Boston Private Financial Holdings 10-K 2008
Documents found in this filing:
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTIONS 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2007
For the transition period from to
Commission file number 0-17089
BOSTON PRIVATE FINANCIAL HOLDINGS, INC.
(Exact name of registrant as specified in its charter)
(Registrants telephone number, including area code): (617) 912-1900
Securities registered pursuant to Section 12(b) of the Act:
Securities registered pursuant to Section 12(g) of the Act:
Indicate by check mark whether the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Security Act. Yes x No ¨
Indicate by check mark whether the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Security Act. Yes ¨ No x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check One)
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.) Yes ¨ No x
The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant, computed by reference to the last reported sales price on the NASDAQ Global Market on June 30, 2007 was $999,639,558.
The number of shares of the registrants common stock outstanding on March 3, 2008 was 37,671,238.
Documents Incorporated by Reference:
Portions of the registrants proxy statement for the Companys 2008 Annual Meeting of Stockholders are incorporated by reference in Items 10, 11, 12, 13 and 14 of Part III.
TABLE OF CONTENTS
The discussions set forth below and elsewhere herein, may contain statements that may be considered forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the Securities Act), and Section 21E of the Securities Exchange Act of 1934, as amended (the Exchange Act). All statements, other than statements of historical facts, including statements regarding our strategy, effectiveness of investment programs, evaluations of future interest rate trends and liquidity, expectations as to growth in assets, deposits and results of operations, success of acquisitions, future operations, market position, financial position, and the impact of our results of market conditions and prevailing and future interest rates and prospects, plans and objectives of management are forward-looking statements.
Actual results, performance or achievements could differ materially from those contemplated, expressed or implied by the forward-looking statements contained or incorporated by reference in this document. Important factors that could cause actual results to differ materially from our forward-looking statements are set forth in Part II, Item 7 under the headings Managements Discussion and Analysis of Financial Condition and Results of Operations and Item 1A Risk Factors. Forward-looking statements are based on the current assumptions and beliefs of management and are only expectations of future results. Our actual results could differ materially from those projected in the forward-looking statements as the result of, among other factors, adverse conditions in the capital market, and the impact of such conditions on our private banking and investment advisory activities, interest rate compression which may adversely impact net interest income, competitive pressures from other financial institutions, a deterioration in general economic conditions on a national basis or in the local markets in which we operate, including changes which adversely affect borrowers ability to service and repay our loans, changes in loan defaults and charge-off rates, adequacy of loan loss reserves, reduction in deposit levels necessitating increased borrowing to fund loans and investments, our ability to consummate proposed acquisitions in a timely manner, the risk that difficulties will arise in connection with the integration of the operations of acquired businesses with the operations of our banking or investment management businesses, the passing of adverse government regulation, the risk that goodwill and intangibles recorded in our financial statements will become impaired, and changes in assumptions used in making such forward-looking statements. This is not an exhaustive list and as a result of variations in any of these factors actual results may differ materially from any forward-looking statements.
Forward-looking statements speak only as of the date they are made. You should not place undue reliance on these forward-looking statements. We will not update forward-looking statements to reflect facts, assumptions, circumstances or events which have changed after a forward-looking statement was made.
ITEM 1. BUSINESS
Boston Private Financial Holdings, Inc. (the Company or Boston Private) was incorporated on September 2, 1987, under the laws of the Commonwealth of Massachusetts. On July 1, 1988, the Company became registered with the Board of Governors of the Federal Reserve System (the FRB) as a bank holding company under the Bank Holding Company Act of 1956, as amended (the BHCA), and became the parent holding company of Boston Private Bank & Trust Company (Boston Private Bank), a trust company chartered by the Commonwealth of Massachusetts and insured by the Federal Deposit Insurance Corporation (the FDIC). In addition to Boston Private Bank, the Company owns four other Private Banking affiliate partners, four wholly-owned or majority-owned Investment Management affiliate partners, and four wholly-owned or majority-owned Wealth Advisory affiliate partners.
The Company also holds a 46.2% equity interest in Coldstream Holdings, Inc. (Coldstream Holdings). Coldstream Holdings is the parent of Coldstream Capital Management, Inc. (Coldstream Capital), a registered investment adviser and Coldstream Securities, Inc., a registered broker dealer.
The Company offers a full range of wealth management services to high net worth individuals, families, businesses, and select institutions through its wholly-owned and majority-owned affiliate partners within the Companys three core functional segments: Private Banking, Investment Management, and Wealth Advisory.
On July 1, 2007, the Company acquired Charter Financial Corporation, the holding company of Charter Bank (Charter), situated in the Puget Sound region of Washington State. In the transaction, the Company acquired 100% of Charter Financial Corporations common stock through the issuance of approximately 1.5 million shares of Boston Private common stock valued at $42.5 million and $29.4 million in cash payments to shareholders, including stock options. The purchase price was approximately $77.2 million, which included the trust preferred debt assumed by Boston Private and the Companys transaction costs. In addition, the Company contributed $6.5 million of capital to Charter at the time of the acquisition.
On August 1, 2007, Boston Private increased its ownership interest in Bingham, Osborn, & Scarborough LLC (BOS) from 49.7% to approximately 60.9%. In conjunction with the transaction, BOSs financial results after July 31, 2007 are included in the Companys consolidated financial statements. BOSs operating results for the first seven months of 2007 were accounted for under the equity method of accounting, and included with other income. The Company has the option to increase its ownership in BOS over the next year to approximately 75%.
On November 1, 2007 the Company reduced its ownership interest in Sand Hill Advisors, LLC (Sand Hill), formerly Sand Hill Advisors, Inc., from 100% to 76%. The transaction resulted in the purchase of 24% of the equity and profits of Sand Hill by certain existing members of the Sand Hill management team. The Company believes this transaction better aligns the interests of the Sand Hill management team with those of the Company. The transaction was financed by recourse notes issued by Sand Hill management to Sand Hill at market terms. The Company accounts for the sale of stock in an affiliate partner as a capital transaction.
II. Functional Segments
The Companys approach to the wealth management market is to create a financial umbrella that preserves, grows, and transfers assets over the financial lifetime of a client through the Companys three core functional segments: Private Banking, Investment Management and Wealth Advisory. The Company creates this financial umbrella through a platform of complementary affiliate partners within each functional segment. Each functional segment reflects the services provided by the Company to a distinct segment of the wealth management markets as described below.
In January of 2008, the Company announced a change in its corporate management structure by naming executives to manage each of the three functional segments. Historically, the Company reported financial results on an individual affiliate partner basis. In 2008, the Company will transition its reporting from an individual affiliate partner basis to its three functional segments. This transition will enable the Company to provide the management focus needed to increase the effectiveness and profitability in each of its major lines of business as the Company continues to grow its national platform.
The Companys Private Banking affiliate partners are principally engaged in providing a wide range of banking services, which include deposits and lending activities, and investment management and trust services to high net worth individuals, their families and their businesses.
The Companys five wholly-owned Private Banking affiliate partners are Boston Private Bank, Borel Private Bank & Trust Company (Borel) and First Private Bank & Trust (FPB), both California state banking corporations insured by the FDIC, Gibraltar Private Bank & Trust Company (Gibraltar), a federal savings association insured by the FDIC, and Charter, a Washington state banking corporation insured by the FDIC (together the Banks).
Boston Private Bank & Trust Company
Boston Private Bank, located in the New England region, is a Massachusetts-chartered trust company with $2.8 billion in balance sheet assets and $2.8 billion of assets under management as of December 31, 2007. Boston Private Bank pursues a private banking business strategy and is principally engaged in providing banking, investment and fiduciary products to high net worth individuals, their families and businesses in the greater Boston area and New England. Boston Private Bank offers its clients a broad range of deposit and loan products. Boston Private Bank is headquartered in Boston, Massachusetts, and has wealth management offices in Post Office Square, Back Bay, Seaport, Cambridge, Newton, Wellesley, Lexington, Hingham, and Beverly, Massachusetts. Boston Private Bank also has a loan production office in Jamaica Plain, Massachusetts.
Borel Private Bank & Trust Company
Borel, located in the northern California region, is a California state banking corporation with $1.2 billion in balance sheet assets and $819 million of assets under management as of December 31, 2007. Borel pursues a private banking business strategy and is principally engaged in providing commercial banking, and investment management trust services, to high net worth individuals, their families and their businesses in the San Francisco Bay area. Borel offers its clients a broad range of banking services, which include deposit and lending activities. In addition, Borel offers trust services and provides a variety of other fiduciary services including investment management, advisory and administrative services. Borel is headquartered in San Mateo, California, and has offices in Palo Alto, San Francisco, Los Altos, and Burlingame, California.
First Private Bank & Trust
FPB, located in the southern California region, is a California state banking corporation with $618 million in balance sheet assets and $25 million of assets under management as of December 31, 2007. FPB pursues a private banking strategy and is principally engaged in providing commercial banking and trust services to small and medium-sized businesses and professionals located in the Los Angeles and San Bernardino counties. FPB is headquartered in Encino, California, and has offices in Burbank, Irvine, Granada Hills, Santa Monica and Westlake Village, California.
Gibraltar Private Bank & Trust Company
Gibraltar, principally located in the southern Florida region, is a federal savings association with $1.6 billion in balance sheet assets and $1.1 billion of assets under management as of December 31, 2007. Gibraltar pursues a private banking strategy and is principally engaged in providing commercial and personal banking, and wealth management services to small and medium-sized businesses and professionals located in the Miami-Dade, Monroe, Broward, Collier, and Palm Beach Counties. Gibraltar is headquartered in Coral Gables, Florida and has offices in South Miami, Downtown Miami, Key Largo, Naples, and Fort Lauderdale, Florida. In addition, Gibraltar has a private banking office in New York City.
Charter, located in the Pacific Northwest region, is a Washington state banking corporation with $383 million in balance sheet assets as of December 31, 2007. Charter is a community-oriented commercial bank focused on servicing the financial needs of small businesses and wealthy individuals located throughout Greater King County. Charter is headquartered in Bellevue, Washington, and has offices in Redmond, Kent, and downtown Seattle, Washington.
The Companys Investment Management affiliate partners cover a full spectrum of portfolio management products and services and collectively cover a wide range of asset classes. Their seasoned investment professionals apply research, disciplined processes, and their expertise to successfully oversee their clients' financial assets.
The Companys four wholly-owned or majority-owned Investment Management affiliate partners are Westfield Capital Management Company, LLC (Westfield), Dalton, Greiner, Hartman, Maher & Co., LLC (DGHM), Boston Private Value Investors, Inc. (BPVI), and Anchor Capital Holdings LLC (Anchor), all of which are registered investment advisers (together the Investment Managers).
Westfield Capital Management Company, LLC
Westfield, located in the New England region, is a registered investment adviser with $13.1 billion of assets under management as of December 31, 2007. Westfield is an investment management firm serving the needs of pension funds, endowments, foundations, mutual funds and high net worth individuals throughout the United States (U.S.) and abroad. Westfield specializes in separately managed domestic growth equity portfolios with products across the capitalization spectrum. Additionally, Westfield acts as the investment manager for several limited partnerships and also serves as a portfolio manager to two wrap programs. Westfield is headquartered in Boston, Massachusetts, and conducts all business activities from its headquarters.
Dalton, Greiner, Hartman, Maher & Co, LLC
DGHM, located in the New York metro region, is a registered investment adviser with $1.5 billion of assets under management as of December 31, 2007. DGHM is an investment management firm serving the needs of institutional and high net worth individuals throughout the U.S. and abroad. DGHM specializes in value-driven equity portfolios with products primarily in the small capitalization spectrum. Additionally, DGHM acts as the investment manager for several limited partnerships and also serves as a portfolio manager to several wrap programs. DGHM is headquartered in New York City, and also has an administrative office in Naples, Florida.
Boston Private Value Investors, Inc.
BPVI, located in the New England region, is a registered investment adviser with $803 million of assets under management as of December 31, 2007. BPVI is an investment management firm and serves the needs of high net worth individuals and select institutions throughout the U.S. and abroad. BPVI specializes in value-
driven U.S. equities and balanced portfolios with products primarily in the large capitalization spectrum. BPVI is headquartered in Concord, New Hampshire, and has an office in Boston, Massachusetts.
Anchor Capital Holdings, LLC
Anchor, located in the New England region, is the parent holding company of Anchor Capital and Anchor/Russell, both of which are registered investment advisers. As of December 31, 2007, Anchor Capital and Anchor/Russell had $7.2 billion, and $398 million of assets under management, respectively. Anchor Capital is a value-oriented investment adviser specializing in active investment management for families, trusts, and institutions, including foundations and endowments. Anchor Capital serves clients through its Discretionary Management Accounts division and its Separately Managed Accounts (SMA) division, and offers four core disciplines which include balanced, all-cap, mid-cap, and small-cap styles. Anchor Capitals sister company, Anchor/Russell, structures diversified investment management programs for clients utilizing a host of sophisticated management solutions including institutional multi-manager, multi-style, multi-asset mutual funds and SMA programs sponsored by the Frank Russell Company. Both operating companies, Anchor Capital and Anchor/Russell, are headquartered in Boston, Massachusetts and conduct all of their business activities from their headquarters.
The Companys Wealth Advisory affiliate partners provide integrated wealth management solutions including fee-based financial planning, investment counsel, tax strategies, asset allocation, estate planning and philanthropic services. They work with high net worth individuals, their families, and institutions. Their services are designed to help clients preserve, grow and transfer their assets over a lifetime.
The Companys four wholly-owned or majority-owned Wealth Advisors are Sand Hill, KLS Professional Advisors Group, LLC (KLS), RINET Company, LLC (RINET), and BOS, all of which are registered investment advisers and financial planning firms (together the Wealth Advisors).
Sand Hill Advisors, LLC
Sand Hill, located in the northern California region, is a registered investment adviser with $1.2 billion of assets under management as of December 31, 2007 (including $276 million of assets managed through sub-advisory relationships with Boston Private affiliates). Sand Hill is a wealth adviser, providing comprehensive, planning-based financial strategies for wealthy individuals, families, charitable organizations, and select institutions in northern California. Sand Hill manages investments covering a wide range of asset classes for both taxable and tax-exempt portfolios and has special expertise as transitional wealth counsel. Sand Hill is headquartered in Palo Alto, California and conducts all its business activities from its headquarters.
RINET Company, LLC
RINET, located in the New England region, is a registered investment adviser and financial planning firm with $1.5 billion of assets under advisory as of December 31, 2007. RINET provides fee-only financial planning, tax planning and investment management services to high net worth individuals and their families in the greater Boston area, New England, and other areas of the U.S. The firm offers tax planning and preparation, asset allocation, estate planning, charitable planning and planning for employment benefits, including 401(k) plans, alternative investment analysis and mutual fund investing. Through its Kanon Bloch Carré division, RINET provides an independent, nationally recognized mutual fund rating service. RINET is headquartered in Boston, Massachusetts and conducts all of its business activities from its headquarters.
KLS Professional Advisors Group, LLC
KLS, located in the New York metro region, is a registered investment adviser and financial planning firm with $4.3 billion of assets under advisory as of December 31, 2007. KLS provides fee-only services, specializing in investment management, estate and insurance planning, retirement planning, and income tax planning services for leading law firm partners, senior executives of large companies, and other wealthy individuals both domestic and abroad. The firm offers advice and counsel on every aspect of its clients financial affairs in pursuit of strategies designed to preserve and build clients family wealth. KLS is headquartered in midtown Manhattan and conducts all of its business activities from its headquarters.
Bingham, Osborn & Scarborough, LLC
BOS, located in the northern California region, is a registered investment adviser with $2.1 billion of assets under management as of December 31, 2007. BOS provides fee-only services, specializing in investment counsel, insurance analysis needs, tax management, retirement planning, estate planning, and charitable and intergenerational giving planning to high net worth individuals and non-profit institutions in the San Francisco Bay area. BOS is headquartered in San Francisco, California and has another wealth management office in East Palo Alto, California.
Coldstream Capital Management, Inc.
Coldstream Holdings, located in the Pacific Northwest region, is the parent of Coldstream Capital, a registered investment adviser and Coldstream Securities, Inc. a registered broker dealer. Coldstream Capital had $1.2 billion of assets under advisory as of December 31, 2007. Coldstream Capital is a multi-client family office providing comprehensive wealth management services to high net worth individuals and their families in the Pacific Northwest. Coldstream Capital is headquartered in Bellevue, Washington and has an office in Portland, Oregon.
For revenue, net income, assets, and other financial information for each of the Companys functional segments, see Part II, Item 8Financial Statements and Supplementary DataNote 5: Functional Segments.
The Company operates in the highly competitive wealth management marketplace. The Company believes that by creating regional clusters of companies, it is favorably positioned to access diversified markets to expand its potential client base and mitigate regional economic risks. In addition, the Company believes its regional presence enables it to provide better access to decision makers and more customized personal service for its clients.
In the Companys private banking business, the ability of the Banks to attract loans and deposits may be limited by their small size relative to their competitors. The Banks maintain a smaller staff and have fewer financial and other resources than larger institutions with which they compete in their market areas. In particular, in attempting to attract deposits and originate loans, the Banks encounter competition from other institutions, including larger national, and suburban-based commercial banking organizations, savings banks, credit unions, and other financial institutions and nonbank financial service companies. The principal methods of competition include the level of loan interest rates charged to borrowers, interest rates paid on deposits, range of services provided and the quality of these services. To compete effectively, the Banks rely substantially on local promotional activity, personal contacts by officers, directors, and employees, personalized service and their reputation within the communities they serve.
In this competitive environment, the Banks may be unable to attract sufficient and high quality loans in order to continue their loan growth, which may adversely affect the Banks results of operations and financial condition, including the level of their non-performing assets. The Banks 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. The Banks current commercial borrowing customers may develop needs for credit facilities larger than the Banks can accommodate. Moreover, under the Gramm-Leach-Bliley Act of 1999 (the GLBA), securities firms, insurance companies and other financial services providers that elect to become financial holding companies may acquire banks and other financial institutions. The GLBA has significantly changed the competitive environment in which the Company and its subsidiaries conduct business. (See Bank Regulation and Supervision below.) The financial services industry is also likely to become more competitive as further technological advances enable more companies to provide financial services. These technological advances may diminish the importance of depository institutions and other financial intermediaries in the transfer of funds among parties.
The ability of Boston Privates affiliates to attract investment management and trust business may be inhibited by the relatively short history and record of performance at each affiliate. The Companys principal competitors with respect to investment management and trust services are primarily commercial banks and trust companies, mutual fund companies, investment advisory firms, stock brokerage firms, other financial companies and law firms. Many of Boston Privates competitors have greater resources than its individual affiliates or the Company on a consolidated basis. Competition can impact revenue and current and future fee structures.
The Company believes that the ability to compete effectively with other firms is dependent upon the products, level of investment performance and client service, as well as the marketing and distribution of the investment products. Moreover, Boston Privates ability to retain investment management clients may be impaired by the fact that investment management contracts are typically short-term in nature, allowing clients to withdraw funds from accounts under management, generally at their sole discretion. There can be no assurance that Boston Private will be able to achieve favorable investment performance and retain its existing clients.
In the wealth advisory industry, Boston Private competes with a wide variety of firms including national and regional financial services firms, accounting firms, trust companies, and law firms. Many of these companies have greater resources and broader product lines, and may already have relationships with Boston Privates clients in related product areas. 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. There can be no assurance that the Companys Wealth Advisors will be able to retain their existing clients, expand existing relationships, or add new clients.
At December 31, 2007, the Company had 1,166 employees. The Companys employees are not subject to a collective bargaining agreement, and the Company believes its employee relations are good.
Supervision and Regulation
In addition to the generally applicable state and federal laws governing businesses and employers, the Company is further subject to federal and state laws and regulations applicable to depository institutions and their parent companies. Virtually all aspects of the Companys operations are subject to specific requirements or restrictions and general regulatory oversight. State and federal banking laws have as their principal objective the safety and soundness of depository institutions, the federal deposit insurance system, and the protection of depositors, rather than the protection of stockholders of a bank or its parent company. Many of the Companys affiliates are also subject to regulation under federal and state securities laws as described below under Government Regulation of Other Activities.
Set forth below is a brief description of certain laws and regulations that relate to the supervision and regulation of Boston Private and its affiliate partners. To the extent the following material describes statutory or regulatory provisions, it is qualified in its entirety by reference to the particular statute or regulation.
Certain Restrictions on Activities and Operations of Boston Private
Boston Private is a bank holding company (a BHC) registered with the FRB under the BHCA. As such, Boston Private and its non-bank subsidiaries are subject to the supervision, examination, and reporting requirements of the BHCA and the regulations of the FRB. Boston Private is also a bank holding company for purposes of the laws of the Commonwealth of Massachusetts, and is subject to the jurisdiction of the Massachusetts Board of Bank Incorporation (the BBI) and the Massachusetts Commissioner of Banks (the Commissioner). Boston Private is also a bank holding company for purposes of the laws of the State of California, and is subject to the jurisdiction of the California Department of Financial Institutions (the CDFI). Boston Private is also a bank holding company for purposes of the laws of the State of Washington, and is subject to the jurisdiction of the Washington Department of Financial Institutions (the WDFI). Boston Private has not elected Financial Holding Company (FHC) status under the BHCA and, accordingly, may not engage in certain financial activities, such as merchant banking, that are only authorized under the BHCA for BHCs that have elected FHC status. For purposes of the BHCA, Gibraltar, a federal savings association, which Boston Private acquired in 2005, is a non-banking subsidiary. Gibraltar is regulated by the Office of Thrift Supervision (the OTS).
The FRB has the authority to issue orders to BHCs to cease and desist from unsafe or unsound banking practices and violations of conditions imposed by, or violations of agreements with, the FRB. The FRB is also empowered, among other things, to assess civil money penalties against companies or individuals who violate the BHCA orders or, among other things, regulations thereunder, to order termination of non-banking activities of BHCs, and to order termination of ownership and control of a non-banking subsidiary by a BHC.
BHCA: Activities and Other Limitations. The BHCA prohibits a BHC from acquiring substantially all the assets of a bank or acquiring direct or indirect ownership or control of more than 5% of the voting shares of any bank, or increasing such ownership or control of any bank, or merging or consolidating with any BHC without prior approval of the FRB. The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (Riegle-Neal) permits adequately or well capitalized and adequately or well managed BHCs, as determined by the FRB, to acquire banks in any state, subject to certain deposit concentration limits and other conditions. Riegle-Neal also generally authorizes the interstate merger of banks. In addition, among other things, Riegle-Neal permits banks and federal savings associations to establish new branches on an interstate basis provided that the law of the host state specifically authorizes such action.
Unless a BHC becomes a FHC under the GLBA (as discussed below), the BHCA prohibits a BHC from acquiring a direct or indirect interest in or control of more than 5% of the voting shares of any company that is not a bank or a BHC. In addition, it prohibits engaging directly or indirectly in activities other than those of banking, managing or controlling banks or furnishing services to its subsidiary banks. However, it may engage in and may own shares of companies engaged in certain activities the FRB determines to be so closely related to banking or managing and controlling banks so as to be a proper incident thereto. In making such determinations, the FRB is required to weigh the expected benefit to the public. This determination incorporates greater convenience, increased competition or gains in efficiency, against the possible adverse effects, such as undue concentration of resources, decreased or unfair competition, conflicts of interests or unsafe or unsound banking practices. As discussed more fully below, Massachusetts law imposes certain approval requirements with respect to acquisitions by a BHC of certain banking institutions and to the merger of BHCs.
Capital Requirements. The FRB has adopted capital adequacy guidelines which it uses in assessing the adequacy of capital in examining and supervising a BHC and in analyzing applications upon which it acts. The FRBs capital adequacy guidelines generally require BHCs to maintain total capital equal to 8% of total risk-adjusted assets and off-balance sheet items, with at least 50% of that amount consisting of Tier I or core capital and the remaining amount consisting of Tier II or supplementary capital. Tier I capital for BHCs generally consists of the sum of common stockholders equity, perpetual preferred stock and trust preferred securities (both subject to certain limitations and in the case of the latter to specific limitations on the kind and amount of such
securities which may be included as Tier I capital), and minority interest in the equity accounts of consolidated subsidiaries, less goodwill and other non-qualifying intangible assets. Tier II capital generally consists of hybrid capital instruments, perpetual debt and mandatory convertible debt securities; perpetual preferred stock and trust preferred securities, which is, or to the extent, not eligible to be included as Tier I capital; term subordinated debt and intermediate-term preferred stock; and, subject to limitations, general allowances for loan losses. Assets are adjusted under the risk-based guidelines to take into account different risk characteristics.
In addition to the risk-based capital requirements, the FRB requires BHCs 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 (the Leverage Ratio) of 3.0%. Total consolidated average assets for this purpose does not include, for example, goodwill and any other intangible assets, unrealized gains or losses on investments and investments that the FRB determines should be deducted from Tier I capital. The 3% Leverage Ratio requirement is the minimum for the top-rated BHCs without any supervisory, financial or operational weaknesses or deficiencies or those which are not experiencing or anticipating significant growth. All other BHCs are required to maintain a Leverage Ratio of 4%. BHCs with supervisory, financial, operational or managerial weaknesses, as well as BHCs that are anticipating or experiencing significant growth, are expected to maintain capital ratios above the minimum levels. Finally, the FRB has also imposed certain capital requirements applicable to certain non-banking activities, including adjustments in connection with off-balance sheet items.
U.S. bank regulatory authorities and international bank supervisory organizations, principally the Basel Committee on Banking Supervision the (Basel Committee), continue to consider changes to the risk-based capital adequacy framework which ultimately could affect the appropriate capital guidelines to which Boston Private and the Banks are subject. In 2005, the federal banking agencies issued an advance notice of proposed rulemaking (ANPR) concerning potential changes in the risk-based capital rules (Basel 1-A) that are designed to apply to, and potentially reduce the risk capital requirements of BHCs, such as Boston Private, that are not among the core 20 or so largest U.S. BHCs (the Core Banks). In December 2006, the FDIC issued a revised Interagency Notice of Proposed Rulemaking concerning Basel 1-A (the NPR), which would allow banks and bank holding companies that are not among the Core Banks to either adopt Basel 1-A or remain subject to the existing risk-based capital rules. In July 2007 an interagency press release stated that the federal banking agencies have agreed to issue a proposed rule that would provide non-Core Banks with the option to adopt an approach consistent with the standardized approach of Basel II. The standardized approach measures credit risk using external credit assessments. This proposal would replace Basel 1-A. In December 2007 the federal banking agencies issued the first rule that will implement Basel II for the Core Banks, permitting only the advanced approach. The advanced approach allows Core Banks to develop an internal rating system to determine the capital requirements for a given exposure. The final rule implementing Basel II reiterated that non-Core Banks would have the option to take the standardized approach and that it is the agencys intention to have the standardized proposal finalized before the Core Banks begin the first transitional floor period under Basel II. Accordingly, Boston Private is not yet in a position to determine the effect of such rules on its risk capital requirements.
Limitations on Acquisitions of Common Stock. The Change in Bank Control Act prohibits a person or group of persons from acquiring control of a BHC unless the FRB has been notified and has not objected to the transaction. Under a rebuttable presumption established by the FRB, the acquisition of 10% or more of a class of voting securities of a BHC, such as Boston Private, with a class of securities registered under Section 12 of the Exchange Act, would, under the circumstances set forth in the presumption, constitute the acquisition of control of a BHC. Massachusetts law and California law also impose certain limitations on the ability of persons and entities to acquire control of banking institutions and their parent companies. The Home Owners Loan Act (HOLA) and OTS regulations impose certain limitations on the ability of third parties to acquire control of federal savings associations, such as Gibraltar.
In addition, any company would be required to obtain the approval of the FRB under the BHCA before acquiring 25% (5% in the case of an acquirer that is a BHC) or more, or otherwise obtaining control or a controlling influence over a BHC.
Cash Dividends. The FRB has the authority to prohibit bank holding companies from paying dividends if such payment is deemed to be an unsafe or unsound practice. The FRB has indicated generally that it may be an unsafe or unsound practice for BHCs to pay dividends unless the BHCs net income over the preceding year is sufficient to fund the dividends and the expected rate of earnings retention is consistent with the organizations capital needs, asset quality and overall financial condition. FRB policy further provides that a BHC should not maintain a level of cash dividends to its stockholders that places undue pressure on the capital of bank subsidiaries, or that can be funded only through additional borrowings or other arrangements that may undermine the BHCs ability to serve as a source of strength to bank subsidiaries. The FDIC may also regulate the amount of dividends payable by the subsidiary banks. The inability of the Banks to pay dividends may have an adverse affect on the Company.
Support of Subsidiary Institutions and Liability of Commonly Controlled Depository Institutions. Under FRB policy, Boston Private is expected to act as a source of financial and managerial strength for, and commit its resources to, supporting the Banks during periods of financial stress or adversity. This support may be required at times when Boston Private may not be inclined to provide it. In addition, any capital loans by a BHC to any of its bank subsidiaries are subordinate to the payment of deposits and to certain other indebtedness. In the event of a BHCs bankruptcy, any commitment by the BHC 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.
Depository institutions insured by the FDIC, such as the Banks can be held liable for any loss incurred by, or reasonably expected to be incurred by, the FDIC in connection with the default of a commonly controlled FDIC-insured depository institution or any assistance provided by the FDIC to any commonly controlled FDIC-insured depository institution in danger of default. Default is defined generally as the appointment of a conservator or receiver, and in danger of default is defined generally as the existence of certain conditions indicating that a default is likely to occur in the absence of supervisory assistance. The FDICs claim for damages is superior to claims of stockholders of the insured depository institution or its holding company, but is subordinate to claims of depositors, secured creditors, and holders of subordinated debt (other than affiliates) of the commonly controlled insured depository institution. The Banks are subject to these cross-guarantee provisions. As a result, any loss suffered by the FDIC in respect of any of the Banks would likely result in assertion of the cross-guarantee provisions, the assessment of estimated losses against the other Banks, and a potential loss of Boston Privates investments in the Banks.
Massachusetts Law. As a BHC for purposes of Massachusetts law, Boston Private has registered with the Commissioner and is obligated to make reports to the Commissioner. Further, as a Massachusetts BHC, Boston Private may not acquire all or substantially all of the assets of a banking institution, merge or consolidate with another BHC or acquire direct or indirect ownership or control of any voting stock in any other banking institution if it will own or control more than 5% thereof without the prior consent of the BBI. As a general matter, however, the Commissioner does not rule upon or regulate the activities in which BHCs or their non-bank subsidiaries engage.
California Law. Boston Private is also a BHC within the meaning of Section 3700 of the California Financial Code. As such, Boston Private and its subsidiaries are subject to examination by, and may be required to file reports with, the CDFI.
Florida Law. Gibraltars primary banking regulator is the OTS, therefore, Gibraltar is neither subject to examination nor required to file reports with the Florida Office of Financial Regulations.
Washington Law. Boston Private is also a BHC within the meaning of Chapter 30.04 of the Revised Code of Washington. As such, Boston Private and its subsidiaries are subject to examination by, and may be required to file reports with, the WDFI.
Regulation of the Banks
The Banks are subject to the extensive supervision and regulation of various federal and state authorities, which include the FDIC, the OTS, the CDFI, the WDFI, and the Commissioner. Each of the Banks is subject to numerous state and federal statutes and regulations that affect its business, activities, and operations, and each is supervised and examined by one or more federal or state bank regulatory agencies. Each of the Banks is required to file reports with and obtain approvals from these various regulatory agencies prior to entering into certain transactions, including mergers with, or acquisitions of, other financial institutions. As FDIC-insured institutions, the Banks are also subject to certain requirements applicable to all insured depository institutions.
FDIC Insurance Premiums. The Banks pay deposit insurance premiums to the FDIC based on an assessment rate established by the FDIC. In 2006, the FDIC enacted various rules to implement the provisions of the Federal Deposit Insurance Reform Act of 2005 (the FDI Reform Act). Pursuant to the FDI Reform Act, in 2006 the FDIC merged the Bank Insurance Fund with the Savings Association Insurance Fund to create a newly named Deposit Insurance Fund (the DIF) that covers both banks and savings associations. The FDIC also revised, effective January 1, 2007, the risk-based premium system under which the FDIC classifies institutions based on the factors described below and generally assesses higher rates on those institutions that tend to pose greater risks to the DIF. For most banks and savings associations, including the Banks, FDIC rates will depend upon a combination of CAMELS component ratings and financial ratios. CAMELS ratings reflect the applicable bank regulatory agencys evaluation of the financial institutions capital, asset quality, management, earnings liquidity and sensitivity to risk. For large banks and savings associations that have long-term debt issuer ratings, assessment rates will depend upon such ratings, and CAMELS component ratings. For institutions which are in the lowest risk category, assessment rates will vary initially from five to seven basis points per $100 of insured deposits. The Federal Deposit Insurance Act (FDIA) as amended by the FDI Reform Act requires the FDIC to set a ratio of deposit insurance reserves to estimated insured deposits, the designated reserve ratio (the DRR) for a particular year within a range of 1.15% to 1.50%. For 2007, the FDIC set the initial DRR at 1.25%. During 2007, the Banks paid $1.7 million of FDIC insurance premiums. Under the FDI Reform Act and the FDICs revised premium assessment program, every FDIC-insured institution will pay some level of deposit insurance assessments regardless of the level of the DRR. We cannot predict whether, as a result of an adverse change in U.S. economic conditions and, in particular, declines in the value of real estate in certain markets served by the Banks, the FDIC will be required in the future to increase deposit insurance assessments above 2007 levels. The Company estimates its 2008 FDIC insurance premium will be substantially in excess of the premiums paid in 2007.
Capital Requirements. The FDIC has promulgated regulations and adopted a statement of policy regarding the capital adequacy of state-chartered banks, which, like the Banks, are not members of the Federal Reserve System. These requirements are substantially similar to those adopted by the FRB regarding BHCs, as described above.
Moreover, the federal banking agencies have promulgated substantially similar regulations to implement the system of prompt corrective action established by Section 38 of the FDIA. Under the regulations, a bank generally shall be deemed to be:
An institution generally must file a written capital restoration plan which meets specified requirements with an appropriate FDIC regional director within 45 days of the date that the institution receives notice or is deemed to have notice that it is undercapitalized, significantly undercapitalized or critically undercapitalized. An institution, which is required to submit a capital restoration plan, must concurrently submit a performance guaranty by each company that controls the institution. A critically undercapitalized institution generally is to be placed in conservatorship or receivership within 90 days unless the FDIC formally determines that forbearance from such action would better protect the DIF.
Immediately upon becoming undercapitalized, an institution becomes subject to the provisions of Section 38 of the FDIA, including for example, (i) restricting payment of capital distributions and management fees, (ii) requiring that the FDIC monitor the condition of the institution and its efforts to restore its capital, (iii) requiring submission of a capital restoration plan, (iv) restricting the growth of the institutions assets and (v) requiring prior approval of certain expansion proposals.
At December 31, 2007, each of the Banks, except for FPB, was deemed to be a well capitalized institution for the above purposes. Regulators may raise capital requirements applicable to banking organizations above current levels. We are unable to predict whether higher capital requirements will be imposed and, if so, at what levels and on what schedules. Therefore, we cannot predict what effect such higher requirements may have on us. As discussed above, the Banks would be required to remain well-capitalized institutions at all times if we elected to be treated as a FHC.
FPB was considered adequately capitalized as of December 31, 2007. In February of 2008, FPB made an adjustment to their 2007 allowance for loan losses as of December 31, 2007. This adjustment resulted in FPBs risk based capital ratio to fall below the well capitalized level. Concurrent with the adjustment, Boston Private contributed $11.5 million of additional capital to FPB. The amount of the capital contribution was intended to bring FPBs total risk based capital ratio above 10.0%. Banks must have a total risk based capital ratio above 10.0% and not subject to any written agreement, order or capital directive or prompt corrective action directive to be considered well capitalized.
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 institutions capital category is well capitalized or adequately capitalized. These restrictions have not in the past had a material impact on the operations of the Banks because each of the Banks, except for FPB, are well capitalized at December 31, 2007, and historically they have not relied heavily upon brokered deposits as a source of funding.
Activities and Investments of Insured State-Chartered Banks. Section 24 of the FDIA generally limits the investment activities of FDIC-insured, state-chartered banks, (including Boston Private Bank, Borel, FPB, and Charter but not Gibraltar), when acting as principal to those that are permissible for national banks. In 1999, the FDIC revised its regulations implementing Section 24 of the FDIA to ease the ability of FDIC-insured state-chartered banks to engage in certain activities not permissible for national banks, and to expedite FDIC review of bank applications and notices to engage in such activities.
Further, the GLBA permits national banks and state banks, to the extent permitted under state law, to engage through financial institutions in certain new activities which are permissible for subsidiaries of a FHC. Further, it expressly preserves the ability of national banks and state banks to retain all existing subsidiaries. In order to
form a financial subsidiary, a national bank or state bank must be well capitalized, and such banks would be subject to certain capital deduction, risk management and affiliate transaction rules, among other things. Also, the FDICs final rules governing the establishment of financial subsidiaries adopt the position that activities that a national bank could engage in only through a financial subsidiary, such as securities underwriting, may be conducted only in a financial subsidiary by a state nonmember bank. However, activities that a national bank could not engage in through a financial subsidiary, such as real estate development or investment, continue to be governed by the FDICs standard activities rules. Moreover, to mirror the FRBs actions with respect to state member banks, the final rules provide that a state bank subsidiary that engages only in activities that the bank could engage in directly (regardless of the nature of the activities) will not be deemed to be a financial subsidiary.
Activities and Investments of, and Branching by, Federal Savings Associations. Gibraltar, as a federal savings association, derives its lending and investment powers from the HOLA, and the regulations of the OTS promulgated thereunder. Under these laws and regulations, Gibraltar may invest in mortgage loans secured by residential and non-residential real estate, commercial and consumer loans, certain types of debt securities and certain other assets. Gibraltar may also establish service corporations that may engage in activities not otherwise permissible for Gibraltar, including certain real estate equity investments and securities and insurance brokerage activities. These investment powers are subject to various limitations, including (1) a prohibition against the acquisition of any corporate debt security that is not rated in one of the four highest rating categories, (2) a limit of 400% of an associations capital on the aggregate amount of loans secured by non-residential real estate property, (3) a limit of 20% of an associations assets on commercial loans, with the amount of commercial loans in excess of 10% of assets being limited to small business loans, (4) a limit of 35% of an associations assets on the aggregate amount of consumer loans and acquisitions of certain debt securities, (5) a limit of 5% of assets on non-conforming loans (loans in excess of the specific limitations of HOLA), and (6) a limit of the greater of 5% of assets or an associations capital on certain construction loans. Federal savings associations have extremely broad authority to branch into other states. Gibraltar has used its interstate branching powers to establish an office in New York City.
Qualified Thrift Lender (QTL) Test. The HOLA requires federal savings associations to meet a QTL test. Under the QTL test, a savings association is required to maintain at least 65% of its portfolio assets (total assets less (1) specified liquid assets up to 20% of total assets, (2) intangibles, including goodwill, and (3) the value of property used to conduct business) in certain qualified thrift investments (primarily residential mortgages and related investments, including certain mortgage-backed securities, credit card loans, student loans, and small business loans) on a monthly basis during at least 9 out of every 12 months. As of December 31, 2007, Gibraltar maintained in excess of 73.01% of its portfolio assets in qualified thrift investments and qualified under the QTL test.
A federal savings association that fails the QTL test and does not convert to a bank charter generally will be prohibited from: (1) engaging in any new activity not permissible for a national bank, (2) paying dividends not permissible under national bank regulations, and (3) establishing any new branch office in a location not permissible for a national bank in the associations home state. In addition, if the association does not re-qualify under the QTL test within three years after failing the test, the association would be prohibited from engaging in any activity not permissible for a national bank and would have to repay any outstanding advances from the applicable Federal Home Loan Bank (FHLB) as promptly as possible.
Transactions with Affiliates. Under Sections 23A and 23B of the Federal Reserve Act and Regulation W thereunder, there are various legal restrictions on the extent to which a BHC, such as Boston Private, and its non-bank subsidiaries may borrow, obtain credit from or otherwise engage in covered transactions with its FDIC insured depository institution subsidiaries. Such borrowings and other covered transactions by an insured depository institution subsidiary (and its subsidiaries) with its non-depository institution affiliates are limited to the following amounts:
Covered transactions are defined by statute for these purposes 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 FRB, the acceptance of securities issued by an affiliate as collateral for a loan or extension of credit to any person or company, or the issuance of a guarantee, acceptance, or letter of credit on behalf of an affiliate. Covered transactions are also subject to certain collateral security requirements. Further, a BHC 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.
Community Reinvestment Act. The Community Reinvestment Act (the CRA) requires the FDIC and the OTS to evaluate the Banks performance in helping to meet the credit needs of their entire communities, including low and moderate-income neighborhoods, consistent with their safe and sound banking operations, and to take this record into consideration when evaluating certain applications. The CRA does not establish specific lending requirements or programs for financial institutions, nor does it limit an institutions discretion to develop the type of products and services that it believes are best suited to its particular community, consistent with the purposes of the CRA. Massachusetts has also enacted a similar statute that requires the Commissioner to evaluate Boston Private Banks performance in helping to meet the credit needs of its entire community and to take that record into account in considering certain applications.
The FDICs and OTSs CRA regulations are currently based upon objective criteria of the performance of institutions under three key assessment tests: (i) a lending test, to evaluate the institutions record of making loans in its service areas; (ii) an investment test, to evaluate the institutions 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 institutions delivery of services through its branches, ATMs, and other offices. Each of the banks currently have either a satisfactory or outstanding CRA rating. In 2005, the federal banking agencies adopted less burdensome CRA requirements for intermediatesmall banks, which are banks with $250 million or more, but less than $1 billion in total assets, including, FPB and Charter, under which such banks are examined using only two tests, a Lending Test and a new Community Development Test, and are relieved of certain data collection and reporting requirements.
Customer Information Security. The FDIC, the OTS, and other bank regulatory agencies have adopted final guidelines for establishing standards for safeguarding nonpublic personal information about customers. These guidelines implement provisions of the GLBA. Specifically, the Information Security Guidelines established by the GLBA require each financial institution, under the supervision and ongoing oversight of its Board of Directors or an appropriate committee thereof, to develop, implement and maintain a comprehensive written information security program designed to ensure the security and confidentiality of customer information, 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 customer. The federal banking regulators have issued guidance for banks on response programs for
unauthorized access to customer information. This guidance, among other things, requires notice to be sent to customers whose sensitive information has been compromised if unauthorized use of this information is reasonably possible. A majority of states have enacted legislation concerning breaches of data security and Congress is considering federal legislation that would require consumer notice of data security breaches.
Identity Theft Red Flags. The federal banking agencies jointly issued final rules and guidelines in November, 2007 implementing section 114 of the Fair and Accurate Credit Transactions Act of 2003 (FACT Act) and final rules implementing section 315 of the FACT Act. The rules implementing section 114 require each financial institution or creditor to develop and implement a written Identity Theft Prevention Program (the Program) to detect, prevent, and mitigate identity theft in connection with the opening of certain accounts or certain existing accounts. In addition, the federal banking agencies issued guidelines to assist financial institutions and creditors in the formulation and maintenance of a Program that satisfies the requirements of the rules. The rules implementing section 114 also require credit and debit card issuers to assess the validity of notifications of changes of address under certain circumstances. Additionally, the federal banking agencies are issuing joint rules under section 315 that provide guidance regarding reasonable policies and procedures that a user of consumer reports must employ when a consumer reporting agency sends the user a notice of address discrepancy. The joint final rules and guidelines became effective on January 1, 2008. The mandatory compliance date for this rule is November 1, 2008.
Privacy. 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 statute requires financial institutions to explain to consumers their policies and procedures regarding the disclosure of such nonpublic personal information, and, except as otherwise required or permitted by law, financial institutions are prohibited from disclosing such information except as provided in their policies and procedures.
USA PATRIOT Act. The USA PATRIOT Act of 2001 (the PATRIOT Act), designed to deny terrorists and others the ability to obtain anonymous access to the U.S. financial system, has significant implications for depository institutions, broker-dealers, mutual funds, insurance companies and businesses of other types involved in the transfer of money. The PATRIOT Act, together with the implementing regulations of various federal regulatory agencies, has caused financial institutions such as the Banks to adopt and implement additional or amend existing policies and procedures with respect to, among other things, anti-money laundering compliance, suspicious activity, and 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 affect 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 2006, final regulations under the PATRIOT Act were issued requiring financial institutions, including the Banks, to take additional steps to monitor their correspondent banking and private banking relationships as well as their relationships with shell banks. Management believes that the Company is in compliance with all the requirements prescribed by the PATRIOT Act and all applicable final implementing regulations.
Massachusetts LawDividends. Under Massachusetts law, the board of directors of a trust company, such as Boston Private Bank, may declare from net profits cash dividends no more often than quarterly, provided that there is no impairment to the trust companys capital stock. Moreover, prior Commissioner approval is required if the total of all dividends declared by a trust company 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. These restrictions on Boston Private Banks ability to declare and to pay dividends may restrict Boston Privates ability to pay dividends to its stockholders. We cannot predict future dividend payments of Boston Private Bank at this time.
Washington LawDividends. Under Washington law, a bank, such as Charter, may not declare or pay any dividend greater than its retained earnings without approval from the director of the WDFI. This restriction on Charters ability to declare and to pay dividends may restrict Boston Privates ability to pay dividends to its stockholders. We cannot predict future dividend payments of Charter at this time.
California Law. Boston Private is also a BHC within the meaning of Section 3700 of the California Financial Code. As such, Boston Private and its subsidiaries are subject to examination by, and may be required to file reports with, the CDFI.
OTS RegulationsDividends. The OTS regulates all capital distributions by Gibraltar directly or indirectly to Boston Private, including dividend payments. If the total amount of all capital distributions (including each proposed capital distribution) for the applicable calendar year exceeds net income for that year to date plus the retained net income for the preceding two years, then Gibraltar must file an application and receive the approval of the OTS for a proposed capital distribution. Due to Gibraltars net loss in 2007, they currently would not be able to pay a dividend to Boston Private without OTS approval.
Regulatory Enforcement Authority. The enforcement powers available to federal banking regulators include, among other things, the ability to assess civil money penalties, to issue cease and desist or removal orders and to initiate injunctive actions against banking organizations and institution-affiliated parties, as defined. In general, these enforcement actions may be initiated for violations of law and regulations and unsafe or unsound practices. Other actions or inactions may provide the basis for enforcement action, including misleading or untimely reports filed with regulatory authorities. Under certain circumstances, federal and state law requires public disclosure and reports of certain criminal offenses and also final enforcement actions by the federal banking agencies.
Securities Law Issues. The GLBA also amended the federal securities laws to eliminate the blanket exceptions that banks traditionally have had from the definition of broker, dealer and investment adviser under the Exchange Act. The Securities and Exchange Commissions (SEC) bank dealer regulation, among other things, granted an exemption to banks from dealer registration (as well as from registration as a dealer) with respect to effecting a de minimis number of riskless principal transactions, and to its rule that defines terms used in the bank exception to dealer registration for asset-backed transactions, and included a new exemption for banks from the definition of dealer under the Exchange Act for certain securities lending transactions. The FRB approved Regulation R implementing the bank broker push out provisions under Title II of the GLBA. The GLBA provided 11 exceptions from the definition of broker in Section 3(a)(4) of the Securities Exchange Act of 1934 (the Exchange Act) that permit banks not registered as broker-dealers with the SEC to effect securities transactions under certain conditions. Regulation R implements certain of these exceptions. The exceptions were intended to preserve bank activity after Congress repealed the blanket bank exemption from broker regulation. After several attempts by the SEC that were criticized by banks and banking agencies, Congress required the SEC to withdraw its previous rules, including Regulation B, and issue rules jointly with the FRB. The SEC and the FRB have approved the final Regulation R and a bank must start complying with Regulation R on the first day of the banks fiscal quarter starting after September 30, 2008. The FRB and the SEC have stated that they will jointly issue any interpretations or no-action letters and guidance. Specifically, regarding formal enforcement action, the two agencies have stated that they will consult with each other and the appropriate federal banking agency and coordinate their activities when appropriate. In regard to Exchange Act section 29 risk, which voids contracts made in violation of the Exchange Act, a permanent exemption is provided if the bank acted in good faith and had reasonable policies and procedures in place, and the violation did not result in significant harm or financial loss. With respect to investment adviser registration, the GLBA requires a bank that acts as investment adviser to a registered investment company to register as an investment adviser or to conduct such advisory activities through a separately identifiable department or division of the bank so registered.
Fair Credit Reporting Affiliate Marketing Regulations. In November, 2007, the federal banking agencies published final rules to implement the affiliate marketing provisions in section 214 of the Fair and Accurate Credit Transactions Act of 2003, which amends the Fair Credit Reporting Act. The final rules 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. These rules became effective on January 1, 2008. The mandatory compliance date for these rules is October 1, 2008.
Regulation of Nondepository Trust Companies
On February 1, 2008 Boston Private indirectly acquired a 70.1% share of Davidson Trust Company (DTC). DTC is a Pennsylvania nondepository trust company that is subject to regulation by the Pennsylvania Department of Banking (the PDOB). DTC must maintain total equity capital and liquid assets in the amount of $2 million. DTC is prohibited from paying cash dividends or making other capital distributions that would cause DTCs total equity capital or liquid assets to be less than $2 million.
Government Policies and Legislative and Regulatory Proposals
The operations of the Banks are generally affected by the economic, fiscal, and monetary policies of the U.S. and its agencies and regulatory authorities, particularly the FRB which regulates the money supply of the U.S., reserve requirements against deposits, the discount rate on FRB borrowings and related matters, and which conducts open-market operations in U.S. government securities. The fiscal and economic policies of various governmental entities and the monetary policies of the FRB have a direct effect on the availability, growth, and distribution of bank loans, investments, and deposits.
In addition, various proposals to change the laws and regulations governing the operations and taxation of, and deposit insurance premiums paid by, federally and state-chartered banks and other financial institutions are from time to time pending in Congress and in state legislatures as well as before the FRB, the FDIC, the OTS and other federal and state bank regulatory authorities. The likelihood of any major changes in the future, and the impact any such changes might have on Boston Private Bank, Borel, Charter, FPB, and Gibraltar are not possible to determine.
Government Regulation of Other Activities
Virtually all aspects of the Companys investment management and wealth advisory businesses are subject to extensive regulation. Certain subsidiaries of the Company are registered with the Securities and Exchange Commission (the Commission) as investment advisers under the Investment Advisers Act of 1940, as amended (the Investment Advisers Act). As an investment adviser, each is subject to the provisions of the Investment Advisers Act and the Commissions regulations promulgated thereunder. The Investment Advisers Act imposes numerous obligations on registered investment advisers, including fiduciary, recordkeeping, operational, and disclosure obligations. Certain subsidiaries of the Company are also subject to regulation under the securities laws and fiduciary laws of certain states. Each of the mutual funds for which Westfield, and DGHM act as sub-adviser, is registered with the Commission under the Investment Company Act of 1940, as amended (the 1940 Act). Shares of each such fund are registered with the Commission 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, Westfield and DGHM are subject to requirements under the 1940 Act and the SECs regulations promulgated thereunder. Under the Investment Advisers Act, every investment advisory contract between a registered investment adviser and its clients must provide that it
may not be assigned by the investment adviser without the consent of the client. In addition, under the 1940 Act, each contract with a registered investment company must provide that it terminates upon its assignment. Under both the Investment Advisers Act and the 1940 Act, an investment advisory contract is deemed to have been assigned in the case of a direct assignment of the contract as well as in the case of a sale, directly or indirectly, of a controlling block of the advisers voting securities. Such an assignment may be deemed to take place when a firm is acquired 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.
The Company, and its incorporated affiliate partners are subject to federal income taxation generally applicable to corporations under the Code. The Banks are subject to Subchapter H of the Code which relates to securities, reserves for loan losses, and any common trust funds.
The Company, and its incorporated affiliate partners 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. 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 Companys limited liability companies and their taxable income is included as part of the Companys taxable income.
State and Local Taxation
The Company and its affiliates are subject to the tax rate established in the state in which they perform their operations. Currently the Company has taxable income in the following states; Massachusetts, California, New Hampshire, Florida, New York, and the City of New York.
The Massachusetts tax rate is 10.50% on taxable income apportioned to Massachusetts. Massachusetts taxable income is defined as federal taxable income subject to certain modifications. The Company believes these modifications allow for a deduction for 95% of dividends received from stock where the entity owns 15% or more of the voting stock of the institution paying the dividend and to allow deductions from certain expenses allocated to federally tax exempt obligations. Combined reporting is not permitted under Massachusetts statutes.
The California tax rate is 8.84% for corporations that are not financial institutions whereas the tax rate on income allocated to financial institutions is 10.84%. Californias taxable income is gross income as defined under the Code as of January 1, 2005 subject to certain differences not adopted.
The New Hampshire business enterprise tax rate is 0.75%, and 8.5% on New Hampshire business profits with a credit allowed for the business enterprise tax.
The Florida tax rate is 5.5% on taxable income apportioned to Florida.
The New York state tax rate is 7.5% plus a surcharge for business operations in the Metropolitan Commuter Transportation district.
The New York City tax rate is 8.85% on taxable income apportioned to New York City. In addition to the Companys income tax in New York City, the Company is also subject to an unincorporated business tax (UBT). In computing UBT taxable income, amortization of purchased intangibles and certain payments to principals are not deductible. The UBT rate is 4.0%. A portion of the UBT paid is allowed as a credit in computing the Companys New York City income tax
V. Internet Address
The Companys 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 SEC. The Companys reports filed with, or furnished to, the SEC are also available at the SECs website at www.sec.gov. The quarterly earnings release conference call can also be accessed from the Companys website. Press releases are also maintained on the Companys website. Information on our website is not incorporated by reference into this document and should not be considered part of this Report.
Our business strategy contemplates significant growth and there are challenges and risks inherent in such a growth strategy.
In recent years, we have experienced rapid growth, both due to the expansion of our existing businesses as well as acquisitions. Among the challenges facing the Company is the ongoing need to continue to maintain and develop an infrastructure appropriate to support such growth, including in the areas of management personnel, systems, compliance, and risk management, while taking steps to ensure that the related expense incurred is commensurate with the growth in revenues. Accordingly, there is risk inherent in the Companys pursuit of a growth strategy that revenue will not be sufficient to support such expense and generate profitability at the levels we historically have achieved. A significant decrease in revenues or increases in costs may adversely affect our results of operations or financial condition.
Attractive acquisition opportunities may not be available to us in the future.
We will continue to consider the acquisition of other businesses. However, we may not have the opportunity to make suitable acquisitions on favorable terms in the future, which could negatively impact the growth of our business. We expect that other banking and financial companies, many of which have significantly greater resources than we do, will compete with us to acquire compatible businesses. This competition could increase prices for acquisitions that we would likely pursue. Also, acquisitions of regulated businesses such as banks are subject to various regulatory approvals. If we fail to receive the necessary regulatory approvals, we will not be able to consummate an acquisition that we believe is in our best interests.
In connection with our recent acquisitions and 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, 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:
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.
We have identified certain material weaknesses in our internal controls over financial reporting.
As of December 31, 2007, the Company has identified certain material weaknesses in its internal control over financial reporting. Under applicable standards, a material weakness is a deficiency, or combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of the registrants annual or interim financial statements will not be prevented or detected on a timely basis. A discussion of the material weaknesses that have been identified can be found in Item 9A of Part II of this Form 10-K, together with the Companys remediation plan. If we are unable to remediate the identified material weaknesses or otherwise fail to achieve and maintain an effective system of internal controls over financial reporting, we may be unable to accurately report our financial results, prevent or detect fraud, or provide timely and reliable financial information, which could have a material adverse effect on our business, results of operations or financial condition. Although we believe that the consolidated financial statements included in this Form 10-K present fairly, in all material respects, our financial position, results of operations and cash flow for the periods presented in conformity with GAAP, and we are taking the remedial steps described in Item 9A with respect to the identified material weaknesses, we cannot assure you that additional material weaknesses in our internal control over financial reporting will not be identified in the future.
If we are required to write down goodwill and other intangible assets, our financial condition and results of operations would be negatively affected.
When we acquire a business, a substantial portion of the purchase price of the acquisition 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, 2007, our goodwill and other identifiable intangible assets were approximately $458.2 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. We conduct an annual review to determine whether goodwill and other identifiable intangible assets are impaired.
Our goodwill and intangible assets are tested for impairment annually in the fourth quarter at the reporting unit level. An impairment test also 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. Examples of those events or circumstances would include the following:
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 stockholders equity and financial results.
If further deterioration of loans at FPB or decline in bank valuations in southern California occur prior to the annual impairment testing in the fourth quarter, the Company will accelerate the testing of goodwill for impairment at FPB.
During 2007, the Company recorded an impairment charge with respect to Gibraltar and two such charges with respect to DGHM.
Competition in the local banking industry may impair our ability to attract and retain banking customers at current levels.
Competition in the local banking industry coupled with our relatively small size may limit the ability of our private banking affiliate partners to attract and retain banking customers.
In particular, the Banks 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 customers. Areas of competition include interest rates for loans and deposits, efforts to obtain deposits and range and quality of services provided. Our Banks also face competition from out-of-state financial intermediaries which have opened low-end production offices or which solicit deposits in their respective market areas.
Because our Banks maintain smaller staffs and have fewer financial and other resources than larger institutions with which they compete, they may be limited in their ability to attract customers. In addition, some of the Banks current commercial banking customers may seek alternative banking sources as they develop needs for credit facilities larger than our Banks can accommodate.
If our Banks are unable to attract and retain banking customers, they may be unable to continue their loan growth and their results of operations and financial condition may otherwise be negatively impacted.
Fluctuations in interest rates may negatively impact our banking business.
Fluctuations in interest rates may negatively impact the business of our Banks. Our Banks main source of income from operations is net interest income, which is equal to the difference between the interest
income received 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. Our Banks net interest income can be affected significantly by changes in market interest rates. Changes in relative interest rates may reduce our Banks net interest income as the difference between interest income and interest expense decreases. As a result, our Banks have 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 and funding sources. 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 our Banks 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 write-offs, but also necessitate further increases to the Banks allowances for loan losses. Increases 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.
Our cost of funds for banking operations may increase as a result of general economic conditions, interest rates and competitive pressures.
Our cost of funds for banking operations may increase as a result of general economic conditions, interest rates and competitive pressures. Our Banks have traditionally obtained funds principally through deposits and through 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. Historically and in comparison to commercial banking averages, our Banks have had a higher percentage of their time deposits in denominations of $100,000 or more. Within the banking industry, the amounts of such deposits are generally considered more likely to fluctuate than deposits of smaller denominations. If, as a result of general economic conditions, market interest rates, competitive pressures or otherwise, the value of deposits at our Banks decreases relative to their overall banking operations, our Banks may have to rely more heavily on borrowings as a source of funds in the future.
Defaults in the repayment of loans may negatively impact our business.
A borrowers default on its obligations under one or more of the Banks 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, our Banks may have to write-off the loan in whole or in part. In such situations, the Banks 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.
Our Banks management periodically makes a determination of an allowance for loan losses based on available information, including the quality of their loan portfolio, certain economic conditions, and the value of the underlying collateral and the level of its non-accruing loans. Provisions to this allowance result in an expense for the period. If, as a result of general economic conditions or an increase in defaulted loans, management determines that additional increases in the allowance for loan losses are necessary, the Banks will incur additional expenses.
In addition, bank regulatory agencies periodically review our Banks allowances for loan losses and the values they attribute to real estate acquired through foreclosure or other similar remedies. Such regulatory agencies may require the Banks to adjust their determination of the value for these items. These adjustments could negatively impact our results of operations or financial condition.
A downturn in local economies or real estate markets could negatively impact our banking business.
A downturn in the local economies or real estate markets could negatively impact our banking business. Primarily, our Banks serve individuals and smaller businesses located in six geographic regions: eastern Massachusetts, New York City, northern California, southern California, southern Florida, and the Pacific Northwest. The ability of the Banks customers to repay their loans is impacted by the economic conditions in these areas.
The Banks commercial loans are generally concentrated in the following customer groups:
Our Banks 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 our Banks residential mortgage and home equity loans are secured by residential property. Consequently, our Banks abilities 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 our Banks borrowers to repay their loans and affect the value of the collateral securing these loans.
Recently, FPB has been adversely impacted by real estate market conditions in certain areas in Southern California. As a result FPB has increased its allowance for loan losses primarily in its portfolio of real estate construction development and land loans.
Environmental liability associated with commercial lending could result in losses.
In the course of business, our Banks may acquire, through foreclosure, properties securing loans they have originated or purchased which are in default. Particularly in commercial real estate lending, there is a risk that hazardous substances could be discovered on these properties. In this event, we, or our Banks, might be required to remove these substances from the affected properties at our sole cost and expense. The cost of this removal 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.
Prepayments of loans may negatively impact our business.
Generally, our Banks customers 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 customers discretion. If customers 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 banking business is highly regulated which could limit or restrict our activities and impose financial requirements or limitations on the conduct of our business.
Bank holding companies and banks operate in a highly regulated environment and are subject to supervision and examination by federal and state regulatory agencies. We are subject to the Bank Holding Company Act and to regulation and supervision by the Board of Governors of the Federal Reserve System. Our Banks are subject to regulation and supervision by their respective federal and state regulatory agencies, which currently include: the Massachusetts Commissioner of Banks; the California Department of Financial Institutions, the OTS, the FDIC, and the Washington State Division of Banks.
Federal and state laws and regulations govern numerous matters 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 nonbanking activities, the level of reserves against deposits and restrictions on dividend payments. The FDIC, the OTS, the California Department of Financial Institutions, the Washington State Division of Banks, and the Massachusetts Commissioner of Banks possess cease and desist powers to prevent or remedy unsafe or unsound practices or violations of law by banks subject to their regulation, and the Federal Reserve Board possesses similar powers with respect to bank holding companies. These and other restrictions limit the manner in which our Banks and we may conduct business and obtain financing.
Furthermore, our banking business is affected by the monetary policies of the FRB. Changes in monetary or legislative policies may affect the interest rates our Banks must offer to attract deposits and the interest rates they must charge on their loans, as well as the manner in which they offer deposits and make loans. These monetary policies have had, and are expected to continue to have, significant effects on the operating results of depository institutions generally, including our Banks.
We may not be able to attract and retain investment management and wealth advisory clients at current levels.
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 and successful investment management and wealth advisory firms in these areas. Many of our competitors have greater resources than we have.
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.
For the year ended December 31, 2007, approximately 50% of our revenues were derived from investment management and trust fees and wealth advisory contracts. 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 affiliate partners is a significant factor in our overall results of operations and financial condition.
Our investment management business is highly dependent on people to produce investment returns and to solicit and retain clients.
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:
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 clients 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.
In addition to the loss of key investment managers, 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.
Our investment management business 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. The world financial and securities markets will likely continue to experience significant volatility as a result of, among other things, world economic and political conditions. Decline 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.
Our investment management and wealth advisory businesses are highly regulated, which could 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 subsidiarys registration as an investment adviser.
All of our investment managers and wealth advisory affiliate partners are registered investment advisers under the Investment Advisers Act. The Investment 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 affiliate partners acting as sub-advisers to mutual funds, are registered under the Investment Company Act of 1940 and are subject to that acts provisions and regulations.
We are also subject to the provisions and regulations of ERISA, to the extent 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 the profitability and mode of operations of the Company.
ITEM 1B. UNRESOLVED STAFF COMMENTS
There are no material unresolved written comments that were received from the SEC staff 180 days or more before the end of our fiscal year relating to our periodic or current reports under the Securities Exchange Act of 1934.
ITEM 2. PROPERTIES
The Company and its subsidiaries conduct operations in leased premises except for two owned properties. The Companys headquarters are located at Ten Post Office Square, Boston, Massachusetts. The premises are generally located in the vicinity of the headquarters for all of our affiliate partners. One of our banks also has an office outside the state of its headquarters.
Generally, the initial terms of the leases for these 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 taxes.
ITEM 3. LEGAL PROCEEDINGS
Investment Management Litigation
On May 3, 2002, the Retirement Board of Allegheny County filed a complaint in Pennsylvania state court against Westfield and Grant D. Kalson & Associates bringing breach of contract and other claims for an alleged opportunity loss, notwithstanding that the Fund administered by the Retirement Board grew substantially under Westfields and Kalsons management. Westfield and Kalson have defended the claim vigorously and will continue to do so. Discovery was completed on August 1, 2005. The Plaintiff has initiated no activity on the case since the close of discovery. Westfield thus filed both a motion to dismiss for non pros and a motion for summary judgment in December, 2007. Briefing on Westfield's motions concluded on February 1, 2008, and oral argument was held on February 27, 2008. Additional briefing following oral argument will unfold in March, 2008, and the motions will then be fully briefed and argued.
Since 1984, Borel has served as a trustee of a private family trust (Family Trust) that was a joint owner of certain real property known as the Guadalupe Oil Field. The field was leased for many years to Union Oil Company of California (d/b/a UNOCAL) for oil and gas production. Significant environmental contamination resulting from UNOCALs operations was found on the property in 1994. At that time Borel entered into negotiations to sell the property to UNOCAL, to settle UNOCALs liabilities to the Family Trust, and to obtain a comprehensive indemnity on the Trusts behalf. Certain beneficiaries of the Family Trust brought a series of actions against Borel claiming that Borel had breached its fiduciary duties in managing the oil and gas leases and in negotiating with UNOCAL for settlement and for sale of the property. In the first lawsuit, the beneficiaries sought to remove Borel as trustee. Borel prevailed at trial and obtained final judgment in its favor, but the beneficiaries continued to pursue related litigation against Borel for many years afterwards. In 2002 Borel concluded a settlement with UNOCAL and sold the property to UNOCAL. In 2005 all of the parties, with one
exception noted below, entered into a global settlement whereby UNOCAL agreed to pay the plaintiff beneficiaries certain amounts, and the beneficiaries dismissed all of their pending actions with prejudice, including all actions against Borel, which paid nothing in the settlement.
One beneficiarya contingent remainder beneficiarysplit with the other plaintiff beneficiaries in 2003, filed parallel actions in the state court against Borel, and refused to participate in the otherwise global settlement in 2005. The state court subsequently dismissed those parallel actions against Borel on the merits. The non-settling beneficiary, acting pro se, then filed a new action on June 24, 2005, in the United States District Court for the Northern District of California. In this action, the non-settling beneficiary makes claims similar to those made in the earlier actions that were dismissed by the state court. He seeks to invalidate the settlement with UNOCAL, to compel the return of the Guadalupe Oil Field to the Family Trust, and to recover damages against Borel and others for alleged mismanagement. The complaint does not specify an amount of damages, but in the trial of the action to remove Borel as trustee in 1998, the then plaintiff beneficiaries submitted expert testimony to the effect that Borels actions had damaged the Family Trust in the amount of $102 million. The trial court found this testimony unpersuasive in that context, and Borel and the other defendants prevailed. In the current federal litigation, in November 2005 the court dismissed the entire action as to Borel based on the prior final judgments in the state court and on lack of federal jurisdiction. The non-settling beneficiary appealed from the judgment. The federal court of appeals affirmed the judgment in full. The non-settling beneficiary filed a petition for certiorari in the U.S. Supreme Court. On February 25, 2008 the U.S. Supreme Court denied the non-settling beneficiarys petition for certiorari. There are no further appeals available to the non-settling beneficiary. The parties will now proceed with consummation of the settlement agreement and a final trust accounting.
The Company is also 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 financial condition or results of operations of the Company.
ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Market for Common Stock
The Companys common stock, par value $1.00 per share (the Common Stock), is traded on the NASDAQ Global Market System (NASDAQ) under the symbol BPFH. At March 3, 2008 there were 37,671,238 shares of Common Stock outstanding. The number of record holders of the Companys common stock as of March 3, 2008 was 1,338. The Company believes that the number of beneficial owners of its common stock, as of the record date, was greater.
The following table sets forth the high and low closing sale prices for the Companys Common Stock for the periods indicated, as reported by NASDAQ:
The Company presently plans to pay cash dividends on its Common Stock on a quarterly basis dependent upon the results of operations of the immediately preceding quarters. However, declaration of dividends by the Board of Directors of the Company will depend on a number of factors, including capital requirements, liquidity, regulatory limitations, the Companys operating results and financial condition and general economic conditions.
The Company is a legal entity separate and distinct from its affiliate partners. These affiliate partners are the principal assets of the Company and, as such, provide the main source of payment of dividends by the Company. As to the payment of dividends, as discussed below, each of the Banks is subject to the laws and regulations of its chartering jurisdiction and to the regulations of its primary federal regulator. If the federal banking regulator determines that a depository institution under its jurisdiction is engaged in or is about to engage in an unsafe or unsound practice, the regulator may require, after notice and hearing, that the institution cease and desist from such practice. Depending on the financial condition of the depository institution, an unsafe or unsound practice could include the payment of dividends. The federal banking agencies have indicated that paying dividends that deplete a depository institutions capital base to an inadequate level would be an unsafe and unsound banking practice. Under the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA), a depository institution may not pay any dividend if payment would cause it to become undercapitalized or if it already is undercapitalized. The federal agencies have also issued policy statements that provide that bank holding companies and insured banks should generally only pay dividends out of current operating earnings.
The Company paid dividends on its common stock of $0.36 and $0.32 in 2007 and 2006, respectively.
Under Massachusetts, California, and Washington law and OTS regulations, payment of dividends from the Companys Banks may be restricted and limited under certain circumstances. These restrictions on the Banks ability to pay dividends to the Company may restrict the ability of the Company to pay dividends to the holders of the Common Stock. The payment of dividends by Boston Private and the Banks 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 Companys Investment Mangers and Wealth Advisors ability to pay dividends.
On July 5, 2007 the Company repurchased and retired approximately 1.5 million shares of its common stock at an aggregate price of $40.0 million, or $27.24 per share. The repurchase was effected simultaneously with the sale of the Contingent Convertible Senior Notes. See Part II, Item 8 Financial Statements and Supplementary Data in Note 15: Junior Subordinated Debentures and Other Long-Term Debt to the Consolidated Financial Statements of the Company for the year ended December 31, 2007.
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, including the Companys Consolidated Financial Statements and related Notes, appearing elsewhere herein.
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Managements 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.
I. Executive Summary
The Company offers a full range of wealth management services to high net worth individuals, families, businesses and select institutions through its three functional segments, Private Banking, Wealth Advisory, and Investment Management. This Executive Summary provides an overview of the most significant aspects of our operations in 2007. Details of the matters addressed in this summary are provided elsewhere in this document and, in particular, in the sections immediately following.
Boston Privates strategy is to build a national franchise that delivers exceptional shareholder value by providing a full complement of wealth management services through diversified affiliated companies. The Company typically seeks entry into geographically and demographically attractive areas through acquisitions and focuses on the organic growth of its entities.
In 2007 the Company acquired Charter, increased its equity interest in BOS to a majority interest, and decreased its ownership in Sand Hill from 100% ownership to 76%. In 2006 the Company acquired Anchor. See Part II, Item 8 Financial Statements and Supplementary DataNote 2: Mergers and Acquisitions to the Consolidated Financial Statements for additional information. The combined financial results of these acquired entities have had an impact on the 2007 results of operations and should be considered in comparing the Companys results of operations. See Part II, Item 8 Financial Statements and Supplementary DataNote 5: Functional Segments to the Consolidated Financial Statements for revenue and expense information. The following table provides additional detail for these acquisitions.
At December 31, 2007 the Companys consolidated affiliate partners managed or advised $36.6 billion in client assets under management and had balance sheet assets of approximately $6.8 billion.
In 2007, through organic growth and acquisitions, the Company earned revenues of $403.6 million, an increase of 17.0% over revenues of $344.9 million in 2006. Total expenses in 2007, including impairment and minority interest, were $360.3 million, an increase of 41.8% over expenses, including minority interest, of $254.1 million in 2006. Net income for 2007 was $4.2 million, or $0.11 per diluted share, compared to net income in 2006 of $54.4 million, or $1.43 per diluted share.
The key items that impacted the Companys results in 2007 include: the non-cash impairment charges at both DGHM and Gibraltar, of $47.2 million, net of tax and minority interest, decreasing diluted earnings per share by approximately $1.20; the increase in FPBs classified loans and other related adjustments, of $10.8 million, net of tax, decreasing diluted earnings per share by approximately $0.26; the acquisition of
Charter, net of the funding costs, and consolidation of BOS, added approximately $2.1 million to the Companys net income; and the full year impact from the Companys second quarter 2006 acquisition of Anchor, which added approximately $2.1 million to the Companys net income.
In the second quarter of 2007, the Company recognized a non-cash impairment charge of $10.1 million, net of tax and minority interest, at DGHM. During the Companys 2006 annual impairment testing it was concluded that no impairment existed with respect to the goodwill attributable at DGHM. However, the continued decline of Assets Under Management (AUM) and loss of a key member of the firms Sales and Marketing group during the second quarter of 2007 required the Company to test the goodwill as a result of the adverse events. Based on the outcome of the test, it was determined that a charge for impairment was required to reduce the goodwill carried at DGHM.
During the Companys 2007 annual impairment testing in the fourth quarter, it was concluded that non-cash impairment charges of $29.1 million, and $8.1 million, net of tax, would be accounted for to reduce the goodwill acquired in its October 1, 2005 acquisition of Gibraltar, and to reduce the intangible assets at DGHM, respectively. Since the Companys acquisition of Gibraltar, the market values of bank stocks in general, and of banks headquartered in Florida in particular, have declined significantly. In fact, the SNL bank index declined 25% during 2007, which factored into the reduction of the valuation of the Companys investment in Gibraltar. The Companys review of DGHMs investment advisory contracts determined that the remaining carrying amount acquired in February 2004 would not be fully recoverable. Therefore, the Company accelerated the amortization of DGHMs investment advisory contracts decreasing the value to $10.4 million at December 31, 2007.
The Companys Los Angeles-based affiliate partner, FPB, increased its provision for loan losses, including the provision for unfunded loan commitments, by $17.6 million due to a substantial increase in loans classified as substandard or non-accrual at December 31, 2007. The loans were primarily construction and land development loans in the Inland Empire region of southern California. In addition, FPB reversed $1.1 million of previously recorded interest income on a portion of these loans. Related to this additional provision, the Company reduced salaries and benefits expense by $1.3 million. These entries resulted in a net tax benefit of $6.6 million.
Total expenses and minority interest increased $106.2 million, or 41.8%. $62.6 million, or 58.9% of the total increase is driven by the Companys impairment charges and increase in the provision for unfunded loan commitments related to FPB. The remaining $43.6 million increase in total expenses and minority interest is primarily driven by the Companys acquisition of Charter and Anchor, and the consolidation of BOS. Net income decreased $50.2 million, or 92.3%. $58.0 million, or 115.5%, of the total decrease is driven by the Companys non-cash impairment charges, the increase in FPB classified loans and other related adjustments. The remaining positive increase of $7.8 million is primarily driven by the acquisition of Charter, the full year benefit of the 2006 Anchor acquisition, and the organic growth at the Companys existing affiliate partners.
Income tax expense was $14.3 million in 2007, reflecting an effective tax rate of 77.4%. Income tax expense for 2006 was $30.2 million, reflecting an effective tax rate of 35.7%. The effective tax rate increased in 2007 primarily due to the impairment charges. In 2008, the effective tax rate is expected to be approximately 36%. See Part II, Item 8 Financial Statements and Supplementary DataNote 16: Income Taxes to the Consolidated Financial Statements for additional information.
The return on average assets decreased 95 basis points to 0.07% for the year ended December 31, 2007, compared to 1.02% for the year ended December 31, 2006. Return on average equity decreased 865 basis points to 0.62% for the year ended December 31, 2007, compared to 9.27% for the year ended December 31, 2006. These decreases are primarily due to the impact of the non-cash impairment charges, the increase in FPB classified loans, and other related adjustments. Average assets increased 17.8% during 2007 to $6.3 billion. This increase was primarily due to the acquisition of Charter and loan growth at the Banks. Average equity increased
13.8% during 2007 to $667.3 million. The increase in average equity is primarily due to the common stock issued in the Charter acquisition, stock issued for deferred acquisition payments, option exercised, and net income partially offset by the stock repurchase.
On July 1, 2007 the Company successfully completed the acquisition of Charter Financial Corporation, the holding company of Charter. The acquisition gives the Company the opportunity to grow its private banking business in its Pacific Northwest platform. See Part II, Item 8 Financial Statements and Supplementary DataNote 2: Mergers and Acquisitions to the Consolidated Financial Statements for additional information.
On July 31, 2007 the Company successfully completed its consolidation of BOS. The Company increased its equity ownership in BOS from 49.7% to majority ownership of 60.85%. The Company has the option to increase its ownership in BOS over the next year up to 75%. See Part II, Item 8 Financial Statements and Supplementary DataNote 2: Mergers and Acquisitions to the Consolidated Financial Statements for additional information.
On November 1, 2007 the Company reduced its ownership interest in Sand Hill from 100% to 76%. The transaction resulted in the purchase of 24% of the equity and profits of Sand Hill by certain existing members of the Sand Hill management team. The Company believes this transaction better aligns the interests of the Sand Hill management team with those of the Company. The transaction was financed by recourse notes from Sand Hill management issued to Sand Hill at market terms. The Company accounts for the sale of stock in an affiliate partner as a capital transaction. See Part II, Item 8 Financial Statements and Supplementary DataNote 2: Mergers and Acquisitions to the Consolidated Financial Statements for additional information.
Management will continue to focus on identifying attractive acquisition candidates in areas where the Company can build regional platforms from which to serve the targeted client base. The Company will continue to look at acquisition targets with an eye towards further geographic and business line diversification. By diversifying geographically, the Company mitigates the impact of regional economic risks. By diversifying by revenue stream between the three distinct lines of business, the Company expects to achieve more stable revenue and earnings. In evaluating any acquisition, management will consider the types of assets under management or advisory and the diversifying impact a potential acquisition may have on our existing investment management concentrations.
The following table illustrates the Companys functional profit growth in each key business line.
The Companys Private Banking profits decreased $37.0 million, or 75.4%. The Private Banking profits were negatively impacted by the non-cash goodwill impairment charge of $29.1 million at Gibraltar and the increase in the allowance for loan losses related to the increase in FPBs classified loans of $11.4 million, net of tax, partially offset by the acquisition of Charter. Private Banking profit for 2007 was also impacted negatively by the challenging interest rate and deposit gathering environment. As a result of the Banks strong loan growth outpacing deposit growth, the Banks had additional FHLB borrowings which generally are more costly than deposits.
During the Companys 2007 annual impairment testing in the fourth quarter, it was concluded that a non-cash impairment charge would be accounted for to reduce the goodwill acquired in its October 1, 2005
acquisition of Gibraltar. Since the Companys acquisition of Gibraltar, the market values of bank stocks in general, and the banks headquartered in Florida in particular, have declined significantly. In fact, the SNL bank index declined 25% during 2007, which factored into the reduction of the valuation of the Companys investment in Gibraltar.
Significant assumptions used in the valuation of Gibraltar using the discounted cash flow method include:
The valuation using the comparable market multiples approach calculates value by comparing Gibraltar to similar publicly traded businesses. Twelve similar businesses were identified and valuation multiples based on price to earnings multiples, price to book value, and price to tangible book value were calculated.
The following table shows a summary of certain financial components of the Companys Private Banks, by region, at December 31, 2007.
The Company believes private banking is an attractive growth market and that net interest income, net interest margin, deposit growth, loan growth and loan quality are the important business metrics in evaluating the condition of its private banking business.
Net Interest Income. For 2007, the Companys net interest income increased $14.4 million to $187.9 million, an 8.3% increase. On a fully-taxable equivalent (FTE) basis, net interest income increased by 8.7%, or $15.7 million, to $194.9 million, compared to $179.3 million in 2006. This growth in net interest income was accomplished through growing the Companys loan portfolio with proceeds from increased deposits, and additional borrowings. The $14.4 million increase in net interest income in 2007 is the net result of a $26.7 million increase in business volumes, (change in average balance multiplied by the prior year average interest rate) and a $12.3 million decrease due to an increase in cost of funds, (change in average interest rate multiplied by the prior year average balance) which was partially offset by an increased yield on assets.
Net Interest Margin. On a FTE basis net interest margin declined 32 basis points to 3.52% for 2007 compared to 3.84% for 2006. This decrease in net interest margin was due to several factors. The competitive market for deposits caused the Banks to increase rates paid significantly to attract new deposits and retain current deposits. The strong growth in loans, as compared to deposits, required the Banks to increase FHLB borrowings which generally have higher rates than deposits. The increase in non-accrual loans has also reduced interest income.
Deposits. In 2007, the Companys deposits grew $297.3 million, or 7.3%, to $4.4 billion from $4.1 billion in 2006. The cost of deposits increased 66 basis points to 3.58% during 2007 due to the mix of deposits, coupled with the rates paid on interest bearing deposit accounts and certificates of deposit due to the competitive market
for those accounts. The increase in deposits can be attributed to organic growth, the recent opening of new private banking offices, and the acquisition of Charter. The low growth rate of deposits compared to our historical average can be attributed to increased competition and, in some instances, customers moving a portion of their deposits to higher yielding money market mutual funds.
Loans. In 2007, the Companys loan portfolio increased $948.6 million, or 22.0%, to $5.3 billion, as compared to $4.3 billion in 2006.
The commercial loan portfolio increased $454.5 million, or 24.4%. The increase in the commercial loan portfolio was due to a combination of increased loan volume at our Banks, and the acquisition of Charter.
The construction loan portfolio increased $231.4 million, or 36.6%. The increase in the construction loan portfolio is affected by the demand and the market for new construction which is highly dependent upon the local economies that each of our Banks operate in.
The residential loan portfolio increased $218.3 million, or 14.1%. The Banks generally keep variable rate residential loans originated in their portfolios and sell fixed rate loan originations in the secondary market. The increase in the residential loans is impacted by the mix between fixed and variable rate loan originations and the level of current customers refinancing their mortgage with a competitor.
The home equity and consumer loan portfolio increased $44.5 million, or 16.6%. The home equity and consumer loan portfolio is a small percentage of the overall loan portfolio. The balance of this category is primarily influenced by the amount of usage of customers home equity lines of credit. Generally, there is a substantial portion of available credit on unused lines of credit.
Loan Quality. The Company considers credit quality to be an extremely important priority in managing the Companys loan portfolio. At the end of 2007, the ratio of non-accrual loans to total loans was 1.00% compared to 0.23% at the end of 2006. The allowance for loan losses to total loans was 1.35% at the end of 2007 compared to 1.01% at the end of 2006. The total allowance for loan losses at the end of 2007 is $71.0 million, representing coverage of 1.35 times our non-accrual loans of $52.6 million, compared to 4.34 times the non-accrual loans of $10.0 million in 2006. In 2007, the Company had net loan charge-offs of $78 thousand. The Company has recently initiated steps to enhance the loan review processes at each of the Banks in an effort to identify credit issues in a more timely manner. Further, the Company will continue to monitor credit quality closely in light of adverse conditions in certain of the markets in which the Banks operate.
The Companys Investment Managers profits decreased $11.9 million, or 56.3%. The Investment Managers profits were negatively impacted by the non-cash goodwill impairment charge of $10.1 million, net of tax and minority interest, in the second quarter of 2007, and the $8.1 million non-cash intangible impairment charge, net of tax, in the fourth quarter of 2007. The increase excluding these charges is primarily driven by the full year impact of the 2006 acquisition of Anchor, and increased performance fees and revenues.
During the Companys 2006 annual impairment testing it was concluded that no impairment existed with respect to the goodwill attributable at DGHM. However, the continued decline of AUM and loss of a key member of the firms Sales and Marketing group during the second quarter of 2007 required the Company to test the goodwill as a result of the adverse events. Based on the outcome of the test, it was determined that a charge for impairment was required to reduce the goodwill carried at DGHM. The fair value was determined using a weighted average of the discounted cash flow method and comparable market multiples method. Significant assumptions used in the valuation of DGHM using the discounted cash flow method included:
The valuation in the second quarter of 2007 used the comparable market multiples approach calculates value by comparing DGHM to similar publicly traded businesses. Eight similar businesses were identified and valuation multiples based on sales and on earnings before interest expense, taxes, depreciation and amortization (EBITDA) were calculated. The EBITDA multiples ranged from 8.05 to 18.01 and the sales multiples ranged from 0.84 to 6.53 for the comparable companies. An EBITDA multiple of 8.0 and a sales multiple of 3.0 were used in the valuation based on the expectation that DGHMs short-term growth would be slower than the comparable companies due to the loss of AUM.
In the fourth quarter of 2007, the Company recognized an impairment loss to reduce the value of advisory contracts at DGHM. DGHM experienced significant net asset outflows which caused management to increase the estimated attrition rate from the 13.0% estimate used in the second quarter valuation to 16.9%. This change, along with a reduction in AUM in excess of that anticipated, caused the projected future cash flows to be less than the carrying value. The revised carrying value was calculated using estimated cash flows discounted at 18%.
In 2007, the Company conducted its investment management business through four affiliate partners. The following table shows a summary of certain financial components of these four investment managers, at December 31, 2007.
The Company believes investment management is an attractive growth market and that assets under management, market growth and performance are the important business metrics in evaluating the condition of its investment management business.
Assets Under Management. The Company measures the level of AUM each reporting period to monitor how net flows and market value changes impact current and future revenues. Each individual firm measures AUM for billing purposes and provides data related to net flows and market value changes to the Companys management. Certain estimates and allocations are made by the firms in providing this data to the Companys management. Client AUM by the Companys investment management firms increased $3.2 billion to $23.1 billion at December 31, 2007, compared to $19.8 billion at December 31, 2006.
The following table shows the components of the AUM growth for the periods ended December 31, 2007 and 2006:
Net New Business. New AUM, which include new investment management accounts and net new contributions to existing investment management accounts, less lost accounts, for 2007 were $401 million compared to net outflows of approximately $465 million in 2006.
DGHM experienced significant net outflows of approximately $875 million during 2007. Net outflows in the first quarter were in line with results projected in the fourth quarter 2006 annual impairment test. However, DGHM experienced significantly higher than anticipated account resignations in the second quarter of 2007, resulting in the goodwill impairment charge. The net outflows were mostly attributable to client rebalancings and less than satisfactory investment performance in earlier periods. Investment performance has substantially improved in 2007, and the firm has launched new products which should bode well for attracting new clients and retaining existing clients.
Market Impact. The table below highlights the aggregate composition of AUM from our investment management firms as of December 31, 2007.
During 2007, the S&P 500 Index appreciated 3.5%. This had a positive impact on our AUM due to the concentration of our AUM in the growth and value categories. Accordingly, any change in the stock market will have a significant impact on the value of the AUM and the related management fees, the majority of which are calculated as a percentage of AUM. The favorable market conditions in 2007 increased total asset values by $2.8 billion, or 14.4%, for the year. Approximately $2 billion of the increase was contributed by Westfield.
Investment Performance. Investment performance is an important driver of new business growth and client retention.
In 2006, the Company enhanced its product mix and gained a national distribution channel though the acquisition of Anchor. As a well established mid-cap equity value manager, Anchor provides the Company with access to the rapidly growing SMA market segment. Under the SMA program Anchor provides investment management services to individual clients through relationships with approximately 18 broker/sponsors. Anchor experienced strong asset growth in 2007, as AUM increased approximately $1.2 billion or 18.0%. This growth is due to both positive net asset flows and strong market performance. Anchors investment performance of its Mid Cap Value and Balanced products significantly outperformed relevant benchmarks during 2007.
The Companys wealth advisory segment benefited from the consolidation of BOS and increased assets under advisory across the Companys wealth advisory firms. BOS added approximately $5.6 million in revenues and $2.1 billion in assets under advisory at December 31, 2007. Client assets under advisory by the Companys wealth advisory firms increased $2.8 billion to $9.1 billion at December 31, 2007 from $6.2 billion at December 31, 2006. $2.0 billion of the increase was driven by the consolidation of BOS; the remaining $800 million increase was driven by performance and organic growth.
Wealth advisory adds profitable fee income to Boston Privates revenue base that is more resistant to fluctuations in market conditions in comparison to the investment management businesses since financial planning fees are usually not tied to the market value of AUM. For 2007, Wealth Advisory revenues were comprised of approximately 44% asset based fees and 56% non asset-based fees. Revenues from BOS, Sand Hill, and a portion of RINET are asset based, and driven by the underlying market value changes in AUM. A greater portion of Wealth Advisory revenues in 2008 will be derived from asset based fees due to the full year impact of the financial results from BOS and the February 1, 2008 acquisition of DTC. Wealth Advisory fees were 9.2% of the Companys 2007 revenues and increased approximately $9.6 million, or 34.6%, over 2006.
A. Condensed Consolidated Balance Sheet and Discussion
Total Assets. Total assets increased $1.1 billion, or 18.3%, to $6.8 billion at December 31, 2007 from $5.8 billion at December 31, 2006. The acquisition of Charter and consolidation of BOS in 2007 increased total assets by approximately $381.0 million including the purchase method accounting entries. The remaining increase in total assets was due to organic growth at our existing affiliate partners and the increase in equity primarily from the Companys issuance of common stock and net income.
Investments. Total investments (consisting of cash and cash equivalents, investment securities, and stock in the Federal Home Loan Bank and Bankers Bank) increased $89.1 million, or 10.9% from the prior year to $906.4 million, or 13.3% of total assets. The increase was primarily due to the acquisition of Charter. $66.3 million, or 74.4%, was driven by the acquisition of Charter. Excluding Charter, other drivers causing the increase include the increased investments at the Banks and the increased market values of the Companys available-for-sale securities.
Investment maturities, principal payments and sales of the Companys available-for-sale and held-to-maturity securities provided $1.4 billion of cash proceeds; and $1.5 billion was spent on purchases of new investments. The timing of sales and reinvestments is based on various factors, including managements evaluation of interest rate trends and the Companys liquidity. The Companys available-for-sale investment portfolio carried a total of $4.6 million of unrealized gains and $737 thousand of unrealized losses at December 31, 2007, compared to $667 thousand of unrealized gains and $4.1 million of unrealized losses at December 31, 2006.
The Banks investment policies establish a portfolio of securities which will provide liquidity necessary to facilitate funding of loans and to cover deposit fluctuations, and to mitigate the Banks overall balance sheet exposure to interest rate risk, while at the same time achieving a satisfactory return on the funds invested. The securities in which the Banks may invest are subject to regulation and are generally limited to securities that are considered investment grade securities. In addition, the Banks have an internal investment policy which restricts investments to the following categories: U.S. Treasury securities, obligations of U.S. Government agencies and corporations, mortgage-backed securities, including securities issued by the Federal National Mortgage Association (FNMA), the Government National Mortgage Association (GNMA) and the Federal Home Loan Mortgage Corporation (FHLMC), securities of states and political subdivisions and corporate debt, all of which must be considered investment grade by a recognized rating service. The credit rating of each security or obligation in the portfolio is monitored and reviewed by each Banks portfolio manager and Asset/Liability Management Committee. The Company has determined that none of its available-for-sale or held-to-maturity investments are other-than-temporarily impaired at December 31, 2007 and 2006. At December 31, 2007 there were no cost method investments, which are included in other assets that are other-than-temporarily impaired. See Part II, Item 8, Financial Statements and Supplementary DataNote 6: Investment Securities to the Consolidated Financial Statements for further information.
The majority of the investments held by the Company are primarily within the Private Banking function. The Investment Managers and Wealth Advisors held approximately $1.4 million in other available-for-sale securities and approximately $2.0 million in held-to-maturity securities at December 31, 2007.
The following table summarizes the Companys carrying value (market value) of available-for-sale investments at the dates indicated:
The following table summarizes the Companys carrying value (amortized cost) of held-to-maturity investments at the dates indicated:
The following table sets forth the maturities of investment securities available-for-sale, based on contractual maturity, at December 31, 2007, and the weighted average yields of such securities:
Mortgage-backed securities are shown based on their final maturity, but due to prepayments, they are expected to have shorter lives. Certain securities are callable before their final maturity.
The following table sets forth the maturities of investment securities held-to-maturity, based on contractual maturity, at December 31, 2007, and the weighted average yields of such securities:
Mortgage-backed securities are shown based on their final maturity, but due to prepayments, they are expected to have shorter lives. Included in U.S. Agencies are 57 investments which can be called prior to maturity.
The following table presents the concentration of securities with any one issuer that exceeds ten percent of stockholders equity as of December 31, 2007:
Loans Held for Sale. Loans held for sale increased $1.6 million, or 29.8% from the prior year to $6.8 million, or 0.1% of total assets. This increase was primarily the result of the timing of loan sales and the type of residential loans originated at the Banks as well as the secondary market for jumbo mortgages. The Banks sell a majority of their fixed rate residential loan originations and hold most variable rate loans to mitigate interest rate risk.
Loans. Total portfolio loans increased $948.6 million, or 22.0%, from the prior year to $5.3 billion, or 77.1% of total assets. $237.1 million or 25.0% of the increase is the result of the loans acquired in the Charter acquisition. The remaining increase was primarily driven by organic growth of commercial (including construction) loans which increased $592.7 million, or 23.7%, excluding the Charter loans acquired.
The majority of the Companys loan portfolio is managed by the Banks. Less than 1%, or $5.9 million, of the Companys portfolio loans are managed by the Holding Company and a nonbanking affiliate partner. Loans managed by the Holding Company and the nonbanking affiliate partner are loans made to certain principals at DGHM, Anchor, BOS, and at Sand Hill. The Holding Company is defined as Boston Private on an unconsolidated basis.
The Banks specialize in lending to individuals, real estate investors, and middle market businesses, including corporations, partnerships, associations and nonprofit organizations. Loans made by the Banks to individuals include residential mortgage loans and mortgage loans on investment and vacation properties to individuals, unsecured and secured personal lines of credit, home equity loans, and overdraft protection. Loans made by the Banks to businesses include commercial construction and mortgage loans, revolving lines of credit, working capital loans, equipment financing and letters of credit.
At December 31, 2007, the Banks had loans outstanding of $5.3 billion which represented approximately 77.1% of the Companys total assets. The interest rates charged on these 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, 2007, approximately 75% of the Banks outstanding loans had interest rates that were either floating or adjustable in nature. See Part II, Item 7AQuantitative and Qualitative Disclosures about Market RiskInterest Rate Sensitivity and Market Risk.
The Banks loans are impacted by the economic and real estate environments in which they are located. Generally commercial, construction, and land loans are affected more than residential loans in a downturn. Of the Banks $5.2 billion in loans, approximately $3.2 billion were in these categories.
At December 31, 2007, the statutory lending limit to any single borrower ranged from $5.9 million to $35.7 million at the Banks, subject to certain exceptions provided under applicable law. At December 31, 2007, none of the Banks had any outstanding lending relationships in excess of the legal lending limit. The Banks have internal house limits which limits the amount of loans that the individual bank will make to any single borrower which is generally substantially lower than the statutory lending limit. All loans to Directors and executive officers were 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 Banks also have policies regarding the extension of loans to Directors and executive officers of the Company and its subsidiaries, and the aggregate principal amount of loans to all Directors and executive officers of the Company and its subsidiaries is limited by law to 100% of capital. At December 31, 2007, the aggregate principal amount of all loans by Banks to Directors and executive officers of the Company and its subsidiaries was $29.0 million, or 4.4% of capital.
Geographic concentration. Boston Private Bank primarily serves individuals and smaller businesses located in eastern Massachusetts and adjoining areas, with a particular concentration in the Greater Boston Metropolitan Area. Borel has a similar customer base located in northern California. FPB primarily serves small and medium-sized businesses and professionals in southern California. Gibraltar primarily serves small and medium-sized businesses and professionals in southern Florida and New York City, since they opened a new office in the fourth quarter of 2006. Charter is a community-oriented commercial bank, focused on servicing the financial needs of small businesses and wealthy individuals located throughout Greater King County in the State of Washington. A downturn in any of these local economies or real estate markets could negatively impact the Companys banking business. The following table details the Banks outstanding loan balance concentrations based on the location of the lender:
Loan Portfolio Composition and Maturity. The following table sets forth the Banks outstanding loan balances for certain loan categories at the dates indicated and the percent of each category to total gross loans. The table does not include loans from the Holding Company to certain principals of the Companys subsidiaries or loans at nonbanking affiliate partners.
The following table discloses the scheduled contractual maturities of loans in the Banks portfolios at December 31, 2007. 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 which have fixed or adjustable interest rates.
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 give the Banks 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 fact that the Banks 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 Banks 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. See Part II, Item 7Managements Discussion and Analysis of Financial Condition and Results of OperationsAsset Quality.
Commercial and Construction Loans. Commercial and construction loans include working capital loans, equipment financings, standby letters of credit, term loans, revolving lines of credit, commercial real estate, and construction and land loans.
At December 31, 2007, the Banks had outstanding commercial and construction loans totaling $3.2 billion, which represented 60.6% of the Banks total loans. Of the Banks commercial and construction loan portfolio, $1.2 billion, or 37.2%, is due or repriceable within one year and $2.0 billion, or 62.8%, is due after one year. Loans are priced on a fixed rate or floating rate basis. Floating rate loans accounted for 67% of the Banks commercial and construction loan portfolio as of December 31, 2007. The average balance of the Banks outstanding commercial and construction loans was approximately $2.8 billion for 2007, with an average loan size of approximately $688 thousand at December 31, 2007.
Residential Mortgage Loans. At December 31, 2007, the Banks had outstanding residential mortgage loans of $1.8 billion representing 33.6% of the Banks total loan portfolio. While the Banks have no minimum size for its mortgage loans, they concentrate their origination activities in the Jumbo segment of the market. This segment consists of loans secured by single-family properties in excess of the amount eligible for purchase by the FNMA, which was $417 thousand at December 31, 2007. The average loan size of the Companys outstanding residential mortgage loans was approximately $516 thousand at December 31, 2007.
Home Equity & Other Consumer Loans. Home equity and other consumer loans consist of balances outstanding on home equity loans, consumer loans, credit cards and loans arising from overdraft protection extended to individual and business customers. At December 31, 2007, the Banks had $306.7 million of such loans. The amount of home equity loans and other consumer loans typically depends on customer demand.
Allowance for Loan Losses. The following table is an analysis of the Banks allowances for loan losses for the periods indicated:
The allowance for loan losses is formulated based on the judgment and experience of the management at each Bank, who utilize historical experience, product types, economic trends, and industry benchmarks. The allowance is segregated into three components; specific, general and unallocated. The specific component is established by allocating a portion of the allowance for loan losses to individual impaired loans on the basis of specific circumstances and assessments. The general component is determined by applying coverage percentages to groups of loans based on risk ratings and product types. Coverage percentages applied are determined based on industry practice and managements judgment. The unallocated component supplements the first two components based on managements judgment of the effect of current and forecasted economic conditions on the borrowers abilities to repay, an evaluation of the allowance for loan losses in relation to the size of the overall loan portfolio, and consideration of the relationship of the allowance for loan losses to non-performing loans, net charge-off trends, and other factors. The unallocated component is generally in the 5 to 20 basis point range of total loans. The unallocated percentage can fluctuate based on short-term trends in loan classifications.
The following table represents the allocation of the Banks allowance for loan losses and the percent of loans in each category to total loans as of the dates indicated:
This allocation of the allowance for loan losses reflects managements judgment of the relative risks of the various categories of the Banks loan portfolio. This allocation should not be considered an indication of the future amounts or types of possible loan charge-offs. The unallocated portion of the allowance for loan losses increased $5.9 million, or 198%, from December 31, 2006 to December 31, 2007. The majority of the increase was due to approximately $4.0 million at FPB related to the increase in substandard and non-accrual loans. Given the uncertainty in the real estate and construction markets and the high concentration of commercial and construction loans, the Company believes this amount is prudent. See Part II, Item 7Managements Discussion and Analysis of Financial Conditions and Results of OperationsRisk Elements. and Part II, Item 8, Financial Statements and Supplementary DataNote 7: Loans Receivable and Note 8: Allowance for Credit Losses to the Consolidated Financial Statements for further information.
Deposits. Total deposits increased $297.3 million, or 7.3% from prior year to $4.4 billion, or 64.2% of total assets. $226.0 million, or 76.0% of the increase is the result of the deposits acquired in the Charter acquisition. The remaining $71.3 million increase is due to the organic growth at the Companys existing Banks attributed to strong sales organizations, successful expansion of banking offices, retention of clients, and competitive products.
Deposits are the principal source of the Banks funds for use in lending, investments, and liquidity. At December 31, 2007, the Banks had a total of 31,560 checking accounts consisting of demand deposit and NOW accounts with an average account balance of approximately $38 thousand, 6,761 savings accounts with an average account balance of approximately $38 thousand, and 11,832 money market accounts with an average account balance of approximately $152 thousand. Certificates of deposits represented approximately 25.9% and 21.1% of total deposits at December 31, 2007 and 2006, respectively. See Part II, Item 8 Financial Statements and Supplementary DataNote 12: Deposits to the Consolidated Financial Statements for further information.
The following table sets forth the average balances and interest rates paid on the Banks deposits:
Time 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 (repurchase agreements), Federal Funds purchased, FHLB borrowings, junior subordinated debentures and other long-term debt) increased $718.4 million, or 78.6%, to $1.6 billion, or 24.0% of total assets. $64.8 million, or 9.1% of the increase is the result of the borrowings acquired from Charter.
Junior subordinated debentures and other long-term debt increased $291.6 million, or 124.6% from the prior years to $525.6 million, or 7.7% of total assets. $287.5 million, or 98.6%, of the increase was due to the Note offering that the Company completed at the beginning of the third quarter 2007. The Company used approximately $40 million of the net proceeds from the Notes to buyback approximately 1.5 million shares of its common stock in a private transaction negotiated simultaneously with the Notes, $30.0 million of the proceeds was used to repay the outstanding balance on the line of credit used to finance the acquisition of Charter, and the remainder was lent to the Companys private banking affiliate partners to repay higher costing debt used to fund current loans outstanding as well as to fund future loan growth and investments. The remaining $4.1 million increase was due to the trust preferred securities assumed in the acquisition of Charter.
FHLB borrowings including unamortized discount or premiums increased $234.1 million, or 38.8%, from the prior year to $837.0 million, or 12.3% of total assets. $43.0 million, or 18.4%, of the increase is the result of the FHLB borrowings acquired in the Charter acquisition. Excluding the loans and deposits acquired through the Charter acquisition, the Companys loan growth continued to outpace the deposit growth, as a result the Companys Banks used additional FHLB borrowings to fund a portion of the loan demand.
The Banks have established various borrowing arrangements to provide additional sources of liquidity and funding. Management believes that the Banks currently have adequate liquidity available to respond to current demands. As members of a FHLB the Banks have access to both short and long-term borrowings. As of
December 31, 2007, the Banks had $836.5 million outstanding FHLB borrowings with a weighted average interest rate of 4.56%, compared to $602.9 million of FHLB borrowings, including federal funds, outstanding with a weighted average interest rate of 4.88% at December 31, 2006. In addition, the Banks had FHLB borrowings available of $743.9 million. See Part II, Item 8 Financial Statements and Supplementary DataNote 13: Federal Home Loan Bank Borrowings to the Consolidated Financial Statements for further information.
The Banks also obtain funds from the sales of securities to institutional investors and deposit customers under repurchase agreements. Repurchase agreements increased $186.7 million, or 240.6%. In a repurchase agreement transaction, the Banks will generally sell an investment security, agreeing to repurchase either the same or a substantially identical security on a specified later date (generally not more than 90 days for institutional investors and overnight for deposit customers) 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. The investment securities underlying these agreements may be delivered to securities dealers who arrange such transactions as collateral for the repurchase obligation. Repurchase agreements represent a cost competitive funding source for the Banks. However, the Company is subject to the risk that the borrower of the securities may default at maturity and not return the collateral. In order to minimize this potential risk, the Banks generally deal with large, established investment brokerage firms when entering into such transactions with institutional investors, and deal with established deposit customers on overnight transactions. 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 Companys Consolidated Financial Statements. At December 31, 2007, the total amount of outstanding repurchase agreements was $264.3 million with a weighted average interest rate of 2.80%, compared to $77.6 million with a weighted average interest rate of 2.0% at December 31, 2006. See Part II, Item 8 Financial Statements and Supplementary DataNote 14: Short-term Borrowings to the Consolidated Financial Statements for further information.
From time to time the Banks purchase federal funds from the FHLB and other banking institutions to supplement their liquidity positions. The Banks have federal fund lines of credit totaling $268.0 million with correspondent institutions to provide them with immediate access to overnight borrowings. At December 31, 2007, the Banks had $6.0 million outstanding under these federal funds lines with a weighted average interest rate of 2.50%. The Banks have also negotiated brokered deposit agreements with several institutions that have nationwide distribution capabilities. At December 31, 2007, the Banks had $60.6 million of brokered deposits outstanding under these agreements. See Part II, Item 7Managements Discussion and Analysis of Financial Condition and Results of OperationsLiquidity.
B. Asset Quality
The Companys non-performing assets include non-accrual loans, other real estate owned (OREO), and repossessed assets. The following table sets forth information regarding non-accrual loans, OREO, repossessed assets, loans past due 90 days or more, but still accruing, and delinquent loans 30-89 days past due as to interest or principal, held by the Company at the dates indicated.
Interest income that would have been recorded on non-accrual loans in accordance with the loans original terms would have been $4.9 million in 2007 and $935 thousand in 2006, compared with amounts that were actually recorded of $2.1 million and $287 thousand, respectively.
C. Risk Elements of the Loan Portfolio
The Banks discontinue the accrual of interest on a loan when the collectibility of principal or interest is in doubt. In certain instances, loans that have become 90 days 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. OREO consists of real estate acquired through foreclosure proceedings and real estate acquired through acceptance of a deed in lieu of foreclosure. In addition, the Company may, under certain circumstances, restructure loans as a concession to a borrower.
Non-Performing Assets. Total non-performing assets increased from $10.5 million, or 0.18% of total assets at December 31, 2006, to $53.8 million, or 0.79% of total assets, at December 31, 2007 an increase of $43.3 million, or 410.1%. The increase in non-performing assets was primarily due to additional non-accrual loans at both FPB and Gibraltar. FPBs non-accrual loans are primarily construction and land development. These non-accrual loans at FPB are mainly the result of the slowdown in the housing and construction market in the Inland Empire of California. The non-accrual loans at Gibraltar are primarily residential and commercial real estate and commercial construction. Decline in market values of the collateral for the non-performing assets could result in additional future expense depending on the timing and severity of the decline.
The Company had $50.0 million of impaired loans at December 31, 2007. $35.7 million of impaired loans had specific reserves of $7.8 million. $14.3 million of impaired loans did not have any specific reserves. For loans classified as impaired, the Company did not recognize any interest income in 2007 while the loans were considered impaired. The average investment in impaired loans in 2007 was $17.2 million. The amount of impaired loans at December 31, 2006 was immaterial.
The Banks continue to evaluate the underlying collateral of each non-performing loan and pursues the collection of interest and principal. Where appropriate, the Banks obtain updated appraisals on the collateral. Also see Part II, Item 8, Financial Statements and Supplementary DataNote 7: Loans Receivable and Note 8: Allowance for Credit Losses to Consolidated Financial Statements for further information on non-performing assets.
Delinquencies. At December 31, 2007, $22.4 million, or 0.43% of total loans, were 30-89 days past due, an increase of $8.9 million, or 66.6%, from the $13.4 million, or 0.31% of total loans, at December 31, 2006. There were no loans 90 days past due and still accruing as of December 31, 2007. At December 31, 2006 there were $24 thousand of such loans. The increase in loan delinquencies is primarily due to a small number of large loans as well as the growth of the Banks loan portfolios. The Company believes most of these loans are adequately secured and the payment performance of these borrowers varies from month to month. Further deterioration in the real estate market where the collateral is located or the local economy could lead to these delinquent loans going to a non-accrual status and corresponding downgrade of the credit. Downgrades would generally result in additional provision for loan loss expenses.
Potential Problem Loans. The Banks management adversely classifies certain loans using an internal rating system based on criteria established by federal bank regulatory authorities. These loans evidence weakness or potential weakness related to repayment history, the borrowers financial condition, or other factors. Delinquent loans may or may not be adversely classified depending upon managements judgment with respect to each individual loan. At December 31, 2007, the Company had classified $165.7 million of loans as substandard, special mention, doubtful, or loss based on the rating system adopted by the Company, compared to $35.1 million at December 31, 2006. The increase in classified loans reflects a decline in the valuation of collateral and or a deterioration of the credit worthiness of the borrower.
Allowance for Loan Losses. The allowance for loan losses is established through provisions charged to operations. Assessing the adequacy of the allowance for loan losses involves substantial uncertainties and is based upon managements evaluation of the amounts required to meet estimated charge-offs in the loan portfolio after weighing various factors. Among these factors are the risk characteristics of the loan portfolio, the quality of specific loans, the level of nonaccruing and classified loans, current economic conditions, trends in delinquencies and charge-offs, and the value of underlying collateral, all of which can change frequently. In connection with the determination of the allowance for loan losses, management obtains independent appraisals for significant properties.
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 institutions allowance for loan losses and carrying amounts of OREO. Such agencies may require the financial institution to recognize additions to the allowance based on their judgments about information available to them at the time of their examination.
D. Capital Resources
Total stockholders equity of the Company at December 31, 2007 was $662.5 million, compared to $635.2 million at December 31, 2006, an increase of $27.3 million. The increase was the result of our current year earnings, proceeds from options exercised including tax benefits, if any, common stock issued in connection with stock grants to employees, common stock issued for acquisitions, including contingent payments, and the change in accumulated other comprehensive income. These increases were partially offset by dividends paid to stockholders and the Companys stock repurchase.
As a bank holding company, the Company is subject to a number of regulatory capital requirements that have been adopted by the FRB. At December 31, 2007, the Companys Tier I leverage capital ratio stood at 7.28%, compared to 8.22% at December 31, 2006. The Company is also subject to a risk-based capital measure. The risk-based capital guidelines include both a definition of capital and a framework for calculating risk-weighted assets by assigning balance sheet assets and off-balance sheet items to broad risk categories. At December 31, 2007, the Company had a Tier I risk-based capital ratio of 9.42% compared to 10.70% at December 31, 2006. The Company had a Total risk-based capital ratio of 10.84% at December 31, 2007, compared to 12.24% at December 31, 2006. The minimum Tier I leverage, Tier I risk-based, and Total risk-based capital ratios necessary to enable the Company to be classified for regulatory purposes as a well capitalized institution are 5.00%, 6.00% and 10.00%, respectively.
The decrease in the Companys Total risk-based capital ratio, as compared to the prior year-end, resulted from the strong asset growth at the Banks and goodwill and intangibles recorded on the Companys acquisitions.
At December 31, 2007 and 2006, the Companys Banks were considered well capitalized for Tier I leverage and Tier I risk-based capital ratios. The Companys Banks, except for FPB, were considered well capitalized for Total risk based capital ratios. FPB was considered adequately capitalized as of December 31, 2007. In February of 2008, FPB made an adjustment to their 2007 allowance for loan losses as of December 31, 2007. This adjustment resulted in FPBs risk based capital ratio to fall below the well capitalized level. Concurrent with the adjustment, Boston Private contributed $11.5 million of additional capital to FPB. The amount of the capital contribution was intended to bring FPBs total risk based capital ratio above 10.0%. See Part I, Item 1, BusinessBank Regulatory ConsiderationsCertain Restrictions on Activities and Operations of Boston PrivateCapital Requirements.
Liquidity is defined as the Companys ability to generate cash adequate to meet its needs for day-to-day operations and material long and short-term commitments. The Company manages its liquidity based on demand, commitments, specific events and uncertainties to meet current and future financial obligations of a short-term
nature. The Companys objective in managing liquidity is to respond to the needs of depositors and borrowers as well as to earnings enhancement opportunities in a changing marketplace.
Management is responsible for establishing and monitoring liquidity targets as well as strategies to meet these targets. In general, the Company maintains a relatively high degree of liquidity. At December 31, 2007, consolidated cash and cash equivalents and securities available-for-sale amounted to $843.9 million, or 12.4% of total assets of the Company.
Liquidity at the Holding Company should also be considered separately from the consolidated liquidity as there are restrictions on the ability of the Banks to distribute funds to the Holding Company. The Holding Companys primary sources of funds are dividends from its subsidiaries, a $75 million committed line of credit with an unaffiliated bank, and access to the money and capital markets. The purpose of the line of credit is to provide short-term working capital to the Company and its subsidiaries, if necessary. The Company is required to maintain various loan covenants in conjunction with the revolving credit agreement. As of December 31, 2007, the Company was not in compliance with these covenants and there were no outstanding borrowings under this line of credit. In January 2008, the Company entered into a new $75 million line of credit to replace the facility in place as of December 31, 2007, which by its terms had expired. As a result of the increased provision to FPBs allowance for loan losses, and related circumstances, the Company is not in compliance with certain covenants under this revolving credit agreement. In light of its non-compliance, the Company is in discussions with its lenders regarding the satisfaction of certain provisions of the credit agreement. The Company has $3.0 million outstanding under the line of credit as of March 12, 2008. No additional borrowings are available under the line of credit until the non-compliance is waived or the credit agreement is modified. In the event that the Company and its lenders do not reach an agreement on amendments to the credit agreement, the Company would likely be requested to repay promptly amounts due and owed under the credit agreement, and would seek other sources of financing and liquidity. The Company does not anticipate that any inability to access the line of credit, or the request that it repay currently outstanding amounts under the credit agreement, will have a material adverse effect upon its liquidity. In the short-term, management anticipates the cost of borrowing under the line of credit would be lower than the cost of accessing the capital markets to issue additional common stock. However, it may be necessary to raise capital to meet regulatory requirements even though it would be less expensive to borrow the cash needed.
In addition, the Holding Company has $214 million of 4.20% fixed rate notes receivable from the Banks, except for FPB, due July, 2009. Management expects the Banks would not be adverse to prepaying these notes in the current interest rate environment.
Dividends from the Banks are limited by various regulatory requirements relating to capital adequacy and retained earnings. See Part II, Item 5 Market for Registrants Common Equity and Related Stockholders Matters. Management believes that the Company has adequate liquidity to meet its commitments for the foreseeable future.
Bank Liquidity. The Banks are each a member of their regional FHLB, and as such, have access to short and long-term borrowings from those institutions. At December 31, 2007, the Banks had available credit of $743.9 million from the various FHLBs. Liquid assets (i.e. cash and due from banks, federal funds sold, and investment securities available-for-sale) of the Banks totaled $810.8 million, which equals 14.0% of the Banks total liabilities and 12.5% of the Banks total assets. Management believes that the Banks have adequate liquidity to meet their commitments for the foreseeable future.
In addition to the above liquidity, the Banks have access to the Federal Reserve Banks Discount Window facility which can provide short-term liquidity as lender of last resort.
Holding Company Liquidity. At December 31, 2007, the estimated cash payments accrued under deferred purchase obligations was approximately $2.8 million which is to be paid in 2008 and 2009. The timing of these payments varies depending on the specific terms of each business acquisition agreement. Variability exists in
these estimated cash flows because certain payments may be based on amounts yet to be determined, such as earn out agreements that may be based on adjusted earnings, revenues or selected AUM.
Additionally, the Company along with several of the Companys majority-owned affiliate partners have put and call options that would require the Company to purchase (and the majority-owned affiliate partners to sell) the remaining minority ownership interests in these companies at the then fair market value. Future payments under these put and call options can not be estimated accurately due to the unpredictability of exercises of those rights and fair market values at future dates.
The Company is required to pay interest quarterly on its junior subordinated debentures and long-term debt. The estimated cash outlay for the interest payments in 2008 is approximately $20.9 million. The Company presently plans to pay cash dividends on its common stock on a quarterly basis. Based on the current dividend rate and estimated shares outstanding, the Company estimates the amount to be paid out in 2008 for dividends to shareholders will be approximately $15.3 million. See Part II, Item 5, Market for Registrants Common Equity and Related Stockholders Matters.
Consolidated cash flow comparison for the years ended December 31, 2007 and 2006
Net cash provided by operating activities totaled $90.8 million and $74.5 million for the years ended December 31, 2007 and 2006, respectively. Cash flows from operating activities are generally the cash effects of transactions and other events that enter into the determination of net income. Cash provided by operating activities increased $15.4 million from 2006 to 2007 due to increased earnings excluding the non-cash impairment charges and additional provision for loan losses.
Net cash used in investing activities totaled $819.2 million and $746.7 million for the years ended December 31, 2007 and 2006, respectively. Investing activities of the Company include loan activities, investment activities and capital expenditures. The $72.5 million increase in cash used in investing activities was primarily due to increased growth of the Banks loan and investment portfolio as compared to 2006, partially offset by increased proceeds from the maturities and calls of the Banks investment portfolio.
Net cash provided by financing activities totaled $675.4 million and $539.3 million for the years ended December 31, 2007 and 2006, respectively. The $137.1 million increase in cash provided by financing activities was due to the proceeds from the Note offering and increases in short-term borrowings which were partially offset by the share buyback and slower growth in deposits.
Consolidated cash flow comparison for the years ended December 31, 2006 and 2005
Net cash provided by operating activities totaled $74.5 million and $95.2 million for the years ended December 31, 2006 and 2005, respectively. Cash flows from operating activities are generally the cash effects of transactions and other events that enter into the determination of net income. Cash provided by operating activities decreased $20.8 million from 2005 to 2006 due to lower net proceeds from the sale of mortgage loans, and other operating activities; partially offset by increases in net income and depreciation and amortization.
Net cash used in investing activities totaled $746.7 million and $455.3 million for the years ended December 31, 2006 and 2005, respectively. Investing activities of the Company include loan activities, investment activities and capital expenditures. The $291.4 million increase in cash used in investing activities was primarily due to increased growth of the Banks loan portfolio as compared to 2005, and cash paid for acquisitions, net of cash acquired, which include payments in the Anchor acquisition and certain earn-out payments from prior acquisitions.
Net cash provided by financing activities totaled $539.3 million and $603.5 million for the years ended December 31, 2006 and 2005, respectively. The $64.2 million decrease in cash provided by financing activities was due to the proceeds from the trust preferred debt and the settlement of the Companys forward sale agreement to fund the Gibraltar acquisition in 2005; slower growth in deposits and increased use of borrowings to fund a portion of the loan growth in 2006.
The schedules below present a detail of the maturities of the Companys contractual obligations and commitments as of December 31, 2007. See Part II, Item 8 Financial Statements and supplementary DataNotes 13 to 15 to the Consolidated Financial Statements for terms of borrowing arrangements and interest rates.
The amounts below related to commitments to originate loans, unused lines of credit, and letters of credit are at the discretion of the customer and may never actually be drawn upon. The contractual amount of the Companys financial instruments with off-balance sheet risk are as follows:
F. Off-Balance Sheet Arrangements
The Company and its affiliate partners own equity interests in certain limited partnerships and limited liability companies. Most of these are investment vehicles that are managed by the Companys investment adviser subsidiaries. The Company accounts for these investments under the equity method of accounting so the total amount of assets and liabilities of the investment partnerships are not included in the consolidated financial statements of the Company.
In 2007, Boston Private demonstrated growth in the fundamental drivers of its business within the Companys control. The Company is also strategically aligned to benefit from stock market appreciation while continuing to manage the impact of a competitive deposit environment and a challenging real estate market.
A. 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 Companys 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). Changes attributable to the combined impact of volumes and rates have been allocated proportionately to separate volume and rate categories.
B. 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 of the average rate earned on total interest earning assets and the average rate paid on total interest-bearing liabilities. Net interest margin is the amount of net interest income, on a fully taxable-equivalent basis, expressed as a percentage of average interest-earning assets. The average rate earned on earning assets is the amount of taxable equivalent interest income expressed as a percentage of average earning assets. The average rate paid on interest-bearing liabilities is equal to interest expense expressed as a percentage of average interest-bearing liabilities. The following table sets forth the composition of the Companys net interest margin for the years ended December 31, 2007, 2006, and 2005.
C. Condensed Consolidated Statement of Operations and Discussion