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BPFH > SEC Filings for BPFH > Form 10-K on 28-Feb-2014All Recent SEC Filings

Show all filings for BOSTON PRIVATE FINANCIAL HOLDINGS INC

Form 10-K for BOSTON PRIVATE FINANCIAL HOLDINGS INC


28-Feb-2014

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 2013. 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 $70.5 million for the year ended December 31, 2013, compared to net income of $53.3 million in 2012 and $39.1 million in 2011. The Company recognized diluted earnings per share of $0.68 for the year ended December 31, 2013, compared to diluted earnings per share of $0.61 in 2012 and $0.46 in 2011.
Key items that affected the Company's 2013 results include:
? Recurring fees and income, which includes investment management fees, wealth advisory fees, private banking wealth management and trust fees, other banking fee income, and gain on sale of loans, net, for the year ended December 31, 2013 was $122.7 million, an increase of $13.3 million, or 12%, from 2012. The 2013 increase was due to increased fee-based revenue, primarily related to the increase in AUM.

?            The Company issued Series D preferred stock for net proceeds of
             $47.8 million, and at the same time repurchased all of its Series B
             preferred stock for $69.8 million. The repurchase of the Series B
             preferred stock resulted in a deemed dividend, which reduced net
             income available to common shareholders by $11.7 million and diluted
             EPS by $0.15 per share.


?            The Company completed the sale of the Bank's Pacific Northwest
             offices and recorded a $10.6 million pretax gain on the sale.


?            The Company recorded a credit to the provision for loan losses of
             $10.0 million for the year ended December 31, 2013, compared to a
             credit to the provision for loan losses of $3.3 million in 2012. The
             2013 credit to the provision for loan losses was primarily due to
             reductions in criticized loans; net recoveries in 2013, compared to
             net charge offs in 2012; partially offset by loan growth during
             2013.


?            The Company recorded total operating expenses of $221.4 million for
             the year ended December 31, 2013, compared to total operating
             expenses of $232.5 million in 2012. The 2012 expenses included
             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. The Company also had reduced
             expenses related to salaries and employee benefits, professional
             services, and occupancy and equipment.


?            The low interest rate environment continued to affect net interest
             income. Net interest margin ("NIM") decreased 17 basis points to
             3.05% in 2013 from 3.22% in 2012, after decreasing 3 basis points
             from 3.25% in 2011. Net interest income for the year ended December
             31, 2013 was $174.0 million, a decrease of $9.3 million, or 5%,
             compared to 2012. The 2013 decrease was due to lower average yields
             on loans and investments, partially offset by lower average rates
             paid on the Company's deposits and borrowings and the increase in
             volume of the loan portfolio.


?            Assets under management and advisory ("AUM") increased 19% during
             2013 due to $3.7 billion of market appreciation and $0.2 billion of
             net flows. Increases in AUM were experienced in all three segments.


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Private Banking
The following table presents a summary of selected financial data for the
Private Banking segment continuing operations for 2013, 2012, and 2011.
                          As of and for the year ended December 31,              2013 vs. 2012               2012 vs. 2011
                          2013                 2012             2011         $ Change      % Change     $ Change       % Change
                                                                   (In thousands)
Net interest income $      178,199       $      189,260     $   186,006     $ (11,061 )        (6 )%   $   3,254           2  %
Fees and other
income:
Private banking
wealth management
and trust fees              26,550               23,645          23,553         2,905          12  %          92           -  %
Gain on sale of
Pacific Northwest
offices                     10,574                    -               -        10,574          nm              -          nm
Other income                11,877               10,723          15,655         1,154          11  %      (4,932 )       (32 )%
Total fees and
other income                49,001               34,368          39,208        14,633          43  %      (4,840 )       (12 )%
Total revenues             227,200              223,628         225,214         3,572           2  %      (1,586 )        (1 )%
Provision/ (credit)
for loan losses            (10,000 )             (3,300 )        13,160        (6,700 )        nm        (16,460 )        nm
Operating expenses         139,876              145,801         146,792        (5,925 )        (4 )%        (991 )        (1 )%
Restructuring
expense                          -                4,014           5,446        (4,014 )      (100 )%      (1,432 )       (26 )%
Income before
income taxes                97,324               77,113          59,816        20,211          26  %      17,297          29  %
Income tax expense          32,696               25,901          19,697         6,795          26  %       6,204          31  %
Net income
attributable to the
Company             $       64,628       $       51,212     $    40,119     $  13,416          26  %   $  11,093          28  %
Total loans (1)     $    5,112,320       $    4,813,614     $ 4,648,759     $ 298,706           6  %   $ 164,855           4  %
Assets              $    6,251,087       $    6,269,390     $ 5,843,089     $ (18,303 )         -  %   $ 426,301           7  %
Deposits (2)        $    5,153,707       $    4,955,472     $ 4,639,169     $ 198,235           4  %   $ 316,303           7  %
AUM                 $    4,565,000       $    3,941,000     $ 3,571,000     $ 624,000          16  %   $ 370,000          10  %


____________
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 $64.6 million in the year ended December 31, 2013, compared to net income attributable to the Company of $51.2 million in 2012 and $40.1 million in 2011. The 2013 increase in net income was due to the increased credit to the provision for loan losses, decreased operating expenses, the 2012 restructuring charge, and the gain on sale of the Pacific Northwest offices. These were partially offset by the decrease in net interest income. The 2012 increase was due to the credit to the provision for loan losses in 2012 and the decrease in operating and restructuring expenses, partially offset by decreased noninterest income.
In May 2013, the Company sold the Bank's three offices in the Pacific Northwest region. This sale resulted in a gain on sale of $10.6 million. 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 $0.6 billion, or 16%, to $4.6 billion at December 31, 2013 from $3.9 billion at December 31, 2012, due to both investment performance and positive net flows.
Total loans at the Bank increased $298.7 million, or 6%, to $5.1 billion, or 82% of total assets at the Bank, at December 31, 2013 from $4.8 billion, or 77% of total assets at the Bank, at December 31, 2012. A discussion of the Company's loan portfolio can be found below in Part II. Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations - Loan Portfolio and Credit Quality."


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Deposits at the Bank increased $198.2 million, or 4%, to $5.2 billion in 2013 from $5.0 billion in 2012. 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 selected financial data for the
Investment Management segment continuing operations for 2013, 2012, and 2011.
                        As of and for the year ended December 31,               2013 vs. 2012                2012 vs. 2011
                           2013              2012            2011          $ Change       % Change      $ Change       % Change
                                                                   (In thousands)
Investment
management fees     $         43,816     $    39,163     $    39,803     $     4,653          12 %     $    (640 )        (2 )%
Other income and
net interest income               79              69              73              10          14 %            (4 )        (5 )%
Total revenues                43,895          39,232          39,876           4,663          12 %          (644 )        (2 )%
Operating expenses            33,195          31,359          31,181           1,836           6 %           178           1  %
Income before
income taxes                  10,700           7,873           8,695           2,827          36 %          (822 )        (9 )%
Income tax expense             3,493           2,688           2,803             805          30 %          (115 )        (4 )%
Noncontrolling
interests                      2,164           1,599           1,727             565          35 %          (128 )        (7 )%
Net income
attributable to the
Company             $          5,043     $     3,586     $     4,165     $     1,457          41 %     $    (579 )       (14 )%
AUM                 $     10,401,000     $ 8,444,000     $ 7,594,000     $ 1,957,000          23 %     $ 850,000          11  %

The Company's Investment Management segment reported net income attributable to the Company of $5.0 million in the year ended December 31, 2013, compared to net income attributable to the Company of $3.6 million in 2012 and $4.2 million in 2011. The $1.5 million, or 41%, increase in 2013 was primarily due to an increase in investment management fees, partially offset by an increase in operating expenses. The increase in investment management fees was due to additional performance fees related to the increase in AUM.
AUM increased $2.0 billion, or 23%, to $10.4 billion at December 31, 2013 from $8.4 billion at December 31, 2012. In 2013, the increase in AUM was primarily the result of market appreciation of $2.2 billion, partially offset by net outflows of $0.3 billion.

Wealth Advisory
The following table presents a summary of selected financial data for the Wealth
Advisory segment continuing operations for 2013, 2012, and 2011.
                        As of and for the year ended December 31,              2013 vs. 2012                 2012 vs. 2011
                          2013              2012            2011          $ Change       % Change       $ Change        % Change
                                                                    (In thousands)
Wealth advisory
fees                $        42,352     $    37,659     $    34,553     $     4,693          12 %     $     3,106           9  %
Other income and
net interest income              64              14              27              50          nm               (13 )       (48 )%
Total revenues               42,416          37,673          34,580           4,743          13 %           3,093           9  %
Operating expenses           29,588          28,001          25,193           1,587           6 %           2,808          11  %
Income before
income taxes                 12,828           9,672           9,387           3,156          33 %             285           3  %
Income tax expense            4,807           3,561           3,439           1,246          35 %             122           4  %
Noncontrolling
interests                     1,784           1,523           1,421             261          17 %             102           7  %
Net income
attributable to the
Company             $         6,237     $     4,588     $     4,527     $     1,649          36 %     $        61           1  %
AUM                 $     9,336,000     $ 8,052,000     $ 6,994,000     $ 1,284,000          16 %     $ 1,058,000          15  %

The Company's Wealth Advisory segment reported net income attributable to the Company of $6.2 million in the year ended December 31, 2013, compared to net income attributable to the Company of $4.6 million in 2012 and $4.5 million


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in 2011. The $1.6 million, or 36%, increase in 2013 was due to increased wealth advisory fee revenue offset by increased salaries and employee benefits expense and increased professional services expense.
AUM increased $1.3 billion, or 16%, to $9.3 billion at December 31, 2013 from $8.1 billion at December 31, 2012. In 2013, the increase in AUM was primarily the result of market appreciation of $1.0 billion and net inflows of $0.3 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. Changes to the required level in the allowance result in either a provision for loan loss expense, if an increase is required, or a credit to the provision, if a decrease is required. 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 pass graded loans, allocated reserves on non-impaired special mention and substandard loans, and the allocated reserves on impaired loans. The calculation of the allowance involves a high degree of management judgment and estimates designed to reflect the the inherent risk of loss in the loan portfolio at the measurement date.
General reserves are calculated for each loan pool consisting of 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 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, management reviews the loss factors to determine if there


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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 adversely 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.
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 to the general reserve 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), 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.
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 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


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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. The Company's non-compete agreements became fully amortized during 2013.
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 more likely than not that an impairment has occurred. Goodwill is tested for impairment using a two-step process that begins with an estimation of the fair value of a reporting unit. Goodwill impairment exists when a reporting unit's carrying value of goodwill exceeds its implied fair value. Significant judgment is applied when goodwill is assessed for impairment. This judgment includes developing cash flow projections, selecting appropriate discount rates, identifying relevant market comparables, incorporating general economic and market conditions, and selecting an appropriate control premium. The selection and weighting of the various fair value techniques may result in a higher or lower fair value. Judgment is applied in determining the weightings that are most representative of fair value.
The first step ("Step 1") of impairment testing requires a comparison of each reporting unit's fair value to its carrying value to identify potential . . .

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