Tuesday, March 1, 2016

44th AIM Student Equity Update. Boston Private Financial (BPFH): "Have we reached the bottom yet?"

Boston Private Financial Holdings (Ticker: BPFH): Inflection Point or Blood in the Water?
By: Ryan Johnston, student at Marquette University

Image result for boston private financial holdings logo

Disclosure: The AIM Equity Fund currently holds this position. This article was written by myself, and it expresses my own opinions. I am not receiving compensation for it and I have no business relationship with any company whose stock is mentioned in this article.

Brief Firm Overview: Boston Private is a wealth management and private banking company that operates affiliates in New England, New York, Los Angeles and the San Francisco Bay Area. The firm positions its affiliates to serve the high net worth marketplace with high quality products and services of unique appeal to private clients. Boston Private generates income from three separate revenue streams including Private Banking (60%); Wealth Advisory, including Wealth Management & Trust Services (25%); and Investment Management (15%).


• The hedge funds cometh. Like sharks, hedge funds smell blood and are seeing an opportunity to collect a premium on the firm, which may be acquired. Over the past six months more than 5% of shares outstanding have been gobbled up by hedge funds; leading the way is Millennium owning almost 5% of shares outstanding.

• BPFH has been struggling with stagnating revenues and compressing margins. As of 4Q 2015 net interest margin (NIM) stood at 2.9%, which has significantly sank over the past five years from 3.3%. Return on assets is 0.94%, which is well below the industry average of roughly 1.2%.

• With the Fed’s indecisiveness, banks are generally being punished because of the possibility of a prolonged period of ultra low interest rates. For Boston Private, this is a one-two punch both punishing their yields on loans and by ensuing volatility in the markets stressing the firm’s wealth management efforts.

Boston Private Financial. (NASDAQ: BPFH) The AIM fund originally initiated coverage on Boston Private during early October 2014. At that time we were encouraged by the firm’s growth potential with an acquisition, which would help grow the firm’s wealth management capabilities. Also, there were several macro tailwinds like strong capital markets and a more hawkish Fed. Now everything seems to have reversed with volatile capital markets and a concerned Fed. This has caused the firm to suffer from decreasing AUM, which has slid by $2.2 billion to $27.6 billion. Over the past eight quarters the firm has only recorded one period of positive inflows.

Even with the decline in AUM, Boston Private’s non-interest revenues have been able to grow at a 5 year CAGR of nearly 10%. The firm has also seen modest loan growth at about 8% YoY. While this is encouraging, over the past three years expenses have grown by nearly 6%, causing the firm’s pretax margin to settle at 24%.  Expenses are being driven by new hiring trends after a handful of portfolio managers left the firm in 2014 after the Banyan deal.
Lastly, if there is not already enough cause for concern, Boston Private’s loan loss provision has been declining at a concerning rate and was a negative $1.7 million as of the fourth quarter. This is best illustrated with the firm’s allowance for loan losses to total loans, which was 2.1% in 2011 but is now 1.4%. This demonstrates an unsustainable trend and going forward the provision will have to increase.

What has the stock done lately?
Since the Domestic AIM fund initiated coverage, the stock has closed as high as $14 on December 29, 2014. This was during the acquisition of Banyan Partners and the market was viewing the deal as a positive growth driver. Since then, Boston Private has established a trading range of roughly $9 - $11, which is down 16% since the fund added the stock in mid-October.

Past Year Performance: Year-to-date the stock is down 12% and is down 20% over the last 12 months. After reconstructing a DDM and P/E multiple, the firm is trading at a 10% discount. Assumptions behind this lower value are compressing margins, a higher loan loss provision, more volatile capital markets, and a lower yielding environment. The main revenue growth drivers will be above average investment performance and the growth the firm’s advisory unit. I believe these updated assumptions are totally within reason and should be fully baked into the stock price in the next one to two years.

Source: FactSet

So why are we still holding Boston Private? Our sector team believes there may be a unique opportunity to harvest a premium on an acquisition. Boston Private’s management team has made it clear they are not shopping around to be bought out, but they are not against it either. The banking M&A market is starting to heat up with banks that have their costs under control looking to grow their operations. 

BPFH is a great target since it is currently trading at 1.2x book value. We will be diligently following the firm to watch for any further deterioration in the firm’s fundamentals and if this occurs we will sell. We believe this has a conservative 10% upside, which is built around the premises of subpar fundamentals and the potential to be acquired.

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