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BPFH > SEC Filings for BPFH > Form 10-K on 12-Mar-2013All Recent SEC Filings

Show all filings for BOSTON PRIVATE FINANCIAL HOLDINGS INC | Request a Trial to NEW EDGAR Online Pro

Form 10-K for BOSTON PRIVATE FINANCIAL HOLDINGS INC


12-Mar-2013

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Management's discussion and analysis of financial condition and results of operations should be read in conjunction with the Consolidated Financial Statements, the notes thereto, and other statistical information included in this annual report.

Executive Summary
The Company offers a wide range of wealth management services to high net worth individuals, families, businesses and select institutions through its three reportable segments: Private Banking, Investment Management, and Wealth Advisory. This Executive Summary provides an overview of the most significant aspects of our operating segments and the Company's operations in 2012. Details of the matters addressed in this summary are provided elsewhere in this document and, in particular, in the sections immediately following.
Net income attributable to the Company was $53.3 million for the year ended December 31, 2012, compared to net income of $39.1 million in 2011 and a net loss of $11.0 million in 2010. The Company recognized diluted earnings per share of $0.61 for the year ended December 31, 2012, compared to diluted earnings per share of $0.46 in 2011 and diluted loss per share of $0.29 in 2010. Key items that affected the Company's 2012 results include:
? The Company recorded a credit to the provision for loan losses of $3.3 million for the year ended December 31, 2012, compared to a provision for loan losses of $13.2 million in 2011. The 2012 credit to the provision for loan losses was primarily due to:

Reductions in criticized loans;

Lower net charge-offs;

                  The transfer of $276.7 million of loans from the Pacific
                   Northwest market to loans held for sale at the loans' carrying
                   amounts as a result of the announced plans for the Bank to
                   sell its three offices in this market area. As a result of
                   this transfer, a credit of $4.7 million was recorded to the
                   allowance for loan losses; and


                  The transfer from the loan portfolio to loans held for sale at
                   the loans' carrying amounts, and the subsequent sale, of
                   approximately $108.7 million of residential loans.


                  The above credits to the provision for loan losses were
                   partially offset by loan growth during 2012.


?            The low interest rate environment continues to affect net interest
             income. Net interest margin ("NIM") decreased 3 basis points to
             3.22% in 2012 from 3.25% in 2011, after decreasing 5 basis points
             from 3.30% in 2010. While NIM has declined, net interest income for
             the year ended December 31, 2012 was $183.3 million, an increase of
             $4.3 million, or 2%, compared to 2011. The 2012 increase is due to
             lower average rates paid on the Company's deposits and borrowings,
             prepayment penalties, and the increase in volume of the loan
             portfolio. These factors were partially offset by lower average
             yields on loans.


?            Recurring fees and income, which includes investment management and
             trust fees, wealth advisory fees, other banking fee income, and gain
             on sale of loans, net, for the year ended December 31, 2012 was
             $109.4 million, an increase of $2.5 million, or 2%, from 2011. The
             2012 increase is due primarily to increases in wealth advisory fees
             and gains on sale of loans.


?            The Company recorded total operating expenses of $231.9 million for
             the year ended December 31, 2012, compared to total operating
             expenses of $233.9 million in 2011. The 2012 expenses include
             restructuring charges of $5.9 million primarily related to severance
             costs for changes made in 2012 to the Company's management structure
             at the Bank and Holding Company. In addition, $2.1 million in
             prepayment penalties were incurred in 2012 related to the prepayment
             of FHLB borrowings and repurchase agreements. The purpose of these
             transactions was to actively manage the Company's cost of funds as
             the declining yields on interest earning assets continue to compress
             NIM.


?            Assets under management and advisory ("AUM") increased 13% during
             2012 due to $0.6 billion of net flows and $1.7 billion of market
             appreciation. Increases in AUM were experienced in all three
             segments.


Table of Contents

The Company continued to actively manage its balance sheet in 2012 in order to maintain capital, reduce credit and operating risk, and increase profitability. The Company continues to pursue expense reduction opportunities enabled by the improved credit quality profile and the Bank consolidation. The Company's focus is to continue to actively manage its balance sheet while managing for increased growth across all markets and businesses.

Private Banking
The following table presents a summary of profits/ (losses), revenues and
expenses for the Private Banking segment continuing operations for 2012, 2011,
and 2010.

                          As of and for the year ended December 31,              2012 vs. 2011                2011 vs. 2010
                          2012                 2011             2010         $ Change      % Change      $ Change       % Change
                                                                    (In thousands)
Net interest income $      189,260       $      186,006     $   190,104     $   3,254           2  %   $   (4,098 )        (2 )%
Fees and other
income:
Investment
management and
trust fees                  23,645               23,553          23,257            92           -  %          296           1  %
Other income                10,119               15,185          12,827        (5,066 )       (33 )%        2,358          18  %
Total fees and
other income                33,764               38,738          36,084        (4,974 )       (13 )%        2,654           7  %
Total revenues             223,024              224,744         226,188        (1,720 )        (1 )%       (1,444 )        (1 )%
Provision/ (credit)
for loan losses             (3,300 )             13,160          87,178       (16,460 )      (125 )%      (74,018 )       (85 )%
Operating expenses         145,197              146,322         149,996        (1,125 )        (1 )%       (3,674 )        (2 )%
Restructuring
expense                      4,014                5,446               -        (1,432 )       (26 )%        5,446          nm
Income/ (loss)
before income taxes         77,113               59,816         (10,986 )      17,297          29  %       70,802          nm
Income tax expense/
(benefit)                   25,901               19,697         (10,219 )       6,204          31  %       29,916          nm
Net income/ (loss)
attributable to the
Company             $       51,212       $       40,119     $      (767 )   $  11,093          28  %   $   40,886          nm
Total loans (1)     $    4,813,614       $    4,648,759     $ 4,478,427     $ 164,855           4  %   $  170,332           4  %
Assets              $    6,269,390       $    5,843,089     $ 5,948,100     $ 426,301           7  %   $ (105,011 )        (2 )%
Deposits (2)        $    4,955,472       $    4,639,169     $ 4,598,911     $ 316,303           7  %   $   40,258           1  %
AUM                 $    3,941,000       $    3,571,000     $ 3,592,000     $ 370,000          10  %   $  (21,000 )        (1 )%


____________
nm - not meaningful


(1) Loans presented in this table are loans from the Private Banking segment and do not include loans of non-banking affiliates or the Holding Company. Loans presented in this table also do not include loans held for sale.

(2) Deposits presented in this table do not include intercompany eliminations related to deposits in the Bank from non-banking affiliates or the Holding Company. Deposits presented in this table also do not include deposits held for sale.

The Company's Private Banking segment reported net income attributable to the Company of $51.2 million in the year ended December 31, 2012, compared to net income attributable to the Company of $40.1 million in 2011 and a net loss attributable to the Company of $0.8 million in 2010. The credit to the provision for loan losses in 2012 and the decrease in the provision for loan losses from 2010 to 2011 are the primary drivers of the increases in net income in 2012 and 2011. The positive effects of the changes in provision/ (credit) for loan losses were partially offset by decreased other income in 2012 and increased restructuring expense in 2011.
During 2012, the Bank implemented a senior executive restructuring of Bank leadership in order to create a more streamlined organization and to refine the Bank's cost base. To implement the new structure the Bank incurred severance charges of $2.9 million in the year ended December 31, 2012.
AUM increased $0.4 billion, or 10%, to $3.9 billion at December 31, 2012 from $3.6 billion at December 31, 2011, due to both positive net flows and investment performance.
Total loans at the Bank increased $164.9 million, or 4%, to $4.8 billion, or 77% of total assets at the Bank, at December 31, 2012 from $4.6 billion, or 80% of total assets at the Bank, at December 31, 2011. When normalized for loans in the Pacific Northwest region, which were classified as held for sale at December 31, 2012, total loans at the Bank increased 9% in 2012 from $4.4 billion at December 31, 2011. A discussion of the Company's loan portfolio can be found below in

Part II.


Table of Contents

Item 7. "Management's Discussion and Analysis of Financial Condition and Results
of Operations - Loan Portfolio and Credit Quality." Deposits at the Bank increased $316.3 million, or 7%, to $5.0 billion in 2012 from $4.6 billion in 2011 and 2010. A discussion of the Company's deposits can be found below in Part II. Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations - Financial Condition."

Investment Management
The following table presents a summary of profits/ (losses), revenues and
expenses for the Investment Management segment continuing operations for 2012,
2011, and 2010.

                        As of and for the year ended December 31,             2012 vs. 2011                 2011 vs. 2010
                          2012              2011            2010         $ Change       % Change       $ Change       % Change
                                                                   (In thousands)
Investment
management and
trust fees          $        39,163     $    39,803     $    36,942     $    (640 )        (2 )%     $    2,861           8  %
Other income and
net interest income              69              73             178            (4 )        (5 )%           (105 )       (59 )%
Total revenues               39,232          39,876          37,120          (644 )        (2 )%          2,756           7  %
Operating expenses           31,359          31,181          29,720           178           1  %          1,461           5  %
Income/ (loss)
before income taxes           7,873           8,695           7,400          (822 )        (9 )%          1,295          18  %
Income tax expense/
(benefit)                     2,688           2,803           2,682          (115 )        (4 )%            121           5  %
Noncontrolling
interests                     1,599           1,727           1,383          (128 )        (7 )%            344          25  %
Net income/ (loss)
attributable to the
Company             $         3,586     $     4,165     $     3,335     $    (579 )       (14 )%     $      830          25  %
AUM                 $     8,444,000     $ 7,594,000     $ 8,140,000     $ 850,000          11  %     $ (546,000 )        (7 )%

The Company's Investment Management segment reported net income attributable to the Company of $3.6 million in the year ended December 31, 2012, compared to net income attributable to the Company of $4.2 million in 2011 and $3.3 million in 2010. The $0.6 million, or 14%, decrease in 2012 was primarily due to a decrease in investment management and trust fees and an increase in operating expenses. The decrease in investment management and trust fees while AUM increased was related to timing of the changes in AUM in 2011 and 2012 compared to the timing of client billings.
AUM increased $0.9 billion, or 11%, to $8.4 billion at December 31, 2012 from $7.6 billion at December 31, 2011. In 2012, the increase in AUM was primarily the result of market appreciation of $0.9 billion, partially offset by net outflows.

Wealth Advisory
The following table presents a summary of profits/ (losses), revenues and expenses for the Wealth Advisory segment continuing operations for 2012, 2011, and 2010.


Table of Contents

                        As of and for the year ended December 31,              2012 vs. 2011                 2011 vs. 2010
                          2012              2011            2010          $ Change        % Change       $ Change      % Change
                                                                   (In thousands)
Wealth advisory
fees                $        37,659     $    34,553     $    31,733     $     3,106           9  %     $    2,820           9 %
Other income and
net interest income              14              27              23             (13 )       (48 )%              4          17 %
Total revenues               37,673          34,580          31,756           3,093           9  %          2,824           9 %
Operating expenses           28,001          25,193          23,872           2,808          11  %          1,321           6 %
Income/ (loss)
before income taxes           9,672           9,387           7,884             285           3  %          1,503          19 %
Income tax expense/
(benefit)                     3,561           3,439           2,942             122           4  %            497          17 %
Noncontrolling
interests                     1,523           1,421           1,203             102           7  %            218          18 %
Net income/ (loss)
attributable to the
Company             $         4,588     $     4,527     $     3,739     $        61           1  %     $      788          21 %
AUM                 $     8,052,000     $ 6,994,000     $ 6,844,000     $ 1,058,000          15  %     $  150,000           2 %

The Company's Wealth Advisory segment reported net income attributable to the Company of $4.6 million in the year ended December 31, 2012, compared to net income attributable to the Company of $4.5 million in 2011 and $3.7 million in 2010. The $0.1 million, or 1%, increase in 2012 was due to increased wealth advisory fee revenue offset by increased salaries and employee benefits expense and increased professional services expense.
AUM increased $1.1 billion, or 15%, to $8.1 billion at December 31, 2012 from $7.0 billion at December 31, 2011, after increasing $150.0 million, or 2%, from $6.8 billion at December 31, 2010. AUM changes for the Wealth Advisors in 2012 were primarily the result of market appreciation of $0.6 billion and net inflows of $0.5 billion.
The Wealth Advisory segment adds fee income to the Company's revenue base that is more resistant to fluctuations in market conditions in comparison to the Investment Management segment since financial planning fees are typically less correlated to the equity markets.

Critical Accounting Policies
Critical accounting policies are reflective of significant judgments and uncertainties, and could potentially result in materially different results under different assumptions and conditions. The Company believes that its most critical accounting policies upon which its financial condition depends, and which involve the most complex or subjective decisions or assessments are as follows:
Allowance for Loan and Lease Losses
The allowance for loan losses ("allowance") is an estimate of the inherent risk of loss in the loan portfolio as of the consolidated balance sheet dates. Management estimates the level of the allowance based on all relevant information available. The allowance is established through the provision for loan losses, which is a direct charge to earnings. Loan losses are charged to the allowance when management believes that the collectability of the loan principal is unlikely. Recoveries on loans previously charged-off are credited to the allowance when received in cash.
The Company's allowance is accounted for in accordance with guidance issued by various regulatory agencies, including: the Federal Financial Institutions Examination Council Policy Statement on the Allowance for Loan and Lease Losses (December 2006); SEC Staff Accounting Bulletin No. 102, Selected Loan Loss Methodology and Documentation Issues; the Financial Accounting Standards Board (the "FASB") Accounting Standards Codification ("ASC") 310, Receivables ("ASC 310"); and ASC 450, Contingencies.
The allowance consists of three primary components: general reserves on acceptable or pass graded loans, allocated reserves on non-impaired special mention and substandard loans, and the allocated reserves on impaired loans. The allowance involves a high degree of management judgment and estimates, and results in an adequate allowance which is reflective of the inherent risk of loss in the loan portfolio at the measurement date.
General reserves are calculated for each loan pool consisting of acceptable or pass graded loans segregated by portfolio segment, by applying estimated net loss percentages based upon the Bank's actual historical net charge-offs and, adjusted as appropriate, on a consistent manner based upon consideration of qualitative factors to arrive at a total loss factor for each portfolio segment. The rationale for qualitative adjustments is to more accurately reflect the current inherent risk of loss in


Table of Contents

the respective portfolio segments than would be determined through the sole consideration of the Bank's actual historical net charge-off rates. The numerical factors assigned to each qualitative factor are based upon observable data, if applicable, as well as management's analysis and judgment. The qualitative factors considered by the Company include:
Volume and severity of past due, nonaccrual, and adversely graded loans,

Volume and terms of loans,

Concentrations of credit,

          Management's experience, as well as loan underwriting and loan review
           policy and procedures,


          Economic and business conditions impacting the Bank's loan portfolio,
           as well as consideration of collateral values, and


          External factors, including consideration of loss factor trends,
           competition, and legal and regulatory requirements.

The Bank makes an independent determination of the applicable loss rate for these factors based on relevant local market conditions, credit quality, and portfolio mix. Each quarter, the Bank reviews the loss factors to determine if there have been any changes in its loan portfolio, market conditions, or other risk indicators which would result in a change to the current loss factor. Allocated reserves on non-impaired special mention and substandard loans reflect management's assessment of increased risk of losses associated with these types of graded loans. An allocated reserve is assigned to these pools of loans based upon management's consideration of the credit attributes of individual loans within each pool of loans, including consideration of loan to value ratios, past due status, strength and willingness of the guarantors, and other relevant attributes, including the qualitative factors considered for the general reserve as discussed above. These considerations are determined separately for each type of portfolio segment. The allocated reserves are a multiple of the general reserve for each respective portfolio segments, with a greater multiple for loans with increased risk (i.e., special mention loans versus substandard loans).
A loan (usually a commercial type loan) is considered impaired in accordance with ASC 310 when, based upon current information and events, it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. Impairment is measured based on the fair value of the loan, expected future cash flows discounted at the loan's effective interest rate, or as a practical expedient, impairment may be determined based upon the observable market price of the loan, or the fair value of the collateral, less estimated costs to sell, if the loan is "collateral dependent." For collateral dependent loans, appraisals are generally used to determine the fair value. Generally real estate appraisals are updated every 12 to 18 months or sooner, if deemed necessary during periods of declining values, if a loan continues to be impaired. Appraised values are generally discounted for factors such as the Bank's intention to liquidate the property quickly in a foreclosure sale or the date when the appraisal was performed if the Bank believes that collateral values have declined since the date the appraisal was done. The Bank may use a broker opinion of value in addition to an appraisal to validate the appraised value. In certain instances, the Bank may use broker opinions of value while an appraisal is being prepared due to the time constraint generally in obtaining new appraisals.
If the loan is deemed to be collateral dependent, generally the difference between the book balance (client balance less any prior charge-offs or client interest payments applied to principal) and the fair value of the collateral is taken as a partial charge-off through the allowance for loan losses in the current period. If the loan is not determined to be collateral dependent, then a specific allocation is established for the difference between the book balance of the loan and the expected future cash flows discounted at the loan's effective interest rate. Charge-offs for loans not considered to be collateral dependent are made when it is determined a loss has been incurred. Impaired loans are removed from the general loan pools. There may be instances where the loan is considered impaired although based on the fair value of underlying collateral or the discounted expected future cash flows there is no impairment to be recognized. In addition, all loans which are classified as troubled debt restructurings ("TDRs") are considered impaired.
In addition to the three primary components of the allowance for loan losses discussed above (general reserve, allocated reserves on non-impaired special mention and substandard loans, and the allocated reserves on impaired loans), generally the Bank also maintains an insignificant amount of additional allowance for loan losses (the unallocated allowance for loan losses) which primarily relates to a general imprecision assessment of the potential variability of applicable qualitative factors subject to a higher degree of variability. The respective qualitative factors, as discussed above, are considered for each respective portfolio segment. Only the assessment of the potential variability of applicable qualitative factors is included in the unallocated allowance for loan losses. The unallocated allowance for loan losses is not considered significant by the Company.


Table of Contents

While this evaluation process utilizes historical and other objective information, the classification of loans and the establishment of the allowance for loan losses rely to a great extent on the judgment and experience of management. While management evaluates currently available information in establishing the allowance for loan losses, future adjustments to the allowance may be necessary if economic conditions differ substantially from the assumptions used in making the evaluations. In addition, various regulatory agencies, as an integral part of their examination process, periodically review a financial institution's allowance for loan losses as well as loan grades/classifications. Such agencies may require the financial institution to recognize additions to the allowance or increases to adversely graded classified loans based on their judgments about information available to them at the time of their examination.
Valuation of Goodwill/Intangible Assets and Analysis for Impairment The Company allocates the cost of an acquired entity to the assets acquired and liabilities assumed based on their estimated fair values at the date of acquisition. Other intangible assets identified in acquisitions generally consist of advisory contracts, core deposit intangibles, and non-compete agreements. The value attributed to advisory contracts is based on the time period over which they are expected to generate economic benefits. The advisory contracts are generally amortized over 8-15 years depending on the contract. Core deposit intangibles are valued based on the expected longevity of the core deposit accounts and the expected cost savings associated with the use of the existing core deposit base rather than alternative funding sources. The core deposit intangibles are generally amortized, on an accelerated basis, over a period of 10-12 years. The Company currently has no core deposit intangibles. Non-compete agreements are valued based on the expected receipt of future economic benefits protected by clauses in the non-compete agreements that restrict competitive behavior. Non-compete agreements are amortized over the life of the agreement, generally seven years.
Other intangible assets with definite lives are tested for impairment at the reporting unit level at least annually in the fourth quarter or more frequently when events or circumstances occur that indicate that it is more likely than not that an impairment has occurred. The Company tests other intangible assets with definite lives for impairment by comparing the carrying amount to the sum of the net undiscounted cash flows expected to be generated by the asset whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. If the carrying amount of the asset exceeds its net undiscounted cash flows, then an impairment loss is recognized for the amount by which the carrying amount exceeds its fair value, determined based upon the discounted value of the expected cash flows generated by the asset. The intangible impairment test is performed at the reporting unit level, and each affiliate is considered a reporting unit for goodwill and intangible impairment testing purposes, if applicable. Intangible assets with an indefinite useful economic life are not amortized, but are subject to impairment testing at the reporting unit on an annual basis, or when events or changes in circumstances indicate that the carrying amounts are impaired.
The excess of the purchase price for acquisitions over the fair value of the net assets acquired, including other intangible assets, is recorded as goodwill. Goodwill is not amortized but is tested for impairment at the reporting unit level, defined as the affiliate level, at least annually in the fourth quarter or more frequently when events or circumstances occur that indicate that it is . . .

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