ITEM 1. BUSINESS
I.General
Boston Private Financial Holdings, Inc. (the “Company,” “BPFH,” “we,” “us,” or “our”) was incorporated on September 2, 1987, under the laws of The Commonwealth of Massachusetts. On July 1, 1988, the Company registered with the Board of Governors of the Federal Reserve System (the “Federal Reserve”) as a bank holding company under the Bank Holding Company Act of 1956, as amended (the “BHCA”), and became the parent holding company (the “Holding Company”) of Boston Private Bank & Trust Company (the “Bank” or “Boston Private Bank”), a trust company chartered by The Commonwealth of Massachusetts and insured by the Federal Deposit Insurance Corporation (the “FDIC”).
We are a wealth management company that offers a full range of wealth management services to high net worth individuals, families, businesses, and select institutions through a financial umbrella that helps to preserve, grow, and transfer assets over the financial lifetime of a client through our four functional segments: Private Banking, Wealth Management and Trust, Investment Management, and Wealth Advisory. Each reportable segment reflects the services provided by the Company to a distinct segment of the wealth management market as described below.
Private Banking
The Private Banking segment has one affiliate, Boston Private Bank, a trust company chartered by The Commonwealth of Massachusetts and insured by the FDIC. The Private Banking segment primarily operates in three geographic markets: New England, San Francisco Bay, and Southern California. In December 2012, the Bank entered into a definitive agreement to sell its three offices in the Pacific Northwest market. This transaction closed in May 2013.
The Bank currently conducts business under the name of Boston Private Bank & Trust Company in all of its markets. The Bank is principally engaged in providing private banking services to high net worth individuals, privately owned businesses, private partnerships, and nonprofit organizations. In addition, the Bank is an active provider of financing for affordable housing, first-time homebuyers, economic development, social services, community revitalization and small businesses.
Wealth Management and Trust
The Wealth Management and Trust segment is comprised of Boston Private Bank's existing wealth management and trust business as well as the business activities of Boston Private Wealth, LLC (“Boston Private Wealth”), an independent registered investment adviser (“RIA”) which is a wholly owned subsidiary of the Bank. Boston Private Wealth was formed with the acquisition of Banyan Partners, LLC (“Banyan”), in the fourth quarter of 2014. The segment provides comprehensive wealth management solutions for high net worth individuals and families, including customized investment solutions, wealth planning, trust, and family office services. The Wealth Management and Trust segment operates in New England; South Florida; Texas; California; Atlanta, Georgia; and Madison, Wisconsin. For comparative purposes, the Wealth Management and Trust data that was previously included within the Private Banking segment has been reclassified into the Wealth Management and Trust segment.
Investment Management
The Investment Management segment has two affiliates: Dalton, Greiner, Hartman, Maher & Co., LLC (“DGHM”), and Anchor Capital Advisors LLC (“Anchor”), both of which are registered investment advisers (together, DGHM and Anchor are referred to as the “Investment Managers”). The Investment Managers serve the needs of pension funds, endowments, trusts, foundations and select institutions, mutual funds and high net worth individuals and their families throughout the United States (“U.S.”) and abroad. The Investment Managers specialize in value-driven equity portfolios with products across the capitalization spectrum. The specific mix of products, services and clientele varies between affiliates. The Investment Managers are located in New England and New York, with one affiliate administrative office in South Florida.
Wealth Advisory
The Wealth Advisory segment has two affiliates: KLS Professional Advisors Group, LLC (“KLS”), and Bingham, Osborn & Scarborough, LLC (“BOS”), both of which are wealth management firms and registered investment advisers (together, the “Wealth Advisors”). The Wealth Advisors provide comprehensive, planning-based financial strategies to high net
worth individuals and their families, and non-profit institutions. The services the firms offer include fee-only financial planning, tax planning, tax preparation, estate and insurance planning, retirement planning, charitable planning and intergenerational gifting and succession planning. The Wealth Advisors manage investments covering a wide range of asset classes for both taxable and tax-exempt portfolios. The Wealth Advisors are located in New York, Southern California, and Northern California.
Collectively, the Wealth Management and Trust, Investment Management, and Wealth Advisory segments are referred to as the “Wealth and Investment” businesses.
For revenue, net income, assets, and other financial information for each of the Company’s reportable segments, see Part II. Item 8. “Financial Statements and Supplementary Data - Note 20: Reportable Segments.”
The Company’s Internet address is www.bostonprivate.com. The Company makes available on or through its Internet website, without charge, its annual reports on Form 10-K, quarterly reports on Form 10-Q, and current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after such reports are electronically filed with, or furnished to, the Securities and Exchange Commission (the “SEC”). The Company’s reports filed with, or furnished to, the SEC are also available at the SEC’s website at www.sec.gov. The quarterly earnings release conference call can also be accessed from the Company’s website. Press releases are also maintained on the Company’s website for one year. Information on our website is not incorporated by reference into this document and should not be considered part of this Report.
II.Acquisitions, Asset Sales, and Divestitures
In October 2014, Boston Private Bank acquired Banyan. Effective January 1, 2015, Banyan and the wealth management and trust operations from Boston Private Bank were combined to form Boston Private Wealth, which now operates as its own reportable segment of the Company. Boston Private Wealth is a wholly-owned subsidiary of Boston Private Bank.
In December 2012, the Bank entered into a definitive agreement to sell its three offices in the Pacific Northwest market. This transaction closed in May 2013.
In the second quarter of 2012, the Company sold its majority-owned affiliate, Davidson Trust Company (“DTC”). Prior to the Company’s sale of DTC, it was included in the Wealth Advisory segment.
In 2011, the Company’s wholly-owned banking subsidiaries, Borel Private Bank & Trust (“Borel”), First Private Bank & Trust (“FPB”) and Charter Private Bank (“Charter”), merged into Boston Private Bank.
At December 31, 2010, the Company held approximately 45% of the equity interest in Coldstream Holdings, Inc. (“Coldstream”). In January 2011, the Company sold all of BPFH’s stock holdings in Coldstream back to management of the firm. The Company’s investment in Coldstream, prior to the sale, was accounted for using the equity method, and was included in other assets in the consolidated balance sheets.
In 2009, the Company divested its interest in Westfield Capital Management Company, LP, formerly known as Westfield Capital Management Company, LLC (“Westfield”). Westfield was previously included in the Investment Management segment. While the Company will continue to have no significant involvement or influence on Westfield, it retains a 12.5% share in Westfield’s revenues (up to an annual maximum of $11.6 million) through December 2017 subject to certain conditions. The Company defers gains related to these payments until determinable. Such revenue share payments are included in net income from discontinued operations in the consolidated statements of operations for the period in which the revenue is recognized.
For further details relating to the Company’s divestitures, see Part II. Item 8. “Financial Statements and Supplementary Data - Note 3: Acquisitions, Asset Sales, and Divestitures.”
III. Competition
The Company operates in the highly competitive wealth management marketplace. The Bank encounters competition from larger national and regional commercial banking organizations, savings banks, credit unions, and other financial institutions and non-bank financial service companies, which may offer lower interest rates on loans and higher interest rates on deposits. The Bank’s competitors also include major financial companies whose greater resources may afford them a marketplace advantage by enabling them to maintain numerous banking locations and mount extensive promotional and advertising campaigns. The financial services industry is also likely to become more competitive as further technological advances enable more companies to provide financial services, including through the Internet. These technological advances may diminish the importance of depository institutions and other financial intermediaries, among other industry sectors, in the transfer of funds among parties. To compete effectively, the Bank relies on local promotional activity, personal contacts by officers, directors, and employees, customized service, and the Bank’s reputation within the communities that it serves.
The Company’s principal competitors with respect to investment management services are primarily commercial banks and trust companies, mutual fund companies, investment advisory firms, stock brokerage firms, other financial companies and law firms. The Company believes that its ability to compete effectively with other investment management firms is dependent upon its products, level of investment performance and client service, as well as the marketing and distribution of the investment products.
In the wealth advisory industry, the Company competes with a wide variety of firms, including national and regional financial services firms, accounting firms, trust companies, and law firms. The Company believes that the ability of its wealth advisory affiliates to compete effectively with other firms is dependent upon the quality and level of service, personal relationships, and investment performance.
IV. Employees
At December 31, 2014, the Company had 875 employees. The Company’s employees are not subject to a collective bargaining agreement, and the Company believes its employee relations are good.
V. Supervision and Regulation
The following discussion addresses elements of the regulatory framework applicable to bank holding companies and their subsidiaries. This regulatory framework is intended primarily to protect the safety and soundness of depository institutions, the federal deposit insurance system, and depositors, rather than the shareholders of a bank holding company such as the Company.
As a bank holding company, the Company is subject to regulation, supervision and examination by the Federal Reserve under the BHCA. The Bank is subject to extensive regulation, supervision and examination by the Massachusetts Commissioner of Banks (the “Commissioner”) and the FDIC. The Bank’s California branches are also subject to regulation, supervision and examination by the California Division of Financial Institutions (the “DFI”).
Boston Private Bank's wealth management and trust subsidiary and the Company’s investment management and wealth advisory subsidiaries are subject to extensive regulation by the SEC, the Financial Industry Regulatory Authority and state securities regulators.
The following is a summary of certain aspects of various statutes and regulations applicable to the Company and its subsidiaries. This summary is not a comprehensive analysis of all applicable laws, and is qualified by reference to the applicable statutes and regulations.
Regulation of the Company
The Company is subject to regulation, supervision and examination by the Federal Reserve, which has the authority, among other things, to order bank holding companies to cease and desist from unsafe or unsound banking practices; to assess civil money penalties; and to order termination of non-banking activities or termination of ownership and control of a non-banking subsidiary by a bank holding company.
Source of Strength. Under the BHCA, as amended by the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), the Company is required to serve as a source of financial strength for the Bank. This support may be required at times when the Company may not have the resources to provide support to the Bank. In the event of a bank holding company’s bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a bank subsidiary will be assumed by the bankruptcy trustee and entitled to a priority of payment.
Acquisitions and Activities. The BHCA prohibits a bank holding company, without prior approval of the Federal Reserve, from acquiring all or substantially all the assets of a bank, acquiring control of a bank merging or consolidating with another bank holding company, or acquiring direct or indirect ownership or control of any voting shares of another bank or bank holding company if, after such acquisition, the acquiring bank holding company would control more than 5% of the voting shares of such other bank or bank holding company.
The BHCA also prohibits a bank holding company from engaging directly or indirectly in activities other than those of banking, managing or controlling banks or furnishing services to its subsidiary banks. However, a bank holding company may engage in and may own shares of companies engaged in certain activities that the Federal Reserve determines to be closely related to banking or managing and controlling banks.
Limitations on Acquisitions of Company Common Stock. The Change in Bank Control Act prohibits a person or group of persons from acquiring “control” of a bank holding company unless the Federal Reserve has been notified and has not objected to the transaction. Under a rebuttable presumption established by the Federal Reserve, the acquisition of 10% or more of a class of voting securities of a bank holding company with a class of securities registered under Section 12 of the Exchange Act would constitute the acquisition of control of a bank holding company.
In addition, the BHCA prohibits any company from acquiring control of a bank or bank holding company without first having obtained the approval of the Federal Reserve. Among other circumstances, under the BHCA a company has control of a bank or bank holding company if the company owns, controls or holds with power to vote 25% or more of a class of voting securities of the bank or bank holding company, controls in any manner the election of a majority of directors or trustees of the bank or bank holding company, or the Federal Reserve has determined, after notice and opportunity for hearing, that the company has the power to exercise a controlling influence over the management or policies of the bank or bank holding company.
Regulation of the Bank
The Bank is subject to the supervision and regulation of the Commissioner and the FDIC, and with respect to its California branches, the DFI. The Federal Reserve may also directly examine the subsidiaries of the Company, including the Bank. The enforcement powers available to federal and state banking regulators include, among other things, the ability to issue cease and desist or removal orders, to terminate insurance of deposits, to assess civil money penalties, to issue directives to increase capital, to place the bank into receivership, and to initiate injunctive actions against banking organizations and institution-affiliated parties.
Deposit Insurance. Substantially all of the deposits of the Bank are insured up to applicable limits by the FDIC’s Deposit Insurance Fund (“DIF”) and are subject to deposit insurance assessments to maintain the DIF. The Dodd-Frank Act permanently increased the FDIC deposit insurance limit to $250,000 per depositor for deposits maintained in the same right and capacity at a particular insured depository institution. The Federal Deposit Insurance Act (the “FDIA”), as amended by the Federal Deposit Insurance Reform Act and the Dodd-Frank Act, requires the FDIC to take steps as may be necessary to cause the ratio of deposit insurance reserves to estimated insured deposits - the designated reserve ratio - to reach 1.35% by September 30, 2020, and it mandates that the reserve ratio designated by the FDIC for any year may not be less than 1.35%. The FDIC utilizes a risk-based assessment system that imposes insurance premiums based upon a risk matrix that takes into account a bank’s capital level and supervisory rating. Assessment rates may also vary for certain institutions based on long-term debt issuer ratings, secured or brokered deposits. Deposit premiums are based on assets. To determine its deposit insurance premium, the Bank computes the base amount of its average consolidated assets less its average tangible equity (defined as the amount of Tier I capital) and the applicable assessment rate. The FDIC has the power to adjust deposit insurance assessment rates at any time. In addition, under the FDIA, the FDIC may terminate deposit insurance upon a finding that the institution has engaged in unsafe and unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC. For 2014, the FDIC insurance expense for the Bank was $3.5 million.
Acquisitions and Branching. Prior approval from the Commissioner and the FDIC is required in order for the Bank to acquire another bank or establish a new branch office. Well capitalized and well managed banks may acquire other banks in any state, subject to certain deposit concentration limits and other conditions, pursuant to the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994, as amended by the Dodd-Frank Act. In addition, the Dodd-Frank Act authorizes a state-chartered bank, such as the Bank, to establish new branches on an interstate basis to the same extent a bank chartered by the host state may establish branches.
Activities and Investments of Insured State-Chartered Banks. Section 24 of the FDIA generally limits the types of equity investment an FDIC-insured state-chartered bank, such as the Bank, may make and the kinds of activities in which such a bank may engage, as a principal, to those that are permissible for national banks. Further, the Gramm-Leach-Bliley Act of
1999 (the “GLBA”) permits national banks and state banks, to the extent permitted under state law, to engage - via financial subsidiaries - in certain activities that are permissible for subsidiaries of a financial holding company. In order to form a financial subsidiary, a state-chartered bank must be well capitalized, and such banks would be subject to certain capital deduction, risk management and affiliate transaction rules, among other things.
Lending Restrictions. Federal law limits a bank’s authority to extend credit to its directors, executive officers and 10% shareholders, as well as to entities controlled by such persons. Among other things, extensions of credit to insiders are required to be made on terms that are substantially the same as, and follow credit underwriting procedures that are not less stringent than, those prevailing for comparable transactions with unaffiliated persons. The terms of such extensions of credit may not involve more than the normal risk of repayment or present other unfavorable features and may not exceed certain limitations on the amount of credit extended to such persons, individually and in the aggregate, which limits are based, in part, on the amount of the bank’s capital. The Dodd-Frank Act explicitly provides that an extension of credit to an insider includes credit exposure arising from a derivatives transaction, repurchase agreement, reverse repurchase agreement, securities lending transaction or securities borrowing transaction. Additionally, the Dodd-Frank Act requires that asset sale transactions with insiders must be on market terms, and if the transaction represents more than 10% of the capital and surplus of the Bank, approved by a majority of the disinterested directors of the Bank.
Brokered Deposits. Section 29 of the FDIA and FDIC regulations generally limit the ability of an insured depository institution to accept, renew or roll over any brokered deposit unless the institution’s capital category is “well capitalized” or, with the FDIC’s approval, “adequately capitalized.” Depository institutions, other than those in the lowest risk category, that have brokered deposits in excess of 10% of total deposits will be subject to increased FDIC deposit insurance premium assessments.
Community Reinvestment Act. The Community Reinvestment Act (“CRA”) requires the FDIC to evaluate the Bank’s performance in helping to meet the credit needs of the entire communities it serves, including low and moderate-income neighborhoods, consistent with its safe and sound banking operations, and to take this record into consideration when evaluating certain applications. The FDIC’s CRA regulations are generally based upon objective criteria of the performance of institutions under three key assessment tests: (i) a lending test, to evaluate the institution’s record of making loans in its service areas; (ii) an investment test, to evaluate the institution’s record of investing in community development projects, affordable housing, and programs benefiting low or moderate income individuals and businesses; and (iii) a service test, to evaluate the institution’s delivery of services through its branches, ATMs, and other offices. The Bank's last evaluation from the FDIC was an “outstanding” rating. The FDIC is currently reviewing the Bank’s recent performance and the Bank anticipates the FDIC to issue their current report and rating in the second quarter of 2015. Massachusetts has also enacted a similar statute that requires the Commissioner to evaluate the performance of the Bank in helping to meet the credit needs of its entire community and to take that record into account in considering certain applications.
Capital Adequacy and Safety and Soundness
Regulatory Capital Requirements. The Federal Reserve and the FDIC have issued substantially similar risk-based and leverage capital rules applicable to U.S. banking organizations such as the Company and the Bank. These guidelines are intended to reflect the relationship between the banking organization’s capital and the degree of risk associated with its operations based on transactions recorded on-balance sheet as well as off-balance sheet. The Federal Reserve and the FDIC may from time to time require that a banking organization maintain capital above the minimum levels discussed below, due to the banking organization’s financial condition or actual or anticipated growth.
The capital adequacy guidelines define qualifying capital instruments and specify minimum amounts of capital as a percentage of assets that banking organizations are required to maintain. Tier I capital for banks and bank holding companies generally consists of the sum of common shareholders’ equity, non-cumulative perpetual preferred stock, and related surplus, and, in certain cases and subject to limitations, minority interests in consolidated subsidiaries, less goodwill, other non-qualifying intangible assets, and certain other deductions. Tier II capital generally consists of hybrid capital instruments, perpetual debt and mandatory convertible debt securities, cumulative perpetual preferred stock, term subordinated debt and intermediate-term preferred stock, and, subject to limitations, allowances for loan losses. The sum of Tier I and Tier II capital less certain required deductions represents qualifying total risk-based capital. Prior to the effectiveness of certain provisions of the Dodd-Frank Act, bank holding companies were permitted to include trust preferred securities and cumulative perpetual preferred stock in Tier I capital, subject to limitations. However, the Federal Reserve’s capital rule applicable to bank holding companies permanently grandfathered nonqualifying capital instruments, including trust preferred securities, issued before May 19, 2010 by depository institution holding companies with less than $15 billion in total assets as of December 31, 2009, subject to a limit of 25% of Tier I capital. In addition, under rules that became effective January 1, 2015, accumulated other comprehensive income (positive or negative) must be reflected in Tier I capital; however, the Company may make a one-time, permanent election to continue to exclude accumulated other comprehensive income from capital. If the Company does not
make this election, unrealized gains and losses, net of taxes, will be included in the calculation of the Company’s regulatory capital. The Company intends to make this election.
Under the capital rules, risk-based capital ratios are calculated by dividing Tier I and total risk-based capital, respectively, by risk-weighted assets. Assets and off-balance sheet credit equivalents are assigned to one of four categories of risk-weights, based primarily on relative risk. Under rules in effect through December 31, 2014, the minimum required Tier I risk-based capital ratio was 4% and the minimum total risk-based capital ratio was 8%. As of December 31, 2014, the Company’s Tier I risk-based capital ratio was 13.28% and its total risk-based capital ratio was 14.54%.
In addition to the risk-based capital requirements, under rules in effect through December 31, 2014, the Federal Reserve required top-rated bank holding companies to maintain a minimum leverage capital ratio of Tier I capital (defined by reference to the risk-based capital guidelines) to its average total consolidated assets of at least 3.0%. For most other bank holding companies (including the Company), the minimum leverage capital ratio was 4.0%. Bank holding companies with supervisory, financial, operational or managerial weaknesses, as well as bank holding companies that were anticipating or experiencing significant growth, were expected to maintain capital ratios well above the minimum levels. The Company’s Tier I leverage ratio as of December 31, 2014 was 9.53%.
Prior to the effectiveness of the Dodd-Frank Act, the FDIC had adopted a statement of policy regarding the capital adequacy of state-chartered banks and promulgated regulations to implement the system of prompt corrective action established by Section 38 of the FDIA. Under the FDIC regulations, which were in effect through December 31, 2014, a bank was considered “well capitalized” if it had: (i) a total risk-based capital ratio of 10.0% or greater; (ii) a Tier I risk-based capital ratio of 6.0% or greater; (iii) a leverage capital ratio of 5.0% or greater; and (iv) was not subject to any written agreement, order, capital directive, or prompt corrective action directive to meet and maintain a specific capital level for any capital measure.
In 2010, the Basel Committee on Banking Supervision released new capital requirements, known as Basel III, setting forth higher capital requirements, enhanced risk coverage, a global leverage ratio, provisions for counter-cyclical capital, and liquidity standards. In 2013, the Federal Reserve, along with the other federal banking agencies, issued final rules implementing the Basel III capital standards and establishing the minimum capital requirements for banks and bank holding companies required under the Dodd-Frank Act. These rules, which became effective January 1, 2015, establish a minimum common equity Tier I capital ratio of 6.5% of risk-weighted assets for a “well capitalized” institution, and increases the minimum total Tier I capital ratio for a “well capitalized” institution from 6.0% to 8.0%. Additionally, subject to a transition schedule, these rules require an institution to establish a capital conservation buffer of Tier I capital in an amount above the minimum risk-based capital requirements for “adequately capitalized” institutions equal to 2.5% of total risk weighted assets, or face restrictions on the ability to pay dividends, pay discretionary bonuses, and to engage in share repurchases.
Under rules effective January 1, 2015, a bank holding company, such as the Company, is considered “well capitalized” if the bank holding company (i) has a total risk based capital ratio of at least 10%, (ii) has a Tier I risk-based capital ratio of at least 6%, and (iii) is not subject to any written agreement order, capital directive or prompt corrective action directive to meet and maintain a specific capital level for any capital measure. In addition, the FDIC has amended its prompt corrective action rules to reflect the revisions made by the joint final rule, or the “Final Capital Rule,” issued by the federal banking agencies implementing the Basel III capital standards and establishing the minimum capital levels required under the Dodd-Frank Act. Under the FDIC’s revised rules, which became effective January 1, 2015, an FDIC supervised institution is considered “well capitalized” if it (i) has a total risk-based capital ratio of 10.0% or greater; (ii) a Tier I risk-based capital ratio of 8.0% or greater; (iii) a common Tier I equity ratio of at least 6.5% or greater, (iv) a leverage capital ratio of 5.0% or greater; and (iv) is not subject to any written agreement, order, capital directive, or prompt corrective action directive to meet and maintain a specific capital level for any capital measure.
The Company and the Bank are currently considered “well capitalized” under all regulatory definitions.
Safety and Soundness Standards. The FDIA requires the federal bank regulatory agencies to prescribe standards, by regulations or guidelines, relating to internal controls, information systems and internal audit systems, risk management, loan documentation, credit underwriting, interest rate risk exposure, asset growth, asset quality, earnings, stock valuation and compensation, fees and benefits, and such other operational and managerial standards as the agencies deem appropriate. Guidelines adopted by the federal bank regulatory agencies establish general standards relating to internal controls and information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth and compensation, fees and benefits. In general, these guidelines require, among other things, appropriate systems and practices to identify and manage the risk and exposures specified in the guidelines. The guidelines prohibit excessive compensation as an unsafe and unsound practice and describe compensation as excessive when the amounts paid are unreasonable or disproportionate to the services performed by an executive officer, employee, director or principal stockholder. In addition, the federal banking agencies adopted regulations that authorize, but do not require, an agency to order an institution that has been
given notice by an agency that it is not satisfying any of such safety and soundness standards to submit a compliance plan. If, after being so notified, an institution fails to submit an acceptable compliance plan or fails in any material respect to implement an acceptable compliance plan, the agency must issue an order directing action to correct the deficiency and may issue an order directing other actions of the types to which an undercapitalized institution is subject under the “prompt corrective action” provisions of the FDIA. See “-Regulatory Capital Requirements” above. If an institution fails to comply with such an order, the agency may seek to enforce such order in judicial proceedings and to impose civil money penalties.
Dividend Restrictions
The Company is a legal entity separate and distinct from the Bank and our Wealth and Investment subsidiaries. The revenue of the Company (on a parent-only basis) is derived primarily from dividends paid to it by the Bank and our Wealth and Investment subsidiaries. The right of the Company, and consequently the right of shareholders of the Company, to participate in any distribution of the assets or earnings of the Bank and our Wealth and Investment subsidiaries through the payment of such dividends or otherwise is necessarily subject to the prior claims of creditors of the Bank (including depositors) and our Wealth and Investment subsidiaries, except to the extent that certain claims of the Company in a creditor capacity may be recognized.
Restrictions on Bank Holding Company Dividends. The Federal Reserve has the authority to prohibit bank holding companies from paying dividends if such payment is deemed to be an unsafe or unsound practice. The Federal Reserve has indicated generally that it may be an unsafe or unsound practice for bank holding companies to pay dividends unless the bank holding company’s net income over the preceding year is sufficient to fund the dividends and the expected rate of earnings retention is consistent with the organization’s capital needs, asset quality and overall financial condition. Further, when the Final Capital Rule comes into effect, the Company’s ability to pay dividends would be restricted if it does not maintain capital above the conservation buffer. See “-Capital Adequacy and Safety and Soundness -Regulatory Capital Requirements” above.
Restrictions on Bank Dividends. The FDIC has the authority to use its enforcement powers to prohibit a bank from paying dividends if, in its opinion, the payment of dividends would constitute an unsafe or unsound practice. Federal law also prohibits the payment of dividends by a bank that will result in the bank failing to meet its applicable capital requirements on a pro forma basis. Under Massachusetts law, the board of directors of the Bank may declare from “net profits” cash dividends no more often than quarterly, provided that there is no impairment to the trust company’s capital stock. Moreover, prior approval by the Commissioner is required if the total of all dividends declared by the Bank in any calendar year would exceed the total of its net profits for that year combined with its retained net profits for the previous two years, less any required transfer to surplus or a fund for the retirement of any preferred stock.
Certain Transactions by Bank Holding Companies with their Affiliates
There are various statutory restrictions on the extent to which bank holding companies and their non-bank subsidiaries may borrow, obtain credit from or otherwise engage in “covered transactions” with their insured depository institution subsidiaries. The Dodd-Frank Act amended the definition of affiliate to include an investment fund for which the depository institution or one of its affiliates is an investment adviser. An insured depository institution (and its subsidiaries) may not lend money to, or engage in covered transactions with, its non-depository institution affiliates if the aggregate amount of covered transactions outstanding involving the bank, plus the proposed transaction exceeds the following limits: (i) in the case of any one such affiliate, the aggregate amount of covered transactions of the insured depository institution and its subsidiaries cannot exceed 10% of the capital stock and surplus of the insured depository institution; and (ii) in the case of all affiliates, the aggregate amount of covered transactions of the insured depository institution and its subsidiaries cannot exceed 20% of the capital stock and surplus of the insured depository institution. For this purpose, “covered transactions” are defined by statute to include a loan or extension of credit to an affiliate, a purchase of or investment in securities issued by an affiliate, a purchase of assets from an affiliate unless exempted by the Federal Reserve, the acceptance of securities issued by an affiliate as collateral for a loan or extension of credit to any person or company, the issuance of a guarantee, acceptance or letter of credit on behalf of an affiliate, securities borrowing or lending transactions with an affiliate that creates a credit exposure to such affiliate, or a derivatives transaction with an affiliate that creates a credit exposure to such affiliate. Covered transactions are also subject to certain collateral security requirements. Covered transactions as well as other types of transactions between a bank and a bank holding company must be on market terms and not otherwise unduly favorable to the holding company or an affiliate of the holding company. Moreover, Section 106 of the BHCA provides that, to further competition, a bank holding company and its subsidiaries are prohibited from engaging in certain tying arrangements in connection with any extension of credit, lease or sale of property of any kind, or furnishing of any service.
Consumer Protection Regulation
The Company and the Bank are subject to federal and state laws designed to protect consumers and prohibit unfair or deceptive business practices, including the Equal Credit Opportunity Act, Fair Housing Act, Home Ownership Protection Act, Fair Credit Reporting Act, as amended by the Fair and Accurate Credit Transactions Act of 2003 (“FACT Act”), the GLBA, the Truth in Lending Act, the CRA, the Home Mortgage Disclosure Act, Real Estate Settlement Procedures Act, National Flood Insurance Act and various state law counterparts. These laws and regulations mandate certain disclosure requirements and regulate the manner in which financial institutions must interact with clients when taking deposits, making loans, collecting loans and providing other services. Further, the Dodd-Frank Act established the Consumer Financial Protection Bureau (“CFPB”), which has the responsibility for making rules and regulations under the federal consumer protection laws relating to financial products and services. The CFPB also has a broad mandate to prohibit unfair or deceptive acts and practices and is specifically empowered to require certain disclosures to consumers and draft model disclosure forms. Failure to comply with consumer protection laws and regulations can subject financial institutions to enforcement actions, fines and other penalties. The FDIC will examine the Bank for compliance with CFPB rules and will enforce CFPB rules with respect to the Bank.
Mortgage Reform. The Dodd-Frank Act prescribes certain standards that mortgage lenders must consider before making a residential mortgage loan, including verifying a borrower’s ability to repay such mortgage loan and allows borrowers to assert violations of certain provisions of the Truth in Lending Act as a defense to foreclosure proceedings. Under the Dodd-Frank Act, prepayment penalties are prohibited for certain mortgage transactions and creditors are prohibited from financing insurance policies in connection with a residential mortgage loan or home equity line of credit. In addition, the Dodd-Frank Act prohibits mortgage originators from receiving compensation based on the terms of residential mortgage loans and generally limits the ability of a mortgage originator to be compensated by others if compensation is received from a consumer. The Dodd-Frank Act requires mortgage lenders to make additional disclosures prior to the extension of credit, in each billing statement and for negative amortization loans and hybrid adjustable rate mortgages.
Privacy and Customer Information Security. The GLBA requires financial institutions to implement policies and procedures regarding the disclosure of nonpublic personal information about consumers to nonaffiliated third parties. In general, the Bank must provide its clients with an annual disclosure that explains its policies and procedures regarding the disclosure of such nonpublic personal information, and, except as otherwise required or permitted by law, the Bank is prohibited from disclosing such information except as provided in such policies and procedures. The GLBA also requires that the Bank develop, implement and maintain a comprehensive written information security program designed to ensure the security and confidentiality of client information (as defined under GLBA), to protect against anticipated threats or hazards to the security or integrity of such information and to protect against unauthorized access to or use of such information that could result in substantial harm or inconvenience to any client. The Bank is also required to send a notice to clients whose “sensitive information” has been compromised if unauthorized use of the information is “reasonably possible.” Most states, including the states where the Bank operates, have enacted legislation concerning breaches of data security and the duties of the Bank in response to a data breach. Congress continues to consider federal legislation that would require consumer notice of data security breaches. In addition, Massachusetts has promulgated data security regulations with respect to personal information of Massachusetts residents. Pursuant to the FACT Act, the Bank has developed and implemented a written identity theft prevention program to detect, prevent, and mitigate identity theft in connection with the opening of certain accounts or certain existing accounts. Additionally, the FACT Act amends the Fair Credit Reporting Act to generally prohibit a person from using information received from an affiliate to make a solicitation for marketing purposes to a consumer, unless the consumer is given notice and a reasonable opportunity and a reasonable and simple method to opt out of the making of such solicitations.
Anti-Money Laundering
The Bank Secrecy Act. Under the Bank Secrecy Act (“BSA”), a financial institution is required to have systems in place to detect certain transactions, based on the size and nature of the transaction. Financial institutions are generally required to report to the U.S. Treasury any cash transactions involving more than $10,000. In addition, financial institutions are required to file suspicious activity reports for transactions that involve more than $5,000 and which the financial institution knows, suspects or has reason to suspect involves illegal funds, is designed to evade the requirements of the BSA or has no lawful purpose. The Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the “USA PATRIOT Act”), which amended the BSA, together with the implementing regulations of various federal regulatory agencies, has caused financial institutions, such as the Bank, to adopt and implement additional policies or amend existing policies and procedures with respect to, among other things, anti-money laundering compliance, suspicious activity, currency transaction reporting, customer identity verification and customer risk analysis. In evaluating an application under Section 3 of the BHCA to acquire a bank or an application under the Bank Merger Act to merge banks or effect a purchase of assets and assumption of deposits and other liabilities, the applicable federal banking regulator must consider the anti-money laundering compliance record of both the applicant and the target. In addition, under the USA PATRIOT Act, financial institutions are required to take steps to monitor their correspondent banking and private banking relationships as well as, if applicable, their relationships with “shell banks.”
OFAC. The U.S. has imposed economic sanctions that affect transactions with designated foreign countries, nationals and others. These sanctions, which are administered by the U.S. Treasury’s Office of Foreign Assets Control (“OFAC”), take many different forms. Generally, however, they contain one or more of the following elements: (i) restrictions on trade with or investment in a sanctioned country, including prohibitions against direct or indirect imports from and exports to a sanctioned country and prohibitions on “U.S. persons” engaging in financial or other transactions relating to a sanctioned country, or with certain designated persons and entities; (ii) a blocking of assets in which the government or specially designated nationals of the sanctioned country have an interest, by prohibiting transfers of property subject to U.S. jurisdiction (including property in the possession or control of U.S. persons); and (iii) restrictions on certain transactions with or involving certain persons or entities. Blocked assets (for example, property and bank deposits) cannot be paid out, withdrawn, set off or transferred in any manner without a license from OFAC. Failure to comply with these sanctions could have serious legal and reputational consequences for the Company.
Regulation of Other Activities
Investment Management, Wealth Advisory, and Wealth Management and Trust. Certain subsidiaries of the Company are registered with the SEC as investment advisers under the Investment Advisers Act of 1940, as amended (the “Advisers Act”). The Advisers Act imposes numerous obligations on registered investment advisers, including fiduciary, recordkeeping, operational, and disclosure obligations. Certain investment management, wealth advisory, and wealth management and trust subsidiaries of the Company are also subject to regulation under the securities laws and fiduciary laws of certain states.
The Dodd-Frank Act requires the SEC to study the standard of care for brokers and investment advisers and report its findings to Congress. Further, the Dodd-Frank Act permits the SEC to impose a uniform standard of care on brokers and investment advisers based on the study’s findings. Pursuant to the Dodd-Frank Act, the SEC must also harmonize the enforcement of fiduciary standard violations under the Exchange Act and the Advisers Act. It is unclear how the studies and rulemaking relating to the fiduciary duties of brokers and investment advisers will affect the Company and its investment management and wealth advisory subsidiaries.
Each of the mutual funds for which one or more of the Company’s investment management subsidiaries acts as sub-adviser is registered with the SEC under the Investment Company Act of 1940, as amended (the “1940 Act”). Shares of each such fund are registered with the SEC under the Securities Act, and the shares of each fund are qualified for sale (or exempt from such qualification) under the laws of each state and the District of Columbia to the extent such shares are sold in any of such jurisdictions. The Company is also subject to the Employee Retirement Income Security Act of 1974 (“ERISA”), and to regulations promulgated thereunder, insofar as it is a “fiduciary” under ERISA with respect to certain of its clients. ERISA and the applicable provisions of the Internal Revenue Code of 1986, as amended (the “Code”), impose certain duties on persons who are fiduciaries under ERISA and prohibit certain transactions by the fiduciaries (and certain other related parties) to such plans.
As sub-advisers to registered investment companies, the Company’s investment management subsidiaries are subject to requirements under the 1940 Act and related SEC regulations. Under provisions of the 1940 Act and Advisers Act governing advisory contracts, an assignment terminating the Company’s sub-advisory contract can occur as a result of the acquisition of a firm by the Company.
The foregoing laws and regulations generally grant supervisory agencies and bodies broad administrative powers, including the power to limit or restrict certain subsidiaries of the Company from conducting their business in the event that they fail to comply with such laws and regulations. Possible sanctions that may be imposed in the event of such noncompliance include the suspension of individual employees, limitations on the business activities for specified periods of time, revocation of registration as an investment adviser, commodity trading adviser and/or other registrations, and other censures and fines.
Volcker Rule Restrictions on Proprietary Trading and Sponsorship of Hedge Funds and Private Equity Funds. The Dodd-Frank Act bars banking organizations, such as the Company, from engaging in proprietary trading and from sponsoring and investing in hedge funds and private equity funds, except as permitted under certain circumstances, pursuant to a provision commonly referred to as the “Volcker Rule.” Under the Dodd-Frank Act, proprietary trading generally means trading by a banking entity or its affiliate for its trading account. Hedge funds and private equity funds are described by the Dodd-Frank Act as funds that would be registered under the 1940 Act but for certain enumerated exemptions. The Volcker Rule restrictions apply to the Company, the Bank, and all of their subsidiaries and affiliates.
VI.Taxation
Federal Taxation
The Company and its incorporated affiliates are subject to federal income taxation generally applicable to corporations under the Code. In addition, the Bank is subject to Subchapter H of the Code, which provides specific rules for the treatment of securities, reserves for loan losses, and any common trust funds.
The Company and its incorporated affiliates are members of an affiliated group of corporations within the meaning of Section 1504 of the Code and file a consolidated federal income tax return. Some of the advantages of filing a consolidated tax return include the avoidance of tax on intercompany distributions and the ability to offset operating and capital losses of one company against operating income and capital gains of another company.
The Company’s taxable income includes its share of the taxable income or loss from its subsidiaries that are limited liability companies.
State and Local Taxation
The Company and its affiliates are subject to the tax rate established in the states in which they do business. Substantially all of the Company’s taxable state and local income is derived from Massachusetts, California, Florida, New York, and the City of New York.
The Massachusetts tax rate is 9.0% on taxable income apportioned to Massachusetts. Massachusetts’ taxable income is defined as federal taxable income subject to certain modifications. These modifications include a deduction for 95% of dividends received from entities in which the Company owns 15% or more of the voting stock, income from federally tax exempt obligations and deductions for certain expenses allocated to federally tax exempt obligations.
The California tax rate is 8.84% for corporations that are not financial institutions and 10.84% for financial institutions. The California tax is on California taxable income, which is defined as federal taxable income subject to certain modifications. These modifications include income from federally tax exempt obligations and deductions for certain expenses allocated to federally tax exempt obligations.
The Florida tax rate is 5.5% on taxable income apportioned to Florida. Florida’s taxable income is defined as federal taxable income subject to certain modifications. These modifications include income from federally tax exempt obligations and deductions for certain expenses allocated to federally tax exempt obligations.
The New York state tax rate is 7.1% on taxable income apportioned to New York (subject to various alternative minimum taxes that may be based on taxable assets, investment capital, alternative net income, a minimum taxable base, or a fixed dollar minimum), plus a surcharge for business operations in the Metropolitan Commuter Transportation district. New York taxable income is defined as federal taxable income subject to certain modifications. These modifications include an adjustment for interest expense attributable to subsidiary capital (for non-banking corporations), a deduction for 60% of dividends received from subsidiary capital (for banking corporations), income from federally tax exempt obligations, and deductions for certain expenses allocated to federally tax exempt obligations. Combined reporting is required starting in 2015. The New York state tax rate will decrease to 6.5% starting in 2016.
The New York City tax rate is 8.85% under the General Corporation Tax and 9.0% for banking corporations on taxable income apportioned to New York City (in each case subject to various alternative minimum taxes that may be based on taxable assets, investment capital, alternative net income, a minimum taxable base, or a fixed dollar minimum). New York City
taxable income is defined as federal taxable income subject to certain modifications. These modifications include an adjustment for interest expense attributable to subsidiary capital (for non-banking corporations), a deduction for 60% of dividends received from subsidiary capital (for banking corporations), income from federally tax exempt obligations, and deductions for certain expenses allocated to federally tax exempt obligations.
ITEM 1A.
ITEM 1A.RISK FACTORS
Before deciding to invest in us or deciding to maintain or increase your investment, you should carefully consider the risks described below, in addition to the other information contained in this report and in our other filings with the SEC. The risks and uncertainties described below and in our other filings are not the only ones facing us. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also affect our business. If any of these known or unknown risks or uncertainties actually occur, our business, financial condition and results of operations could be seriously harmed. In that event, the market price for our common stock could decline and you may lose your investment.
Risks Related to our Banking Business
Our banking business is highly regulated, which could limit or restrict our activities and impose financial requirements or limitations on the conduct of our business.
We are subject to regulation and supervision by the Federal Reserve, and the Bank is subject to regulation and supervision by the Commissioner and the FDIC. Federal and state laws and regulations govern numerous matters affecting us, including changes in the ownership or control of banks and bank holding companies, maintenance of adequate capital and the financial condition of a financial institution, permissible types, amounts and terms of extensions of credit and investments, permissible non-banking activities, the level of reserves against deposits and restrictions on dividend payments. The FDIC and the Commissioner have the power to issue cease and desist orders to prevent or remedy unsafe or unsound practices or violations of law by banks subject to their regulation, and the Federal Reserve possesses similar powers with respect to bank holding companies. These and other restrictions limit the manner in which we and the Bank may conduct business and obtain financing.
Our banking business is also affected by the monetary policies of the Federal Reserve. Changes in monetary or legislative policies may affect the interest rates the Bank must offer to attract deposits and the interest rates it must charge on loans, as well as the manner in which it offers deposits and makes loans. These monetary policies have had, and are expected to continue to have, significant effects on the operating results of depository institutions generally, including the Bank.
Because our business is highly regulated, the laws, rules, regulations, and supervisory guidance and policies applicable to us are subject to regular modification and change. It is impossible to predict the competitive impact that any such changes would have on the banking and financial services industry in general or on our business in particular. Such changes may, among other things, increase the cost of doing business, limit permissible activities, or affect the competitive balance between banks and other financial institutions. The Dodd-Frank Act instituted major changes to the banking and financial institutions regulatory regimes in light of government intervention in the financial services sector following the 2008 financial crisis. Other changes to statutes, regulations, or regulatory policies, including changes in interpretation or implementation of statutes, regulations, or policies, could affect us in substantial and unpredictable ways. Such changes could subject us to additional costs, limit the types of financial services and products we may offer, and/or increase the ability of non-banks to offer competing financial services and products, among other things. Failure to comply with laws, regulations, or policies could result in sanctions by regulatory agencies, civil money penalties, and/or reputation damage, which could have a material adverse effect on our business, financial condition, and results of operations. See Part I. Item 1. “Business - Supervision and Regulation.”
Additional requirements imposed by the Dodd-Frank Act could adversely affect us.
The Dodd-Frank Act comprehensively reformed the regulation of financial institutions, products and services. In addition, the Dodd-Frank Act established the CFPB as an independent bureau of the Federal Reserve. The CFPB has the authority to prescribe rules for all depository institutions governing the provision of consumer financial products and services, which may result in rules and regulations that reduce the profitability of such products and services or impose greater costs and restrictions on us and our subsidiaries. The Dodd-Frank Act also established new minimum mortgage underwriting standards for residential mortgages, and the regulatory agencies have focused on the examination and supervision of mortgage lending and servicing activities. See Part 1. Item 1. “Business - Supervision and Regulation - Consumer Protection Regulation - Mortgage Reform.”
On December 10, 2013, pursuant to the Dodd-Frank Act, federal banking and securities regulators issued final rules to implement Section 619 of the Dodd-Frank Act, also known as the “Volcker Rule.” Generally, the Volcker Rule restricts banking organizations and their affiliated companies from engaging in proprietary trading and from sponsoring and investing in hedge funds and private equity funds, except as permitted under certain limited circumstances. After a conformance period, which is currently set to end on July 21, 2015 (except for certain investments and activities existing before December 31, 2013), the Volcker Rule restrictions will apply to the Holding Company, the Bank and all of our subsidiaries.
The CFPB’s new qualified mortgage rule, as amended, or “QM Rule,” became effective on November 3, 2014. The QM Rule is designed to clarify how lenders can manage the potential legal liability under the Dodd-Frank Act which would hold lenders accountable for insuring a borrower’s ability to repay a mortgage. Loans that meet the definition of “qualified mortgage” will be presumed to have complied with the new ability-to-repay standard. The QM Rule on qualified mortgages and similar rules could limit the Bank’s ability to make certain types of loans or loans to certain borrowers, or could make it more expensive and time-consuming to make these loans, which could limit the Bank’s growth or profitability.
Current and future legal and regulatory requirements, restrictions, and regulations, including those imposed under the Dodd-Frank Act, may adversely impact our profitability and may have a material and adverse effect on our business, financial condition, and results of operations; may require us to invest significant management attention and resources to evaluate and make any changes required by the legislation and related regulations; and may make it more difficult for us to attract and retain qualified executive officers and employees.
We will become subject to more stringent capital requirements.
As of January 1, 2015, we are required to comply with the Final Capital Rule. The Final Capital Rule established a minimum common equity Tier I capital ratio of 6.5% of risk-weighted assets for a “well capitalized” institution and increased the minimum Tier I capital ratio for a “well capitalized” institution from 6% to 8%. Additionally, subject to a transition period, the Final Capital Rule requires an institution to maintain a 2.5% common equity Tier I capital conservation buffer above the minimum risk-based capital requirements for “adequately capitalized” institutions to avoid restrictions on the ability to pay dividends, discretionary bonuses, and to engage in share repurchases. If these requirements were in place at December 31, 2014, the Company would meet these minimum requirements. The Final Capital Rule permanently grandfathered trust preferred securities issued before May 19, 2010 for institutions with less than $15 billion in total assets as of December 31, 2009, subject to a limit of 25% of Tier I capital. The Final Capital Rule increased the required capital for certain categories of assets, including high volatility construction real estate loans and certain exposures related to securitizations; however, the Final Capital Rule retained the current capital treatment of residential mortgages. Under the Final Capital Rule, we may make a one-time, permanent election to continue to exclude accumulated other comprehensive income from capital. If we do not make this election, unrealized gains and losses, net of taxes, will be included in the calculation of our regulatory capital. The Company plans to make this election.
Implementation of these standards, or any other new regulations, may adversely affect our ability to pay dividends, or require us to reduce business levels or raise capital, including in ways that may adversely affect our results of operations or financial condition.
The soundness of other financial institutions could adversely affect us.
Our ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial services institutions are interrelated as a result of trading, clearing, counterparty and other relationships. We have exposure to many different counterparties, and we routinely execute transactions with counterparties in the financial industry, including brokers and dealers, other commercial banks, investment banks, mutual and hedge funds, and other financial institutions. As a result, defaults by, or even rumors or questions about, one or more financial services institutions, or the financial services industry generally, could lead to market-wide liquidity problems and losses or defaults by us or by other institutions and organizations. Many of these transactions expose us to credit risk in the event of default of our counterparty or client. In addition, our credit risk may be exacerbated when the collateral held by us cannot be liquidated or is liquidated at prices not sufficient to recover the full amount of the financial instrument exposure due to us. There is no assurance that any such losses would not materially and adversely affect our results of operations.
Deterioration in local economies or real estate markets could negatively impact our banking business.
The Private Banking Segment primarily serves individuals and smaller businesses located in three geographic regions: New England, San Francisco Bay, and Southern California. The ability of the Bank’s clients to repay their loans is impacted by the economic conditions in these areas.
The Bank’s commercial loans are generally concentrated in the following client groups:
•
real estate developers and investors;
•
financial service providers;
•
technology companies;
•
manufacturing and communications companies;
•
professional service providers;
•
general commercial and industrial companies; and
•
individuals.
The Bank’s commercial loans, with limited exceptions, are secured by real estate (usually income producing residential and commercial properties), marketable securities, or corporate assets (usually accounts receivable, equipment or inventory). Substantially all of the Bank’s residential mortgage and home equity loans are secured by residential property. Consequently, the Bank’s ability to continue to originate real estate loans may be impaired by adverse changes in local and regional economic conditions in the real estate markets, or by acts of nature, including earthquakes, hurricanes, and flooding. Due to the concentration of real estate collateral in the geographic regions in which we operate, these events could have a material adverse impact on the ability of the Bank’s borrowers to repay their loans and affect the value of the collateral securing these loans.
Competition in the banking industry may impair our ability to attract and retain banking clients at current levels.
Competition in the markets in which the Bank operates may limit the ability of the Bank to attract and retain banking clients. The Bank’s competitors include several major financial companies whose greater resources may afford them a marketplace advantage by enabling them to maintain numerous banking locations and mount extensive promotional and advertising campaigns. Additionally, banks and other financial institutions with larger capitalization and financial intermediaries not subject to bank regulatory restrictions have larger lending limits and are able to serve the credit and investment needs of larger clients. The Bank also faces competition from out-of-state financial intermediaries that have opened low-end production offices or that solicit deposits in its respective market areas. There is also increased competition by out-of-market competitors through the Internet. Because the Bank maintains a smaller staff and has fewer financial and other resources than larger institutions with which it competes, it may be limited in its ability to attract clients. In addition, the Bank’s current commercial banking clients may seek alternative banking sources as they develop needs for credit facilities larger than the Bank can accommodate. If the Bank is unable to attract and retain banking clients, it may be unable to continue its loan growth and its results of operations and financial condition may otherwise be negatively impacted.
Our cost of funds for banking operations may increase as a result of general economic conditions, interest rates and competitive pressures.
The Bank has traditionally obtained funds principally through deposits and borrowings. As a general matter, deposits are a cheaper source of funds than borrowings, because interest rates paid for deposits are typically less than interest rates charged for borrowings. If, as a result of general economic conditions, market interest rates, competitive pressures, or otherwise, the amount of deposits at the Bank decreases relative to its overall banking operations, the Bank may have to rely more heavily on borrowings as a source of funds in the future.
Defaults in the repayment of loans may require additional loan loss reserves and negatively impact our banking business.
A borrower’s default on its obligations under one or more Bank loans may result in lost principal and interest income and increased operating expenses as a result of the allocation of management time and resources to the collection and work-out of the loan. In certain situations, where collection efforts are unsuccessful or acceptable work-out arrangements cannot be reached, the Bank may have to charge-off the loan in whole or in part. In such situations, the Bank may acquire real estate or other assets, if any, which secure the loan through foreclosure or other similar available remedies. In such cases, the amount owed under the defaulted loan often exceeds the value of the assets acquired.
The Bank’s management periodically makes a determination of an allowance for loan losses based on available information, including the quality of its loan portfolio, certain economic conditions, the value of the underlying collateral, and the level of its nonaccruing and criticized loans. We rely on our loan quality reviews, our experience and our evaluation of economic conditions, among other factors, in determining the level required for the allowance for loan losses. Increases in the allowance result in an expense for the period. If, as a result of general economic conditions, changes in estimates, or an increase in defaulted loans, management determines that further increases in the allowance for loan losses are necessary, we will incur additional expenses.
If it is determined that the Bank should sell certain loans or a portfolio of loans, we are required to classify those loans as “held for sale” which requires us to carry such loans at the lower of amortized cost or market. If we decide to sell loans at a time when the fair value of those loans is less than their carrying value, the adjustment will result in a charge to the allowance for loan losses if the decline in value is due to credit issues. We may from time to time decide to sell particular loans or groups of loans, and the required adjustment could negatively affect our financial condition or results of operations.
In addition, bank regulatory agencies periodically review the Bank’s allowance for loan losses and the values it attributes to real estate acquired through foreclosure or other similar remedies. Such regulatory agencies may require the Bank to adjust its determination of the value for these items. These adjustments could negatively impact our results of operations or financial condition.
Fluctuations in interest rates may negatively impact our banking business.
Fluctuations in interest rates may negatively impact the business of the Bank. The Bank’s main source of income from operations is net interest income, which represents the difference between the interest income earned on interest-bearing assets (usually loans and investment securities) and the interest expense incurred in connection with interest-bearing liabilities (usually deposits and borrowings). These rates are highly sensitive to many factors beyond our control, including general economic conditions, both domestic and foreign, and the monetary and fiscal policies of various governmental and regulatory authorities. The Bank’s net interest income can be affected significantly by changes in market interest rates. Changes in relative interest rates may reduce the Bank’s net interest income as the difference between interest income and interest expense decreases. As a result, the Bank has adopted asset and liability management policies to minimize the potential adverse effects of changes in interest rates on net interest income, primarily by altering the mix and maturity of loans, investments funding sources, and derivatives. However, even with these policies in place, a change in interest rates can impact our results of operations or financial condition.
An increase in interest rates could also have a negative impact on the Bank’s results of operations by reducing the ability of borrowers to repay their current loan obligations, which could not only result in increased loan defaults, foreclosures, and charge-offs, but also necessitate increases to our allowances for loan losses. Fluctuations in interest rates, in certain circumstances, may also lead to high levels of loan prepayments, which may also have an adverse impact on our net interest income.
Prepayments of loans may negatively impact our banking business.
Generally, the Bank’s clients may prepay the principal amount of their outstanding loans at any time. The speed at which such prepayments occur, as well as the size of such prepayments, are within our clients’ discretion. If clients prepay the principal amount of their loans, and we are unable to lend those funds to other borrowers or invest the funds at the same or higher interest rates, our interest income will be reduced. A significant reduction in interest income could have a negative impact on our results of operations and financial condition.
Our loan portfolio includes commercial loans, commercial real estate loans, and construction and land loans, which are generally riskier than other types of loans.
At December 31, 2014, our commercial loans, commercial real estate loans, and construction and land loans portfolios comprised 54% of total loans. Commercial loans generally carry larger loan balances and involve a higher risk of nonpayment or late payment than residential mortgage loans. These loans may lack standardized terms and may include a balloon payment feature. The ability of a borrower to make or refinance a balloon payment may be affected by a number of factors, including the financial condition of the borrower, prevailing economic conditions, interest rates, and collateral values. Repayment of these loans is generally more dependent on the economy and the successful operation of a business. Because of the risks associated with commercial loans, we may experience higher rates of default than if the portfolio were more heavily weighted toward residential mortgage loans. Higher rates of default could have an adverse effect on our financial condition and results of operations.
Environmental liability associated with commercial lending could result in losses.
In the course of business, the Bank may acquire, through foreclosure, properties securing loans it has originated or purchased which are in default. Particularly in commercial real estate lending, there is a risk that material environmental violations could be discovered at these properties. In this event, we or the Bank might be required to remedy these violations at the affected properties at our sole cost and expense. The cost of this remedial action could substantially exceed the value of affected properties. We may not have adequate remedies against the prior owner or other responsible parties and could find it difficult or impossible to sell the affected properties. These events could have a material adverse effect on our business, results of operations and financial condition.
Risks Related to our Investment Management and Wealth Advisory Businesses
Our investment management and wealth advisory businesses are highly regulated, and the regulators have the ability to limit or restrict our activities and impose fines or suspensions on the conduct of our business.
Our investment management and wealth advisory businesses are highly regulated, primarily at the federal level. The failure of any of our subsidiaries that provide investment management and wealth advisory services to comply with applicable laws or regulations could result in fines, suspensions of individual employees or other sanctions including revocation of such affiliate’s registration as an investment adviser.
All of our investment managers and wealth advisory affiliates are registered investment advisers under the Advisers Act. The Advisers Act imposes numerous obligations on registered investment advisers, including fiduciary, record keeping, operational and disclosure obligations. These subsidiaries, as investment advisers, are also subject to regulation under the federal and state securities laws and the fiduciary laws of certain states. In addition, the affiliates acting as sub-advisers to mutual funds are subject to certain provisions and regulations of the 1940 Act.
We are also subject to the provisions and regulations of ERISA to the extent that we act as a “fiduciary” under ERISA with respect to certain of our clients. ERISA and the applicable provisions of the federal tax laws, impose a number of duties on persons who are fiduciaries under ERISA and prohibit certain transactions involving the assets of each ERISA plan which is a client, as well as certain transactions by the fiduciaries (and certain other related parties) to such plans.
In addition, applicable law provides that all investment contracts with mutual fund clients may be terminated by the clients, without penalty, upon no more than 60 days’ notice. Investment contracts with institutional and other clients are typically terminable by the client, also without penalty, upon 30 days’ notice.
Changes in these laws or regulations could have a material adverse impact on our profitability and mode of operations.
Our investment management businesses may be negatively impacted by changes in economic and market conditions.
Our investment management business may be negatively impacted by changes in general economic and market conditions because the performance of such business is directly affected by conditions in the financial and securities markets. The financial markets and businesses operating in the securities industry are highly volatile (meaning that performance results can vary greatly within short periods of time) and are directly affected by, among other factors, domestic and foreign economic conditions and general trends in business and finance, all of which are beyond our control. We cannot assure you that broad market performance will be favorable in the future. Declines in the financial markets or a lack of sustained growth may result in a corresponding decline in our performance and may adversely affect the assets that we manage.
In addition, our management contracts generally provide for fees payable for investment management services based on the market value of assets under management, although there are a portion of our contracts that provide for the payment of fees based on investment performance in addition to a base fee. Because most contracts provide for a fee based on market values of securities, fluctuations in securities prices may have a material adverse effect on our results of operations and financial condition.
We may not be able to attract and retain investment management and wealth advisory clients at current levels due to competition.
Due to intense competition, our investment management and wealth advisory subsidiaries may not be able to attract and retain clients at current levels. Competition is especially strong in our geographic market areas because there are numerous well-established, well-resourced, well-capitalized, and successful investment management and wealth advisory firms in these areas.
Our ability to successfully attract and retain investment management and wealth advisory clients is dependent upon our ability to compete with competitors’ investment products, level of investment performance, client services and marketing and distribution capabilities. If we are not successful, our results of operations and financial condition may be negatively impacted.
Investment management contracts are typically terminable upon less than 30 days’ notice. Most of our investment management clients may withdraw funds from accounts under management generally in their sole discretion. Wealth advisory client contracts must typically be renewed on an annual basis and are terminable upon relatively short notice. The combined financial performance of our investment management and wealth advisory affiliates is a significant factor in our overall results of operations and financial condition.
Our investment management business is highly dependent on investment managers to produce investment returns and to solicit and retain clients, and the loss of a key investment manager could adversely affect our investment management and wealth advisory business.
We rely on our investment managers to produce investment returns. We believe that investment performance is one of the most important factors for the growth of our assets under management. Poor investment performance could impair our revenues and growth because existing clients might withdraw funds in favor of better performing products, which would result in lower investment management fees or our ability to attract funds from existing and new clients might diminish.
The market for investment managers is extremely competitive and is increasingly characterized by frequent movement of investment managers among different firms. In addition, our individual investment managers often have regular direct contact with particular clients, which can lead to a strong client relationship based on the client’s trust in that individual manager. The loss of a key investment manager could jeopardize our relationships with our clients and lead to the loss of client accounts. Losses of such accounts could have a material adverse effect on our results of operations and financial condition.
Risks Related to Our Overall Business and Operations
Our business and earnings have been adversely affected, and may continue to be adversely affected, by the U.S. and international financial markets and economic conditions.
The performance of our business has been and may continue to be adversely affected by general business and economic conditions in the U.S., including the level and volatility of short- and long-term interest rates, inflation, home prices, unemployment and under-employment levels, bankruptcies, household income, consumer spending, fluctuations in both debt and equity capital markets, liquidity of the global financial markets, the availability and cost of credit, investor confidence, and the strength of the U.S. economy. Deterioration of any of these conditions can adversely affect our residential portfolio, consumer and commercial businesses, and securities portfolios, as well as our earnings.
We may incur significant losses as a result of ineffective risk management processes and strategies.
We seek to monitor and control our risk exposure through a risk and control framework encompassing a variety of separate but complementary financial, credit, operational, compliance, and legal reporting systems; internal controls; management review processes; and other mechanisms. While we employ a broad and diversified set of risk monitoring and risk mitigation techniques, those techniques and the judgments that accompany their application may not be effective and may not anticipate every economic and financial outcome in all market environments or the specifics and timing of such outcomes. Market conditions over the last several years have involved unprecedented dislocations and highlight the limitations inherent in using historical data to manage risk.
We may be unable to attract and retain key employees.
Our success depends, in large part, on our ability to attract and retain key employees. Competition for the best people can be intense and we may not be able to hire or retain the key employees that we depend upon for success. The unexpected loss of services of one or more of our key employees could have a material adverse impact on our business because of their skills, knowledge of the markets in which we operate, years of industry experience, and the difficulty of promptly finding qualified replacement employees.
Our ability to attract and retain clients and employees, and to maintain relationships with vendors, third-party service providers and others, could be adversely affected to the extent our reputation is harmed.
We are dependent on our reputation within our market area, as a trusted and responsible financial company, for all aspects of our relationships with clients, employees, vendors, third-party service providers, and others with whom we conduct business or potential future business. Our ability to attract and retain clients and employees at our banking, investment management, and wealth advisory subsidiaries could be adversely affected to the extent our reputation is damaged. Our actual or perceived failure to address various issues could give rise to reputational risk that could cause harm to us and our business prospects. These issues also include, but are not limited to, legal and regulatory requirements; privacy; properly maintaining client and employee personal information; record keeping; money-laundering; sales and trading practices; ethical issues; appropriately addressing potential conflicts of interest; and the proper identification of the legal, reputational, credit, liquidity, and market risks inherent in our products. Failure to appropriately address any of these issues could also give rise to additional regulatory restrictions, reputational harm, and legal risks, which could, among other consequences, increase the size and number of litigation claims and damages asserted or subject us to enforcement actions, fines, and penalties and cause us to incur related costs and expenses. In addition, our investment management business is dependent on the integrity of our asset managers and our employees. If an asset manager or employee were to misappropriate any client funds, the reputation of our asset management business could be negatively affected, which may result in the loss of accounts and have a material adverse effect on our results of operations and financial condition.
We rely on other companies to provide key components of our business infrastructure.
Third party vendors provide key components of our business infrastructure such as internet connections, network access and core application processing. While we have selected these third party vendors carefully, using established criteria and complying with applicable regulatory guidance to evaluate each vendor’s overall capabilities, financial stability, and internal control environment, we do not control their daily business environment and actions. Any problems caused by these third parties, including as a result of their not providing us their services for any reason or their performing their services poorly, could adversely affect our ability to deliver products and services to our customers, impair our ability to conduct our business efficiently and effectively, and/or result in regulatory action, financial loss, litigation, and loss of reputation. Replacing these third party vendors could also entail significant delay and expense.
We may suffer losses as a result of operational risk or technical system failures.
We are subject to certain operational risks, including, but not limited to, data processing system failures and errors, inadequate or failed internal processes, customer or employee fraud and catastrophic failures resulting from terrorist acts or natural disasters. We depend upon data processing, software, communication, and information exchange on a variety of computing platforms and networks and over the Internet, and we rely on the services of a variety of vendors to meet our data processing and communication needs. Despite instituted safeguards, we cannot be certain that all of our systems are entirely free from vulnerability to attack or other technological difficulties or failures. Information security risks have increased significantly due to the use of online, telephone and mobile banking channels by clients and the increased sophistication and activities of organized crime, hackers, terrorists and other external parties. Our technologies, systems, networks and our clients’ devices have been subject to, and are likely to continue to be the target of, cyber-attacks, computer viruses, malicious code, phishing attacks or information security breaches that could result in the unauthorized release, gathering, monitoring, misuse, loss or destruction of our or our clients’ confidential, proprietary and other information, the theft of client assets through fraudulent transactions or disruption of our or our clients’ or other third parties’ business operations. If information security is breached or other technology difficulties or failures occur, information may be lost or misappropriated, services and operations may be interrupted and we could be exposed to claims from clients. While we maintain a system of internal controls and procedures, any of these results could have a material adverse effect on our business, financial condition, results of operations or liquidity.
We may incur fines, penalties and other negative consequences from regulatory violations, possibly even inadvertent or unintentional violations.
We maintain systems and procedures designed to ensure that we comply with applicable laws and regulations. However, some legal/regulatory frameworks provide for the imposition of fines or penalties for noncompliance even though the noncompliance was inadvertent or unintentional and even though there were systems and procedures designed to ensure compliance in place at the time. For example, we are subject to regulations issued by the Office of Foreign Assets Control, or “OFAC,” that prohibit financial institutions from participating in the transfer of property belonging to the governments of certain foreign countries, designated nationals of those countries, and certain other persons or entities whose interest in property is blocked by OFAC-administered sanctions. OFAC may impose penalties for inadvertent or unintentional violations even if reasonable processes are in place to prevent the violations. There may be other negative consequences resulting from a finding of noncompliance, including restrictions on certain activities. Such a finding may also damage our reputation as described below and could restrict the ability of institutional investment managers to invest in our securities.
We face significant legal risks, both from regulatory investigations and proceedings and from private actions brought against us.
From time to time we are named as a defendant or are otherwise involved in various legal proceedings, including class actions and other litigation or disputes with third parties. There is no assurance that litigation with private parties will not increase in the future. Future actions against us may result in judgments, settlements, fines, penalties or other results adverse to us, which could materially adversely affect our business, financial condition or results of operations, or cause serious reputational harm to us. As a participant in the financial services industry, it is likely that we could experience a high level of litigation related to our businesses and operations.
Our businesses and operations are also subject to increasing regulatory oversight and scrutiny, which may lead to additional regulatory investigations or enforcement actions. These and other initiatives from federal and state officials may subject us to further judgments, settlements, fines or penalties, or cause us to be required to restructure our operations and activities, all of which could lead to reputational issues, or higher operational costs, thereby reducing our profitability.
To the extent that we acquire other companies in the future, our business may be negatively impacted by certain risks inherent in such acquisitions.
We continue to consider the acquisition of other private banking, wealth management and trust, investment management, and wealth advisory companies. To the extent that we acquire other companies in the future, our business may be negatively impacted by certain risks inherent in such acquisitions. These risks include, but are not limited to, the following:
•
the risk that we will incur substantial expenses in pursuing potential acquisitions without completing such acquisitions;
•
the risk that we may lose key clients or employees of the acquired business as a result of the change of ownership to us;
•
the risk that the acquired business will not perform in accordance with our expectations;
•
the risk that difficulties will arise in connection with the integration of the operations of the acquired business with the operations of our private banking, investment management, or wealth advisory businesses, particularly to the extent we may enter new geographic markets;
•
the risk that we will need to make significant investments in infrastructure, controls, staff, emergency backup facilities or other critical business functions that become strained by our growth;
•
the risk that management may divert its attention from other aspects of our business;
•
the risk that unanticipated costs relating to potential acquisitions could reduce our earnings per share;
•
the risk associated with entering into geographic and product markets in which we have limited or no direct prior experience;
•
the risk that we may assume potential liabilities of the acquired company as a result of the acquisition; and
•
the risk that an acquisition will dilute our earnings per share, in both the short and long term, or that it will reduce our regulatory and tangible capital ratios.
As a result of these risks, any given acquisition, if and when consummated, may adversely affect our results of operations or financial condition. In addition, because the consideration for an acquisition may involve cash, debt or the issuance of shares of our stock and may involve the payment of a premium over book and market values, existing stockholders may experience dilution in connection with any acquisition.
Risks Related to Accounting and Accounting Changes
Our financial statements are based in part on assumptions and estimates, which, if wrong, could cause unexpected losses in the future.
Pursuant to accounting principles generally accepted in the U.S. (“GAAP”), we are required to use certain assumptions and estimates in preparing our financial statements, including in determining loan loss reserves, reserves related to litigation, if any, and the fair value of certain assets and liabilities, among other items. If assumptions or estimates underlying our financial statements are incorrect, we may experience material fluctuations in our results of operations. For additional information, see Part II. Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Policies.”
Changes in accounting standards can be difficult to predict and can materially impact how we record and report our financial condition and results of operations.
Our accounting policies and methods are fundamental to how we record and report our financial condition and results of operations. From time to time, the Financial Accounting Standards Board changes the financial accounting and reporting standards that govern the preparation of our financial statements. These changes can be hard to anticipate and implement and can materially impact how we record and report our financial condition and results of operations.
Goodwill and other intangible asset impairment would negatively affect our financial condition and results of operations.
When the purchase price of an acquired business exceeds the fair value of its tangible assets, the excess is allocated to goodwill and other identifiable intangible assets. The amount of the purchase price which is allocated to goodwill is determined by the excess of the purchase price over the net identifiable assets acquired. At December 31, 2014, our goodwill and net intangible assets totaled $191.8 million. Under current accounting standards, if we determine goodwill or intangible assets are impaired, we will be required to write down the value of these assets. Our goodwill and intangible assets are tested for impairment annually in the fourth quarter at the reporting unit level. In addition, an impairment test could be triggered between annual testing dates if an event occurs or circumstances change that would more likely than not reduce the fair value below the carrying amount. We last took an impairment charge in 2009. We cannot assure you that we will not be required to take further impairment charges in the future. Any impairment charge would have a negative effect on our shareholders’ equity and financial results.
Our deferred tax assets may not ultimately be realized or our tax positions may be subject to challenge by taxing authorities.
Our deferred tax assets may provide significant future tax savings. Our use of these deferred tax benefits may depend on a number of factors including our ability to generate significant future taxable income; the character of that income (ordinary versus capital); the absence of a future ownership change that could limit or eliminate the tax benefits; the acceptance by the taxing authorities of the positions taken on our tax returns as to the amount and timing of our income and expenses; and future changes in laws or regulations relating to tax credits, tax deductions, and net operating losses. At December 31, 2014, our net deferred tax assets were $47.6 million.
We assess the likelihood that deferred tax assets will be realizable based primarily on future taxable income and tax planning strategies and, if necessary, establish a valuation allowance for those deferred tax assets determined to not likely be realizable. Management judgment is required in determining the appropriate recognition of deferred tax assets and liabilities, including projections of future taxable income, as well as the character of that income.
In evaluating the need for a valuation allowance, management considers the following:
•
cumulative pre-tax income or loss, as adjusted for permanent book-to-tax differences, over the current and previous two years;
•
future reversals of existing taxable temporary differences;
•
the projection of future taxable income to be generated by operations during the available loss carryforward period;
•
tax planning strategies that are available and whether any are limited based upon the Company’s market capitalization in excess of its book value; and
•
whether there has been any operating loss or tax credit carry-overs expiring unused.
There can be no absolute assurance however, that the net deferred tax assets will ultimately be realized.
Risks Related to Our Liquidity
We are a holding company and depend on our subsidiaries for dividends.
We are a legal entity that is separate and distinct from the Bank and our Wealth and Investment subsidiaries and depend on dividends from the Bank and our Wealth and Investment subsidiaries to fund dividend payments on our common and preferred stock and to fund all payments on our other obligations. Our revenue (on a parent-only basis) is derived primarily from dividends paid to us by the Bank and our Wealth and Investment subsidiaries. Our right, and consequently the right of our shareholders, to participate in any distribution of the assets or earnings of the Bank and our Wealth and Investment subsidiaries through the payment of such dividends or otherwise is necessarily subject to the prior claims of creditors of the Bank (including depositors) and our Wealth and Investment subsidiaries, except to the extent that certain claims of ours in a creditor capacity may be recognized.
Holders of our common stock are entitled to receive dividends only when, as, and if declared by our board of directors. Although we have historically declared cash dividends on our common and preferred stock, we are not required to do so. Our board of directors may reduce or eliminate our common stock dividend in the future. Further, if we do not pay dividends on our preferred stock, we may not pay any dividends on our common stock. The Federal Reserve has authority to prohibit bank holding companies from paying dividends if such payment is deemed to be an unsafe or unsound practice. Additionally, the FDIC has the authority to use its enforcement powers to prohibit a bank from paying dividends if, in its opinion, the payment of dividends would constitute an unsafe or unsound practice. When the Final Capital Rule comes into effect, our ability to pay dividends would be restricted if we do not maintain a capital conservation buffer. A reduction or elimination of dividends could adversely affect the market price of our common stock. See Part I. Item 1. “Business - Supervision and Regulation - Dividend Restrictions” and “Business - Supervision and Regulation - Regulatory Capital Requirements.”
Risks Related to Our Common Stock
Future capital offerings may adversely affect the market price of our common stock.
In the future, we may attempt to increase our capital resources or, if our or the Bank’s capital ratios fall below required minimums, we or the Bank could be forced to raise additional capital by making additional offerings of debt, common or preferred stock, trust preferred securities, and senior or subordinated notes. Upon liquidation, holders of our debt securities and shares of preferred stock and lenders with respect to other borrowings will receive distributions of our available assets prior to the holders of our common stock.
Additional equity offerings may dilute the holdings of our existing shareholders or reduce the market price of our common stock, or both. Because our decision to issue securities in any future offering will depend on market conditions and other factors beyond our control, we cannot predict or estimate the amount, timing or nature of our future offerings.
We cannot assure you that such capital will be available to us on acceptable terms or at all. Our inability to raise sufficient additional capital on acceptable terms when needed could adversely affect our businesses, financial condition, and results of operations. Thus, our shareholders bear the risk of our future offerings reducing the market price of our common stock and diluting their stock holdings in us.
The market price and trading volume of our common stock may be volatile.
The market price of our common stock may be volatile. In addition, the trading volume in our common stock may fluctuate and cause significant price variations to occur. We cannot assure you that the market price of our common stock will not fluctuate or decline significantly in the future. Some of the factors that could negatively affect our share price or result in fluctuations in the price or trading volume of our common stock include:
•
quarterly variations in our operating results or the quality of our assets;
•
operating results that vary from the expectations of management, securities analysts, and investors;
•
changes in expectations as to our future financial performance;
•
announcements of innovations, new products, strategic developments, significant contracts, acquisitions, and other material events by us or our competitors;
•
the operating and securities price performance of other companies that investors believe are comparable to us;
•
our past and future dividend practices;
•
future sales of our equity or equity-related securities; and
•
changes in global financial markets and global economies and general market conditions, such as interest rates, stock, commodity or real estate valuations or volatility.
Anti-takeover provisions could negatively impact our shareholders.
Provisions of Massachusetts law, the BHCA, and provisions of our articles of organization and by-laws could make it more difficult for a third party to acquire control of us or have the effect of discouraging a third party from attempting to acquire control of us. Our articles of organization authorize our board of directors to issue preferred stock without shareholder approval and such preferred stock could be issued as a defensive measure in response to a takeover proposal. These and other provisions could make it more difficult for a third party to acquire us, even if an acquisition might be in the best interest of our shareholders.
ITEM 1B.
ITEM 1B.UNRESOLVED STAFF COMMENTS
None.
ITEM 2.
ITEM 2.PROPERTIES
The Company and its subsidiaries primarily conduct operations in leased premises; however, the Bank owns two of its office locations. The Company’s headquarters are located at Ten Post Office Square, Boston, Massachusetts. The premises for our Wealth and Investment affiliates are generally located in the vicinity of the headquarters of such affiliates. See “Private Banking,” “Investment Management,” and “Wealth Advisory” in Part I. Item 1. “Business - General” for further detail.
Generally, the initial terms of the leases for our leased properties range from five to fifteen years. Most of the leases also include options to renew at fair market value for periods of five to ten years. In addition to minimum rentals, certain leases include escalation clauses based upon various price indices and include provisions for additional payments to cover real estate taxes.
ITEM 3.
ITEM 3.LEGAL PROCEEDINGS
The Company is involved in routine legal proceedings occurring in the ordinary course of business. In the opinion of management, final disposition of these proceedings will not have a material adverse effect on the consolidated balance sheets or consolidated statements of operations of the Company.
ITEM 4.
ITEM 4.MINE SAFETY DISCLOSURES
Not applicable.
PART II
ITEM 5.
ITEM 5.
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES
I.Market for Common Stock
The Company’s common stock, par value $1.00 per share, is traded on the NASDAQ Global Select Market (“NASDAQ”) under the symbol “BPFH.” At February 23, 2015, there were 83,126,009 shares of common stock outstanding. The number of holders of record of the Company’s common stock as of February 23, 2015 was 1,066. The closing price of the Company’s common stock on February 23, 2015 was $12.66.
The following table sets forth the high and low sale prices for the Company’s common stock for the periods indicated, as reported by NASDAQ:
II.Dividends
The Company paid dividends on its common stock of $0.32 and $0.24 in 2014 and 2013, respectively. On January 21, 2015, the Company announced an increase in its quarterly dividend from $0.08 per share to $0.09 per share for the fourth quarter of 2014.
The Company is a legal entity separate and distinct from its affiliates. These affiliates are the principal assets of the Company and, as such, provide the main source of payment of dividends by the Company. See Part I. Item 1. “Business - Supervision and Regulation - Dividend Restrictions,” which is incorporated by reference herein, for a discussion of statutory restrictions on the payment of dividends by the Company and the Bank. The payment of dividends by the Company and the Bank may also be affected or limited by other factors, such as the requirement to maintain adequate capital above regulatory guidelines. There are no such comparable statutory restrictions on the Company’s Investment Managers’ and Wealth Advisors’ ability to pay dividends.
III.Securities Authorized for Issuance Under Equity Compensation Plans
Information regarding securities authorized for issuance under our equity compensation plans will be included in the definitive Proxy Statement (the “Proxy Statement”) for the 2015 Annual Meeting of Shareholders to be held on April 15, 2015 and is incorporated herein by reference.
IV.Recent Sales of Unregistered Securities
None.
V.Issuer Repurchases
None.
VI.Performance Graph
The Total Return Performance Graph set forth below is a line graph comparing the yearly percentage change in the cumulative total shareholder return on the Company’s common stock, based on the market price of the Company’s common stock, with the total return on companies within the NASDAQ Composite Index and companies within the SNL $5B-$10B Bank Index. The calculation of cumulative return assumes a $100 investment in the Company’s common stock, the NASDAQ Composite Index, and the SNL $5B-$10B Bank Index on December 31, 2009. It also assumes that all dividends are reinvested during the relevant periods.
___________
Source: SNL
ITEM 6.
ITEM 6.SELECTED FINANCIAL DATA
The following table represents selected financial data for the five fiscal years ended December 31. The data set forth below does not purport to be complete. It should be read in conjunction with, and is qualified in its entirety by, the more detailed information appearing elsewhere herein, including the Company’s Consolidated Financial Statements and related notes. All items presented below, if applicable, have been adjusted for discontinued operations related to the divestiture of DTC in 2012.
____________
nm - not meaningful
(1)
Cash and investments includes the following line items from the consolidated balance sheets: cash and cash equivalents, investment securities, and stock in Federal Home Loan Banks.
(2)
Book value per share is calculated by reducing the Company’s total equity by the preferred stock balance, then dividing that value by the total common shares outstanding as of the end of that period.
(3)
The Company calculates Average Common Equity by adjusting Average Equity to exclude Average Non-convertible Preferred Equity. When Average Non-convertible Preferred Equity is excluded, the Company also reduces Net Income Attributable to the Company by dividends paid on that preferred equity.
The Company calculates Average Tangible Common Equity by adjusting Average Equity to exclude Average Goodwill and Intangible Assets, net and Average Non-convertible Preferred Equity.
Reconciliations from the Company’s GAAP Return on Average Equity ratio to the Non-GAAP Return on Average Common Equity ratio, and the Non-GAAP Return on Average Tangible Common Equity ratio are presented below:
____________
(a)
Includes average goodwill and intangible assets of divested affiliates for years 2011 and 2010.
(4)
The Company calculates the Efficiency Ratio, Fully Taxable Equivalent (“FTE”) Basis by reducing operating expenses by amortization of intangibles and restructuring expense and increasing total revenue by the FTE adjustment. A reconciliation from GAAP efficiency ratio to Non-GAAP efficiency ratio (FTE basis) is presented below:
(5)
Net interest margin represents net interest income on a fully-taxable equivalent basis as a percent of average interest-earning assets.
(6)
Total revenue is defined as net interest income plus fees and other income.
(7)
The Company calculates tangible assets by adjusting total assets to exclude goodwill and intangible assets. The Company calculates tangible common equity by adjusting total shareholders’ equity to exclude goodwill, intangible assets, and, the equity from the Series D preferred stock (non-convertible). The Company uses certain non-GAAP financial measures, such as the Tangible Common Equity to Tangible Assets ratio, to provide information for investors to effectively analyze financial trends of ongoing business activities, and to enhance comparability with peers across the financial sector. A reconciliation from the Company’s GAAP Total Shareholders’ Equity to Total Assets ratio to the Non-GAAP Tangible Common Equity to Tangible Assets ratio and to the Non-GAAP Tier I Common Equity to Risk Weighted Assets ratio is presented below:
____________
(a)Includes goodwill and intangible assets of divested affiliates for years 2011 and 2010.
(b)
Risk Weighted Assets are calculated under current capital rules. Components of Tier I Common Equity, for all years presented, are based on the Final Capital Rules.
ITEM 7.
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 four reportable segments: Private Banking, Wealth Management and Trust, 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 2014. 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 $68.8 million for the year ended December 31, 2014, compared to net income of $70.5 million in 2013 and $53.3 million in 2012. The Company recognized diluted earnings per share of $0.79 for the year ended December 31, 2014, compared to diluted earnings per share of $0.68 in 2013 and $0.61 in 2012.
Key items that affected the Company’s 2014 results include:
▪
On October 2, 2014, the Bank completed the acquisition of Banyan. The transaction was paid for by a combination of cash and common stock in the Company. The operations of Banyan since the date of acquisition are included in the consolidated results of the Company for 2014. As a result of the acquisition, a new operating segment of the Company, Wealth Management and Trust, was created. The new segment is comprised of Boston Private Bank's existing wealth management and trust business, as well as the business activities of Banyan.
▪
Recurring fees and income, which includes investment management fees, wealth advisory fees, wealth management and trust fees, other banking fee income, and gain on sale of loans, net, for the year ended December 31, 2014 was $139.0 million, an increase of $16.3 million, or 13%, from 2013. The 2014 increase was due to increased fee-based revenue, primarily related to the Banyan acquisition and equity market appreciation.
▪
The Company recorded a credit to the provision for loan losses of $6.4 million for the year ended December 31, 2014, compared to a credit to the provision for loan losses of $10.0 million in 2013. The 2014 credit to the provision for loan losses was primarily due to net recoveries, the sale of commercial loans from the loan portfolio in the second quarter of 2014, continuing credit improvement, and changes in the composition of the loan portfolio, partially offset by loan growth in 2014.
▪
The Company recorded total operating expenses of $227.1 million for the year ended December 31, 2014, compared to total operating expenses of $220.7 million in 2013. The increase in expense in 2014 related to the acquisition of Banyan in the fourth quarter, which accounted for $7.4 million of operating expenses in 2014.
▪
The low interest rate environment continued to affect net interest income. Net interest margin (“NIM”) decreased seven basis points to 2.98% in 2014 from 3.05% in 2013, after decreasing 17 basis points from 3.22% in 2012. Net interest income for the year ended December 31, 2014 was $179.7 million, an increase of $5.7 million, or 3%, compared to 2013. The 2014 increase was due to higher yields on investments and the increase in volume of investments and the loan portfolio, partially offset by lower average yields on loans and higher volume of deposits.
▪
Assets under management and advisory (“AUM”) increased 23% during 2014 primarily due to the Bank's acquisition of Banyan in the fourth quarter of 2014, which added $4.3 billion in AUM. The increase was also due to $1.7 billion of market appreciation, partially offset by $0.3 billion of net outflows. The net outflows were driven by the Company's investment managers, while the wealth advisory segment and the newly-formed wealth management and trust segment both produced net inflows. Increases in AUM were experienced in all three segments.
Private Banking
The following table presents a summary of selected financial data for the Private Banking segment for 2014, 2013, and 2012.
____________
nm - not meaningful
(1)
Loans presented in this table are loans from the Private Banking segment and do not include loans of Wealth and Investment 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 Wealth and Investment 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 $58.7 million in the year ended December 31, 2014, compared to net income attributable to the Company of $61.2 million in 2013 and $48.1 million in 2012. The 2014 increase in net income, excluding the effect of the 2013 gain on sale of the Pacific Northwest offices, was due to decreased operating expenses, partially offset by lower revenues and a lower credit to the provision for loan losses. 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.
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.
Total loans at the Bank increased $0.2 billion, or 3%, to $5.3 billion, or 80% of total assets at the Bank, at December 31, 2014 from $5.1 billion, or 82% of total assets at the Bank, at December 31, 2013. 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.”
Deposits at the Bank increased $365.3 million, or 7%, to $5.5 billion in 2014 from $5.2 billion in 2013. 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.”
Wealth Management and Trust
The following table presents a summary of selected financial data for the Wealth Management and Trust segment for 2014, 2013, and 2012.
____________
nm - not meaningful
The Company’s Wealth Management and Trust segment reported net income attributable to the Company of $3.0 million in the year ended December 31, 2014, compared to net income attributable to the Company of $3.4 million in 2013 and $3.1 million in 2012. The year-to-year changes are not comparable due to the acquisition of Banyan in 2014.
AUM increased $4.7 billion, or over 100%, to $9.3 billion at December 31, 2014 from $4.6 billion at December 31, 2013. In 2014, the increase in AUM was primarily the result of the acquisition of Banyan in the fourth quarter, which added $4.3 billion of AUM. In addition to the acquisition, the increase was the result of market appreciation of $0.3 billion and net flows of $0.1 billion. In 2013, the increase in AUM was primarily the result of market appreciation of $0.5 billion and net flows of $0.1 billion.
Investment Management
The following table presents a summary of selected financial data for the Investment Management segment for 2014, 2013, and 2012.
The Company’s Investment Management segment reported net income attributable to the Company of $5.7 million in the year ended December 31, 2014, compared to net income attributable to the Company of $5.0 million in 2013 and $3.6 million in 2012. The $0.7 million, or 13%, increase in 2014 was primarily due to an increase in investment management fees, partially offset by an increase in salaries and employee benefits expense and professional services expense. The increase in investment management fees was due to the increase in AUM.
AUM increased $0.4 billion, or 4%, to $10.8 billion at December 31, 2014 from $10.4 billion at December 31, 2013. In 2014, the increase in AUM was primarily the result of market appreciation of $1.1 billion, partially offset by net
outflows of $0.7 billion. 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 for 2014, 2013, and 2012.
The Company’s Wealth Advisory segment reported net income attributable to the Company of $7.2 million in the year ended December 31, 2014, compared to net income attributable to the Company of $6.2 million in 2013 and $4.6 million in 2012. The $0.9 million, or 15%, increase in 2014 was due to increased wealth advisory fee revenue partially offset by increased salaries and employee benefits, occupancy and equipment, and professional services expense.
AUM increased $0.5 billion, or 6%, to $9.9 billion at December 31, 2014 from $9.3 billion at December 31, 2013. In 2014, the increase in AUM was primarily the result of market appreciation of $0.3 billion and net inflows of $0.3 billion. 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 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 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. When a collateral dependent loan becomes impaired, an updated appraisal of the collateral is obtained, if appropriate. 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, trade names, 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. Trade names are not amortized. 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 impairment exists when a reporting unit’s carrying value of goodwill exceeds its implied fair value.
An entity may assess qualitative factors to determine whether it is more likely than not (that is, a likelihood of more than 50 percent) that the fair value of a reporting unit is less than its carrying amount, including goodwill (“Step 0”). In evaluating whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount, an entity assesses relevant events and circumstances, such as the following:
•
Macroeconomic conditions such as a deterioration in general economic conditions, limitations on accessing capital, or other developments in equity and credit markets.
•
Industry and market considerations such as a deterioration in the environment in which an entity operates, an increased competitive environment, a decline in market-dependent multiples or metrics (consider in both absolute terms and relative to peers), a change in the market for an entity’s products or services, or a regulatory or political development.
•
Overall financial performance such as negative or declining cash flows or a decline in actual or planned revenue or earnings compared with actual and projected results of relevant prior periods.
•
Other relevant entity-specific events such as changes in management, key personnel, strategy, or customers; contemplation of bankruptcy; or litigation.
•
Events affecting a reporting unit such as a change in the composition or carrying amount of its net assets, a more-likely-than-not expectation of selling or disposing all, or a portion, of a reporting unit, the testing for recoverability of a significant asset group within a reporting unit, or recognition of a goodwill impairment loss in the financial statements of a subsidiary that is a component of a reporting unit.
If, after assessing the totality of events or circumstances such as those described in the preceding paragraph, an entity determines that it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then the first and second steps of the goodwill impairment test, as described below, are unnecessary.
Goodwill is tested for impairment using a two-step process that begins with an estimation of the fair value of a reporting unit. 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 impairment. The reporting units fall under one of the four segments: Private Banking, Wealth Management and Trust, Investment Management, and Wealth Advisory.
For the Private Banking segment, the Company utilizes a market approach to determine fair value. For the market approach, earnings and market capitalization multiples of comparable public companies are selected and applied to the Private Banking reporting unit’s applicable metrics.
For the Investment Management, Wealth Advisory, and Wealth Management and Trust segments, the Company utilizes both the income and market approaches to determine fair value. The income approach is primarily based on discounted cash flows derived from assumptions of income statement activity. For the market approach, earnings before interest, taxes, depreciation and amortization (“EBITDA”) and revenue multiples of comparable companies are selected and applied to the financial services reporting unit’s applicable metrics.
The aggregate fair values are compared to market capitalization as an assessment of the appropriateness of the fair value measurements. A control premium analysis is performed to determine whether the implied control premium was within range of overall control premiums observed in the market place.
The second step (“Step 2”) of impairment testing is necessary only if a reporting unit’s carrying amount exceeds its fair value. Step 2 compares the implied fair value of the reporting unit goodwill with the carrying amount of the goodwill for the reporting unit. The implied fair value of goodwill is determined in the same manner as goodwill that is recognized in a business combination. Significant judgment and estimates are involved in estimating the fair value of the assets and liabilities of the reporting unit. The excess goodwill is recognized as an impairment loss.
Income Tax Estimates
The Company accounts for income taxes in accordance with ASC 740, Income Taxes (“ASC 740”). The deferred tax assets and/or liabilities are determined by multiplying the differences between the financial reporting and tax reporting basis for assets and liabilities by the enacted tax rates expected to be in effect when such differences are recovered or settled. The effect on deferred taxes for a change in tax rates is recognized in income in the period that includes the enactment date. Valuation allowances on deferred tax assets are estimated based on our assessment of the realizability of such amounts. Significant management judgment is required in determining the provision for income taxes and, in particular, any valuation allowance recorded against our deferred tax assets.
In accordance with ASC 740, deferred tax assets are to be reduced by a valuation allowance if, based on the weight of available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. The realization of the tax benefit depends upon the existence of sufficient taxable income within the carry-back and carry-forward periods.
Management considered the following items in evaluating the need for a valuation allowance:
▪
Cumulative pre-tax income, as adjusted for permanent book-to-tax differences, during the 2012 through 2014 period.
▪
Deferred tax assets are expected to reverse in periods when there will be taxable income.
▪
The Company projects sufficient future taxable income to be generated by operations during the available carryforward period.
▪
Certain tax planning strategies are available, such as reducing investments in tax-exempt securities.
▪
The Company has not had any operating loss or tax credit carryovers expiring unused in recent years.
The Company believes that it is more likely than not that the net deferred tax asset, excluding the net deferred tax asset on capital losses, will be realized based upon the ability to generate future taxable income, as well as the availability of current and historical taxable income. The net deferred tax asset at December 31, 2014 and 2013 is net of a valuation allowance for capital losses. Capital losses are deductible to the extent of offsetting capital gains and the Company does not anticipate that it will generate capital gains in future periods. Therefore, the Company has recorded a valuation allowance on capital losses in excess of capital gains as of December 31, 2014 and 2013.
Results of Operations
Comparison of Years Ended December 31, 2014, 2013 and 2012
Net Income. The Company recorded net income from continuing operations for the year ended December 31, 2014 of $67.4 million, compared to net income of $66.7 million and $48.8 million in 2013 and 2012, respectively. Net income attributable to the Company, which includes income from both continuing and discontinued operations, for the year ended December 31, 2014 was $68.8 million, compared to income of $70.5 million and $53.3 million in 2013 and 2012, respectively.
The Company recognized diluted earnings per share from continuing operations for the year ended December 31, 2014 of $0.72 per share, compared to earnings of $0.59 per share and $0.52 per share in 2013 and 2012, respectively. Diluted earnings per share attributable to common shareholders, which includes both continuing and discontinued operations, for the year ended December 31, 2014 was $0.79 per share, compared to earnings of $0.68 per share and $0.61 per share in 2013 and 2012, respectively. Net income from continuing operations in 2014, 2013 and 2012 was offset by charges that reduce income available to common shareholders. See Part II. Item 8. “Financial Statements and Supplementary Data - Note 16: Earnings Per Share” for further detail on the charges made to arrive at income attributable to the common shareholder.
The Company’s 2014 earnings were positively impacted by the credit to the provision for loan losses, increases in fee-based revenue, and net interest income. These changes were partially offset by higher operating expenses, particularly salaries and employee benefits and occupancy and equipment expenses.
The Company’s 2013 earnings were positively impacted by the credit to the provision for loan losses, the gain on sale of the Pacific Northwest banking offices, increases in investment management fees, wealth management and trust fees, and wealth advisory fee revenues, and lower operating expenses. These changes were partially offset by lower net interest income.
The Company’s 2012 earnings were positively impacted by the credit to the provision for loan losses, an increase in wealth advisory fee revenue, and lower operating expenses. These changes were partially offset by lower net interest income and lower gains on sale of other real estate owned (“OREO”).
The following discussions are based on the Company’s continuing operations, unless otherwise stated.
The following table presents selected financial highlights:
________________
nm - not meaningful
Net Interest Income and Margin
Net interest income represents the difference between interest earned, primarily on loans and investments, and interest paid on funding sources, primarily deposits and borrowings. Interest rate spread is the difference between the average rate earned on total interest-earning assets and the average rate paid on total interest-bearing liabilities. Net interest margin (“NIM”) is the amount of net interest income, on a fully taxable-equivalent (“FTE”) basis, expressed as a percentage of average interest-earning assets. The average rate earned on earning assets is the amount of annualized taxable equivalent interest income expressed as a percentage of average earning assets. The average rate paid on interest-bearing liabilities is equal to annualized interest expense as a percentage of average interest-bearing liabilities. When credit quality declines and loans are placed on nonaccrual status, NIM can decrease because the same assets are earning less income. $38.9 million of loans that were graded substandard but were still accruing interest income at December 31, 2014 could be placed on nonaccrual status if their credit quality declines further.
Net interest income for the year ended December 31, 2014 was $179.7 million, an increase of $5.7 million, or 3%, compared to 2013, after a decrease of $9.3 million, or 5%, from 2012 to 2013. The increase for the year was due to higher yields on investments, higher volume in the investment and loan portfolios, lower average rates paid on the Company’s deposits and borrowings, and a decrease in the average volume of borrowings. This was partially offset by lower average yields on loans and an increase in the average volume of interest-bearing deposits. The NIM was 2.98%, 3.05%, and 3.22% for the years ended December 31, 2014, 2013, and 2012, respectively.
The following tables present the composition of the Company’s NIM on a FTE basis for the years ended December 31, 2014, 2013, and 2012; however, the discussion following these tables reflects non-FTE data.
________________________
(1)
Available-for-sale investment securities are shown in the average balance sheet at amortized cost.
(2)
Interest income on non-taxable investments and loans is presented on a FTE basis using statutory rates. The discussion following these tables reflects non-FTE data, except where noted.
(3)
Includes loans held for sale and nonaccrual loans.
(4)
Includes assets and liabilities of discontinued operations, if any.
(5)
Includes deposits held for sale, if any.
Rate/Volume Analysis
The following table describes the extent to which changes in interest rates and changes in the volume of interest-earning assets and interest-bearing liabilities have affected the Company’s interest income and interest expense during the periods indicated. Information is provided in each category with respect to: (i) changes attributable to changes in volumes (changes in average balance multiplied by prior year average rate) and (ii) changes attributable to changes in rate (change in average interest rate multiplied by prior year average balance), while (iii) changes attributable to the combined impact of volumes and rates have been allocated proportionately to separate volume and rate categories. Changes in rate are presented on a non-FTE basis in the table below.
____________
(1)
Interest income on non-taxable investments and loans is presented on a non-FTE basis in this Rate-Volume table. The discussion following this table also reflects non-FTE data, except where noted.
Net Interest Income. Net interest income increased 3% from 2013 to 2014, after decreasing 5% from 2012 to 2013. The increase in net interest income in 2014 was due to higher yields on investments, higher volume in the investment and loan portfolios, lower average rates paid on the Company’s deposits and borrowings, and a decrease in the average volume of borrowings, all of which was partially offset by lower average yields on loans and an increase in the average volume of interest-bearing deposits. The decline in net interest income in 2013 was primarily due to lower average yields on loans and investments and increased volume of deposits, partially offset by lower average rates paid on deposits and borrowings and a decrease in the volume of borrowings. These changes are discussed in more detail below.
The Company’s net interest margin, on a FTE basis, decreased seven basis points to 2.98% in 2014 from 3.05% in 2013, after decreasing 17 basis points in 2013 from 3.22% in 2012. The decrease in the Company’s net interest margin in 2014 and 2013 was primarily related to the lower interest rates earned on loans as borrowers refinance at lower current market rates and new loans originated at lower rates. Due to the already low market rates on deposits and borrowings, the decline in interest rates on loans cannot be completely offset by lower cost of funds.
Interest and Dividend Income. Interest and dividend income for the year ended December 31, 2014 was $206.8 million, an increase of $3.7 million, or 2%, compared to 2013, after a decrease of $20.1 million, or 9%, in 2013 from 2012. The 2014 increase was primarily due to higher volume of loans, higher volume and yields on investments, and lower rates paid and volume of borrowed funds, partially offset by lower loan yields and higher volume of deposits. The 2013 decrease was primarily due to lower loan yields in 2013, partially offset in 2013 by increased loan volume. Included in interest and dividend income was the amortization of loan fees, (net of deferred costs), of $(1.2) million, $(1.4) million, and $(0.9) million for the years ended December 31, 2014, 2013, and 2012, respectively.
The Bank generally has interest income that is either recovered or reversed related to nonaccruing loans each quarter. Based on the net amount recovered or reversed, the impact on interest income and related yields can be either positive or negative. In addition, the Bank collects prepayment penalties on certain commercial loans that pay off prior to maturity which could also impact interest income and related yields positively. The amount and timing of prepayment penalties varies from quarter to quarter.
Interest income on commercial loans (including construction loans), on a non-FTE basis, for the year ended December 31, 2014 was $119.6 million, an increase of $0.8 million, or 1%, compared to 2013, after decreasing $9.4 million, or 7%, in 2013 from 2012. The 2014 increase was primarily the result of a five percent increase in average balance, partially offset by a 17 basis point decrease in average yield. The 2013 decrease was primarily the result of a 37 basis point decrease in average yield and a flat average balance. The 2014 and 2013 decreases in the average yield were the result of market conditions leading to lower rates due to competition for higher quality loans as discussed below in Part II. Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Loan Portfolio and Credit Quality.” The 2014 increase in average balance was due to organic growth in the loan portfolio, primarily in commercial and industrial loans in all three regions. The 2013 average balance was consistent with the average balance in 2012, however the 2012 balance included loans from the three Pacific Northwest banking offices for the full year, while the 2013 average balance only included them through the close of the sale in May 2013.
Interest income on residential mortgage loans for the year ended December 31, 2014 was $65.0 million, flat as compared to 2013, after decreasing $6.7 million, or 9%, in 2013 from 2012. The 2014 income was primarily the result of a 12 basis point decrease in average yield, offset by a 4% increase in average balance. The 2013 decrease was primarily the result of a 39 basis point decrease in average yield, partially offset by a 2% increase in average balance. The 2014 and 2013 decreases in the average yields were primarily due to adjustable rate mortgage (“ARM”) loans repricing to lower rates, clients refinancing into lower rates and new loan originations at historically low rates. The declines in U.S. Treasury yields and the London Interbank Offered Rate (“LIBOR”), the indexes to which the ARMs are typically linked, have decreased the yields on these mortgage loans. The 2014 and 2013 increases in the average balances were due to the organic growth of the residential loan portfolio at the Bank.
Interest income on home equity and other consumer loans for the year ended December 31, 2014 was $7.1 million, a decrease of $0.8 million, or 10%, compared to 2013, after decreasing $1.6 million, or 17%, in 2013 from 2012. The 2014 decrease was primarily the result of a 13 basis point decrease in average yield and a 6% decrease in average balance. The 2013 decrease was primarily the result of a 25 basis point decrease in average yield and a 10% decrease in average balance. The 2014 and 2013 decreases in average yield were primarily due to lower market rates on consumer loans. The 2014 and 2013 decreases in average balances were primarily due to changes in average balances in consumer loans, which typically vary depending on client demand.
Investment income, on a non-FTE basis, for the year ended December 31, 2014 was $15.2 million, an increase of $3.6 million, or 31%, compared to 2013, after decreasing $2.4 million, or 17%, in 2013 from 2012. The 2014 increase was the result of a 19% increase in average balance and a 12 basis point increase in the average yield. The 2013 decrease was primarily the result of a 5% decrease in average balance and a 19 basis point decrease in the average yield. The changes in the average balances in 2014 and 2013 were primarily due to timing and volume of deposit balances as compared to the level of loans outstanding. The decrease in the average yields in 2013 was primarily due to lower yields on short-term liquid investments such as U.S. Government and Agency securities as well as longer term mortgage-backed securities and municipals. Investment decisions are made based on anticipated liquidity, loan demand, and asset-liability management considerations.
Interest expense. Interest expense on deposits and borrowings for the year ended December 31, 2014 was $27.1 million, a decrease of $2.0 million, or 7%, compared to 2013, after decreasing $10.9 million, or 27%, in 2013 from 2012.
Interest expense on deposits for the year ended December 31, 2014 was $14.1 million, an increase of $0.7 million, or 5%, compared to 2013, after decreasing $4.2 million, or 24%, in 2013 from 2012. The 2014 increase was primarily the result of a 7% increase in average balance and a two basis point increase in average rate paid on money market deposits, partially offset by decreases in average rates paid on other interest-bearing deposits and a 4% decrease in the average balance of certificates of deposit. The 2013 decrease was primarily the result of a 12 basis point decrease in average rate, partially offset by a 2% increase in average balance. While 2014 rates declined in two of the three categories of deposits and 2013 average rates declined in all three categories of deposits, the average balance increase was only experienced in money market accounts and savings accounts, whereas certificates of deposit in both years experienced decreases in average balance. The 2014 and 2013 decreases in the average rates paid were primarily due to the Bank’s ability to lower interest rates on savings accounts, certificates of deposit, and, in 2013, on money market deposits due to the low interest rate environment. The small increase in rates in 2014 on money market deposits was due to interest expense associated with pay-fixed interest rate hedges placed on brokered money deposits to protect the Bank against rising interest rates.
Interest paid on borrowings for the year ended December 31, 2014 was $13.0 million, a decrease of $2.7 million, or 17%, compared to 2013, after decreasing $6.6 million, or 30%, in 2013 from 2012. The 2014 decrease was primarily the result of a 33 basis point decrease in average rate paid and a 4% decrease in average balance on Federal Home Loan Banks (“FHLB”) borrowings and other, as well as a 15% decrease in average balance on junior subordinated debentures. This was partially offset by a 13 basis point increase in average rate paid on junior subordinated debentures related to the repurchase of junior subordinated debentures which had lower rates. The 2013 decrease was primarily the result of a 31 basis point decrease in average rate paid and a 20% decrease in average balance on FHLB borrowings and other, as well as a 27 basis point decrease in average rate paid and a 25% decrease in average balance on junior subordinated debentures. The 2014 and 2013 decreases in the average rate paid were primarily due to the higher-rate FHLB borrowings maturing and being replaced with current lower rates, the repurchase of a portion of the Company's junior subordinated debentures in 2013, and the prepayment of FHLB borrowings in 2013 and 2014.
Provision/ (credit) for loan losses. For the year ended December 31, 2014, the provision/ (credit) for loan losses was a credit of $6.4 million, compared to credits of $10.0 million and $3.3 million in 2013 and 2012, respectively. The 2014 credit to the provision for loan losses was primarily due to net recoveries, the sale of commercial loans from the loan portfolio in the second quarter of 2014, continuing credit improvement, and changes in the composition of the loan portfolio, partially offset by loan growth in 2014. The 2013 credit was due to reductions in criticized loans and net recoveries of $2.3 million on loans previously charged off, partially offset by increases due to loan growth.
The provision/ (credit) for loan losses is determined as a result of the required level of the allowance for loan losses, estimated by management, which reflects the inherent risk of loss in the loan portfolio as of the balance sheet dates. The factors used by management to determine the level of the allowance for loan losses include the trends in problem loans, economic and business conditions, strength of management, real estate collateral values, and underwriting standards. For further details, see Part II. Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Loan Portfolio and Credit Quality” below.
Fees and other income. For the year ended December 31, 2014, fees and other income was $140.8 million, an increase of $4.5 million, or 3%, compared to 2013, after an increase of $21.2 million, or 18%, from 2012 to 2013. The 2014 increase is primarily due to increases in fee-based income including investment management fee income, wealth advisory fee income, and wealth management and trust fee income, and increased gain on sale of OREO. These changes were partially offset by the 2013 gain on sale of the Pacific Northwest banking offices, decreases in other income and lower gains on repurchase of debt and on sale of loans. The 2013 decrease is primarily due to the gain on sale of the Pacific Northwest banking offices, and increases in fee-based income including investment management fee income, wealth advisory fee income, wealth management and trust fee income, and other banking fee income. These changes were partially offset by decreases in gain on repurchase of debt and gain on sale of loans.
Investment management fee income for the year ended December 31, 2014 was $47.1 million, an increase of $3.3 million, or 8%, compared to 2013, after an increase of $4.7 million, or 12%, from 2012 to 2013. AUM at the Investment Managers increased $0.4 billion, or 4%, to $10.8 billion at December 31, 2014 from $10.4 billion at December 31, 2013. In 2014, the increase in AUM was primarily the result of market appreciation of $1.1 billion, partially offset by net outflows of $0.7 billion. Investment management fees are typically calculated based on a percentage of AUM. Changes in revenue generally lag one quarter behind changes in AUM. The 2013 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 fee income for the year ended December 31, 2014 was $48.1 million, an increase of $5.7 million, or 14%, compared to 2013, after an increase of $4.7 million, or 12%, from 2012 to 2013. AUM as of December 31, 2014, managed by the Wealth Advisors was $9.9 billion, an increase of $0.5 billion, or 6%, compared to December 31, 2013. AUM changes for the Wealth Advisors in 2014 were primarily the result of market appreciation of $0.3 billion and net inflows of $0.3 billion. AUM changes for the Wealth Advisors in 2013 were primarily the result of market appreciation of $1.0 billion and net inflows of $0.3 billion.
Wealth management and trust fee income for the year ended December 31, 2014 was $34.6 million, an increase of $8.0 million, or 30%, after an increase of $2.9 million, or 12%, from 2012 to 2013. AUM at the Bank increased $4.7 billion, or over 100%, to $9.3 billion at December 31, 2014 from $4.6 billion at December 31, 2013. In 2014, Boston Private Bank acquired Banyan, which added $4.3 billion in AUM. Excluding the acquisition of Banyan, AUM increased 6% as a result of market appreciation of $0.3 billion and net inflows of $0.1 billion. Wealth management and trust fees are typically calculated based on a percentage of AUM. In 2013, the increase in AUM was primarily the result of market appreciation of $0.5 billion and net inflows of $0.1 billion.
Gain on sale of loans for the year ended December 31, 2014 was $2.2 million, a decrease of $0.4 million, or 14%, compared to 2013, after decreasing $0.7 million, or 22%, from 2012 to 2013. During 2014, in addition to its regular practice of originating certain residential mortgage loans with the intent of immediately selling them, the Company sold $57.0 million of loans from its commercial loan portfolio, recognizing a $1.6 million gain on sale.
Gain/ (loss) on sale of OREO for the year ended December 31, 2014 was a gain of $1.0 million, compared to a loss of less than $0.1 million in 2013, after a $0.9 million decrease from the gain in 2012 to the loss in 2013. In 2014, there was a net transfer in to OREO of $0.3 million, related to three properties, one of which was fully charged-off at transfer. This compares to net transfers (out of)/into OREO of $(0.4) million and $2.7 million in 2013 and 2012, respectively. OREO properties are recorded at the lower of the recorded investment in the loan at the time of acquisition or the fair value, as established by a current appraisal, comparable sales, and other estimates of value obtained principally from independent sources, less estimated costs to sell. Gains or losses on the sale of OREO result from changes in value of the real estate from time of acquisition to the ultimate sale.
The Company recorded a gain on the sale of the Bank’s Pacific Northwest offices for the year ended December 31, 2013 of $10.6 million. The sale of the Bank’s three Pacific Northwest offices, which was announced in December 2012, was completed in May 2013.
Total Operating Expense. Total operating expense for the year ended December 31, 2014 was $227.1 million, an increase of $6.4 million, or 3%, compared to 2013, after a decrease of $11.3 million, or 5%, from 2012 to 2013. Included in operating expense were restructuring expenses of $0.7 million in 2014, $0 in 2013, and $5.9 million in 2012. Excluding the restructuring, operating expense for the year ended December 31, 2014 increased $5.7 million, or 3%, compared to 2013, after decreasing $5.4 million, or 2%, from 2012 to 2013.
Salaries and employee benefits expense, the largest component of operating expense, for the year ended December 31, 2014 was $146.6 million, an increase of $5.9 million, or 4%, compared to 2013, after a decrease of $3.1 million, or 2%, from 2012 to 2013. 75% of the increase in 2014 was due to the acquisition of Banyan. Other factors include higher variable, bonus and incentive compensation. The decrease in 2013 was primarily due to lower salaries, bonus, and stock grant expenses related to the sale of the Bank’s three offices in the Pacific Northwest and the efficiencies gained from the 2012 restructuring. These decreases were partially offset by increased performance- and commission-based compensation, and post-employment benefits.
Occupancy and equipment expense for the year ended December 31, 2014 was $31.0 million, an increase of $1.2 million, or 4%, compared to 2013, after a decrease of $1.0 million, or 3%, from 2012 to 2013. 69% of the increase in 2014 was due to the acquisition of Banyan. Other factors include increased rent and depreciation related to occupying new office space at some of the Company's affiliates. The decrease in 2013 was primarily related to a $1.5 million decrease in rent expense at the Bank, which was due to the sale of the three Pacific Northwest offices and savings on a renegotiated lease.
Professional services expense for the year ended December 31, 2014 was $12.5 million, an increase of $0.4 million, or 3%, compared to the same period in 2013 after a decrease of $1.0 million, or 8%, from 2012 to 2013. 79% of the increase in 2014 was due to the acquisition of Banyan. Other factors include the acceleration of certain fee-sharing arrangements in the investment management segment, partially offset by a decrease in legal and audit expenses. The decrease in 2013 was primarily due to decreases in legal services for general corporate and loan workout matters, as well as decreases in director and audit fees.
Marketing and business development expense for the year ended December 31, 2014 was $8.0 million, an increase of $0.9 million, or 13%, compared to 2013, after a decrease of $0.2 million, or 3%, from 2012 to 2013. The increase in 2014 was primarily related to additional marketing programs at the Bank, some of which related to the acquisition of Banyan.
Restructuring expense of $0.7 million was incurred in year ended December 31, 2014 related to the acquisition of Banyan. No restructuring expense was incurred in 2013, while $5.9 million was incurred in 2012 related to a senior executive restructuring at the Holding Company and Bank in order to create a more streamlined organization and to refine the Company’s cost base. See Part II. Item 8. “Financial Statements and Supplementary Data - Note 2: Restructuring” for further detail.
Other expense for the year ended December 31, 2014 was $14.1 million, a decrease of $2.9 million, or 17%, compared to 2013, after remaining relatively flat from 2012 to 2013. The 2014 decrease was primarily due to lower prepayment penalties recognized in 2014.
Income Tax Expense. Income tax expense for continuing operations for the year ended December 31, 2014 was $32.4 million. The effective tax rate for continuing operations for the year ended December 31, 2014 was 32.4%, compared to effective tax rates of 33.1% and 30.0% in 2013 and 2012, respectively. The effective tax rate and expense for 2014 was lower than 2013 primarily due to an increase in earnings from tax-exempt investments, income tax credits and income attributable to noncontrolling interests. In addition, state and local income taxes for 2014 were lower than 2013 primarily due to the benefit of the New York tax law changes recognized in 2014 as compared to the expense for the settlement of the New York state tax audit recognized in 2013. These reductions were partially offset by an increase in unrecognized tax benefits in 2014 as a result of interactions with taxing authorities. The effective tax rate for continuing operations for the years 2014 and 2013 were higher than 2012 primarily due to earnings from tax-exempt investments, state and local income taxes, income tax credits and income attributable to noncontrolling interests. These factors each have a different impact on the effective tax rate due primarily to the increase in income before taxes in years 2014 and 2013 as compared to 2012. See Part II. Item 8. “Financial Statements and Supplementary Data - Note 17: Income Taxes” for further detail.
Net Income from Discontinued Operations. Net income from discontinued operations for the year ended December 31, 2014, was $6.2 million, a decrease of $1.6 million, or 21%, compared to 2013, after an increase of $0.2 million, or 2%, from 2012 to 2013. The 2014 decrease was primarily due to additional revenue received in 2013 from an affiliate divested in 2012 as part of the negotiated sale agreement. The 2013 increase was primarily due to additional revenue received from an affiliate divested in 2012 as part of the negotiated sale agreement. The majority of net income from discontinued operations relates to a revenue sharing agreement with Westfield which continues through December 2017.
Financial Condition
Condensed Consolidated Balance Sheets and Discussion
Total Assets. Total assets increased $360.8 million to $6.8 billion at December 31, 2014 from $6.4 billion at December 31, 2013. This increase was due to the increase in loans and investments as well as the increase in goodwill and intangible assets due to the acquisition of Banyan.
Cash and Investments. Total cash and investments (consisting of cash and cash equivalents, investment securities, and stock in the FHLBs) increased $141.4 million, or 14%, to $1.2 billion, or 17% of total assets at December 31, 2014 from $1.0 billion, or 16% of total assets at December 31, 2013. The increase was due to the $138.3 million, or 20%, increase in available-for-sale securities, and the $28.7 million, or 26%, increase in held-to-maturity securities, partially offset by the $19.3 million, or 10%, decrease in cash and cash equivalents. The changes in cash and investments were the net result of short-term fluctuations in liquidity due to changes in levels of deposits, borrowings and loans outstanding. The purchase of the held-to-maturity securities provided the Bank with longer duration, higher yield investments.
The majority of the investments held by the Company are held by the Bank. The Bank’s investment policy requires management to maintain a portfolio of securities which will provide liquidity necessary to facilitate funding of loans, to cover
deposit fluctuations, and to mitigate the Bank’s overall balance sheet exposure to interest rate risk, while at the same time earning a satisfactory return on the funds invested. The securities in which the Bank may invest are subject to regulation and are generally limited to securities that are considered “investment grade.”
Purchases of available-for-sale and held-to-maturity securities, net of investment maturities, principal payments, and sales, used $167.6 million of cash during the year ended December 31, 2014, compared to $123.4 million in net proceeds for the year ended December 31, 2013. Net proceeds are generally used to purchase new investments or fund a portion of loan growth. The timing of sales and reinvestments is based on various factors, including management’s evaluation of interest rate trends, credit risk, and the Company’s liquidity. The Company’s available-for-sale investment portfolio carried a total of $6.8 million of unrealized gains and $3.6 million of unrealized losses at December 31, 2014, compared to $4.5 million of unrealized gains and $7.6 million of unrealized losses at December 31, 2013. For information regarding the weighted average yield and maturity of investments, see Part II. Item 8. “Financial Statements and Supplementary Data - Note 4: Investment Securities.”
No impairment losses were recognized through earnings related to investment securities during the year ended December 31, 2014 and 2013. The amount of investment securities in an unrealized loss position greater than 12 months as well as the total amount of unrealized losses was not significant and was primarily due to movements in interest rates since the securities were purchased.
The Company had no intent to sell any securities in an unrealized loss position at December 31, 2014, and it was not more likely than not that the Company would be forced to sell any of these securities prior to the full recovery of all unrealized losses.
The following table summarizes the Company’s carrying value (fair value) of available-for-sale investments at the dates indicated:
______________________
(1)
All mortgage-backed securities are guaranteed by U.S. government agencies or government-sponsored entities.
Additionally, at December 31, 2014 and December 31, 2013, the Company held $140.7 million and $112.0 million, respectively, of held-to-maturity securities at amortized cost. All of the held-to-maturity securities were mortgage-backed securities which were guaranteed by U.S. government agencies or government-sponsored entities. No held-to-maturity securities were held at December 31, 2012.
Loans held for sale. Loans held for sale increased $1.0 million, or 16%, to $7.1 million at December 31, 2014 from $6.1 million at December 31, 2013. The balance of loans held for sale usually relates to the timing and volume of residential loans originated for sale and the ultimate sale transaction which is typically executed within a short-time following the loan origination. During 2014 and 2013, respectively, the Bank sold $57.0 million and $9.1 million of loans that had been held in the loan portfolio. The decision to sell these loans was made to improve the Bank’s liquidity and capital position as well as to give the Bank additional flexibility for more profitable and strategic future lending opportunities.
Goodwill and intangible assets, net. Goodwill and intangible assets increased $61.0 million, or 47%, to $191.8 million at December 31, 2014 from $130.8 million at December 31, 2013. The increase was due primarily to the Boston Private Bank acquisition of Banyan in the fourth quarter of 2014, partially offset by the amortization of intangible assets. The Company tests goodwill for impairment on an annual basis and between annual dates if events or circumstances change that would more likely than not reduce the fair value of the reporting unit below its carrying value, in accordance with ASC 350, Intangibles-Goodwill and Other. Management performed its annual goodwill impairment testing in the fourth quarter of 2014 and concluded at December 31, 2014 that there was no impairment, nor were there any triggering events during the year ended December 31, 2014.
Other. Other assets, consisting of OREO, premises and equipment, net, fees receivable, accrued interest receivable, deferred income taxes, net, and other assets, remained flat at $229.3 million at December 31, 2014 as compared to $229.9 million at December 31, 2013.
OREO increased $0.2 million, or 20%, to $0.9 million at December 31, 2014 from $0.8 million at December 31, 2013. In 2014, two properties were transferred into OREO, while two properties with carrying values of zero were sold. In 2013, one property was transferred into OREO, while six properties were sold, three of which were sold as part of the sale of the Pacific Northwest banking offices. The balance at December 31, 2014 represented four properties. The balance at December 31, 2013 represented four properties, one of which was fully written off.
Deferred income taxes, net decreased $7.8 million, or 14%, to $47.6 million at December 31, 2014 from $55.4 million at December 31, 2013. The decrease was primarily due to a decline in the gross deferred tax assets for allowance for loan losses and unrealized loss on investments and an increase in the gross deferred tax liability for goodwill and acquired intangible assets, partially offset by an increase in the gross deferred tax asset for deferred and accrued compensation. At December 31, 2014, no valuation allowance on the net deferred tax asset was required, other than for capital losses, due primarily to the expectation of future taxable income, the ability to carry back current taxable income, and the availability of historical taxable income.
Other assets, which consist primarily of Bank-owned life insurance (“BOLI”), prepaid expenses, investment in partnerships, the fair value of interest rate derivatives, and other receivables, increased $1.9 million, or 2%, to $120.0 million at December 31, 2014 from $118.0 million at December 31, 2013. The increase was primarily due to increases in prepaid expenses, derivatives, and BOLI, partially offset by decreases in security deposits and accounts receivable.
Deposits. Total deposits increased $343.5 million, or 7%, to $5.5 billion, at December 31, 2014 from $5.1 billion at December 31, 2013. Deposits are the principal source of the Bank’s funds for use in lending, investments, and liquidity. Certificates of deposits represented approximately 11% and 12% of total deposits at December 31, 2014 and December 31, 2013, respectively. See Part II. Item 8. “Financial Statements and Supplementary Data - Note 10: Deposits” for further information.
The following table sets forth the average balances and interest rates paid on the Bank’s deposits:
Certificates of deposit in denominations of $100,000 or greater had the following schedule of maturities:
Borrowings. Total borrowings (consisting of securities sold under agreements to repurchase, FHLB borrowings, and junior subordinated debentures) decreased $69.0 million, or 12%, to $0.5 billion at December 31, 2014 from $0.6 billion at December 31, 2013.
FHLB borrowings increased $2.9 million, or 1%, to $370.2 million at December 31, 2014 from $367.3 million at December 31, 2013. FHLB borrowings are generally used to provide additional funding for loan growth when it is in excess of deposit growth and to manage interest rate risk, but can also be used as an additional source of liquidity for the Bank. During 2014, the Company incurred prepayment penalties related to the prepayment of FHLB borrowings of approximately $0.8 million, as compared to $0.4 million in 2013. The purpose of these transactions was to reduce higher cost borrowings as liquidity from lower cost deposit growth exceeded loan growth in 2014.
Repurchase agreements decreased $71.9 million, or 70%, to $30.5 million at December 31, 2014 from $102.4 million at December 31, 2013. There were no prepayment penalties incurred on repurchase agreements in 2014, as compared to $1.4 million during 2013. Repurchase agreements are generally linked to commercial demand deposit accounts with an overnight sweep feature.
Other. Other liabilities, which consist primarily of accrued interest, accrued bonus, the fair value of interest rate derivatives, and other accrued expenses increased $14.6 million, or 15%, to $112.2 million at December 31, 2014 from $97.6 million at December 31, 2013. The increase was primarily due to an increase in bonus accruals, supplemental executive retirement plan (“SERP”) liability, and the unrealized loss on interest rate derivatives.
Loan Portfolio and Credit Quality
Loans. Total portfolio loans increased $157.5 million, or 3%, to $5.3 billion, or 78%, of total assets at December 31, 2014, from $5.1 billion, or 79%, of total assets at December 31, 2013. Increases in residential loans of $99.8 million, or 5%, commercial and industrial loans of $87.0 million, or 10%, and home equity and other consumer loans of $24.2 million, or 10%, were partially offset by a decrease in construction and land loans of $28.6 million, or 19% and commercial real estate loans of $25.0 million, or 1%. The change in commercial real estate loans includes the impact of the sale of $57.0 million of these loans during 2014.
The Bank specializes in lending to individuals, real estate investors, and middle market businesses, including corporations, partnerships, associations and nonprofit organizations. Loans made by the Bank to individuals may include residential mortgage loans and mortgage loans on investment or vacation properties, unsecured and secured personal lines of credit, home equity loans, and overdraft protection. Loans made by the Bank to businesses include commercial and mortgage loans, revolving lines of credit, working capital loans, equipment financing, community lending programs, and construction and land loans. The types and sizes of loans the Bank originates are limited by regulatory requirements.
The Bank’s loans are affected by the economic and real estate markets in which they are located. Generally, commercial real estate, construction, and land loans are affected more than residential loans in an economic downturn.
Geographic concentration. The following table presents the Company’s outstanding loan balance concentrations at December 31, 2014 based on the location of the regional offices to which they are attributed.
Loan Portfolio Composition. The following table sets forth the Bank’s outstanding loan balances for certain loan categories at the dates indicated and the percent of each category to total Bank loans. The table does not include immaterial loans at the Holding Company or at Wealth and Investment affiliates.
________________
(1)
Includes commercial and industrial loans and commercial real estate loans.
Commercial, Construction and Land Loans. Included within commercial loans are all commercial real estate loans, and commercial and industrial loans. Commercial real estate loans are generally acquisition financing for commercial properties such as office buildings, retail properties, apartment buildings, and industrial/warehouse space. Commercial and industrial loans include working capital and revolving lines of credit, term loans for equipment and fixed assets, and Small Business Administration (“SBA”) loans. Construction and land loans include loans for financing of new developments as well as financing for improvements to existing buildings.
Residential Loans. While the Bank has no minimum size for mortgage loans, it concentrates its origination activities in the “Jumbo” segment of the market. This segment consists of loans secured by single-family and one-to-four unit properties in excess of the amount eligible for purchase by the Federal National Mortgage Association, which was $417 thousand at December 31, 2014 for the “General” limit and $470 thousand to $626 thousand for single-family properties for the “High-Cost” limit, depending on which specific geographic region of the Bank’s primary market areas the loan was originated. The majority of the Bank’s residential loan portfolio, including jumbo mortgage loans, are ARMs. The ARM loans the Bank originates generally have a fixed interest rate for the first 3 to 7 years and then adjust annually based on a market index such as U.S. Treasury or LIBOR yields. ARM loans may negatively impact the Bank’s interest income when they reprice if yields on U.S. Treasuries or LIBOR are lower than the yields at the time of origination. If rates reset higher, the Bank could see increased delinquencies if clients’ ability to make payments is impacted by the higher payments.
Home Equity, Consumer, and Other Loans. Home equity, consumer, and other loans consist of balances outstanding on second mortgages, home equity lines of credit, consumer loans including personal lines of credit, and loans arising from overdraft protection extended to individual and business clients. Personal lines of credit are typically for high net worth clients whose assets may not be liquid due to investments or closely held stock. The amount of home equity, consumer, and other loans typically depends on client demand.
Portfolio mix. The portfolio mix of the Bank’s loans as of December 31, 2014 remained stable as compared to prior years as evidenced by the Loan Portfolio Composition table presented above. Commercial loans, which include both commercial and industrial loans and commercial real estate loans, comprised 52% of the total loan portfolio as of December 31, 2014, unchanged from 52% as of December 31, 2013. Residential loans comprised 41% of the total loan portfolio as of December 31, 2014, up from 40% of the total loan portfolio as of December 31, 2013. Home equity, consumer, and other loans comprised 5% of the total loan portfolio, unchanged from 5% of the total loan portfolio as of December 31, 2013. Construction and land loans comprised 2% of the total loan portfolio as of December 31, 2014, down from 3% as of December 31, 2013.
The following table discloses the scheduled contractual maturities of loans in the Bank’s portfolio at December 31, 2014. Loans having no stated maturity are reported as due in one year or less. The following table also sets forth the dollar amounts of loans that are scheduled to mature after one year segregated between fixed and adjustable interest rate loans.
________________
(1)
Includes commercial and industrial loans, commercial real estate loans, and construction and land loans.
Scheduled contractual maturities typically do not reflect the actual maturities of loans. The average maturity of loans is substantially less than their average contractual terms because of prepayments and, in the case of conventional mortgage loans, due on sale clauses, which generally gives the Bank the right to declare a loan immediately due and payable in the event, among other things, that the borrower sells the real property subject to the mortgage. The average life of mortgage loans tends to increase when current market rates are substantially higher than rates on existing mortgage loans and decrease when current market rates are substantially lower than rates on existing mortgages (due to refinancing of adjustable-rate and fixed-rate loans at lower rates). Under the latter circumstances, the weighted average yield on loans decreases as higher yielding loans are repaid or refinanced at lower rates. In addition, due to the likelihood that the Bank will, consistent with industry practice, “rollover” a significant portion of commercial real estate and commercial loans at or immediately prior to their maturity by renewing credit on substantially similar or revised terms, the principal repayments actually received by the Bank are anticipated to be significantly less than the amounts contractually due in any particular period. A portion of such loans also may not be repaid due to the borrowers’ inability to satisfy the contractual obligations of the loan.
The interest rates charged on loans vary with the degree of risk, maturity, and amount of the loan and are further subject to competitive pressures, market rates, the availability of funds, and legal and regulatory requirements. At December 31, 2014, approximately 61% of the Bank’s outstanding loans due after one year had interest rates that were either floating or adjustable in nature. See Part II. Item 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate Sensitivity and Market Risk
The Company considers interest rate risk to be a significant market risk for the Bank. Interest rate risk is the exposure to adverse changes in the net income of the Company as a result of changes in interest rates. Consistency in the Company’s earnings is related to the effective management of interest rate-sensitive assets and liabilities due to changes in interest rates, and on the degree of fluctuation of investment management fee income due to movements in the bond and equity markets.
Fee income from investment management, wealth advisory, and wealth management and trust services is not directly dependent on market interest rates and may provide the Company a relatively stable source of income in varying market interest rate environments. However, this fee income is generally based upon the value of AUM and, therefore, can be significantly affected by changes in the values of equities and bonds. Furthermore, performance fees and partnership income earned by some of the Company’s affiliates, as managers of limited partnerships, are directly dependent upon short-term investment performance that can fluctuate significantly with changes in the capital markets. The Company does not have any trading operations for its own account.
In addition to directly impacting net interest income (“NII”), changes in the level of interest rates can also affect (i) the amount of loans originated and sold by the Company, (ii) the ability of borrowers to repay adjustable rate loans, (iii) the average maturity of loans and mortgage-backed securities, (iv) the rate of amortization of premiums paid on securities and, (v) the amount of unrealized gains and losses on securities available for sale.
The principal objective of the Bank’s asset/liability management (“ALM”) is to maximize profit potential while minimizing the vulnerability of its operations to changes in interest rates by means of managing the ratio of interest rate-sensitive assets to interest rate-sensitive liabilities within specified maturities or repricing dates. The Bank’s actions in this regard are taken under the guidance of its Asset/Liability Committee (“ALCO”), which is composed of members of the Bank’s senior management. This committee is actively involved in formulating the economic assumptions that the Bank uses in its financial planning and budgeting process and establishes policies which control and monitor the sources, uses and pricing of funds. The Bank may utilize hedging techniques to reduce interest rate risk. See Part II. Item 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
BOSTON PRIVATE FINANCIAL HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
See accompanying notes to consolidated financial statements.
BOSTON PRIVATE FINANCIAL HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
BOSTON PRIVATE FINANCIAL HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
See accompanying notes to consolidated financial statements.
BOSTON PRIVATE FINANCIAL HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
See accompanying notes to consolidated financial statements.
BOSTON PRIVATE FINANCIAL HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
See accompanying notes to consolidated financial statements.
BOSTON PRIVATE FINANCIAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1.BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Boston Private Financial Holdings, Inc. (the “Company” or “BPFH”), is a bank holding company (the “Holding Company”) with four reportable segments: Private Banking, Wealth Management and Trust, Investment Management, and Wealth Advisory.
The Private Banking segment is comprised of the banking operations of Boston Private Bank & Trust Company (the “Bank” or “Boston Private Bank”), a trust company chartered by The Commonwealth of Massachusetts, insured by the Federal Deposit Insurance Corporation (the “FDIC”), and a wholly-owned subsidiary of the Company. Boston Private Bank currently operates in three geographic markets: New England, San Francisco Bay, and Southern California. In December 2012, the Bank entered into a definitive agreement to sell its three offices in the Pacific Northwest market. The sale was completed in May 2013. The Bank currently conducts business under the name of Boston Private Bank & Trust Company in all markets.
The Wealth Management and Trust segment is comprised of Boston Private Bank's existing wealth management and trust business as well as the acquisition of Banyan Partners, LLC (“Banyan”), which Boston Private Bank purchased in the fourth quarter of 2014. The segment offers investment management, wealth management, family office, and trust services to individuals, families, and institutions. The Wealth Management and Trust segment operates in New England; South Florida; Texas; California; Atlanta, Georgia; and Madison, Wisconsin. For comparative purposes, the Wealth Management and Trust data that was previously included within the Private Banking segment has been reclassified into the Wealth Management and Trust segment.
The Investment Management segment has two consolidated affiliates, consisting of Dalton, Greiner, Hartman, Maher & Co., LLC (“DGHM”) and Anchor Capital Advisors, LLC (“Anchor”) (together, the “Investment Managers”). Effective January 1, 2013, Anchor/Russell Capital Advisors LLC (“Anchor Russell”) merged into Anchor, with Anchor as the surviving entity. Anchor Capital Holdings, LLC, the former holding company of Anchor and Anchor Russell, which was dissolved upon the merger of Anchor and Anchor Russell, has been reinstated but will remain a pass through entity with no operations. It will continue to be disregarded for tax purposes.
The Wealth Advisory segment has two consolidated affiliates, consisting of KLS Professional Advisors Group, LLC (“KLS”) and Bingham, Osborn & Scarborough, LLC (“BOS”) (together, the “Wealth Advisors” and, together with the Wealth Management and Trust and Investment Management segments, the “Wealth and Investment businesses”). In the second quarter of 2012, the Company sold its affiliate Davidson Trust Company (“DTC”). Accordingly, prior period and current financial information related to DTC is included with discontinued operations.
Basis of Presentation
The consolidated financial statements of the Company include the accounts of the Company and its wholly-owned and majority-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation, and the portion of income allocated to owners other than the Company is included in “Net income attributable to noncontrolling interests” in the consolidated statements of operations. Redeemable noncontrolling interests in the consolidated balance sheets reflect the maximum redemption value of agreements with other owners. All accounts related to divested affiliates are included within the results of discontinued operations for all periods presented.
The financial statements are prepared in accordance with accounting principles generally accepted in the United States (“U.S.”) (“GAAP”). Reclassifications of amounts in prior years’ consolidated financial statements are made whenever necessary to conform to the current year’s presentation.
On January 1, 2014, the Company early-adopted Accounting Standards Update (“ASU”) 2014-01 Investments - Equity Methods and Joint Ventures (Topic 323): Accounting for Investments in Qualified Affordable Housing Projects, (“ASU 2014-01”). As a result of adopting ASU 2014-01, amortization expense of these investments, which was previously reported as an operating expense, is now reported with income tax expense and is measured using the proportional amortization method. There was no change to the reporting of the related tax benefits from tax losses and credits, which have always been reported within income tax expense. ASU 2014-01 required retrospective adoption. Therefore, prior periods have been reclassified to conform to current period presentation. Included within income tax expense for the years ended December 31, 2014, 2013, and 2012 are $1.0 million, $0.7 million, and $0.6 million, respectively, of amortization of investments and $1.1 million, $0.7 million, and $0.6 million, respectively, of related tax benefits from tax losses and credits.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Use of Estimates
In preparing the consolidated financial statements, management is required to make certain estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and revenues and expenses for the period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to change, in the near term, relate to the determination of the allowance for loan losses, evaluation of potential impairment of goodwill and other intangibles, and income tax estimates.
Significant Group Concentrations of Credit Risk
Most of the Company’s activities are with clients within the New England, San Francisco Bay, and Southern California regions of the country. The Company does not believe it has any significant concentrations in any one industry, geographic location, or with any one client. Part II. Item 8. “Financial Statements and Supplementary Data - Note 4: Investment Securities,” highlights the types of securities in which the Company invests, and Part II. Item 8. “Financial Statements and Supplementary Data - Note 5: Loan Portfolio and Credit Quality,” describes the concentration of the Private Banking loan data based on the location of the lender.
Statement of Cash Flows
For purposes of reporting cash flows, the Company considers cash and due from banks and federal funds sold, all of which have original maturities with 90 days or less, to be cash equivalents.
Cash and Due from Banks
The Bank is required to maintain average reserve balances in an account with the Federal Reserve based upon a percentage of certain deposits. As of December 31, 2014 and 2013, the daily amounts required to be held in the aggregate for the Bank were $8.1 million and $5.8 million, respectively.
Investment Securities
Available-for-sale investment securities are reported at fair value, with unrealized gains and losses credited or charged, net of the estimated tax effect, to accumulated other comprehensive income/(loss). Held-to-maturity investment securities are those which the Company has the positive intent and ability to hold to maturity and are reported at amortized cost.
Premiums and discounts on the investment securities are amortized or accreted into net interest income by the level-yield method. Actual prepayment experience is reviewed periodically and the timing of the accretion and amortization is adjusted accordingly. Gains and losses on the sale of the available-for-sale investments are recognized at the trade date on a specific identification basis. Dividend and interest income is recognized when earned and is recorded on the accrual basis as adjusted for amortization of premium and accretion of discount.
The Company conducts a quarterly review and evaluation of its investment securities to determine if the decline in fair value of a security below its amortized cost is deemed to be other-than-temporary. Other-than-temporary impairment losses are recognized on securities when: (i) the holder has an intention to sell the security; (ii) it is more likely than not that the security will be required to be sold prior to recovery; or (iii) the holder does not expect to recover the entire amortized cost basis of the security. Other-than-temporary losses are reflected in earnings as a charge against gain on sale of investments, net, to the extent the impairment is related to credit losses. The amount of the impairment related to other factors is recognized in accumulated other comprehensive income/ (loss). The Company has no intention to sell any securities in an unrealized loss position at December 31, 2014 nor is it more likely than not that the Company would be required to sell such securities prior to the recovery of the unrealized losses. As of December 31, 2014, the Company believes that all impairments of investment securities are temporary in nature. No other-than-temporary impairment losses were recognized in the consolidated statements of operations for the years ended December 31, 2014, 2013, and 2012.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Loans Held for Sale
Loans originated and held for sale in the secondary market are carried at the lower of cost or estimated fair value in the aggregate. Fair value is based on commitments on hand from investors or prevailing market prices. Unrealized losses, if any, are recognized through a valuation allowance by charges to income. Loans transferred to the held for sale category from the loan portfolio are transferred at the lower of cost or fair value, usually as determined at the individual loan level. If fair value is less than cost, then a charge for the difference will be made to the allowance for loan losses if the decline in value is due to credit issues. Gains or losses on the sale of loans are recognized at the time of sale on a specific identification basis. Interest income is recognized on an accrual basis when earned.
Loans
Loans are carried at the principal amount outstanding, net of deferred loan origination fees and costs, charge-offs, and interest payments applied to principal on nonaccrual loans. Loan origination fees, net of related direct incremental loan origination costs, are deferred and recognized into income over the contractual lives of the related loans as an adjustment to the loan yield, using the level-yield method. If a loan is paid off prior to maturity, the unamortized portion of net fees/cost is recognized into interest income. If a loan is sold, the unamortized portion of net fees/cost is recognized at the time of sale as a component of the gain or loss on sale of loans.
When the Company analyzes its loan portfolio to determine the adequacy of its allowance for loan losses, it categorizes the loans by portfolio segment and class of financing receivable based on the similarities in risk characteristics for the loans. The Company has determined that its portfolio segments and classes of financing receivables are one and the same. The level at which the Company develops and documents its allowance for loan loss methodology is consistent with the grouping of financing receivables based upon initial measurement attributes, risk characteristics, and the Company’s method for monitoring and assessing credit risks. These portfolio segments and classes of financing receivables are:
•
Commercial and industrial
•
Commercial real estate
•
Construction and land
•
Residential mortgage
•
Home equity
•
Consumer and other
The past due status of a loan is determined in accordance with its contractual repayment terms. All portfolio segments are reported past due when one scheduled payment is due and unpaid for 30 days or more.
The Bank’s policy is to discontinue the accrual of interest on a loan when the collectability of principal or interest is in doubt. When management determines that it is probable that the Bank will not collect all principal and interest on a loan in accordance with the original loan terms, the loan is designated as impaired. Impaired loans are usually commercial loans, which include construction and land loans, for which it is probable that the Company will not collect all amounts due according to the contractual terms of the loan agreement, and all loans restructured in a troubled debt restructuring. Accrual of interest income is discontinued and all interest previously accrued but not collected is reversed against current period interest income when a loan is initially classified as nonaccrual. Generally, interest received on nonaccrual loans is applied against principal or, on a limited basis, reported as interest income on a cash basis, when according to management’s judgment, the collectability of principal is reasonably assured. The Bank’s general policy for returning a loan to accrual status requires the loan to be brought current, for the client to show a history of making timely payments (generally six consecutive months), and when the financial position of the borrower and other relevant factors indicate there is no longer doubt as to the collectability of the loan.
The Bank’s loan commitments are generally short-term in nature with terms that are primarily variable. Given the limited interest rate exposure posed by the commitments, the Bank estimates the fair value of these commitments to be immaterial.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Credit Quality Indicators
The Bank uses a risk rating system to monitor the credit quality of its loan portfolio. Loan classifications are assessments made by the Bank of the status of the loans based on the facts and circumstances known to the Bank, including management’s judgment, at the time of assessment. Some or all of these classifications may change in the future if there are unexpected changes in the financial condition of the borrower, including but not limited to, changes resulting from continuing deterioration in general economic conditions on a national basis or in the local markets in which the Bank operates adversely affecting, among other things, real estate values. Such conditions, as well as other factors which adversely affect borrowers’ ability to service or repay loans, typically result in changes in loan default and charge-off rates, and increased provisions for loan losses, which would adversely affect the Company’s financial performance and financial condition. These circumstances are not entirely foreseeable and, as a result, it may not be possible to accurately reflect them in the Company’s analysis of credit risk.
A summary of the rating system used by the Bank follows:
Pass - All loans graded as pass are considered acceptable credit quality by the Bank and are grouped for purposes of calculating the allowance for loan losses. Only commercial loans, including commercial real estate, commercial and industrial loans, and construction and land loans are given a numerical grade. For residential, home equity and consumer loans, the Bank classifies loans as pass unless there is known information such as delinquency or client requests for modifications which, due to financial difficulty, would then generally result in a risk rating such as special mention or more severe depending on the factors.
Special Mention - Loans rated in this category are defined as having potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may, at some future date, result in the deterioration of the repayment prospects for the credit or the Bank’s credit position. These loans are currently protected but have the potential to deteriorate to a substandard rating. For commercial loans, the borrower’s financial performance may be inconsistent or below forecast, creating the possibility of liquidity problems and shrinking debt service coverage. In loans having this rating, the primary source of repayment is still good, but there is increasing reliance on collateral or guarantor support. Collectability of the loan is not yet in jeopardy. In particular, loans in this category are considered more variable than other categories, since they will typically migrate through categories more quickly.
Substandard - Loans rated in this category are inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. A substandard credit has a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected. Substandard loans may be either still accruing or nonaccruing depending upon the severity of the risk and other factors such as the value of the collateral, if any, and past due status.
Doubtful - Loans rated in this category indicate that collection or liquidation in full on the basis of currently existing facts, conditions, and values, is highly questionable and improbable. Loans in this category are usually on nonaccrual and classified as impaired.
Restructured Loans
When the Bank, for economic or legal reasons related to a borrower’s financial difficulties, grants a concession to a troubled borrower that it would not otherwise consider, the loan is classified as a restructured loan pursuant to Accounting Standards Codification (“ASC”) 470, Debt. The concession either stems from an agreement between the creditor and the Bank or is imposed by law or a court. The concessions may include:
•
Deferral of principal and/or interest payments
•
Lower interest rate as compared to a new loan with comparable risk and terms
•
Extension of the maturity date
•
Reduction in the principal balance owed
All loans whose terms have been modified in a troubled debt restructuring, including commercial, residential, and consumer, are evaluated for impairment under ASC 310, Receivables.
Generally, a nonaccrual loan that is restructured remains on nonaccrual status for a period of at least six months to demonstrate that the borrower can meet the restructured terms. However, performance prior to the restructuring, or significant events that coincide with the restructuring, are considered when assessing whether the borrower can meet the new terms and
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
may result in the loan being returned to accrual status at the time of the restructuring or after a shorter performance period. If the borrower’s ability to meet the revised payment schedule is uncertain, the loan remains classified as a nonaccrual loan.
A loan may be removed from a restructured classification after the next fiscal year end, if the restructured terms include a market interest rate and the borrower has demonstrated performance with the restructured terms.
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); Securities and Exchange Commission (“SEC”) Staff Accounting Bulletin No. 102, Selected Loan Loss Methodology and Documentation Issues; 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 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 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, as well as 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).
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
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. When a collateral dependent loan becomes impaired, an updated appraisal of the collateral is obtained, if appropriate. 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 consider broker opinions of value as well as other qualitative factors 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 for loan losses or increases to adversely graded loans based on their judgments about information available to them at the time of their examination.
Reserve for Unfunded Loan Commitments
The Company maintains a reserve for unfunded loan commitments for such items as unused portion of lines of credit and unadvanced construction loans. The reserve is maintained at a level that reflects the risk in these various commitments. Once a loan commitment is funded, the reserve for unfunded loan commitment is reversed and a corresponding allowance for loan loss reserve is established. This unfunded loan commitment reserve is included in other liabilities in the consolidated balance sheets. Net adjustments to the reserve for unfunded commitments are included in other operating expense in the consolidated statements of operations.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Other Real Estate Owned (“OREO”)
OREO is comprised of property acquired through foreclosure proceedings or acceptance of a deed-in-lieu of foreclosure in partial or total satisfaction of certain loans. Properties are recorded at the lower of the recorded investment in the loan at the time of acquisition or the fair value, as established by a current appraisal, comparable sales, and other estimates of value obtained principally from independent sources, less estimated costs to sell. Any decline in fair value compared to the carrying value of a property at the time of acquisition is charged against the allowance for loan losses. Any subsequent valuation adjustments to reflect declines in current fair value, as well as gains or losses on disposition are reported in gain/(loss) on OREO, net in the consolidated statements of operations. Expenses incurred for holding or maintaining OREO properties such as real estate taxes, utilities, and insurance are charged as incurred to other operating expenses in the consolidated statements of operations. Rental income earned, although generally minimal, is offset against other operating expenses.
Premises and Equipment
Premises and equipment consists of leasehold improvements, furniture, fixtures, equipment, art, buildings, and land. Equipment consists primarily of computer equipment. Premises and equipment are carried at cost, less accumulated depreciation and amortization. Depreciation and amortization are computed primarily by the straight-line method over the estimated useful lives of the assets, or the terms of the leases, if shorter, for leasehold improvements. The estimated useful lives for leasehold improvements and buildings are 5-15 years and 40 years, respectively. The estimated useful life for furniture and fixtures is 2-10 years and is 3-5 years for computer equipment. The costs of improvements that extend the life of an asset are capitalized, while the cost of repairs and maintenance are expensed as incurred. Neither land nor art are depreciated.
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, trade names, 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. Trade names are not amortized. 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 expected 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 impairment exists when a reporting unit’s carrying value of goodwill exceeds its implied fair value.
An entity may assess qualitative factors to determine whether it is more likely than not (that is, a likelihood of more than 50 percent) that the fair value of a reporting unit is less than its carrying amount, including goodwill (“Step 0”). In evaluating whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount, an entity assesses relevant events and circumstances, such as the following:
•
Macroeconomic conditions such as a deterioration in general economic conditions, limitations on accessing capital, or other developments in equity and credit markets.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
•
Industry and market considerations such as a deterioration in the environment in which an entity operates, an increased competitive environment, a decline in market-dependent multiples or metrics (consider in both absolute terms and relative to peers), a change in the market for an entity’s products or services, or a regulatory or political development.
•
Overall financial performance such as negative or declining cash flows or a decline in actual or planned revenue or earnings compared with actual and projected results of relevant prior periods.
•
Other relevant entity-specific events such as changes in management, key personnel, strategy, or customers; contemplation of bankruptcy; or litigation.
•
Events affecting a reporting unit such as a change in the composition or carrying amount of its net assets, a more-likely-than-not expectation of selling or disposing all, or a portion, of a reporting unit, the testing for recoverability of a significant asset group within a reporting unit, or recognition of a goodwill impairment loss in the financial statements of a subsidiary that is a component of a reporting unit.
If, after assessing the totality of events or circumstances such as those described in the preceding paragraph, an entity determines that it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then the first and second steps of the goodwill impairment test, as described below, are unnecessary.
Goodwill is tested for impairment using a two-step process that begins with an estimation of the fair value of a reporting unit. 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 carrying value to identify potential impairment. The reporting units fall under one of the four segments: Private Banking, Wealth Management and Trust, Investment Management, and Wealth Advisory.
For the Private Banking segment, the Company utilizes a market approach to determine fair value. For the market approach, earnings and market capitalization multiples of comparable public companies are selected and applied to the Private Banking reporting unit’s applicable metrics.
For the Investment Management, Wealth Advisory, and Wealth Management and Trust segments, the Company utilizes both the income and market approaches to determine fair value. The income approach is primarily based on discounted cash flows derived from assumptions of income statement activity. For the market approach, earnings before interest, taxes, depreciation and amortization (“EBITDA”) and revenue multiples of comparable companies are selected and applied to the financial services reporting unit’s applicable metrics.
The aggregate fair values are compared to market capitalization as an assessment of the appropriateness of the fair value measurements. A control premium analysis is performed to determine whether the implied control premium was within range of overall control premiums observed in the market place.
The second step (“Step 2”) of impairment testing is necessary only if a reporting unit’s carrying amount exceeds its fair value. Step 2 compares the implied fair value of the reporting unit goodwill with the carrying amount of the goodwill for the reporting unit. The implied fair value of goodwill is determined in the same manner as goodwill that is recognized in a business combination. Significant judgment and estimates are involved in estimating the fair value of the assets and liabilities of the reporting unit. The excess goodwill is recognized as an impairment loss.
Income Tax Estimates
The Company accounts for income taxes in accordance with ASC 740, Income Taxes (“ASC 740”). The deferred tax assets and/or liabilities are determined by multiplying the differences between the financial reporting and tax reporting basis for assets and liabilities by the enacted tax rates expected to be in effect when such differences are recovered or settled. The effect on deferred taxes for a change in tax rates is recognized in income in the period that includes the enactment date. Valuation allowances on deferred tax assets are estimated based on our assessment of the realizability of such amounts. Significant management judgment is required in determining the provision for income taxes and, in particular, any valuation allowance recorded against our deferred tax assets.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
In accordance with ASC 740, deferred tax assets are to be reduced by a valuation allowance if, based on the weight of available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. The realization of the tax benefit depends upon the existence of sufficient taxable income within the carry-back and carry-forward periods.
Management considered the following items in evaluating the need for a valuation allowance:
▪
Cumulative pre-tax income, as adjusted for permanent book-to-tax differences, during the 2012 through 2014 period.
▪
Deferred tax assets are expected to reverse in periods when there will be taxable income.
▪
The Company projects sufficient future taxable income to be generated by operations during the available carryforward period.
▪
Certain tax planning strategies are available, such as reducing investments in tax-exempt securities.
▪
The Company has not had any operating loss or tax credit carryovers expiring unused in recent years.
The Company believes that it is more likely than not that the net deferred tax asset, excluding the net deferred tax asset on capital losses, will be realized based upon the ability to generate future taxable income, as well as the availability of current and historical taxable income. The net deferred tax asset at December 31, 2014 and 2013 is net of a valuation allowance for capital losses. Capital losses are deductible to the extent of offsetting capital gains and the Company does not anticipate that it will generate capital gains in future periods. Therefore, the Company has recorded a valuation allowance on capital losses in excess of capital gains as of December 31, 2014 and 2013.
Derivative Instruments and Hedging Activities
The Company records derivatives on the consolidated balance sheet at fair value. The accounting for changes in the fair value of derivatives depends on the intended use of the derivative and the resulting designation. Derivatives used to hedge exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk, such as interest rate risk, are considered fair value hedges. Derivatives used to hedge exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges.
For derivatives designated as cash flow hedges, the effective portion of changes in the fair value of the derivative is initially reported in other comprehensive income/ (loss) (a component of shareholders’ equity), net of tax, and subsequently reclassified to earnings when the hedged transaction affects earnings, and the ineffective portion of changes in the fair value of the derivative is recognized directly in earnings. The Company assesses the effectiveness of each hedging relationship by comparing the changes in cash flows of the derivative hedging instrument with the changes in cash flows of the designated hedged transactions.
For derivatives designated as fair value hedges, changes in the fair value of the derivative are recognized in earnings together with the changes in the fair value of the related hedged item. Therefore, the net amount, if any, representing hedge ineffectiveness, is reflected in earnings.
Investment Management, Wealth Advisory, and Wealth Management and Trust Fees
The Company generates fee income from providing wealth management, investment management and wealth advisory services through the Wealth and Investment businesses and from providing trust services to its clients at the Bank. Investment management fees are generally based upon the value of assets under management and are billed monthly, quarterly, or annually. Asset-based advisory fees are recognized as services are rendered and are based upon a percentage of the fair value of client assets managed. Certain wealth advisory fees are not asset-based and are negotiated individually with clients. Any fees collected in advance are deferred and recognized as income over the period earned. Performance-based advisory fees are generally assessed as a percentage of the investment performance realized on a client’s account, generally over an annual period, and are not recognized until any contingencies in the contract that could require the performance fee to be reduced have been eliminated.
Assets under management and advisory (“AUM”) at the Company’s consolidated affiliates totaled $29.9 billion and $24.3 billion at December 31, 2014 and 2013, respectively. These assets are not included in the consolidated financial statements since they are held in a fiduciary or agency capacity and are not assets of the Company.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Stock-Based Incentive Plans
At December 31, 2014, the Company has three stock-based incentive compensation plans. These plans encourage and enable the officers, employees, and non-employee directors of the Company to acquire an interest in the Company. The Company accounts for share-based awards in accordance with ASC 718, Compensation - Stock Compensation. Costs resulting from the issuance of such share-based payment awards are required to be recognized in the financial statements based on the grant date fair value of the award. Stock-based compensation expense is recognized over the requisite service period, which is generally the vesting period.
Earnings Per Share (“EPS”)
Basic EPS is computed by dividing net income/ (loss) attributable to common shareholders by the weighted average number of common shares outstanding during the year. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock (such as stock warrants and stock options, among others) were exercised or converted into additional common shares that would then share in the earnings of the entity. Diluted EPS is computed by dividing net income attributable to common shareholders by the weighted average number of common shares outstanding for the year, plus an incremental number of common-equivalent shares computed using the treasury stock method. Dilutive potential common shares could consist of: stock options, performance-based restricted stock, time-based restricted stock not participating in common stock dividends, warrants or other dilutive securities, and conversion of the convertible trust preferred securities. Additionally, when dilutive, interest expense (net of tax) related to the convertible trust preferred securities is added back to net income attributable to common shareholders. The calculation of diluted EPS excludes the potential dilution of common shares and the inclusion of any related expenses if the effect is antidilutive.
Unvested time-based restricted stock issued prior to 2013 and Series B Non-Cumulative Perpetual Contingent Convertible Preferred Stock (“Series B Preferred”), both of which include the right to receive non-forfeitable dividends, are considered to participate with common stock in undistributed earnings for purposes of computing EPS. Companies, such as BPFH, that have such participating securities are required to calculate basic EPS using the two-class method and diluted EPS using the more dilutive amount resulting from the application of either the two-class method or the if-converted method. Calculations of basic and diluted EPS under the two-class method (i) exclude from the numerator any dividends paid or owed on participating securities and any undistributed earnings considered to be attributable to participating securities, and (ii) exclude from the denominator the dilutive impact of the participating securities. Calculations of EPS under the if-converted method (i) include in the numerator any dividends paid or owed on participating securities, and (ii) include the dilutive impact of the participating securities using the treasury stock method.
The Company repurchased the Series B Preferred on April 24, 2013. The effects of the Series B Preferred for the year ended December 31, 2013 are on a weighted average basis for purposes of calculating EPS.
In 2013, the Company adjusted its time-based restricted stock grant agreements so that dividends would be accumulated and paid only upon vesting, only as to the amount of shares that vest. As a result of this adjustment, time-based restricted stock granted in or after 2013 no longer contains a right to receive non-forfeitable dividends, and therefore is not considered a participating security for purposes of the EPS calculation. Time-based restricted stock issued prior to 2013 was not modified and is still considered a participating security until it vests or is forfeited or cancelled.
For the calculation of the Company’s EPS, see Part II. Item 8. “Financial Statements and Supplementary Data - Note 16: Earnings Per Share.”
Recent Accounting Pronouncements
In January 2014, the Financial Accounting Standards Board (the “FASB”) issued ASU No. 2014-04, Receivables - Troubled Debt Restructuring by Creditors (Subtopic 310-40) - Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure. The amendments to this update are intended to clarify when a creditor should be considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan such that the loan should be derecognized and the real estate recognized. The new guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2014 and interim periods within annual periods beginning after December 15, 2015. The Company does not expect this ASU to have a material effect on its consolidated financial statements.
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606) (“ASU 2014-09”), amending the ASC and creating a new Topic 606, Revenue from Contracts with Customers. This issuance was part of the joint project between the FASB and the International Accounting Standards Board to clarify the principles of recognizing revenue and to develop a common revenue standard for GAAP and International Financial Reporting Standards.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
ASU 2014-09 is effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. Early adoption is not permitted. The impact of ASU 2014-09 on the Company’s consolidated financial statements is not yet known.
2.RESTRUCTURING
On May 27, 2011, the Company completed the merger of its four private banks, operating in the New England, San Francisco Bay, Southern California and Pacific Northwest markets, under a single Massachusetts charter. During this period of restructuring, the Company sought to reduce expenses by simplifying the portfolio businesses and streamlining the Holding Company structure, while incurring certain merger-related expenses such as severance charges, costs to terminate contracts, legal, audit and consulting costs, and other costs. The Company had substantially completed the merger-related restructuring as planned in the first half of 2012.
During the second half of 2012, the Company implemented a senior executive restructuring at the Holding Company and Bank. The purpose of this restructuring was to create a more streamlined organization and to refine the Company’s cost base. To implement the new structure, the Company incurred an additional severance charge of $4.8 million, all during the second half of 2012. The Company expects no additional severance charges associated with this initiative.
In the fourth quarter of 2014, the Company incurred restructuring charges related to the acquisition of Banyan. The purpose of this restructuring was to realign the management structure within the Wealth Management and Trust segment. The total cost of the restructuring incurred in Q4 2014 was $0.7 million.
Restructuring expenses incurred since the plans of restructuring were first implemented in 2011 totaled $14.7 million, with the Private Banking segment incurring $9.5 million, the Wealth Management segment incurring $0.7 million and the remaining $4.5 million incurred by the Holding Company.
The following table presents a summary of the restructuring activity for the years ended December 31, 2014, 2013 and 2012.
3.ACQUISITIONS, ASSET SALES, AND DIVESTITURES
Acquisitions
On October 2, 2014, the Bank completed the acquisition of Banyan, a registered investment advisory firm headquartered in Palm Beach Gardens, Florida. At the time of acquisition, Banyan had approximately $4.3 billion in client assets and locations in New England; South Florida; Texas; California; Atlanta, Georgia; and Madison, Wisconsin.
In the transaction, Boston Private Bank acquired 100% of certain assets and liabilities of Banyan through the issuance of approximately 1.7 million shares of the Company’s stock, valued at $21.0 million, and $43.9 million in cash
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
payments to shareholders, including $5.0 million in a holdback account. The total purchase price, including estimated contingent consideration, was $66.9 million.
Goodwill of $41.9 million was recorded as a result of the transaction. The goodwill is expected to be deductible for tax purposes. Intangible assets for advisory contracts of $23.9 million were also recorded and are expected to be amortized over 12 years.
In addition to the initial BPFH shares and cash paid at closing, the shareholders of Banyan have the ability for additional stock and cash consideration to be paid in 2016 and 2017. The fair value of the contingent consideration of $2.0 million was recorded at the time of acquisition and was included in goodwill as a component of the purchase price. Any changes to the initial estimate of the contingent payments will result in income or expense to the Bank. The contingent payments will be paid if the fourth quarter of 2015 and/or 2016 annualized EBITDA, plus $3.0 million, exceeds the baseline EBITDA as defined by the Asset Purchase Agreement. The amount of the contingent payment(s) would be three times such excess amount. The 2017 payment, if any, would be reduced by the 2016 payment, if any.
The rationale for the transaction was that by merging Banyan with the existing Boston Private Bank wealth management business, additional technical expertise and financial acumen would be generated. Banyan has been merged with the existing wealth management and trust business from Boston Private Bank, and the combined company has been renamed Boston Private Wealth, LLC (“Boston Private Wealth”). As a wholly-owned subsidiary of the Bank, Boston Private Wealth will also operate as its own segment, Wealth Management and Trust, separate from the Private Banking operations of the Bank.
Assets held for sale
In December 2012, the Bank announced plans to sell its three offices in the Pacific Northwest market. The assets and liabilities to be included in this transaction did not meet the criteria for classification as a component of an entity, and therefore were classified as held for sale, and not discontinued operations, at December 31, 2012. The sale was completed in May 2013 and resulted in a pretax gain on sale of $10.6 million.
Divestitures
In the second quarter of 2012, the Company divested its interests in DTC, formerly an affiliate in the Wealth Advisory segment. The Company recorded a gain of $0.8 million on the DTC transaction, which included $0.6 million of tax benefits. The Company will have no future influence on DTC and deferred potential future gains from contingent payments, if any, until determinable. Such contingent payments were included in net income from discontinued operations in the consolidated statements of operations for the period in which the revenue is recognized. The Company recorded its final contingent payments from DTC in 2013, and recognized $1.5 million in pretax income from discontinued operations related to these contingent payments.
In 2009, the Company divested its interests in Westfield Capital Management Company, LP, formerly known as Westfield Capital Management Company, LLC (“Westfield”). While the Company will continue to have no significant involvement or influence on Westfield, it retains a 12.5% share in Westfield’s revenues (up to an annual maximum of $11.6 million) through December 2017 subject to certain conditions. The Company defers gains related to these payments until determinable. Such revenue share payments are included in net income from discontinued operations in the consolidated statements of operations for the period in which the revenue is recognized.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
4. INVESTMENT SECURITIES
The following table presents a summary of investment securities:
_________________
(1)
All mortgage-backed securities are guaranteed by U.S. government agencies or Government-sponsored entities.
In the tables below, the weighted average yield is calculated based on average amortized cost which does not include the effect of unrealized changes in fair value. Certain securities are callable before their final maturity. Additionally, certain securities (such as mortgage-backed securities) are shown within the table below based on their final (contractual) maturity, but, due to prepayments, are expected to have shorter lives.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The following table presents the maturities of investment securities available for sale, based on contractual maturity, and the weighted average yields of such securities as of December 31, 2014:
The following table presents the maturities of held-to-maturity investment securities, based on contractual maturity, and the weighted average yields of such securities as of December 31, 2014:
___________________
(1)
Certain securities are callable before their final maturity.
(2)
Mortgage-backed securities are shown based on their final (contractual) maturity, but, due to prepayments, they are expected to have shorter lives.
(3)
Yield shown on a fully taxable equivalent (“FTE”) basis.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(4)
Other securities consist of money market mutual funds and equity securities held at certain Wealth and Investment businesses.
The weighted average remaining maturity at December 31, 2014 was 9.2 years for investment securities available for sale, with $185.2 million of available-for-sale investment securities callable before maturity. The weighted average remaining maturity at December 31, 2013 was 9.7 years for investment securities available for sale, with$169.0 million of available-for-sale investment securities callable before maturity.
The weighted average remaining maturity at December 31, 2014 was 14.8 years for held-to-maturity investment securities. The weighted average remaining maturity at December 31, 2013 was 15.4 years for held-to-maturity investment securities.
The following table presents the proceeds from sales, gross realized gains and gross realized losses for available-for-sale investment securities that were sold during the following years:
The following table presents information regarding securities at December 31, 2014 having temporary impairment, due to the fair values having declined below the amortized cost of the individual securities, and the time period that the investments have been temporarily impaired.
___________________
(1)
All mortgage-backed securities are guaranteed by U.S. government agencies or Government-sponsored entities.
The U.S. government and agencies securities, government-sponsored entities securities, and mortgage-backed securities in the table above had Moody’s credit ratings of Aaa or Standard and Poor’s credit ratings of AA+. The municipal bonds in the table above had Moody’s credit ratings of at least A3 or Standard and Poor’s credit ratings of AAA. One of the U.S. government and agencies securities in the table above was not rated by Standard and Poor’s or Moody’s. The other securities consisted of equity securities. At December 31, 2014, the Company does not consider these investments other-than-temporarily impaired because the decline in fair value on investments is primarily attributed to changes in interest rates and not credit quality.
At December 31, 2014 and 2013, the amount of investment securities in an unrealized loss position greater than 12 months as well as in total was not significant and was primarily due to movements in interest rates. The Company has no intent to sell any securities in an unrealized loss position at December 31, 2014 and it is not more likely than not that the Company
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
would be forced to sell any of these securities prior to the full recovery of all unrealized loss amounts. Subsequent to December 31, 2014 and through the date of the filing of this Annual Report on Form 10-K, no securities were downgraded to below investment grade, nor were any securities in an unrealized loss position sold.
Cost method investments, which are included in other assets, can be temporarily impaired when the fair values decline below the amortized costs of the individual investments. There were no cost method investments with unrealized losses at December 31, 2014 or December 31, 2013. The Company invests primarily in low income housing partnerships which generate tax credits. The Company also holds partnership interests in venture capital funds formed to provide financing to small businesses and to promote community development. The Company had $27.0 million and $26.2 million in cost method investments included in other assets as of December 31, 2014 and December 31, 2013, respectively.
The following table presents the concentration of securities with any one issuer that exceeds ten percent of shareholders’ equity as of December 31, 2014:
5. LOAN PORTFOLIO AND CREDIT QUALITY
The Bank’s lending activities are conducted principally in the regions of New England, San Francisco Bay, and Southern California. The Bank originates single and multi-family residential loans, commercial real estate loans, commercial and industrial loans, construction and land loans, and home equity and other consumer loans. Most loans are secured by borrowers’ personal or business assets. The ability of the Bank’s single family residential and consumer borrowers to honor their repayment commitments is generally dependent on the level of overall economic conditions within the Bank’s lending areas. Commercial, construction, and land borrowers’ ability to repay is generally dependent upon the health of the economy and real estate values, including, in particular, the performance of the construction sector. Accordingly, the ultimate collectability of a substantial portion of the Bank’s loan portfolio is susceptible to changing conditions in the New England, San Francisco Bay, and Southern California economies and real estate markets.
Total loans include deferred loan origination fees/(costs), net, of $(5.4) million and $(4.1) million as of December 31, 2014 and 2013, respectively.
Mortgage loans serviced for others totaled $93.8 million and $114.1 million as of December 31, 2014 and 2013, respectively, and are not included in the Company’s total loans.
In 2014, the Bank transferred $57.0 million of commercial real estate loans from its loan portfolio to the loans held for sale category, which subsequently sold for a for a $1.6 million gain.
In 2013, the Bank transferred $9.1 million of residential loans from its loan portfolio to the loans held for sale category, which subsequently sold for a $0.2 million net gain.
In 2012, the Bank transferred $108.7 million of adjustable-rate, interest-only residential first mortgage loans from its loan portfolio to the loans held for sale category, which subsequently sold for a $0.9 million net gain.
In the fourth quarter of 2012, as part of an agreement to sell its offices in the Pacific Northwest region, the Bank transferred $276.7 million of loans from its loan portfolio to the loans held for sale category. These loans were comprised of $40.8 million of commercial and industrial loans, $151.2 million of commercial real estate loans, $2.9 million of construction and land loans, $78.5 million of residential loans, $2.0 million of home equity loans, and $1.3 million of consumer loans. The loans were transferred to held for sale at their carrying values, as there was no expected gain or loss on the sale of these loans. The loans transferred to held for sale were all performing loans.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The following table presents a summary of the loan portfolio based on the portfolio segment as of the dates indicated:
The following table presents nonaccrual loans receivable by class of receivable as of the dates indicated:
The Bank’s policy is to discontinue the accrual of interest on a loan when the collectability of principal or interest is in doubt. In certain instances, although infrequent, loans that have become 90 days or more past due may remain on accrual status if the value of the collateral securing the loan is sufficient to cover principal and interest and the loan is in the process of collection. There were no loans 90 days or more past due, but still accruing, as of December 31, 2014 and $0.1 million as of December 31, 2013. The Bank’s policy for returning a loan to accrual status requires the loan to be brought current and for the client to show a history of making timely payments (generally six consecutive months). For TDRs, a return to accrual status generally requires timely payments for a period of six months in accordance with the restructured loan terms, along with meeting other criteria.
The following tables present the payment status of loans receivable by class of receivable as of the dates indicated:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Nonaccrual and delinquent loans are affected by many factors, such as economic and business conditions, interest rates, unemployment levels, and real estate collateral values, among others. In periods of prolonged economic decline, borrowers may become more severely affected over time as liquidity levels decline and the borrower’s ability to continue to make payments deteriorates. With respect to real estate collateral values, the declines from the peak, as well as the value of the real estate at the time of origination versus the current value, can impact the level of problem loans. For instance, if the loan to value ratio at the time of renewal has increased due to the decline in the real estate value since origination, the loan may no longer meet the Bank’s underwriting standards and may be considered for classification as a problem loan dependent upon a review of risk factors.
Generally when a collateral dependent loan becomes impaired, an updated appraisal of the collateral, if appropriate, is obtained. If the impaired loan has not been upgraded to a performing status within a reasonable amount of time, the Bank will continue to obtain updated appraisals as deemed necessary, especially during periods of declining property values.
The past due status of a loan is determined in accordance with its contractual repayment terms. All loan types are reported past due when one scheduled payment is due and unpaid for 30 days or more.
The following tables present the loan portfolio’s credit risk profile by internally assigned grade and class of receivable as of the dates indicated:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The following tables present, by class of receivable, the balance of impaired loans with and without a related allowance, the associated allowance for those impaired loans with a related allowance, and the total unpaid principal on impaired loans:
___________________
(1)
Recorded investment represents the client loan balance net of historical charge-offs and historical nonaccrual interest paid, which was applied to principal.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
____________________
(1)
Recorded investment represents the client loan balance net of historical charge-offs and historical nonaccrual interest paid, which was applied to principal.
When management determines that it is probable that the Bank will not collect all principal and interest on a loan in accordance with the original loan terms, the loan is designated as impaired.
Loans that are designated as impaired require an analysis to determine the amount of impairment, if any. Impairment would be indicated as a result of the carrying value of the loan exceeding the estimated collateral value, less costs to sell, for collateral dependent loans or the net present value of the projected cash flow, discounted at the loan’s contractual effective interest rate, for loans not considered to be collateral dependent. Generally, shortfalls in the analysis on collateral dependent loans would result in the impairment amount being charged-off to the allowance for loan losses. Shortfalls on cash flow dependent loans may be carried as specific allocations to the general reserve unless a known loss is determined to have occurred, in which case such known loss is charged-off.
Loans in the held for sale category are carried at the lower of amortized cost or estimated fair value in the aggregate and are excluded from the allowance for loan losses analysis.
The Bank may, under certain circumstances, restructure loans as a concession to borrowers who are experiencing financial difficulty. Such loans are classified as TDRs and are included in impaired loans. TDRs typically result from the Bank’s loss mitigation activities which, among other things, could include rate reductions, payment extensions, and/or principal forgiveness. As of December 31, 2014 and 2013, TDRs totaled $44.8 million and $54.5 million, respectively. As of December
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
31, 2014, $24.3 million of the $44.8 million of TDRs were on accrual status. As of December 31, 2013, $28.4 million of the $54.5 million of TDRs were on accrual status. As of December 31, 2014 and 2013, the Company had $0.3 million and $0.1 million, respectively, in commitments to lend additional funds to debtors for loans whose terms had been modified in a troubled debt restructuring.
Since all TDR loans are considered impaired loans, they are individually evaluated for impairment. The resulting impairment, if any, would have an impact on the allowance for loan losses as a specific reserve or charge-off. If, prior to the classification as a TDR, the loan was not impaired, there would have been a general or allocated reserve on the particular loan. Therefore, depending upon the result of the impairment analysis, there could be an increase or decrease in the related allowance for loan losses. Many loans initially categorized as TDRs are already on nonaccrual status and are already considered impaired. Therefore, there is generally not a material change to the allowance for loan losses when a nonaccruing loan is categorized as a TDR.
The following tables present the balance of TDRs that were restructured or defaulted during the periods indicated:
__________________
(1)
Represents the following concessions: extension of term.
(2)
Represents the following concessions: extension of term.
(3)
Represents the following concessions: temporary rate reduction.
(4)
Represents the following concessions: extension of term.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
__________________
(1)
Represents the following concessions: extension of term (1 loan; post-modification recorded investment of $1.0 million); temporary rate reduction (1 loan; post-modification recorded investment of $0.2 million); and combination of concessions (1 loan; post-modification recorded investment of $0.2 million).
(2)
Represents the following concessions: extension of term (4 loans; post-modification recorded investment of $9.0 million); temporary rate reduction (1 loan; post-modification recorded investment of $0.9 million); and combination of concessions (3 loans; post-modification recorded investment of $2.4 million).
(3)
Represents the following concessions: extension of term.
(4)
Represents the following concessions: temporary rate reduction.
(5)
Represents the following concessions: extension of term.
Any loans to senior management, executive officers, and directors are made in the ordinary course of business, under normal credit terms, including interest rates and collateral requirements prevailing at the time of origination for comparable transactions with other persons and do not represent more than normal credit risk. The Bank’s current policy is generally not to originate these types of loans. As of December 31, 2014 and 2013, the Company had no loans outstanding to senior management, executive officers, and directors.
In addition, less than 1% of the Company’s loans as of December 31, 2013 were made by the Holding Company and or Wealth and Investment businesses. These loans totaled $0.1 million as of December 31, 2013. These loans were made at market rates and terms to certain principals of DGHM and BOS. As of December 31, 2014 there were no loans outstanding at the Holding Company or Wealth and Investment businesses.
6. ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is reported as a reduction of outstanding loan balances, and totaled $75.8 million and $76.4 million at December 31, 2014 and 2013, respectively.
The following tables present a summary of the changes in the allowance for loan losses for the periods indicated:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The following tables present the Company’s allowance for loan losses and loan portfolio at December 31, 2014 and 2013 by portfolio segment, disaggregated by method of impairment analysis. The Company had no loans acquired with deteriorated credit quality at December 31, 2014 or 2013.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
7. PREMISES AND EQUIPMENT
Premises and equipment consisted of the following:
Depreciation and amortization expense related to premises and equipment was $6.5 million, $6.2 million, and $6.6 million for the years ended December 31, 2014, 2013, and 2012, respectively.
The Company is obligated for minimum payments under non-cancelable operating leases. In accordance with the terms of these leases, the Company is currently committed to minimum annual payments as follows:
Additionally, the Company remains a guarantor on a non-cancelable operating lease for a divested affiliate through 2016. Minimum lease payments on this lease are $0.7 million for 2015 and $0.5 million for 2016.
Rent expense for the years ended December 31, 2014, 2013, and 2012 was $15.7 million, $14.8 million and $16.3 million, respectively.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
8. GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill
The following tables details the changes in carrying value of goodwill by segment during the year ended December 31, 2014. There were no changes in the carrying value of goodwill during 2013.
The following tables detail total goodwill and the cumulative impairment charges thereon as of December 31, 2014 and 2013:
In 2014, additional goodwill of $41.9 million was recorded as a result of the acquisition of Banyan. In the fourth quarter of 2014, goodwill of $2.4 million was reclassified from the Private Banking segment to the newly-created Wealth Management and Trust segment. In 2013, the Company recognized no additional goodwill.
ASC 350, Intangibles - Goodwill and Other, requires the Company to test goodwill and intangible assets for impairment on an annual basis and in between annual dates if events or circumstances change that would more likely than not reduce the fair value of the reporting unit below its carrying value.
Management performed its annual goodwill and intangibles impairment testing during the fourth quarters of 2014 and 2013. The estimated fair value for all reporting units exceeded the carrying value, which resulted in no goodwill or intangible asset impairment charges.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Intangible assets
The following table shows the gross and net carrying amounts of identifiable intangible assets at December 31, 2014 and 2013:
The Company recognized additional identifiable intangible assets of $23.9 million in advisory contracts in 2014 related to the acquisition of Banyan, and less than $0.1 million in 2013 related to mortgage servicing rights.
Boston Private Bank acquired Banyan on October 2, 2014 and allocated approximately $41.9 million of the purchase price to goodwill and $23.9 million to amortizable intangible assets. The intangible assets consist of advisory contracts, including referral networks, and will be amortized over a 12 year period based on the expected economic benefits. See Part I. Item 1. “Notes to Consolidated Financial Statements - Note 3: Acquisitions, Asset sales, and Divestitures” for further details.
Consolidated expense related to intangible assets subject to amortization was $4.8 million, $4.3 million, and $4.4 million for 2014, 2013, and 2012, respectively.
Management reviews, and adjusts if necessary, intangible asset amortization schedules to ensure that the remaining life on the amortization schedule accurately reflects the useful life of the intangible asset. The weighted average amortization period of these intangible assets is 4.65 years.
The estimated annual amortization expense for these identifiable intangibles over the next five years is:
9. DERIVATIVES AND HEDGING ACTIVITIES
The Company is exposed to certain risks arising from both its business operations and economic conditions. The Company principally manages its exposures to a wide variety of business and operational risks through management of its core business activities. The Company manages economic risks, including interest rate, liquidity, and credit risk, primarily by managing the amount, sources, and duration of its assets and liabilities and, to a lesser extent, the use of derivative financial instruments. Specifically, the Company enters into derivative financial instruments to manage exposures that arise from business activities that result in the receipt or payment of future known and uncertain cash amounts, the value of which are generally determined by interest rates. The Company’s derivative financial instruments are used to manage differences in the amount, timing, and duration of the Company’s known or expected cash receipts and its known or expected cash payments principally related to certain loans, deposits, and borrowings.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The following table presents the fair value of the Company’s derivative financial instruments as well as their classification on the consolidated balance sheets as of December 31, 2014 and 2013.
___________________
(1)
For additional details, see Part II. Item 8. “Financial Statements and Supplementary Data - Note 21: Fair Value of Financial Instruments.”
The following table presents the effect of the Company’s derivative financial instruments in the consolidated statement of operations for the years ended December 31, 2014 and 2013.
The Holding Company and the Bank have agreements with their derivative counterparties that contain provisions where, if the Holding Company or Bank defaults on any of its indebtedness, including default where repayment of the indebtedness has not been accelerated by the lender, then the Holding Company or the Bank could also be declared in default on its derivative obligations. The Holding Company and the Bank were in compliance with these provisions as of December 31, 2014 and 2013.
The Holding Company and the Bank also have agreements with certain of their derivative counterparties that contain provisions where, if the Holding Company or Bank fails to maintain its status as a well- or adequately-capitalized institution, then the counterparty could terminate the derivative positions and the Holding Company or the Bank would be required to settle its obligations under the agreements. The Holding Company and the Bank were in compliance with these provisions as of December 31, 2014 and 2013.
Certain of the Holding Company and the Bank’s agreements with their derivative counterparties contain provisions where if specified events or conditions occur that materially change the Holding Company’s or the Bank’s creditworthiness in an adverse manner, the Holding Company or the Bank may be required to fully collateralize their obligations under the derivative instruments. The Holding Company and the Bank were in compliance with these provisions as of December 31, 2014 and 2013.
As of December 31, 2014 and 2013, the termination amounts related to collateral determinations of derivatives in a liability position was $8.9 million and $6.1 million, respectively. The Company has minimum collateral requirements with its derivative counterparties and has posted cash collateral of $3.7 million and $7.3 million, respectively, and pledged securities of $7.0 million and $1.5 million, respectively, as of December 31, 2014 and 2013, against its obligations under these agreements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Cash Flow Hedges of Interest Rate Risk
The Company’s objective in using derivatives is to add stability to interest income and expense and to manage the risk related to exposure to changes in interest rates. To accomplish this objective, the Holding Company entered into an interest rate swap in the second quarter of 2010 with a notional amount of $75 million related to the Holding Company’s cash outflows associated with the subordinated debt related to trust preferred securities to protect against rising London Interbank Offered Rate (“LIBOR”). The interest rate swap had an effective date of December 30, 2010 and a term of 5 years. As of December 30, 2010, the subordinated debt switched from a fixed rate of 6.25% to a variable rate of three-month LIBOR plus 1.68%. The interest rate swap effectively fixed the Holding Company’s interest rate payments on the $75 million of debt at 4.45%.
The Bank also entered into a total of six interest rate swaps, one during 2014 with an effective date of June 1, 2014, and five during 2013 with effective dates of December 1, 2014, September 2, 2014, June 1, 2014, March 1, 2014, and August 1, 2013. The six interest rate swaps each have a notional amount of $25 million and have terms ranging from three to six years. The Bank’s risk management objective and strategy for these interest rate swaps is to reduce its exposure to variability in interest-related cash outflows attributable to changes in the LIBOR swap rate associated with borrowing programs for each of the periods, initially expected to be accomplished with LIBOR-indexed brokered deposits, but may also include LIBOR-indexed FHLB advances. The interest rate swaps will effectively fix the Bank’s interest payments on $150 million of its LIBOR-indexed liabilities at rates between 1.17% and 2.32%, and a weighted average rate of 1.85%.
The Company uses the “Hypothetical Derivative Method” described in ASC 815, Derivatives and Hedging (“ASC 815”), for quarterly prospective and retrospective assessments of hedge effectiveness, as well as for measurements of hedge ineffectiveness. Under this method, the Company assesses the effectiveness of each hedging relationship by comparing the changes in cash flows of the derivative hedging instrument with the changes in cash flows of the designated hedged transactions. The effective portion of changes in the fair value of the derivative is initially reported in other comprehensive income (“OCI”) (outside of earnings) and subsequently reclassified to earnings in interest and dividend income when the hedged transactions affect earnings. Ineffectiveness resulting from the hedge is recorded as a gain or loss in the consolidated statement of operations as part of fees and other income. The Company had no hedge ineffectiveness recognized in earnings during the years ended December 31, 2014 and 2013. The Company also monitors the risk of counterparty default on an ongoing basis.
A portion of the balance reported in accumulated other comprehensive income related to derivatives will be reclassified to interest income or expense as interest payments are made or received on the Company’s interest rate swaps. During the next twelve months, the Company estimates that $2.7 million will be reclassified as an increase in interest expense.
Non-designated Hedges
Derivatives not designated as hedges are not speculative and result from two different services the Bank provides to qualified commercial clients. The Bank offers certain derivative products directly to such clients. The Bank economically hedges derivative transactions executed with commercial clients by entering into mirror-image, offsetting derivatives with third parties. Derivative transactions executed as part of these programs are not designated in ASC 815-qualifying hedging relationships and are, therefore, marked-to-market through earnings each period. Because the derivatives have mirror-image contractual terms, the changes in fair value substantially offset through earnings. Fees earned in connection with the execution of derivatives related to this program are recognized in the consolidated statement of operations in other income. As of December 31, 2014 and 2013, the Bank had 24 and 12 derivatives related to this program, comprised of interest rate swaps and caps, with an aggregate notional amount of $238.7 million and $150.8 million, respectively. As of December 31, 2014 and 2013, the Bank had no foreign currency exchange contracts outstanding related to this program. The derivative asset and liability values for non-designated hedges include an adjustment related to the consideration of credit risk required under ASC 820.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The following table presents the effect of the Company’s derivative financial instruments, not designated as hedging instruments, in the consolidated statements of operations for the years ended December 31, 2014 and 2013.
10. DEPOSITS
Deposits are summarized as follows:
___________________
(1) Includes brokered deposits.
Certificates of deposit had the following schedule of maturities:
Interest expense on certificates of deposit $100,000 or greater was $2.3 million, $2.4 million and $3.4 million for the years ended December 31, 2014, 2013, and 2012, respectively. At both December 31, 2014 and 2013, $0.6 million of overdrawn deposit accounts were reclassified to loans.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
11. FEDERAL FUNDS PURCHASED AND SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
The federal funds purchased generally mature within 30 days of the transaction date.
Repurchase agreements are generally linked to commercial demand deposit accounts with an overnight sweep feature. In a repurchase agreement transaction, the Bank will generally sell an investment security, agreeing to repurchase either the same or a substantially identical security on a specified later date at a price slightly greater than the original sales price. The difference in the sale price and repurchase price is the cost of the use of the proceeds, or interest expense. Repurchase transactions are accounted for as financing arrangements rather than as sales of such securities, and the obligation to repurchase such securities is reflected as a liability in the Company’s consolidated balance sheets. The securities underlying the agreements remain under the Company’s control. Investment securities with a fair value of $205.9 million and $176.4 million were pledged as collateral for the securities sold under agreements to repurchase at December 31, 2014 and 2013, respectively.
As of December 31, 2014 and 2013, the Bank had unused federal funds lines with correspondent banks of $171.0 million and $196.0 million, respectively.
12. FEDERAL HOME LOAN BANK BORROWINGS
The Bank is a member of the Federal Home Loan Bank (“FHLB”) of Boston. As a member of the FHLB of Boston, the Bank has access to short- and long-term borrowings. Borrowings from the FHLB are secured by the Bank’s stock investment in the FHLB and a blanket lien on “qualified collateral” defined principally as a percentage of the principal balance of certain types of mortgage loans. The stock investment cannot be used for additional borrowing collateral. The percentage of collateral valuation from the FHLB varies between 50% and 80% based on the underlying collateral. The Bank had loans pledged as collateral with a book value of $2.1 billion and $1.8 billion, at December 31, 2014 and 2013, respectively. Based on this collateral and the valuation applied, the Bank had borrowings outstanding of $370.2 million and $367.3 million, and available credit with the FHLB of Boston of $1.2 billion and $836.5 million, at December 31, 2014 and 2013, respectively.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
A summary of borrowings from the FHLBs is as follows:
As of December 31, 2014, $13.0 million of the FHLB borrowings are callable by the FHLB prior to maturity. As of December 31, 2013, $38.0 million of the FHLB borrowings are callable by the FHLB prior to maturity.
FHLB Stock
As a member of the FHLB, the Bank is required to own FHLB stock based on a percentage of outstanding advances in addition to a membership stock ownership requirement. Prior to the 2011 merger of the Banks, each of the Banks was a member of its local FHLB located in either Boston, Seattle, or San Francisco. At the time of the merger there were outstanding FHLB borrowings with both the FHLBs of San Francisco and Seattle. As of December 31, 2014, only borrowings with the FHLB of San Francisco remain outstanding. The FHLB stock with Seattle can be redeemed at par subject to a waiting period. The FHLB stock with San Francisco can be redeemed, subject to a waiting period, at par when the remaining advance matures.
For the borrowings with the FHLB of Boston, the Bank is required to own FHLB stock of at least 3.0% to 4.5% of outstanding advances depending on the terms of the advance. In addition, the Bank is required to have a minimum Membership Stock Investment which is based on a percentage of certain assets as reported in the Bank’s FDIC Call Report. FHLB of Boston stock owned in excess of the minimum requirements can be redeemed at par upon request by a member.
As of December 31, 2014 and 2013, the Bank’s FHLB stock holdings totaled $32.3 million and $38.6 million, respectively, of which $27.5 million and $30.8 million, respectively was invested in the FHLB of Boston. The Bank’s investment in FHLB stock is recorded at cost and is redeemable at par. The remaining FHLB stock holdings are invested in the FHLB of San Francisco, of which Borel and First Private were members prior to the merger, and the FHLB of Seattle, of which Charter was a member prior to the merger.
13. JUNIOR SUBORDINATED DEBENTURES
The schedule below presents the detail of the Company’s junior subordinated debentures:
All of the Company’s junior subordinated debentures mature in more than five years.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Boston Private Capital Trust II junior subordinated debentures
In September 2005, the Company and Boston Private Capital Trust II, a Delaware statutory trust (“Trust II”) entered into a Purchase Agreement for the sale of $100 million of trust preferred securities issued by Trust II and guaranteed by the Company on a subordinated basis. Trust II’s preferred securities pay interest quarterly and had an annual distribution rate of 6.25% up to, but not including, December 30, 2010. Subsequently, Trust II’s preferred securities converted to a floating rate of a three-month LIBOR plus 1.68%; provided, however, that the interest rate does not exceed the highest rate permitted by New York law, and may be modified by the U.S. law of general application. At December 31, 2014, the interest rate for the Trust II’s preferred securities was 1.94%. The Company entered into an interest rate swap agreement beginning on December 30, 2010 to hedge the floating rate for a portion of this security. See Part II. Item 8. “Financial Statements and Supplementary Data - Note 9: Derivatives and Hedging Activities” for additional details.
Each of the Trust II preferred securities represents an undivided beneficial interest in the assets of Trust II. The Company owns all of Trust II’s common securities. Trust II’s only assets will be the junior subordinated debentures issued to it by the Company on substantially the same payment terms as Trust II’s preferred securities. The Company’s investment in Trust II was $3.1 million at both December 31, 2014 and 2013.
The junior subordinated debentures mature on December 30, 2035 and became redeemable after December 30, 2010.
The Company has the following covenants with regard to Trust II:
•
for so long as Trust II’s preferred securities remain outstanding, the Company shall maintain 100% ownership of the Trust II’s common securities;
•
the Company will use its commercially reasonable efforts to ensure Trust II remains a statutory trust, except in connection with a distribution of debt securities to the holders of the Trust II securities in liquidation of Trust II, the redemption of all Trust II’s securities or mergers, consolidations or incorporation, each as permitted by Trust II’s declaration of trust;
•
to continue to be classified as a grantor trust for U.S. federal income tax purposes; and
•
the Company will ensure each holder of Trust II’s preferred securities is treated as owning an undivided beneficial interest in the junior subordinated debentures.
At December 31, 2014 and 2013, the Company was in compliance with the above covenants.
So long as the Company is not in default in the payment of interest on the junior subordinated debentures, the Company has the right under the indenture to defer payments of interest for up to 20 consecutive quarterly periods. The Company has no current intention to exercise its right to defer interest payments on the junior debentures issued to Trust II. If the Company defers interest payments, it would be subject to certain restrictions relating to the payment of dividends on or purchases of its capital stock and payments on its debt securities ranking equal with or junior to the junior subordinated debentures.
Boston Private Capital Trust I junior subordinated debentures
In 2004, the Company and Boston Private Capital Trust I, a Delaware statutory trust (“Trust I”), entered into a Purchase Agreement and an option, which was exercised in 2004, for the sale of a combined total of $105 million of convertible trust preferred securities to be issued by Trust I and guaranteed by the Company on a subordinated basis. The convertible trust preferred securities have a liquidation amount of $50.00 per security, pay interest quarterly and have a fixed distribution rate of 4.875%. The quarterly distributions are cumulative. The junior subordinated convertible debentures will mature on October 1, 2034.
From 2009 through 2013, the Company executed a series of repurchases totaling $104.98 million of Trust I’s convertible preferred securities, recognizing a combined pre-tax gain on repurchases of $26.5 million, including gains of $3.4 million in 2012 and $0.6 million in 2013. In 2014, the Company repurchased no trust preferred securities, and therefore recognized no gain on repurchase.
As of December 31, 2014, there was an immaterial amount remaining outstanding of the Trust I convertible trust preferred securities. The Company’s investment in Trust I was $3.2 million at both December 31, 2014 and 2013.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
14. NONCONTROLLING INTERESTS
At the Company, noncontrolling interests typically consist of equity owned by management of the Company’s respective majority-owned affiliates. Net income attributable to noncontrolling interests in the consolidated statements of operations represents the net income allocated to the noncontrolling interest owners of the affiliates. Net income allocated to the noncontrolling interest owners was $4.8 million, $3.9 million, and $3.1 million for the years ended December 31, 2014, 2013, and 2012, respectively.
On the consolidated balance sheets, noncontrolling interests are included as the sum of the capital and undistributed profits allocated to the noncontrolling interest owners. Typically, this balance is included in a company’s permanent shareholders’ equity in the consolidated balance sheets. When the noncontrolling interest owners’ rights include certain redemption features, as described in ASC 480, Distinguishing Liabilities from Equity, such redeemable noncontrolling interests are classified as mezzanine equity and are not included in permanent shareholders’ equity. Due to the redemption features of the noncontrolling interests discussed in this footnote, the Company had redeemable noncontrolling interests held in mezzanine equity in the accompanying consolidated balance sheets of $20.9 million and $19.5 million at December 31, 2014 and 2013, respectively. The aggregate amount of such redeemable noncontrolling equity interests are recorded at the estimated maximum redemption values, as discussed below. In addition, as discussed below, the Company had $0.4 million and $0.2 million in noncontrolling interests included in permanent shareholders’ equity at December 31, 2014 and 2013, respectively.
Each non-wholly owned affiliate operating agreement provides the Company and/or the noncontrolling interests with contingent call or put redemption features used for the orderly transfer of noncontrolling equity interests between the affiliate noncontrolling interest owners and the Company at either a contractually predetermined fair value, multiple of EBITDA, or fair value. The Company may liquidate these noncontrolling interests in cash, shares of the Company’s common stock, or other forms of consideration dependent on the operating agreement.
Generally, these put and call redemption features refer to shareholder rights of both the Company and the noncontrolling interest owners of the Company’s majority-owned affiliate companies. The affiliate company noncontrolling interests generally take the form of limited liability companies (LLC) units, profits interests, or common stock (collectively, the “noncontrolling equity interests”). In most circumstances, the put and call redemption features generally relate to the Company’s right and, in some cases, obligation to purchase and the noncontrolling equity interests’ right to sell their equity interests. There are various events that could cause the puts or calls to be exercised, such as a change in control, death, disability, retirement, resignation or termination. The puts and calls are generally to be exercised at the then fair value or a contractually agreed upon approximation thereof. The terms of these rights vary and are governed by the respective individual operating and legal documents.
The following table presents the contractually determined maximum redemption values to repurchase the noncontrolling interests by affiliate, at the periods indicated:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The following is a summary, by individual affiliate, of the terms of the put and call options:
Anchor
The Company, through its acquisition of Anchor, acquired approximately an 80% interest in each of Anchor and Anchor Russell on June 1, 2006. Effective January 1, 2013, Anchor Russell merged into Anchor, with Anchor as the surviving entity. Anchor management and employees own the remaining noncontrolling equity interests of the firm, approximately 20%. The Anchor operating agreement describes a process for the orderly transfer of noncontrolling equity interests between the Company and the Anchor noncontrolling interest owners at a contractually agreed upon value, with appraisal rights for all parties. Certain events, such as death, disability, retirement, resignation, or termination, may result in repurchase of the noncontrolling equity interests by the Company at the then contractually agreed upon value. The Anchor agreement provides a formulaic mechanism to determine the then value of the noncontrolling equity interests. These noncontrolling equity interests have a five-year vesting period. Beginning six months after vesting, a holder of noncontrolling equity interests may put up to 10% of his or her outstanding equity interests annually to the Company. The six-month holding period ensures the risks and rewards of ownership are transferred to the holder of the noncontrolling equity interests. Holders of noncontrolling equity interests must retain 50% of their total outstanding units until such time as they leave the firm.
During the second quarter of 2013, the Company sold certain repurchased noncontrolling interests to principals at Anchor with modified contingent call and put redemption features. These modified noncontrolling interests have the same terms and conditions as the previously issued noncontrolling interests with the exception that they require the approval of the Company’s CEO in order to be exercised. Therefore, these modified noncontrolling interests are not considered to be mandatorily redeemable and are not included in the redeemable noncontrolling interests within mezzanine equity, but rather within permanent equity.
The maximum redemption value, based on the contractually determined maximum redemption value formula, to repurchase the remaining approximately 20% of Anchor’s noncontrolling equity interests is approximately $11.9 million and $11.5 million, as of December 31, 2014 and 2013, respectively. Of the $11.9 million of noncontrolling equity interests at December 31, 2014, $0.4 million is included in permanent equity and the remainder is included in mezzanine equity. Of the $11.5 million of noncontrolling equity interests at December 31, 2013, $0.2 million is included in permanent equity and the remainder is included in mezzanine equity.
BOS
The Company acquired approximately a 70% interest in BOS through a series of purchases dating back to February 5, 2004. The remaining approximate 30% is owned by BOS principals. The BOS operating agreement describes a procedure for the orderly transfer of noncontrolling equity interests between the BOS noncontrolling interest owners and the Company at the then fair value, with appraisal rights for all parties. Certain events, such as death, disability, retirement, resignation, or voluntary termination, subject to the vesting period, will result in repurchase of the noncontrolling equity interests by the Company at the then fair value, unless another noncontrolling interest owner opts to purchase the noncontrolling equity interests in question. These noncontrolling equity interests have vesting periods of up to seven years. Immediately after vesting, a holder of noncontrolling equity interests may put up to the greater of 10% of his or her outstanding equity interests or 1% of total outstanding equity interests in BOS annually to the Company. Any unexercised portion of the annual put option can be carried forward to future years, provided that noncontrolling interest owners retain approximately 50% of their total outstanding units until such time as they leave the firm. The maximum redemption value, based on fair value, to repurchase the remaining approximately 30% of BOS’ noncontrolling equity interests is approximately $6.1 million and $5.3 million as of December 31, 2014 and 2013, respectively.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
DGHM
The Company, through its acquisition of DGHM, acquired an 80% interest in DGHM on February 6, 2004. DGHM management and employees own the remaining 20% interest in DGHM. The DGHM operating agreement describes a process for the orderly transfer of noncontrolling equity interests between the Company and the DGHM noncontrolling interest owners at a contractually agreed upon value, with appraisal rights for all parties. Certain events, such as a change in control, death, disability, retirement, resignation or termination, may result in repurchase of the noncontrolling equity interests by the Company at the then contractually agreed upon value. The DGHM operating agreement provides a formulaic mechanism to determine the then value of the noncontrolling equity interests. These noncontrolling equity interests have a five-year vesting period. Beginning six months after vesting, a holder of noncontrolling equity interests may put up to 10%-20% of his or her outstanding units annually to the Company. The six-month holding period ensures the risks and rewards of ownership are transferred to the holder of the noncontrolling equity interests. Beginning in December 2009, the Company has an annual call right under which it may elect to repurchase 10-20% of the non-management and management members’ vested units. No more than 40% of the outstanding noncontrolling equity interests’ units can be put in any one year. Certain key members of DGHM management are contractually obligated to retain 50% of their noncontrolling equity interests until such time as they leave the firm. The maximum redemption value, based on the contractually determined maximum redemption value formula, to repurchase the remaining 20% of DGHM’s noncontrolling equity interests is approximately $3.3 million and $2.8 million as of December 31, 2014 and 2013, respectively.
DTC
In the second quarter of 2012, the Company completed the sale of its affiliate DTC. Prior to the sale, the Company held an approximate 70% interest in DTC since the Company’s initial investment on February 1, 2008. DTC management and employees owned the remaining 30% interest in the firm. For additional information on the sale, see Part II. Item 8. “Financial Statements and Supplementary Data - Note 3: Acquisitions, Asset Sales, and Divestitures”
The following table presents an analysis of the Company’s redeemable noncontrolling interests for the periods indicated:
Impact on EPS from Certain Changes in Redemption Value
To the extent that the increase in the estimated maximum redemption amounts exceeds the net income attributable to the noncontrolling interests, such excess may reduce net income attributable to the Company’s common shareholders for purposes of the Company’s EPS computations depending upon how the maximum redemption value is calculated. In cases where the maximum redemption value is calculated using a contractually determined value or predefined formula, such as a multiple of EBITDA, there may be a reduction to the net income attributable to the Company’s common shareholders for purposes of the Company’s EPS computations. However, in cases where maximum redemption value is calculated using the then fair value, there is no effect on EPS. Fair value can be derived through an enterprise value using market observations of comparable firms, a discounted cash flow analysis, or a combination of the two, among other things, rather than a contractually predefined formula or multiple of EBITDA.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
15. EQUITY
Preferred Stock
On April 24, 2013, the Company closed the public offering of 2,000,000 depositary shares (the “Depositary Shares”) pursuant to an Underwriting Agreement dated April 17, 2013, previously disclosed by the Company. Each Depositary Share represents a 1/40th interest in a share of the Company’s 6.95% Non-Cumulative Perpetual Preferred Stock, Series D, par value $1.00 per share and liquidation preference of $1,000 per share (the “Series D preferred stock”). The Company received $47.8 million from the issuance, after issuance costs.
Upon the issuance of the Series D preferred stock on April 24, 2013, the ability of the Company to declare and pay dividends on, or purchase, redeem or otherwise acquire, shares of its preferred stock or any securities of the Company that rank junior to the Series D preferred stock was subject to certain restrictions in the event that the Company does not declare and pay (or set aside) dividends on the Series D preferred stock for the last preceding quarterly dividend period.
Also on April 24, 2013, the Company repurchased all 400.81221 shares of the Company’s Series B Non-Cumulative Perpetual Contingent Convertible Preferred Stock, par value $1.00 per share (the “Series B preferred stock”), held by BP Holdco, L.P., a subsidiary of The Carlyle Group, L.P. (“Carlyle”), pursuant to a Stock Repurchase Agreement, dated as of April 16, 2013, previously disclosed by the Company.
The Series B Preferred stock was convertible into approximately 7.3 million shares of common stock at $5.52 per share, and participated in dividends payable on common stock on an as-converted basis. There were no mandatory redemption features and holders had no rights to require redemption. The conversion price was able to be adjusted upon various changes in outstanding shares of the Company such as the declaration of stock dividends, stock splits, issuance of stock purchase rights, self-tender offers, or a rights plan.
The Series B Preferred stock was initially issued as part of an investment agreement with Carlyle. The Company received approximately $75 million in capital. Under that agreement, Carlyle was issued Series A Preferred stock, Series B Preferred stock, and warrants to purchase shares of common stock. The Series A Preferred stock converted into common stock. In February 2012, the Company repurchased all of the warrants issued in conjunction with this transaction. During 2013, through a series of transactions, Carlyle sold its remaining common stock holdings in the Company to independent third parties on the open market and no longer holds any equity interest in the Company.
Common Stock
The Company has 170 million shares of common stock authorized for issuance. At December 31, 2014, it had 82,961,855 shares outstanding and 87,038,145 shares available for future issuance, including shares reserved for future issuance pursuant to the Company’s stock-based compensation plans, as discussed in Part II. Item 8. “Financial Statements and Supplementary Data - Note 18: Employee Benefits.” At December 31, 2013, it had 79,837,612 shares outstanding and 90,162,388 shares available for future issuance,
Warrants to purchase common stock
The Company currently has one class of warrants to purchase common stock outstanding. These warrants were initially issued to the U.S. Department of the Treasury (the “Treasury”) (the “TARP warrants”). The following table summarizes the terms of the TARP warrant agreements outstanding at December 31, 2014:
___________________
(1)
The TARP warrants, while initially issued to the Treasury, were purchased from the Treasury by unrelated third parties at a market rate.
(2)
Per the terms of the TARP warrants agreement, the exercise price and number of shares issuable upon exercise may be adjusted ratably for dividends paid on the Company’s common stock that exceed the dividend rate at the time the warrants were issued, at which time the Company paid quarterly dividends of $0.01 per share. The current warrant share number and current exercise price of the warrant reflect the warrant as adjusted for common stock dividends through February 6, 2015 the latest dividend record date prior to the filing of this Annual Report.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Accumulated Other Comprehensive Income
Comprehensive income/ (loss) represents the change in equity of the Company during a year from transactions and other events and circumstances from non-shareholder sources. It includes all changes in equity during a year except those resulting from investments by shareholders and distributions to shareholders.
The following table presents the Company’s comprehensive income/ (loss) and related tax effect for the years ended December 31, 2014, 2013, and 2012:
___________________
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(1)
Pre-tax net income attributable to the Company is calculated as income before income taxes, plus net income from discontinued operations, less net income attributable to noncontrolling interests.
The following table presents a summary of the amounts reclassified from accumulated other comprehensive income/ (loss) for the years ended December 31, 2014, 2013, and 2012:
The following table presents the components of the Company’s accumulated other comprehensive income/ (loss) as of December 31:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
16. EARNINGS PER SHARE
Earnings Per Share (“EPS”)
Basic EPS is computed by dividing net income attributable to common shareholders by the weighted average number of common shares outstanding during the year. Diluted EPS is determined in the same manner as basic EPS except that the number of shares is increased assuming exercise or contingent issuance of the options, warrants or other dilutive securities; and conversion of the convertible trust preferred securities and Series B Preferred. Additionally, when dilutive, interest expense (net of tax) related to the convertible trust preferred securities, and dividends related to the preferred stock are added back to net income attributable to common shareholders. The calculation of diluted EPS excludes the potential dilution of common shares and the inclusion of any related expenses if the effect is antidilutive.
On April, 24 2013, the Company repurchased all of its Series B Preferred stock. The effects of the Series B Preferred for the year ended December 31, 2013 are on a weighted average basis for purposes of calculating EPS.
The following table is a reconciliation of the components of basic and diluted EPS computations for the three years ended December 31:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
_____________________
(1)
See Part II. Item 8. “Financial Statements and Supplementary Data - Note 14: Noncontrolling Interests” for a description of the redemption values related to the redeemable noncontrolling interests. In accordance with ASC 480, Distinguishing Liabilities from Equity (“ASC 480”), an increase in redemption values from period to period reduces income attributable to common shareholders. Decreases in redemption value from period to period increase income attributable to common shareholders, but only to the extent that the cumulative change in redemption value remains a cumulative increase since adoption of this standard in the first quarter of 2009.
(2)
Consideration paid in excess of carrying value for the repurchase of the Series B preferred stock of $11.7 million is considered a deemed dividend and, for purposes of calculating EPS, reduces net income attributable to common shareholders for the year ended December 31, 2013.
(3)
The diluted EPS computations for the years ended December 31, 2014, 2013, and 2012 do not assume the conversion, exercise or contingent issuance of the following shares for the following periods because the result would have been antidilutive for the periods indicated. As a result of the anti-dilution, the potential common shares excluded from the diluted EPS computation are as follows:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(a)
If the effect of the conversion of the trust preferred securities would have been dilutive, interest expense, net of tax, related to the convertible trust preferred securities of $0.9 million for the year ended December 31, 2012 would have been added back to net income attributable to common shareholders for the diluted EPS computation. An immaterial amount would have been added back for the years ended December 31, 2014 and 2013.
(b)
Options to purchase shares of common stock, non-participating performance- and certain time-based restricted stock, and other dilutive securities that were outstanding at period ends were not included in the computation of diluted EPS or in the above anti-dilution table because their exercise or conversion prices were greater than the average market price of the common shares during the respective periods.
17. INCOME TAXES
The components of income tax expense for continuing operations for the years ended December 31, 2014, 2013, and 2012 are as follows:
Income tax expense attributable to income from continuing operations differs from the amounts computed by applying the Federal statutory rate to pre-tax income from continuing operations. Reconciliations between the Federal statutory income tax rate of 35% to the effective income tax rate for the years ended December 31, 2014, 2013, and 2012 are as follows:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
On March 31, 2014, New York enacted legislation that requires corporations that are engaged in unitary business operations to file combined returns with their affiliates for tax years beginning on or after January 1, 2015. Starting in 2015, all of the Company's affiliates will be included in the Company's New York tax return instead of just those affiliates with nexus to New York. In addition, the New York tax rate will be reduced from 7.1% to 6.5% for tax years beginning on or after January 1, 2016. The Company incorporated the impact of these New York law changes in 2014 due to the law being enacted in 2014. The Company adjusted the New York state applicable tax rate and apportionment percentages for purposes of measuring deferred tax assets and liabilities that will reverse after the effective date. As a result of these changes, the Company recorded a state tax benefit of $0.5 million, net of federal tax, in 2014.
The components of gross deferred tax assets and gross deferred tax liabilities at December 31, 2014 and 2013 are as follows:
Of the $7.8 million net decrease in the Company’s net deferred tax asset during 2014, $4.6 million was recognized as deferred income tax expense for continuing operations, $0.4 million was recognized as deferred income tax expense for discontinued operations, $2.4 million was recognized as a decrease to shareholders’ equity, and $0.4 million was recognized as an increase to investments in qualified affordable housing projects as a result of the Company adopting the proportional amortization method of accounting in 2014.
In accordance with ASC 740, deferred tax assets are to be reduced by a valuation allowance if, based on the weight of available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. The realization of the tax benefit depends upon the existence of sufficient taxable income within the carry-back and future periods.
The Company believes that it is more likely than not that the net deferred tax asset as of December 31, 2014, excluding the net deferred tax asset on capital losses, will be realized, based upon the ability to generate future taxable income as well as the availability of current and historical taxable income.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The Company believes the existing net deductible temporary differences that give rise to the net deferred tax asset, excluding the capital losses, will reverse in future periods when the Company expects to generate taxable income. Other positive evidence to support the realization of the Company’s net deferred tax asset includes:
•
The Company had cumulative pre-tax income, as adjusted for permanent book-to-tax differences, in the period 2012 through 2014.
•
Certain tax planning strategies are available to the Company, such as reducing investments in tax-exempt securities.
•
The Company has not had any operating loss or tax credit carryovers expiring unused in recent years.
At December 31, 2014, the Company had a $0.2 million deferred tax liability for a $0.4 million potential capital gain related to an installment sale and a $0.5 million deferred tax asset for $1.2 million of capital loss carryovers that are scheduled to expire in 2016. The Company believes it is more likely than not that the net deferred tax asset related to capital losses will not be realized and has recorded a valuation allowance of $0.3 million and $2.0 million at December 31, 2014 and 2013, respectively, attributable to this net deferred tax asset. The net change in the valuation allowance during the year ending December 31, 2014 of $1.7 million is primarily attributable to capital loss carryovers that expired in 2014.
At December 31, 2014, the Company had a $0.1 million deferred tax asset for state net operating loss carryovers totaling $1.9 million that are scheduled to expire in various tax years: $0.2 million in 2030; $0.1 million in 2031; and $1.6 million in 2032. The Company believes that it is more likely than not that the full amount of these state net operating loss carryovers will be utilized before they expire.
A reconciliation of the beginning and ending gross amount of unrecognized tax benefits under the provisions of ASC 740-10 is as follows:
Excluded from the gross amount of unrecognized tax benefits for the years ended December 31, 2014, 2013, and 2012 are the federal tax benefits associated with the gross amount of state unrecognized tax benefits which, if recognized, would affect the effective tax rate. The net amount of unrecognized tax benefit which, if recognized, would affect the effective tax rate is $0.8 million at December 31, 2014, $0.4 million at December 31, 2013, and $0.2 million at December 31, 2012.
During the year ended December 31, 2014, the Company's gross amount of unrecognized tax benefits increased $0.5 million, from $0.5 million at December 31, 2013, to $1.1 million at December 31, 2014, primarily due to interactions with taxing authorities. The Company does not currently believe there is a reasonable possibility of any significant change to unrecognized tax benefits within the next twelve months.
The Company classifies interest and penalties, if applicable, related to unrecognized tax benefits as a component of income tax expense in the consolidated statements of operations. Interest and penalties recognized as part of the Company’s income tax expense is immaterial for the year ending December 31, 2014, a benefit of $0.4 million for the year ended December 31, 2013, and an expense of $0.3 million for the year ended December 31, 2012. The accrued amounts for interest and penalties were immaterial as of December 31, 2014 and 2013 and $0.4 million as of December 31, 2012.
Federal income tax returns are either under examination or remain subject to examination by the Internal Revenue Service for all tax years subsequent to 2008. The Company is currently under examination by the Internal Revenue Service for the tax year ended December 31, 2009. The Company believes it is reasonably possible that the settlement of this examination will occur within the next twelve months and believes the resolution of this examination will not have a significant impact on the effective tax rate.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
State income tax returns for the Company’s major tax jurisdictions of California, Massachusetts, and New York have either been examined or remain subject to examination for all the tax years subsequent to 2009. The examination by the Commonwealth of Massachusetts for the tax year ended December 31, 2009 was settled in October, 2012. The resolution of this examination did not have a significant impact on the effective tax rate. The examination by the State of New York for the tax years ended December 31, 2008 through 2011 was settled in November 2013. The resolution of this examination resulted in a release of gross state unrecognized tax benefits of $1.5 million, of which $0.6 million, including the federal tax benefits associated with the gross amount of these benefits, affected the effective tax rate. As of December 31, 2014, the Company was under examination by the State of New York for the tax year ended December 31, 2012. The Company settled this examination in February 2015. The resolution of this examination did not have a significant impact on the effective tax rate.
18. EMPLOYEE BENEFITS
Employee 401(k) Profit Sharing Plan
The Company established a corporate-wide 401(k) Profit Sharing Plan (the “Plan”) for the benefit of the employees of the Company and its affiliates, which became effective on July 1, 2002. The Plan is a 401(k) savings and retirement plan that is designed to qualify as an ERISA section 404(c) plan. Generally, employees who are at least twenty-one (21) years of age are eligible to participate in the plan on their date of hire. Employee contributions may be matched based on a predetermined formula and additional discretionary contributions may be made. Consolidated 401(k) expenses for all plans were $2.4 million, $2.4 million, and $2.6 million, in the years ended December 31, 2014, 2013, and 2012, respectively.
Salary Continuation Plans
The Bank maintains a salary continuation plan for certain Borel officers in the Bank’s San Francisco Bay market, including current or former officers of the Bank. The officers become eligible for benefits under the salary continuation plan if they reach a defined retirement age while working for the Bank. The Bank also has a deferred compensation plan for certain former directors of Borel. The compensation expense relating to each contract is accounted for individually and on an accrual basis. The expense relating to these plans was $0.1 million, $0.1 million, and $0.2 million for the years ended December 31, 2014, 2013, and 2012, respectively. The amount recognized in other liabilities in the consolidated balance sheets was $1.6 million and $1.7 million at December 31, 2014 and 2013, respectively. The Bank has purchased life insurance contracts to help fund these plans. The Bank has single premium life insurance policies with cash surrender values totaling $6.0 million and $5.8 million, which are included in other assets in the consolidated balance sheets, as of December 31, 2014 and 2013, respectively.
The Bank also maintains a salary continuation plan for certain officers of FPB, including current or former officers of the Bank. The plan provides for payments to the participants at the age of retirement. The expense relating to these plans was $0.2 million for each of the years ended December 31, 2014, 2013, and 2012. The net amount recognized in other liabilities in the consolidated balance sheets was $2.1 million at both December 31, 2014 and 2013. The Bank has purchased life insurance contracts to help fund these plans. These life insurance policies have cash surrender values totaling $4.6 million and $4.5 million at December 31, 2014 and 2013, respectively, which are included in other assets in the consolidated balance sheets.
Deferred Compensation Plan
The Company offers a deferred compensation plan that enables certain executives to elect to defer a portion of their compensation. The amounts deferred are excluded from the employee’s taxable income and are not deductible for income tax purposes by the Company until paid. The employee selects from a limited number of hypothetical mutual funds and the deferred liability is increased or decreased to correspond to the fair value of these underlying hypothetical mutual fund investments. The net amount recognized in other liabilities in the consolidated balance sheets was $6.3 million and $5.8 million at December 31, 2014 and 2013, respectively. The change in value is recognized as compensation expense. The expense relating to these plans was $0.6 million, $0.9 million, and $0.5 million for the years ended December 31, 2014, 2013, and 2012, respectively. The Company established and funded a Rabbi Trust to offset this liability. The Rabbi Trust holds similar assets and approximately mirrors the activity in the hypothetical mutual funds. The net amount recognized in other assets in the consolidated balance sheets was $5.4 million and $5.1 million at December 31, 2014 and 2013, respectively. Increases and decreases in the value of the mutual funds in the Rabbi Trust are recognized in other income in the consolidated statement of operations. The income relating to this plan was $0.6 million, $1.0 million, and $0.5 million for the years ended December 31, 2014, 2013, and 2012, respectively.
Stock-Based Incentive Plans
At December 31, 2014, the Company has three stock-based compensation plans. These plans encourage and enable the officers, employees, and non-employee directors of the Company to acquire a proprietary interest in the Company.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The 2009 Stock Option and Incentive Plan (the “2009 Plan”), replaced the Company’s 2004 Stock Option and Incentive Plan. Under the 2009 Plan, the Company may grant options, stock appreciation rights, restricted stock, restricted stock units, unrestricted stock awards, performance share awards and dividend equivalent rights to its officers, employees, and non-employee directors of the Company for an amount not to exceed 2% of the total shares of common stock outstanding as of the last business day of the preceding fiscal year. The 2009 Plan provides for the authorization and issuance of 4,000,000 shares, along with any residual shares from previous plans. Under the 2009 Plan, the exercise price of each option shall not be less than 100% of the fair market value of the stock on the date the options are granted. Generally, options expire ten years from the date granted and vest over a three-year graded vesting period for officers and employees and a one-year or less period for non-employee directors. Stock grants generally vest over a three-year cliff vesting period. As of December 31, 2014 the maximum number of shares of stock reserved and available for issuance under the Plan was 2,882,787 shares.
Under the Boston Private Financial Holdings, Inc. 2010 Inducement Stock Plan (the “Inducement Plan”) for the purposes of granting equity awards to new employees as an inducement to join the Company. The Company reserved 1,245,000 shares of the Company’s common stock for issuance under the Inducement Plan. The terms of the Inducement Plan are substantially similar to the terms of the 2009 Plan. During 2012, the Company issued 7,246 shares under this plan in conjunction with an executive attaining certain performance metrics for previously-awarded shares. During 2013, the Company issued an additional 30,887 shares under this plan in conjunction with an executive attaining certain performance metrics for previously-awarded shares. During 2014, the Company issued an additional 637,804 shares under this plan in conjunction with the Bank's acquisition of Banyan. At December 31, 2014, the Inducement Plan had 91,897 shares reserved and available for issuance.
The Company maintains a qualified Employee Stock Purchase Plan (“the ESPP”). Under the ESPPs, eligible employees may purchase common stock of the Company at 85 percent of the lower of the closing price of the Company’s common stock on the first or last day of a six month purchase period on The NASDAQ® Global Select Market. Employees pay for their stock purchases through payroll deductions at a rate equal to any whole percentage from 1 percent to 15 percent of after-tax earnings. Participants have a right to a full reimbursement of ESPP deferrals through the end of the offering period. Such a reimbursement would result in a reversal of the compensation expense previously recorded, attributed to that participant. The Company issues shares under the ESPP in January and July of each year. As of December 31, 2014, there were 1,082,108 shares available for issuance in the ESPP. There were 126,219 shares issued to participants under the qualified ESPP in 2014.
Share-based payments recorded in salaries and benefits expense are as follows:
The fair value of each stock option award is estimated on the date of grant using the Black-Scholes option pricing model that uses the assumptions noted in the table below. Expected volatility is determined based on historical volatility of the Company’s stock, historical volatility of industry peers, and other factors. The Company uses historical data to estimate employee option exercise behavior and post-vesting cancellation for use in determining the expected life assumption. The risk-free rate is determined on the grant date of each award using the yield on a U.S. Treasury zero-coupon issue with a remaining term that approximates the expected term for the award. The dividend yield is based on expectations of future dividends paid by the Company and the market price of the Company’s stock on the date of grant. Compensation expense is recognized using the straight-line method over the vesting period of the option or the retirement eligible date, whichever is shorter. Options issued to retirement eligible employees are expensed on the date of grant.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The following table presents the weighted average assumptions used to determine the fair value of each option grant on the date of grant using the Black-Scholes option-pricing model in the years indicated:
__________
(1)
No options were issued in 2014 or 2013.
Stock Options
A summary of option activity under the 2009 Plan for the year ended December 31, 2014 is as follows:
The weighted-average grant-date fair value of options granted during the year ended December 31, 2012 was $5.30. The total intrinsic value of options exercised during the years ended December 31, 2014, 2013, and 2012 was $1.1 million, $0.8 million, and $0.2 million, respectively. As of December 31, 2014, there was $0.1 million of total unrecognized compensation cost related to stock option arrangements granted under the 2009 Plan that is expected to be recognized over a weighted-average period of 0.4 years.
Restricted Stock
A summary of the Company’s nonvested shares as of December 31, 2014 and changes during the year ended December 31, 2014, including shares under both the 2009 Plan and the Inducement Plan, is as follows:
The fair value of nonvested shares is determined based on the closing price of the Company’s stock on the grant date. The weighted-average grant-date fair value of shares granted during the years ended December 31, 2014, 2013, and 2012 was $12.42, $9.79, and $8.93, respectively. At December 31, 2014, there was $17.3 million of total unrecognized compensation cost related to nonvested share-based compensation arrangements under the 2009 Plan and the Inducement Plan, combined. That cost is expected to be recognized over a weighted-average period of 2.4 years. The total fair value of shares that vested during the years ended December 31, 2014, 2013, and 2012 was $5.1 million, $6.1 million, and $4.3 million, respectively.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Included in the restricted stock balances above are performance shares, which are granted to certain employees within the Company and are accounted for in the same manner as restricted stock. At December 31, 2014, there were 863,178 performance shares outstanding, which could increase up to 1,553,720 shares. If the maximum number of performance shares is issued, the Company would incur an additional $7.3 million of compensation costs related to these additional 690,542 shares. The Company recognizes the expense for performance shares based upon the most likely outcome of shares to be issued based on current forecasts.
Supplemental Executive Retirement Plans
The Company has a non-qualified supplemental executive retirement plan (“SERP”) with a former executive officer of the Company. The SERP, which is unfunded, provides a defined cash benefit based on a formula using average compensation, years of service, and age at retirement of the executive. The agreement was amended in July 2004 and then revised in February of 2007. Expected benefits were increased and the full vesting age was increased to age 70. During 2010, the executive officer retired, and the full vesting was accelerated to the actual retirement date by the Company. The estimated actuarial present value of the projected benefit obligation was $8.4 million and $8.1 million at December 31, 2014 and 2013, respectively. The expense associated with the SERP was $1.0 million, $1.4 million, and $0.5 million for the years ended December 31, 2014, 2013, and 2012, respectively. The discount rate used to calculate the SERP liability was 3.85%, 4.65%, and 3.90% for the years ended December 31, 2014, 2013, and 2012, respectively.
The Bank has a SERP with various former executives of the Pacific Northwest market. The SERP, which is unfunded, provides a defined cash benefit based on a formula using compensation, years of service, and age at retirement of the executives. The benefits for each executive under the plan are accrued until the full vesting age of 65. The actuarial present value of the projected benefit obligation was $2.8 million and $2.7 million at December 31, 2014 and 2013, respectively. The expense associated with the SERP was $0.2 million, $0.1 million, and $0.4 million for the years ended December 31, 2014, 2013, and 2012, respectively. The discount rate used to calculate the SERP liability was 3.45%, 4.25%, and 3.95%, for the years ended December 31, 2014, 2013, and 2012, respectively.
KLS has a long term incentive plan (“LTIP”) with certain of its managing directors. This LTIP, which is unfunded, provides for a profit sharing based on current year results as well as a cash benefit at the time of separation of service. The cash payment at separation of service, which is determined based on the profit share and a multiple based on years of service, is payable in three equal annual installments following separation of service. The Company has accrued $7.4 million and $5.5 million at December 31, 2014 and 2013, respectively, for future separation of service payments. The LTIP was effective beginning January 1, 2010. The expense associated with the LTIP was $1.9 million, $1.7 million, and $1.6 million for the years ended December 31, 2014, 2013, and 2012, respectively.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
19. OTHER OPERATING EXPENSE
Major components of other operating expense are as follows:
20. REPORTABLE SEGMENTS
Management Reporting
The Company has four reportable segments: Private Banking, Wealth Management and Trust, Investment Management, and Wealth Advisory, and the Parent Company (Boston Private Financial Holdings, Inc.) (the “Holding Company”). The financial performance of the Company is managed and evaluated by these four areas. The segments are managed separately as a result of the concentrations in each function.
The Company’s Segment Chief Executive Officers (“CEOs”) manage the segments and have full authority and responsibility for the performance and the allocation of resources within their respective segments. The Company’s CEO is the Company’s Chief Operating Decision Maker (“CODM”). The Segment CEO for the Private Banking segment reports to the Company’s CEO. The Segment CEO for the Wealth Management and Trust segment reports to the Company’s CEO. The Company’s CEO is also the Segment CEO for both the Wealth Advisory and Investment Management segments (the “non-banks”). The Company also has a Bank Segment Chief Financial Officer (“CFO”), a Wealth Management and Trust Segment CFO, and a non-bank Segment Controller who provide financial support to the respective Segment CEOs.
Under the current management structure, day to day activities of the non-bank affiliates are managed by the affiliate CEOs. There is only one affiliate within the Bank Segment so the affiliate Bank CEO and the Bank Segment CEO are one and the same. The Segment CEOs have authority with respect to the allocation of capital within their segments, management oversight responsibility, performance assessments, and overall authority and accountability for all of the affiliates, if any, within their segment. The Segment CEO for the non-banks communicates with the affiliate CEOs regarding profit and loss responsibility, strategic planning, priority setting and other matters. The Private Banking segment CFO, the Wealth Management and Trust segment CFO, and the non-banking Segment Controller review the affiliate financial detail with the relevant Segment CEOs. The Holding Company’s CFO reviews all affiliate financial detail with the CODM on a monthly basis.
Description of Reportable Segments
Private Banking
The Private Banking segment operates primarily in three geographic markets: New England, San Francisco Bay, and Southern California.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The Bank currently conducts business under the name of Boston Private Bank & Trust Company in all markets. The Bank is chartered by The Commonwealth of Massachusetts and is insured by the Federal Deposit Insurance Corporation (the “FDIC”). The Bank is principally engaged in providing private banking services to high net worth individuals, privately owned businesses, private partnerships, and nonprofit organizations. In addition, the Bank is an active provider of financing for affordable housing, first-time homebuyers, economic development, social services, community revitalization and small businesses.
Wealth Management and Trust
In the fourth quarter of 2014, Boston Private Bank acquired Banyan. The operations of Banyan and the operations of the existing wealth management and trust business within Boston Private Bank were combined to form a new operating segment, Wealth Management and Trust. The segment provides comprehensive wealth management solutions for high net worth individuals and families, including customized investment solutions, wealth planning, trust, and family office services. The Wealth Management and Trust segment operates in New England; South Florida; Texas; California; Atlanta, Georgia; and Madison, Wisconsin. For comparative purposes, the Wealth Management and Trust data that was previously included within the Private Banking segment has been stated separately for the periods presented in the table below. See Part II. Item 8. “Financial Statements and Supplementary Data - Note 3: Acquisitions, Asset Sales, and Divestitures” for additional details on the acquisition of Banyan.
Investment Management
The Investment Management segment has two consolidated affiliates, including DGHM and Anchor, both of which are registered investment advisers. The Investment Managers serve the needs of pension funds, endowments, trusts, foundations and select institutions, mutual funds and high net worth individuals and their families throughout the U.S. and abroad. The Investment Managers specialize in value-driven equity portfolios with products across the capitalization spectrum. The specific mix of products, services and clientele varies between affiliates. The Investment Managers are located in New England and New York, with one affiliate administrative office in South Florida.
Wealth Advisory
The Wealth Advisory segment has two consolidated affiliates, including KLS and BOS, both of which are registered investment advisers and wealth management firms. The Wealth Advisors provide comprehensive, planning-based financial strategies to high net worth individuals and their families, and non-profit institutions. The services the firms offer include fee-only financial planning, tax planning, tax preparation, estate and insurance planning, retirement planning, charitable planning and intergenerational gifting and succession planning. The Wealth Advisors manage investments covering a wide range of asset classes for both taxable and tax-exempt portfolios. The Wealth Advisors are located in New York, Southern California and Northern California. In the second quarter of 2012, the Company sold its affiliate DTC. Accordingly, prior period and current financial information related to DTC is included with discontinued operations.
Measurement of Segment Profit and Assets
The accounting policies of the segments are the same as those described in Part II. Item 8. “Financial Statements and Supplementary Data - Note 1: Basis of Presentation and Summary of Significant Accounting Policies.”
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Reconciliation of Reportable Segment Items
The following tables present a reconciliation of the revenues, profits, assets, and other significant items of reportable segments as of and for the year ended December 31, 2014, 2013, and 2012. Interest expense on junior subordinated debentures is reported at the Holding Company.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
___________________
(1)
Included in Private Banking non-interest income for the year ended December 31, 2013 is the $10.6 million gain on sale of the Bank’s three offices in the Pacific Northwest.
(2)
Operating expense for 2014 includes $0.7 million in restructuring expenses related to the newly-created Wealth Management and Trust segment. Operating expense for 2013 includes no restructuring expenses. Operating expense for 2012 includes $5.9 million of restructuring expenses; restructuring expenses incurred by the Private Banking segment amounted to $4.0 million, with the remaining $1.9 million incurred by the Holding Company.
(3)
In the second quarter of 2012, the Company sold its Wealth Advisory affiliate, DTC. Accordingly, prior period results for DTC have been reclassified into discontinued operations and are included with Holding Company and Eliminations in the tables above.
(4)
The Company’s effective tax rate for 2014, 2013, and 2012 are not consistent due to earnings from tax-exempt investments, non-deductible compensation, state and local taxes, income tax credits and income attributable to noncontrolling interests having a different impact on the effective tax rate due primarily to the different levels of income before taxes in years 2014, 2013, and 2012. See Part II. Item 8. “Financial Statements and Supplementary Data - Note 17: Income Taxes” for additional details.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(5)
Net income from discontinued operations for the years ended December 31, 2014, 2013 and 2012 of $6.2 million, $7.8 million, and $7.6 million, respectively, are included in Holding Company and Eliminations in the calculation of net income attributable to the Company.
21. FAIR VALUE OF FINANCIAL INSTRUMENTS
Fair value is defined under GAAP as the exchange price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants on the measurement date. The Company determines the fair values of its financial instruments based on the fair value hierarchy established in ASC 820, Fair Value Measurements and Disclosures (“ASC 820”), which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. ASC 820 describes three levels of inputs that may be used to measure fair value. Financial instruments are considered Level 1 when valuation can be based on quoted prices in active markets for identical assets or liabilities. Level 2 financial instruments are valued using quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or models using inputs that are observable or can be corroborated by observable market data of substantially the full term of the assets or liabilities. Financial instruments are considered Level 3 when their values are determined using pricing models, discounted cash flow methodologies or similar techniques and at least one significant model assumption or input is unobservable and when determination of the fair value requires significant management judgment or estimation.
The following tables present the Company’s assets and liabilities measured at fair value on a recurring basis as of December 31, 2014 and 2013, aggregated by the level in the fair value hierarchy within which those measurements fall:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
As of December 31, 2014 and 2013, available-for-sale securities consisted primarily of U.S. government and agency securities, government-sponsored entities securities, municipal bonds, mortgage-backed securities, and other available-for-sale securities. The equities (which are categorized as other available-for-sale securities) and, at December 31, 2014, two U.S. Treasury securities, are valued with prices quoted in active markets. Therefore, they have been categorized as a Level 1 measurement. The government-sponsored entities securities, municipal bonds, mortgage-backed securities, and certain investments in Small Business Administration (“SBA”) loans (which are categorized as U.S. government and agencies securities) generally have quoted prices but are traded less frequently than exchange-traded securities and can be priced using market data from similar assets. Therefore, they have been categorized as a Level 2 measurement. No investments held at December 31, 2014 or 2013 were categorized as Level 3.
The Company uses interest rate customer swaps, interest rate swaps and a junior subordinated debenture interest rate swap to manage its interest rate risk, and customer foreign exchange forward contracts to manage its foreign exchange risk, if any. The valuation of these instruments is determined using widely accepted valuation techniques including discounted cash flow analysis on the expected cash flows of each derivative. This analysis reflects the contractual terms of the derivatives, including the period to maturity, and uses observable market-based inputs, including interest rate curves and implied volatilities. Therefore, they have been categorized as a Level 2 measurement as of December 31, 2014 and 2013. See Part II. Item 8. “Financial Statements and Supplementary Data - Note 9: Derivatives and Hedging Activities” for further details.
To comply with the provisions of ASC 820, the Company incorporates credit valuation adjustments to appropriately reflect both its own nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements. In adjusting the fair value of its derivative contracts for the effect of nonperformance risk, the Company has considered the impact of netting and any applicable credit enhancements, such as collateral postings, thresholds, mutual puts and guarantees. Counterparty exposure is evaluated by netting positions that are subject to master netting agreements, as well as considering the amount of collateral securing the position.
The Company has determined that the majority of the inputs used to value its derivatives fall within Level 2 of the fair value hierarchy, although the credit valuation adjustments associated with its derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by itself and its counterparties. As a result, the Company has determined that its derivative valuations in their entirety are classified in Level 2 of the fair value hierarchy as of December 31, 2014 and 2013.
Other investments, which are not considered available-for-sale investments, consist of deferred compensation trusts, which consist of publicly traded mutual fund investments that are valued at prices quoted in active markets. Therefore, they
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
have been categorized as a Level 1 measurement as of December 31, 2014 and 2013. The remaining other investments categorized as Level 2 consist of the Company’s cost-method investments as of December 31, 2014 and 2013.
There were no Level 3 assets at December 31, 2014 or 2013.
The following tables present the Company’s assets and liabilities measured at fair value on a non-recurring basis during the periods ended December 31, 2014 and 2013, respectively, aggregated by the level in the fair value hierarchy within which those measurements fall.
___________________
(1)
Collateral-dependent impaired loans held at December 31, 2014 that had write-downs in fair value or whose specific reserve changed during 2014.
___________________
(1)
Collateral-dependent impaired loans held at December 31, 2013 that had write-downs in fair value or whose specific reserve changed during 2013.
The following table presents additional quantitative information about assets measured at fair value on a non-recurring basis for which the Company has utilized Level 3 inputs to determine fair value.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Impaired loans include those loans that were adjusted to the fair value of underlying collateral as required under ASC 310, Receivables. The amount does not include impaired loans that are measured based on expected future cash flows discounted at the respective loan’s original effective interest rate, as that amount is not considered a fair value measurement. The Company uses appraisals, which management may adjust to reflect estimated fair value declines, or apply other discounts to appraised values for unobservable factors resulting from its knowledge of the property or consideration of broker quotes. The appraisers use a market, income, and/or a cost approach in determining the value of the collateral. Therefore they have been categorized as a Level 3 measurement.
The following tables present the carrying values and fair values of the Company’s financial instruments that are not measured at fair value on a recurring basis (other than certain loans, as noted below):
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The estimated fair values have been determined by using available quoted market information or other appropriate valuation methodologies. The aggregate fair value amounts presented do not represent the underlying value of the Company taken as a whole.
The fair value estimates provided are made at a specific point in time, based on relevant market information and the characteristics of the financial instrument. The estimates do not provide for any premiums or discounts that could result from concentrations of ownership of a financial instrument. Because no active market exists for some of the Company’s financial instruments, certain fair value estimates are based on subjective judgments regarding current economic conditions, risk characteristics of the financial instruments, future expected loss experience, prepayment assumptions, and other factors. The resulting estimates involve uncertainties and therefore cannot be determined with precision. Changes made to any of the underlying assumptions could significantly affect the estimates.
Cash and cash equivalents
The carrying value reported in the balance sheets for cash and cash equivalents approximates fair value due to the short-term nature of their maturities and are classified as Level 1.
Held-to-maturity investment securities
Held-to-maturity securities currently include mortgage-backed securities. All held-to-maturity securities are fixed income instruments that are not quoted on an exchange, but may be traded in active markets. The fair value of these securities are based on quoted market prices obtained from external pricing services. The principal market for our securities portfolio is the secondary institutional market, with an exit price that is predominantly reflective of bid level pricing in that market. Accordingly, held-to-maturity securities are included in the Level 2 fair value category.
Loans, net
Fair value estimates are based on loans with similar financial characteristics. Fair values of commercial and residential mortgage loans are estimated by discounting contractual cash flows adjusted for prepayment estimates and using discount rates approximately equal to current market rates on loans with similar credit and interest rate characteristics and maturities. The fair value estimates for home equity and other loans are based on outstanding loan terms and pricing in the local markets. The method of estimating the fair value of the loans disclosed in the table above does not incorporate the exit price concept in the presentation of the fair value of these financial instruments. Net loans are included in the Level 3 fair value category based upon the inputs and valuation techniques used.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Loans held for sale
Loans held for sale are recorded at the lower of cost or fair value in the aggregate. Fair value estimates are based on actual commitments to sell the loans to investors at an agreed upon price or current market prices if rates have changed since the time the loan closed. Accordingly, loans held for sale are included in the Level 2 fair value category.
Other financial assets
Other financial assets consist of accrued interest and fees receivable, stock in Federal Home Loan Banks (“FHLBs”), and the cash surrender value of bank-owned life insurance, for which the carrying amount approximates fair value, and are classified as Level 2.
Deposits
The fair values reported for transaction accounts (demand, NOW, savings, and money market) equal their respective book values reported on the balance sheets and are classified as Level 2. The fair values disclosed are, by definition, equal to the amount payable on demand at the reporting date. The fair values for certificates of deposit are based on the discounted value of contractual cash flows. The discount rates used are representative of approximate rates currently offered on certificates of deposit with similar remaining maturities and are classified as Level 2.
Securities sold under agreements to repurchase
The fair value of securities sold under agreements to repurchase are estimated based on contractual cash flows discounted at the Bank’s incremental borrowing rate for FHLB borrowings with similar maturities and have been classified as Level 2.
Federal Home Loan Bank borrowings
The fair value reported for FHLB borrowings is estimated based on the discounted value of contractual cash flows. The discount rate used is based on the Bank’s estimated current incremental borrowing rate for FHLB borrowings of similar maturities and have been classified as Level 2.
Junior subordinated debentures
The fair value of the junior subordinated debentures issued by Boston Private Capital Trust I and Boston Private Capital Trust II were estimated using Level 3 inputs such as the interest rates on these securities, current rates for similar debt, a consideration for illiquidity of trading in the debt, and regulatory changes that would result in an unfavorable change in the regulatory capital treatment of this type of debt.
Other financial liabilities
Other financial liabilities consist of accrued interest payable and deferred compensation for which the carrying amount approximates fair value and are classified as Level 2.
Financial instruments with off-balance sheet risk
The Bank’s commitments to originate loans and for unused lines and outstanding letters of credit are primarily at market interest rates and therefore, the carrying amount approximates fair value.
22. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
The Company is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its clients. These financial instruments include commitments to originate loans, unadvanced portion of loans, unused lines of credit, standby letters of credit, commitments to sell loans, and rate locks related to loans that if originated will be held for sale. The instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets. The contract or notional amounts of those instruments reflect the extent of involvement the Company has in particular classes of financial instruments.
The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for loan commitments and standby letters of credit is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Commitments to originate loans, the unadvanced portion of loans, and the unused lines of credit are agreements to lend to a client, provided there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since certain commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each client’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management’s credit evaluation of the borrower.
Standby letters of credit are conditional commitments issued by the Company to guarantee the performance by a client to a third party. The credit risk involved in issuing standby letters of credit is essentially the same as that involved in extending loan facilities to clients.
Loans sold to investors have recourse to the Company on any loans that are deemed to have been fraudulent or misrepresented. In addition, investors would require the Company to repurchase any loan sold which has a first payment default. The Bank did repurchase one loan from an investor in 2014 due to an underwriting discrepancy. The loan was transferred into the portfolio and is fully performing. The Company has not repurchased any other loans during the three years ended December 31, 2014.
Financial instruments with off-balance sheet risk are summarized as follows:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
23. BOSTON PRIVATE FINANCIAL HOLDINGS, INC. (PARENT COMPANY ONLY)
CONDENSED BALANCE SHEETS
___________________
(1)
Represents the maximum redemption value of noncontrolling interests.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
CONDENSED STATEMENTS OF OPERATIONS
____________
(1)
Includes severance expense of $1.9 million for the year ended December 31, 2012.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
CONDENSED STATEMENTS OF CASH FLOWS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
24. REGULATORY MATTERS
Wealth Management and Trust, Investment Management, and Wealth Advisory
The Company’s wealth management and trust, investment management, and wealth advisory businesses are highly regulated, primarily at the federal level by the SEC, and by state regulatory agencies. The Company has subsidiaries which are registered investment advisers under the Investment Advisers Act of 1940. The Investment Advisers Act of 1940 imposes numerous obligations on registered investment advisers, including fiduciary, record keeping, operational, and disclosure obligations. The subsidiaries, as investment advisers, are also subject to regulation under the federal and state securities laws and the fiduciary laws of certain states. In addition, the Company has subsidiaries which act as sub-advisers to mutual funds, which are registered under the Investment Company Act of 1940 and are subject to that Act’s provisions and regulations. The Company’s subsidiaries are also subject to the provisions and regulations of ERISA, to the extent any such entities act as a “fiduciary” under ERISA with respect to certain of its clients. ERISA and the related provisions of the federal tax laws impose a number of duties on persons who are fiduciaries under ERISA, and prohibit certain transactions involving the assets of each ERISA plan which is a client, as well as certain transactions by the fiduciaries and certain other related parties to such plans.
Banking
The Company and the Bank are subject to extensive supervision and regulation by the Federal Reserve, the FDIC, which insures the deposits of the Bank to the maximum extent permitted by law, and the Massachusetts Commissioner of Banks. The federal and state laws and regulations which are applicable to banks regulate, among other things, the scope of their business, their investments, their reserves against deposits, the timing of the availability of deposited funds, and the nature and amount of collateral for certain loans. The laws and regulations governing the Bank generally have been promulgated to foster the safety and soundness of the Bank and protect depositors, and not for the purpose of protecting shareholders of the Company.
As a bank holding company, the Company is subject to various regulatory capital requirements administered by federal agencies. Failure to meet minimum capital requirements can result in certain mandatory, and possibly additional discretionary actions by regulators that, if undertaken, could have a material effect on the Company’s financial statements. For example, under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank, which is a wholly-owned subsidiary of the Company, must meet specific capital guidelines that involve quantitative measures of the Bank’s assets and certain off-balance sheet items as calculated under regulatory guidelines. The Bank’s capital and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Similarly, the Company is also subject to capital requirements administered by the Federal Reserve with respect to certain non-banking activities, including adjustments in connection with off-balance sheet items.
As of December 31, 2014, quantitative measures established by regulation to ensure capital adequacy required us to maintain minimum ratios of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined in the regulations) and of Tier I capital (as defined in the regulations) to average assets (as defined in the regulations). The following table presents the Company’s and the Bank’s amount of regulatory capital and related ratios as of December 31, 2014 and 2013. Also presented are the minimum requirements established by the Federal Reserve and the FDIC as of those dates for the Company and the Bank, respectively, to meet applicable capital requirements and the requirements of the FDIC as of those dates for the Bank to be considered “well capitalized” under the FDIC’s prompt corrective action provisions. The Federal Reserve, the FDIC, and the Massachusetts Division of Banks may impose higher capital ratios than those listed below based upon the results of regulatory exams. The Bank was categorized as “well capitalized” under the FDIC’s prompt corrective action provisions as of December 31, 2014 and 2013.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Bank regulatory authorities restrict the Bank from lending or advancing funds to, or investing in the securities of, the Company. Further, these authorities restrict the amounts available for the payment of dividends by the Bank to the Company.
As of December 31, 2014, the Company has sponsored the creation of two statutory trusts for the sole purpose of issuing trust preferred securities and investing the proceeds in junior subordinated debentures of the Company. The Company has dissolved three statutory trusts, in August 2013, October 2013, and January 2014, respectively, after the Company repurchased all of the respective trusts’ trust preferred securities.
In accordance with ASC 810-10-55, Consolidation - Overall - Implementation Guidance and Illustrations - Variable Interest Entities, these statutory trusts created by, or assumed by, the Company are not consolidated into the Company’s financial statements; however, the Company reflects the amounts of junior subordinated debentures payable to the preferred stockholders of statutory trusts as debt in its financial statements. As of both December 31, 2014, and 2013, all $100.0 million, of the net balance of these trust preferred securities qualified as Tier I capital.
For the year ended December 31, 2013, the Company repurchased $36.5 million of its junior subordinated debentures. There were no repurchases during 2014.
25. LITIGATION AND CONTINGENCIES
The Company is involved in routine legal proceedings occurring in the ordinary course of business. In the opinion of management, final disposition of these proceedings will not have a material adverse effect on the consolidated balance sheets, consolidated statements of operations, or consolidated statements of cash flows of the Company.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
26. SELECTED QUARTERLY DATA (UNAUDITED)
The following tables present selected quarterly financial data for 2014 and 2013:
___________________
(1)
Due to rounding, the sum of the four quarters may not add to the year to date total.
(2)
Includes the effect of adjustments to net income attributable to the Company to arrive at net income attributable to common shareholders.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Shareholders
Boston Private Financial Holdings, Inc.:
We have audited the accompanying consolidated balance sheets of Boston Private Financial Holdings, Inc. and subsidiaries (the “Company”) as of December 31, 2014 and 2013, and the related consolidated statements of operations, comprehensive income, changes in shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2014. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Boston Private Financial Holdings, Inc. and subsidiaries as of December 31, 2014 and 2013, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2014, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Boston Private Financial Holdings, Inc.’s internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control-Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 2, 2015 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
/s/ KPMG LLP
Boston, Massachusetts
March 2, 2015
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Shareholders
Boston Private Financial Holdings, Inc.:
We have audited Boston Private Financial Holdings, Inc.’s internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control-Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Boston Private Financial Holdings, Inc.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, Boston Private Financial Holdings, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control-Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
Boston Private Financial Holdings, Inc. acquired Banyan Partners LLC during 2014, and management excluded from its assessment of the effectiveness of Boston Private Financial Holdings, Inc.’s internal control over financial reporting as of December 31, 2014, Banyan Partner LLC’s internal control over financial reporting associated with total assets of $75.2 million and total revenues of $6.1 million included in the consolidated financial statements of Boston Private Financial Holdings, Inc. and subsidiaries as of and for the year ended December 31, 2014. Our audit of internal control over financial reporting of Boston Private Financial Holdings, Inc. also excluded an evaluation of the internal control over financial reporting of Banyan Partners LLC.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Boston Private Financial Holdings, Inc. and subsidiaries as of December 31, 2014 and 2013, and the related consolidated statements of operations, comprehensive income, shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2014, and our report dated March 2, 2015 expressed an unqualified opinion on those consolidated financial statements.
/s/ KPMG LLP
Boston, Massachusetts
March 2, 2015
ITEM 9.
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A.
ITEM 9A.CONTROLS AND PROCEDURES.
A.Disclosure Controls and Procedures
As required by Rules 13a-15 and 15d-15 of the Securities Exchange Act of 1934, the Company has evaluated, with the participation of management, including the Chief Executive Officer and the Chief Financial Officer, as of the end of the period covered by this report, the effectiveness of the design and operation of its disclosure controls and procedures.
Based on such evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that such disclosure controls and procedures were effective as of December 31, 2014 in ensuring that material information required to be disclosed by the Company, including its consolidated subsidiaries:
a.
was made known to the certifying officers by others within the Company and its consolidated subsidiaries in the reports that it files or submits under the Exchange Act; and
b.
is recorded, processed, summarized, and reported within the time periods specified in the Securities Exchange Commission rules and forms.
On a quarterly basis, the Company evaluates the disclosure controls and procedures, and may from time to time make changes aimed at enhancing their effectiveness and to ensure that the Company’s systems evolve with its business.
B.Management’s Report on Internal Control Over Financial Reporting
The management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting. The Company’s internal control over financial reporting is a process designed to provide reasonable assurance to the Company’s management and Board of Directors regarding the reliability and preparation of published financial statements in accordance with accounting principles generally accepted in the U.S.
In designing and evaluating the Company’s disclosure controls and procedures, the Company and its management recognize that any controls and procedures, no matter how well designed and operated, can provide only a reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating and implementing possible controls and procedures. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation and may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
The Company’s management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2014. In making this assessment, the Company used the criteria set forth in Internal Control-Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on management’s assessment, the Company believes that, as of December 31, 2014, the Company’s internal control over financial reporting is effective based on the criteria established by Internal Control-Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission COSO.
The Company acquired Banyan Partners, LLC in October 2014, and management excluded from its assessment of the effectiveness of the Company's internal control over financial reporting as of December 31, 2014, Banyan Partner LLC’s internal control over financial reporting associated with total assets of $75.2 million and total revenues of $6.1 million included in the consolidated financial statements of the Company as of and for the year ended December 31, 2014.
KPMG LLP, the independent registered public accounting firm that reported on the Company’s consolidated financial statements, has issued an audit report on the effectiveness of the Company’s internal control over financial reporting as of December 31, 2014. KPMG LLP's audit of internal control over financial reporting of the Company also excluded an evaluation of the internal control over financial reporting of Banyan Partners LLC. This report can be found at the end of Part II. Item 8. “Financial Statements and Supplementary Data.”
C.Changes in Internal Controls over Financial Reporting
There have been no changes in the Company’s internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, the Company’s internal controls over financial reporting in 2014.
ITEM 9B.
ITEM 9B.OTHER INFORMATION
None.
PART III
ITEM 10.
ITEM 10.DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Information with respect to Directors and Executive Officers required by Item 10 shall be included in the Proxy Statement and is incorporated herein by reference.
ITEM 11.
ITEM 11.EXECUTIVE COMPENSATION
Information with respect to executive compensation required by Item 11 shall be included in the Proxy Statement and is incorporated herein by reference.
ITEM 12.
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
Information with respect to security ownership and the other matters required by Item 12 shall be included in the Proxy Statement and is incorporated herein by reference.
ITEM 13.
ITEM 13.CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
Information with respect to certain relationships and related transactions required by Item 13 shall be included in the Proxy Statement and is incorporated herein by reference.
ITEM 14.
ITEM 14.PRINCIPAL ACCOUNTING FEES AND SERVICES
Information with respect to principal accountant fees and services required by Item 14 shall be included in the Proxy Statement and is incorporated herein by reference.
PART IV
ITEM 15.
ITEM 15.EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
Financial Statements and Exhibits
1.Financial Statements
Page No.
a) Consolidated Balance Sheets
b) Consolidated Statements of Operations
c) Consolidated Statements of Comprehensive Income
d) Consolidated Statements of Changes in Shareholders’ Equity
e) Consolidated Statements of Cash Flows
f) Notes to Consolidated Financial Statements
2.Financial Schedules
None
3. Exhibits
* Represents management contract or compensatory plan or agreement.
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on this day, March 2, 2015.
BOSTON PRIVATE FINANCIAL HOLDINGS, INC.
By:
/s/ CLAYTON G. DEUTSCH
Clayton G. Deutsch
Chief Executive Officer and President
(Principal Executive Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant in the capacities indicated.