ratio finished the quarter at 1.32%.
On Slide 7 we show the private banking segment excluding the wealth management portion of our bank. In the second quarter, net interest income decreased 1% to $49.7 million, that's primarily due to lower interest recoveries on previous non-accrual loans.
Total other income was negative $1 million due to the market value adjustments on the derivatives and that's primarily caused by the decline in interest rates. Total market value adjustment during the quarter was a negative $1.5 million. And these factors contributed to the 3% decline in total revenue for the quarter.
Our total operating expenses increased 3% linked quarter to $32.1 million and that includes the non-recurring FHLB debt prepayment costs of approximately $300,000. On a year-over-year basis the reallocation of the holding company expenses into the bank contributes to the increase of -- the year-over-year increase at the private bank expense.
Slide 8 shows the past five quarters of average loan balances and deposit balances by type. The total average loans increased 7% year over year and that's led by C&I which is up 10%, CRE & Construction which is up 9% and resi which is up 4%. We continue to maintain strong momentum expanding our private client franchise on the West Coast and in that market -- in those markets end-of-period loans grew by 5% linked quarter, that's driving the bank's overall loan growth.
Average total deposits increased 6% year over year to $5.7 billion, that's led by growth in core funding. Demand deposits and money market deposits increased 13% and 5% respectively while CDs continued to trend lower. This quarterly decline in deposit balances is consistent with historical patterns of seasonality which is driven primarily by client tax payments.
During the second quarter we transferred $111 million of deposits to the held for sale as a result of our agreement to divest two Southern California branches in Burbank and Granada Hills. But that did not impact our average balances but instead impacted the end-of-period reporting for deposits.
Turning to Slide 9, net interest margin at the bank declined 6 basis points linked quarter to 2.95%. Excluding the interest recovered on previous non-accrual loans, core net interest margin decreased 2 basis points to 2.92%. Borrowing expense for the quarter was elevated due to the increased volume of short term FHLB borrowings taken to replace the seasonal deposit outflows.
With that, I'll now turn it over to Corey Griffin, CEO of Boston Private Wealth. Corey?
Thanks, Dave. Slide 10 contains financial information for the wealth management and trust segment which operates under the Boston Private Wealth brand. Revenue increased 2% on a linked quarter basis to $11.3 million. The revenue increase was attributable to sequential growth of AUM and on-boarding of lift-outs.
Total operating expenses decreased 13% linked quarter to $13.7 million, reflecting the decline of seasonal compensation expenses, the full impact of the first quarter 2016 restructuring and lower professional fees. Expenses in the second quarter of 2016 include a restructuring expense of $900,000.
On Slide 11, we show both net flows and new business flows for Boston Private Wealth for the past eight quarters. AUM development improved considerably as new business generation remained firm and client attrition rate subsided. Net flows were negative 13 -- I'm sorry – net flows were negative $39 million in the second quarter compared to negative $422 million in the first quarter of 2016, reflecting continued strength in new business generation and abating levels of client attrition.
New business flows for the quarter were $235 million in the second quarter driven by bank referrals and our channel partners with June marking the first month of positive net flows in the last 18 months. The momentum in AUM development is further highlighted by the net change in client relationships over the past four quarters. The number of new relationships gained at BPW has increased sequentially for three straight quarters, nearly doubling from the third quarter of 2015 while the number of lost relationships in the second quarter of 2016 was approximately 40% below the levels experienced during the prior three quarters.
Going to the back half of the year I am extremely proud of our team's collective efforts to show progress on stemming client attrition while continuing to generate elevated levels of new business. We are not where we want to be as a firm in terms of client retention, we are trending the right way.
I will now hand it back to Clay.
Thanks, Corey. Let me now address overall net flows across our other wealth management businesses. Slide 12 shows AUM net flows by segment. For the investment management segment, we saw negative net flows of $169 million for the quarter. Our wealth advisory segment had positive net flows of $9 million during the quarter. On a consolidated basis, we had negative net flows of $199 million, a significant improvement compared to prior recent quarters.
On Slide 13, we show the total revenue for the investment management segment was flat linked quarter and decreased 9% year over year. Operating expenses decreased 8% year over year and 2% linked quarter, representing lower incentive compensation. Second quarter 2016 investment management segment EBITDA margin improved to 33% which remains above our 30% corporate target.
Moving to Slide 14, our wealth advisors reported net revenues of $12.6 million, down 1% linked quarter and year over year. Operating expenses decreased 5% linked quarter but have increased 5% year over year to $9.2 million. The increase reflects senior client facing hires in our wealth advisory affiliates.
Second quarter 2016 segment EBITDA margin was 30% compared to 27% in the first quarter of 2016 and 35% in the second quarter of 2015.
That concludes our comments on second quarter 2016 performance. We’ll now open up the line and entertain your questions.
[Operator Instructions] And the first question comes from Casey Haire with Jefferies.
Good morning guys. Just start off I guess on the credit recovery front, obviously a major impact on this quarter. Dave, can you just give us some thoughts on with special mention at $67 million, the potential for credit recovery going forward and how long it might last?
Yeah. As we said in the past, I think there is still potential for further recoveries on the credit front. It's just they’re sort of lumpy. There was one large recovery this quarter which drove the bulk of the $1.9 million. It's just difficult to say, I know there's other credits out there that could recover but whether it occurs third quarter or fourth quarter or first quarter, not sure but overall credit quality is good as you mentioned. And we're pleased with the progress we've made. I think in addition to the recoveries, there's just sort of a lack of downgrades and lack of stuff moving to non-accrual. So we’re seeing good credit out there.
Okay. Corey, on the wealth management front, obviously a very good quarter for you guys on the outflow front, although based on your commentary it sounds like you're still not where you want to be. I mean is there AUM still at risk that you're worried about or have we turned the corner here?
Thanks. To your point about having a good quarter, thank you, but me suggesting that we're not where we want to be. Until we get positive I'm not going to be satisfied nor is anybody that works for me. I do think that we made considerable progress towards getting our clients and our folks more comfortable with the new model. We've moved a number of our clients that we thought were at risk or where we felt -- we weren't as comfortable as we thought we needed to be in terms of their acceptance of the new model, time with new advisors et cetera from kind of higher risk to lower risk or moderate risk. And it's not completely subjective. It's about new contributions, it's about adopting a new strategy. We've had an incredible uptick in the number of clients that have sat down with our advisors and done planning as we evolved from less of an investment only to a planner -- for planning capability where we're trying to move from -- one of just being one of their providers to be the quarterback of all of our clients’ financial needs and investment performance of each of the underlying asset class has been very very good. So we’re feeling very good about the future.
My comment about not being where we want to be is simply maybe an objective point. I don't want to be negative, got to be positive and I feel very comfortable we're going to get there.
Okay, great. And just last one for me, Dave, on the mark to market within the other fee line which was $1.5 million drag on the top line this quarter. Is that something that -- assuming we don't get another leg lower on rates, that we won't see that again, or is there a way to potentially mitigate that?
Well, it is driven by -- it was driven by the drop in rates. And so, yes if we see no further drops, or if the rates go back up, we would actually see reversals of that. And over time you'll pull that back in as well as these swaps mature and our exposure becomes less. So we would expect that to reverse. But it's hard to predict. I mean I'm not in the business of predicting which way rates are going to move. And if they did move down we would be susceptible to another negative but absent that we should be okay.
Thank you and the next question comes from Alex Twerdahl with Sandler O’Neill.
Hey, just to piggyback on the last question, on AUM, it’s still at risk at Boston Private Wealth. I think last quarter you said there was about 600 million those at risk, are you willing to quantify a number this quarter, or are you just keeping it pretty high level with the commentary?
I think we like to keep it high level. I can tell you that the $600 million that we kind of circled last quarter is in a considerably better position, and we retained the high percentage of that AUM and it’s moved from kind of the right side of the page to the left side of the page in terms of the way we think about their comfort level with our business. And as I talked about earlier, not just the subjective ranking but new contributions, new strategies, willing to sit down, do more planning as we gain more share of wallet. I mean we're not taking a victory lap. As I said earlier, in an industry where kind of losing 5% of your assets through a myriad of different reasons, drawdowns, terminations rebalancing et cetera is the standard, I think we're targeted to get closer to that and surpass that over time.
And then just another question on Boston Private Wealth. As I look at Slide 10, what kind of jumps out to me is that yeah, AUM outflows have certainly gotten a lot better this quarter but we're still losing money there, because the expenses are still greater than the revenue. Is there a timeframe that you've laid out for either to bring the expenses down and sort of what levers you have to pull there? Or is it really just going to be growing revenue through growing AUM that’s driving [ph] that to profitability and is there sort of a timeframe you can sort of lay out until we get to profitability at Boston Private Wealth?
Well, certainly growing revenue is key to growing the profitability. In the slide we still are losing money as you pointed out. The restructuring charge is hopefully the end of that restructuring and we'll see some benefits going forward from these past charges both on the personnel and on the non-personal side as we look to get more efficient in terms of our vendor usage. In terms of timing, we're looking at trying to get closer to breakeven in the second half of the year and then 2017 we want to see that profit trend head up toward our corporate target levels.
And then just one other question for you, Clay, at the Boston Private or the wealth advisors, another question on revenue here. I see that that's the one where AUM has actually been moving in the right direction over the past year and over the past quarter. And yet total revenue has declined there both sequentially and year over year as well. Has there been an adjustment to the fee structure there or client mix or sort of what would sort of cause a revenue stream to sort of point back in the correct direction going forward?
Yeah, Alex, first, KLS and Bingham who are the firms you're talking about in that segment, are very strong healthy practices with a tremendous amount of client stability. Client retention rates in those businesses are extremely high. Historically those businesses have grown almost two-thirds, one-third, two thirds through current clients making additional funding contributions and kind of one third net new client gain. What we saw in the first half given very turbulent market conditions was a lot of clients frankly kind of sitting on the sidelines, putting excess year end funds into cash and paying down debt and more or less kind of marching in place from a conservation of liquidity standpoint. And I think that's the single biggest delta that we saw this year, the normal step up in first half of the year funding that we normally see from those wealth accumulation clients was moderate this year.
In addition, I'm proud that both of our firms were very tempered in their thinking about fee rates and fee increases. I think we were cognizant of the fact that we're in a very choppy yield environment. We're trying to be very respectful of clients from a pricing standpoint. I'm actually quite pleased that those businesses have in effect helped serve in a pretty difficult environment. Long term I'm not happy if we're growing at less than kind of 10% year over year but given all the gyrations in the first half of the year and the degree of uncertainty hanging over a lot of our clients, I think we've done the right thing and I think we navigated it in a very responsible way.
So the main difference really is just a higher percentage of cash in the mix versus anything else?
Yeah, we see across our clients a lower level of net investment and net top ups if you will than we have seen historically. And I think it's very explainable by the cloud of global uncertainty that was hanging over -- hanging over us environmentally through the first half of the year.
Thank you and the next question comes from Chris McGratty with KBW.
Clay, on loan growth you got 7% annualized in the quarter but the first half was a little bit slower I think than we had expected. You kind of hesitated on being a little bit more aggressive on the buyback. I'm interested in kind of the outlook for loan growth for the back half.
Well, Chris, we’re a relatively small balance sheet. And little moves quarter to quarter actually go a long way quarter to quarter. So I'm not overly fussed about linked quarter. I tend, when I look at the balance sheet, to try to interact with our executives around longer term how we’re doing year over year. Our long term targets, Chris, remain unchanged. I think given our balance sheet composition and what we're trying to do in the marketplace, 6%, 7% loan growth in aggregate we regard as a healthy sustainable number. I am talking per annum, not quarter to quarter. 6%, 7% loan growth, 7%, 8% deposit build over time is a very sustainable rate of growth that allows us to satisfy private clients' needs and it satisfies our shareholders because we're doing it in an organic capital generation way. So it's not going to be a straight line quarter to quarter but the guidance I give you is our targets haven't changed, kind of 6%, 7% loan growth we're very satisfied in our private client segments that we can generate that. And I think as the results show it’s very high quality. It's very high quality lending. We're comfortable with the exposures. So we're going to continue to keep it in the fairway if you will with respect to those growth targets, even though quarter to quarter you may see ups and downs.
On the share repurchase, I can’t remember the exact comment you made, Chris. I think you said something like gee, we want a little light. Keep in mind we're not hand managing that. That share repurchase is driven by a volume weighted pricing program where on the dips we're buying more. So it’s the pricing metrics driving the share repurchase. Having authorized it, we're not trying to market time and jump in and out. It's ticking away on autopilot based on a pricing metrics. We remain buyers of the stock. So, Dave, if you care to elaborate, that's fine but that's how it's working organically.
No, that’s helpful, the color on loan growth, great. Just in terms of mix, a lot has been said with some of your peers with CRE concentration. Obviously it’s not necessarily an issue with you guys. But commercial loan growth has been a little bit slower to date. I'm wondering if you've seen anything in terms of pricing that make you a little bit more cautious or should we expect the balance of the growth for the back half of the year to kind of be both resi mortgage but also commercial?
I think we're going to continue the loan growth targets that Clay talked about, applied to both the resi and the commercial business. And as Clay said, I think we're still getting very high quality commercial growth. It’s not to say that there aren’t difficulties in terms of pricing, in terms of with competitors but that's frankly why we set our growth targets in that reasonable 6% to 7% range.
Okay, maybe one for you, Dave, on the expense run rate going forward, any help on kind of what you’d adjust for the charges in the quarter and what a fair run rate might be for the back half?
So the only -- outside of the restructuring charge and we mentioned sort of a $300,000 charge in the other expenses, those were the unusual items. I think we are going to get a little bit better in terms of the salaries and employee benefits. So I think we'll get some benefit there with -- as a result of some of the restructuring charges that we did take. But that will move down over time over the next several quarters. So those are the restructuring, the other are the only two unusual items and then like I said we'll get some benefit on the salary and benefits but that'll be over time.
All right. As there is nothing else, I would like to return the call to management for any closing comments.
Thank you all for your interest in us. I'm pleased with our progress thus far and especially pleased with the good things coming out of the Bank and Boston Private Wealth. Our affiliates remain healthy. And I look forward to the second half of the year. We'll be talking to you soon.
Thank you. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.