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Boston Private Financial Holdings Inc (NASDAQ:BPFH)
Q3 2020 Earnings Call
Oct 22, 2020, 8:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day and welcome to the Boston Private Financial Holdings Third 2020 Earnings Conference Call. [Operator Instructions].

I would now like to turn the conference over to Adam Bromley. Please go ahead.

Adam Bromley -- Senior Vice President, Director, Corporate Finance/Investor Relations

Thank you, Alyssa, and good morning everyone. This is Adam Bromley, Director of Investor Relations of Boston Private Financial Holdings. We welcome you to this conference call to discuss our third quarter 2020 financial results. Our call this morning includes references to an earnings presentation, which can be found in the Investor Relations section of our website, bostonprivate.com. Joining me this morning are, Anthony DeChellis, Chief Executive Officer; Steve Gaven, Chief Financial Officer; Paul Simons, President of Private Banking Wealth and Trust; and Jim Brown, President of Commercial Banking.

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 identified 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'll now turn it over to Anthony DeChellis.

Anthony DeChellis -- Chief Executive Officer

Good morning everyone, and thank you for joining us on today's call to discuss our third quarter 2020 results. We hope this call finds you and your family and in good health. While the business and economic outlook in our markets remains uncertain, mainly due to the COVID impact, we are encouraged by our operating performance and overall ability to navigate the challenging environment. We are proud of the work our employees are doing to support our clients, and each other in our communities.

Our team delivered solid results during the quarter, and remains focused on moving forward key elements of our strategic plan, even as we continue to operate in a remote environment. Our technology team continues to deliver outstanding work, delivering projects on time and on budget. During the quarter, we launched the latest upgrade of Salesforce, which will make our advisors more productive, improve our client onboarding experience, and serve as a key component of our technology platform. Our project portfolio remains robust, especially those aimed at enhancing our overall client experience.

Near-term priorities include online account opening, as well as a critical upgrade of our digital platform for Wealth advisors and Wealth clients, which is scheduled for delivery in early 2021. The completion of this platform will represent a key catalyst for our recruiting efforts, which are essential for our growth strategy. It will also match the recent upgrades we already completed for our digital banking platform.

We're encouraged by improving trends within Wealth Management and Trust. We continue to add talented advisors during the quarter, with especially notable progress building our team in Northern California. Our team delivered strong business, with new client attrition at its lowest level since 2017. The segment's outflow for the quarter were primarily driven by client assets going from our fixed income products into our bank deposit products. The assets stay within the firm, but this does affect our segment reporting. We believe this reflects the strength of both our value proposition for clients and business model for shareholders, as we have a broad product set to deliver client solutions within our firm.

Our funding and liquidity profile continues to strengthen, as a result of deposit growth, and we remain optimistic about our momentum and pipeline, in both our bank deposit and Wealth Management AUM outlook for the fourth quarter.

I'd also like to provide an update on Dalton Greiner or DGHM as its sometimes known. Dalton Greiner is our remaining asset management subsidiary, with approximately $700 million AUM, down from $1.1 billion last quarter. The firm is value manager, which as you know, has been a challenging space to occupy during the last decade. As a result of the challenging circumstances within the value space and with Dalton Greiner in general, we decided to make a change in senior leadership. The change provided an impetus for some institutional investors to exit. We believe this anticipated short term disruption will ultimately pay off, as we now have the opportunity to more fully integrate the efforts of Boston Private Wealth, primarily a growth and fixed income manager, with its proprietary strategies, with the complementing skillsets of DGHM value competencies. While it's tough to predict markets, we are confident that value will have its day again, and that we will eventually be rewarded for making this change now. Beyond the strategic benefits, we also see operating efficiencies with the two teams working more closely together.

Finally, as we look ahead to the final weeks of 2020, we are confident in our company's capital and liquidity position, our loan loss reserve levels, and in our overall ability to stay focused on executing our strategic plan. As we have mentioned before, times like these are a great opportunity for us to distinguish our firm and further strengthen client relationships. We will ensure the long-term success of our company, by continuing to earn the trust of our clients each day, and by staying true to our value proposition.

I will now hand it over to Steve, to discuss the details of our third quarter results.

Steve Gaven -- Chief Financial Officer

Thank you, Anthony, and good morning everyone. My comments will begin on slide 3, where we show a summary of our consolidated financial highlights from the third quarter. This quarter, we reported GAAP net income of $22.7 million or $0.28 per share. Our operating results exclude the after-tax impact of a $900,000 gain related to a previous affiliate divestiture. Now excluding the impact of this item, we had operating net income of $22 million or $0.27 per share. A significant driver of improved financial results in this quarter, was the lower loan loss provision, which changed from a $25.4 million provision expense during the second quarter of 2020 to a $2.8 million provision credit during the third quarter. The net $2.8 million credit is comprised of a $4.6 million provision credit, partially offset by a $1.8 million expense related to unfunded loan commitments, which is recognized in non-interest expense. The provision release was primarily driven by an improved economic forecast related to the CECL methodology, and a release on residential loans associated with improving deferral trends.

Average deposits increased 6% linked quarter and 16% year-over-year. Total average loans were flat linked quarter, while average loans, excluding those related to the Paycheck Protection Program, declined 2% linked quarter. Total AUM as of September 30, 2020 was $16.3 billion, a 1% increase linked quarter, while total net flows for the third quarter were negative $407 million, primarily driven by $395 million of outflows at Dalton Greiner.

Moving on to slide 4, we show a consolidated income statement; pre-tax pre-provision income decreased 1% linked quarter to $19.9 million.

Slide 5 shows consolidated revenue trends. Total revenue decreased 1% linked quarter, primarily driven by lower net interest income. Total core fees and income increased 2% linked quarter, primarily driven by higher Wealth Management and Trust fees. Third quarter 2020 miscellaneous income, includes $900,000 of income related to the gain on an affiliate divestiture, which has been excluded from operating results.

On slide 6, we show a detailed breakout for non-interest expense. Total non-interest expense for the third quarter of 2020 was $60.9 million, which includes $1.8 million of provision expense related to unfunded loan commitments. Excluding the impact of the provision expense, third quarter total non-interest expense was $59.2 million, a 1% increase linked quarter and a 7% increase year-over-year. The linked quarter increase was primarily driven by compensation expense, related to new hires, while the year-over-year increase was primarily driven by technology investments.

Slide 7 shows the past five quarters of average loan and average deposit balances by type. Average total loans were flat linked quarter, excluding PPP loans, average total loans declined 1% linked quarter and year-over-year. Within the commercial and industrial loan category, commercial tax exempt loans, a category which includes loans to non-profits and schools grew 3% linked quarter, while revolving line of credit usage declined to 28% from a recent peak of 35% in March. The linked-quarter decline in residential loans, was primarily driven by a $72 million loan sale executed during the quarter.

Total average deposits in the third quarter increased 6% linked quarter and 16% year-over-year, primarily driven by a combination of existing new client balances, and increase in wealth sweep deposits. An additional factor driving growth in interest bearing deposits, was the flow of client assets that were in fixed income products in the Wealth Management and Trust segment, into bank deposit products. We are pleased with the trend of increasing on balance sheet liquidity, which you can see, as the average loan-to-deposit ratio has declined to 95% in the third quarter of 2020, compared to 106% during the third quarter of 2019.

Slide 8 shows a five quarter trend of consolidated net interest income and net interest margin. Net interest income decreased 2% linked quarter, primarily driven by lower loan volumes, lower interest earning asset yields and prepayment penalties received during the second quarter, partially offset by lower funding costs. Net interest margin decreased 14 basis points linked quarter to 2.61%. Net interest margin was pressured by lower loan yields, which declined 19 basis points, while benefiting from lower funding costs, which declined by 13 basis points, including an 8 basis point decrease in deposit costs. Excess cash balances, as a result of strong deposit growth, negatively impacted net interest margin by 8 basis points.

Starting on slide 9, we move into our discussion on credit. Before we move into this quarter's results, we would like to remind you of the material changes in our loan composition, that have incurred since the global financial crisis. Today, our largest asset class includes residential loans. This portfolio demonstrated low loss rates through the crisis, and the residential housing markets we operate in, continues to perform at a high level during the pandemic. At the same time, our current portfolio has lower concentration for the types of loans that were problem areas during the prior crisis, including Southern California construction and land, and Northern California commercial real estate, which was adversely impacted by the presence of special-purpose properties in the portfolio. Also, the company's tangible common equity as a percent of tangible assets has increased from 5.1% in 2007 to 8.3% as of the end of the third quarter.

Slide 10 shows the current state of our adversely graded and nonperforming loans. Since the onset of COVID-19, our team has been focused on identifying potential pockets of risk early, rating those pockets of risk accordingly, and then manage those credits proactively in order to minimize loss. The increase in our criticized and classified loans year-to-date primarily reflects the downgrade of performing commercial real estate loans to the special mention category. These loans comprised 57% of our total criticized and classified loans. We always anticipate with special mention loans, that some percentage will emerge and be upgraded and some percentage will be challenged and downgraded to classified. In this environment, the impact and duration of COVID-19 is obviously the key factor, determining future loan performance.

Overall, non-accrual loans increased linked quarter from 35 basis points of total loans to 57 basis points. The increase was primarily driven by the downgrade of a single relationship in Northern California. This relationship has a combined LTV, that is below 40%. We expect to cure this relationship in the coming quarters. Net charge-offs also remain very low at $200,000 for the quarter, or 1 basis point of total loans on annualized basis.

Slide 11 shows a roll forward of the changes to criticized and classified loans from June 30 to September 30. This quarter's increase reflects the downgrade of approximately $71 million of loans, partially offset by loan pay-offs and pay-downs of approximately $24 million and loan upgrades of $30 million. Downgrades were primarily related to commercial real estate loans secured by hospitality properties, which continue to be challenged by the lack of business and consumer travel, as a result of the pandemic.

On slide 12, we provide additional details on our total exposure to commercial real estate loans, secured by retail and hospitality properties. These loans represent approximately 70% of our total criticized and classified loans. We continue to exercise enhanced monitoring of this portfolio by focusing on three key attributes; pre-COVID LTV, property-level cash flow and sponsor strength. Weakness in one or more of these attributes generally prompts a downgrade. Also as a reminder, our risk rating decisions do not factor in deferral requests or our participation in our debt service reserve program.

In retail, we are seeing improvements in property-level cash flow trends, with rent collections increasing from the high 70s range in June to approximately 80% in September. This is a notable improvement, as 80% collection rates generally suggest that properties generate sufficient rent collections to cover debt service costs, irrespective of whether or not they are participating in the debt reserve program. In hospitality, we have been observing occupancy rates in the low 40s range, which continues to pressure revenue per available room for the properties we have financed. 62% of our total hospitality loans are currently rated as criticized or classified.

On slide 13, we provide an update on our deferral requests. We have seen a material decline in deferrals in both commercial and industrial loans, and residential mortgages since last quarter and we expect continued improvement, as we enter the fourth quarter. As of September 30th, 4.7% of commercial and industrial loans were on deferral, while 3.6% of residential loans were on deferral.

On slide 14, we review the allowance for loan loss and provision for credit losses. This quarter's provision credit was primarily driven by an improved economic forecast, related to the current expected credit loss methodology, and resulted in lower reserves on residential mortgages in construction and land loans. Reserve levels on commercial real loans remain flat at 1.78%. Total reserves as a percentage of our loan portfolio, excluding PPP loans, was 1.23% at the end of the third quarter, down from 1.28% in the previous quarter. Near term provision trends will be determined primarily by loan growth and the level of charge-offs the company experiences.

On slide 15, we show the Private Banking segment, excluding the Wealth Management and Trust portion of our bank. The private bank efficiency ratio increased to 71%, driven by lower net interest income.

I will now turn it over to Paul Simons, to discuss our Wealth Management and Trust segment.

Paul M. Simons -- President of Private Banking, Wealth and Trust

Thank you, Steve and good morning. Slide 16 shows performance highlights for the Wealth Management and Trust segment. Segment EBITDA margin for the quarter was 20% compared to 21% in the prior quarter. As Anthony mentioned, the headline results of negative net flows of $12 million, was primarily driven by flows of client assets from a handful of short-term fixed income mandates in our Wealth Management business, into deposit products at the bank. Outside of existing client flows, the segment generated new business of $299 million in the third quarter, up from $251 million in the prior quarter, while our actual client attrition for the third quarter was the lowest since 2017.

That concludes our prepared comments on our third quarter 2020 reported results. And operator, we'll now open the line for your questions.

Questions and Answers:

Operator

Thank you. We will now begin the question-and-answer session. [Operator Instructions]. The first question today comes from Michael Young of Truist Securities. Please go ahead.

Michael Young -- Truist Securities -- Analyst

Hey, thanks for taking the question. Wanted to start maybe just on spread income. Maybe if you could just provide any kind of the puts and takes we should be thinking about moving forward, with the excess cash balances. Your ability to deploy those, either through growth or securities, and just kind of how we should be thinking about that on a go-forward basis?

Steve Gaven -- Chief Financial Officer

Sure Michael. This is Steve, I'll take that question. So for the fourth quarter, I would expect NII in the $56 million to $57 million range. This doesn't exclude any acceleration of PPP fees. We might get some, but we expect that to really come about, as we get to the first half of next year. From a NIM perspective, depending on where excess liquidity ends of the quarter, NIM anywhere from kind of the high 250s to the low 260s, again depending on where excess cash balances are. In terms of redeploying liquidity, there is a couple of things that we're going to look to do in the coming quarter. So starting with loans, ex PPP, we ended the quarter with $6.85 billion of loans. We're targeting a year-end finish of $7 billion. Most of that growth will come from the residential portfolio, our specialty lending portfolio which includes, as you know the schools and non-profits, and also lower risk segments in multifamily. We don't anticipate growing CRE at this time, and we don't anticipate growing the other segments of C&I at this time.

We will also look to rebuild the securities portfolio. We've been running that down in the past, really three or four years to fund loan growth, so we want to take this opportunity to increase our asset base liquidity. So we'll grow that anywhere from $50 million to $100 million over the coming quarters.

And then finally on the liability side, we have some FHLB borrowings that we will let run off through the end of the year, and then we'll probably look to prepay some FHLB borrowings in the fourth quarter, to better set up NII for next year.

Michael Young -- Truist Securities -- Analyst

Okay, thanks. That's helpful. And I guess maybe for Anthony, just wanted to kind of get an update on hiring and hiring trends, maybe where we -- in this quarter, if there have been any hires or what kind of the outlook is? I know it has been difficult in this work from home environment, etc. But just wanted to get an update on kind of your thoughts and plans there, and if there is any update to kind of the longer-term targets, as a result of that?

Anthony DeChellis -- Chief Executive Officer

Well, as you said, I mean clearly the current environment is not ideal. Having said that, we have managed to add some really high quality people during the last two or three quarters. We expect that to continue. I think we're speaking to as many people as we have throughout the year. So the opportunities remain strong. We are looking forward to being on the other side, obviously, when we can meet folks in person. But I do believe you'll continue to see us hiring people throughout the fourth quarter and in coming quarters.

Michael Young -- Truist Securities -- Analyst

Okay. And I guess in the past, you guys have done a good job of kind of culling expenses to try to fund some of the hiring and investment. Is that still the right way to think about, kind of the expense trajectory going forward? Or is there any incremental upside pressure on expenses, that we should be thinking of?

Anthony DeChellis -- Chief Executive Officer

I mean, we have always -- go ahead Steve.

Steve Gaven -- Chief Financial Officer

Go ahead Anthony. Michael...

Anthony DeChellis -- Chief Executive Officer

Obviously running an efficient shop is something we're always conscious of. Part of the technology efforts obviously are aimed at that. COVID of course brings new considerations, when it comes to efficiencies. But as far as funding our growth, we've always got an eye toward expenses, on how to do that. But at the moment, we feel no limitation in being able to invest, both in technology and people.

Steve Gaven -- Chief Financial Officer

And Michael, just to add, some of the areas we're looking at obviously, given the environment, expense initiatives are front of mind. Next month, we are merging one of our branches. We will continue to look at those opportunities. Now currently we don't have a big retail branch network, so it doesn't represent a huge opportunity for us, but it's something that we'll continue to chip away at. Obviously, as we kind of evolve in this new COVID environment, the way we're thinking about just kind of employee travel, P&E, all that stuff, that can add up to big numbers and in more normal times, I think there will be efficiencies harvested there. I think you're already starting to see some of that.

And then finally, you will see some expense pressure in that Information systems line. We've got two projects that will be going online in the first quarter of next year, so you'll start to see those amortized costs run through the P&L. But like Anthony said, we'll look to other areas to try to offset some of that expense build.

Michael Young -- Truist Securities -- Analyst

Okay, thanks.

Operator

The next question comes from Chris McGratty of KBW. Please go ahead.

Christopher McGratty -- KBW -- Analyst

Great. Good morning.

Anthony DeChellis -- Chief Executive Officer

Good morning Chris.

Christopher McGratty -- KBW -- Analyst

Steve and Anthony, appreciate the color on the flows. How should we be thinking about the trajectory of your non-interest income, given that, I know it's a small line item. But just given where you are in some of your initiatives, how should we be thinking just about the bigger Wealth line, the pace of growth in the next few quarters, given the hiring efforts in the market?

Anthony DeChellis -- Chief Executive Officer

Coming from a Wealth -- go ahead Steve.

Steve Gaven -- Chief Financial Officer

In the coming quarter, Chris, I would expect kind of total fee income in the $22 million to $23 million range. And what you should see there, is continued improvement in Wealth Management and Trust, and you'll have some -- a little bit more leakage from the Dalton Greiner outflows you saw this quarter. Anthony, why don't you talk about the longer-term trajectory?

Anthony DeChellis -- Chief Executive Officer

Obviously, the last couple of quarters, Chris, in the Wealth business have been driven by market performance. Longer term, if we can continue to put up solid growth quarters eventually, you should see a material impact in revenue lines, and the net profit lines from the Wealth business. We are continuing to invest in people and in technology. One of the opportunities I think COVID is bringing, which will take a little while to materialize, is the difference of how people are engaging with financial services firms. And so that's part of the initiative, besides making our teams more efficient and delivering better client services also would open some new doors for opportunity. So there should be a revenue impact from both -- the traditional way we have brought in business, but we hope that the future also holds new avenues for us to grow that line.

Christopher McGratty -- KBW -- Analyst

Great, thanks for that. One other exciting topic, taxes. A lot has been written about, potentially going higher, with the change in administration. I guess two questions Steve, one, can you help us just on the near-term sustainable tax rates? And two, anything different in the way you've been managing taxes that would -- we can use the same math, when taxes went down, proportional math, when taxes went down a couple of years ago.

Steve Gaven -- Chief Financial Officer

Yeah so Chris, on fourth quarter tax rate, 10% is what I would use in your model. We're not actually doing anything different from a tax management perspective. So obviously, if we see the corporate tax rate go to 28%, which is where I think the Biden plan has it going to. Our 21% to 22% tax rate that we've experienced the last couple of years, will go up by a couple of points, when that gets passed. There's obviously elements of that tax plan that will affect other things that we need to get more color on, but it's probably -- I think right now, we're looking at about 300 to 400 basis points higher.

Christopher McGratty -- KBW -- Analyst

Okay. So 300 to 400 for the 7 points. Got it. And then the 10% in the fourth quarter you referenced, that seems a little a little low. Does that normalize into next year, can you just let us know where that would normalize, on a full year basis?

Steve Gaven -- Chief Financial Officer

Yeah. The way we think about the tax rate, just given the environment we're in. Last year again, we were at the 21% to 22% range most of the year. Obviously with the provision build in the first quarter, pre-tax income is down considerably, so probably for the full year, using rough numbers, down maybe about half. And that's why you saw the tax rate basically go from 22% to a full year rate, which will be 11%. So as pre-tax income continues to go higher in the coming quarters, you should see the tax rate follow.

Christopher McGratty -- KBW -- Analyst

Okay, got it. Thank you.

Operator

Your next question comes from Christopher Marinac of Janney Montgomery Scott. Please go ahead.

Christopher Marinac -- Janney Montgomery Scott -- Analyst

Hey thanks. Good morning.

Anthony DeChellis -- Chief Executive Officer

Good morning.

Christopher Marinac -- Janney Montgomery Scott -- Analyst

Can you give us any commentary about the visibility of criticized assets? I mean, would you expect them to kind of circle higher, or do you have any thoughts about them reversing in the near term?

Steve Gaven -- Chief Financial Officer

Yeah, Chris, this is Steve. I'll start and then I'll ask Jim Brown to comment as well. But to your first question, no, we don't see criticized and classifieds going meaningfully higher from this level. Like we said on the last call. We are pretty proactive in risk rating the portfolio early on, and we established what we think is a pretty good baseline of criticized and classified loans right now. So you'll see movement in and out, like you typically would and you saw some of that this quarter, you saw some downgrades. You also saw upgrades in pay-offs. We kind of expect that to be the way that pool of loans will kind of behave in the coming quarters, as we work through the COVID environment. But Jim, anything else you would add on criticized and classifieds, per Chris' question?

Jim Brown -- President Commercial Banking

Yeah, sure. Thanks Steve and thanks for the question, Chris. I would characterize it the way Steve did. I wouldn't expect to see meaningful movement upward going forward. The real driver in Q3 was hospitality, and I think at this point, we've captured the universe of the COVID-related impact in hospitality.

Christopher Marinac -- Janney Montgomery Scott -- Analyst

Thanks for that. Is it possible that the loss content really doesn't change and that these just linger with you for a while. So to your point, they don't necessarily go up, but your loss expectations are kind of already embedded in the reserve?

Steve Gaven -- Chief Financial Officer

Yeah, I think that's fair, Chris. I mean we took the first half of the year like we said, to really go through the portfolio in detail, reserve appropriately. We think that's reflected in where the allowance is today. So from an allowance perspective, we don't see that going meaningfully higher. As it relates to provision expense in the coming quarters, I think you'll probably see it go back to kind of loan growth, and then levels charge-off. Obviously, we have to contend with the forecast and what that means. We will be running it through our models. But all else being equal, I would think that loan growth and charge-offs will influence provision in the coming quarters.

Christopher Marinac -- Janney Montgomery Scott -- Analyst

Okay, great. And then just a follow-up to your explanation on the taxes a minute ago. The fact that the tax adjustment would only be 3% or 4% due to any new investments that you're making, or is it already the tax position that you have in place? I didn't know if you're changing things, if the Biden [Speech Overlap].

Steve Gaven -- Chief Financial Officer

No, so -- again it's based on the -- our tax strategy is in place and has been in place.

Christopher Marinac -- Janney Montgomery Scott -- Analyst

Got it. Just wanted to clarify. Thank you all very much.

Anthony DeChellis -- Chief Executive Officer

Thank you.

Operator

This concludes our question-and-answer session. I would like to turn the conference back over to Anthony DeChellis for any closing remarks.

Anthony DeChellis -- Chief Executive Officer

Great. Thank you for attending the call today. We appreciate your interest. 2020 is obviously a year we will all remember, and I imagine we would all agree that it's not done delivering remarkable occurrences. Personally, I expect that Q4 will be as eventful as any quarter so far this year. Whatever the next quarter brings, I want to wish you and your families all the best, as we continue to navigate these challenging times. Again, thank you all for attending today. Until next time, stay safe.

Operator

[Operator Closing Remarks].

Duration: 31 minutes

Call participants:

Adam Bromley -- Senior Vice President, Director, Corporate Finance/Investor Relations

Anthony DeChellis -- Chief Executive Officer

Steve Gaven -- Chief Financial Officer

Paul M. Simons -- President of Private Banking, Wealth and Trust

Jim Brown -- President Commercial Banking

Michael Young -- Truist Securities -- Analyst

Christopher McGratty -- KBW -- Analyst

Christopher Marinac -- Janney Montgomery Scott -- Analyst

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