Boston Private Shows What to Do Once the Cost-Cutting Is Over

Long movies. Rambling manuscripts. Banks with way too many boxes on the flowchart.

They can all benefit from some editing.

When Clayton Deutsch arrived at the helm of Boston Private Financial Holdings in 2010, he found complex, far-flung operations that had built up over the years and had to be winnowed down.

Prior management had essentially turned the company into a roll-up vehicle starting in 2000, acquiring five whole banks and ten advisory firms over the next several years. It was a bolt-on strategy, without any real integration done, so the potential mutual benefits — the bedrock of dealmaking — were never realized, he said.

"The flaw in the strategy was that they bought them and never touched them, never changed their names, did nothing to influence their business practices," Deutsch said in a recent interview.

Over the next few years, the $6.4 billion-asset company boiled down its 15 or so affiliates to five — two investment management companies, two wealth advisory firms and Boston Private Bank & Trust.

"We think that what we worked through actually resulted in a larger and more powerful organization. We are greatly simplified," Deutsch said.

It also focused on five geographies: Boston, Los Angeles, New York, San Francisco and San Jose.

For instance, the company sold its offices in the Seattle market to Sterling Financial, which was acquired earlier this year by Umpqua Holdings.

"We didn't leave the Northwest because we didn't like the Northwest," Deutsch said. "It was just a minuscule part of our company and we had to be undistracted."

Bloated companies can produce positive operating leverage — essentially revenue growth that exceeds expense growth — by cutting for awhile, but eventually they run out of things to cut.

"I'd say all the home runs and triples in cost saves are gone," Alexander Twerdahl, an analyst at Sandler O'Neill, said about Boston Private's cost-cutting strategy.

Companies have to find ways to grow revenue as a result. With the company streamlined, Boston Private reentered the M&A game. Last month it announced it would acquire Banyan Partners, an investment advisory firm in Palm Beach Gardens, Fla., with $4.3 billion in assets under management. The $60 million deal is expected to close in the fourth quarter and will nearly double the amount of assets Boston Private has under management.

The Banyan deal is a major positive for the company, analysts say.

"Clay and his team have done a masterful job of thinking about overhead. The company was, well, chubby,"said Chris Marinac, an analyst at FIG Partners. "They've worked hard to keep positive operating leverage and at some point that means growing revenue. This move is a step in the right direction because wealth management is a high-margin business."

Marinac added that Boston Private's move might be a harbinger of things to come because it had been focused on trimming longer than others.

"These guys were focused on efficiency and expenses before it was cool," Marinac said.

When Deutsch arrived in the second quarter 2010, the company had a return on equity of 0.75% and anefficiency ratio of 77%. In the second quarter 2014, those ratios were 13.50% and 64% respectively. At the same time, the stock has risen from roughly $6 to more than $12. Although banks stocks were up 40% overall last year, Twerdahl says the company's efforts played a major role in the improvement. Targeting fee income growth could push it higher.

"Clay doubled the stock," he said. "And I think they are now saying, 'The way we are going to get a higher multiple is focusing on the fees.'"

Adding income streams that are not a casualty of the spread has become a major focus in banking over the last few years. Buyers have targeted all sorts of side businesses as a way to boost noninterest income, ranging from doing more M&A work to getting into wealth management.

Deutsch points out that Boston Private's fee businesses are at the root of the company, so it has a keener eye as it searches for acquisitions.

"In a world with a lot of bank and nonbank combinations predicated on transformation, we already know wealth and private banking and have a refined sense of specificity around what we were looking for," he said.

When Deutsch joined Boston Private, its fee revenue already made up 35% of its total revenue, a respectable amount for community banks which typically collect a quarter or less of their revenue from fees. The company wanted it higher and through its existing channels pushed the figure to 42%. The Banyan deal would bring it to roughly half, Deutsch said. That rivals larger banks like U.S. Bancorp.

Deals like the Banyan one make more sense for Boston Private than buying traditional banks. Niche banks that seek to expand revenue via acquisition sometimes are at risk of diluting their specialty.

"We've looked at both kinds of M&A, but we haven't seen a bank deal that made sense for us," said Mark Thompson, the chief executive of the Boston Private Bank unit. "It has to have something special and brings us accelerated access to something. We are not going to do deals unless they advance our strategy. The worst thing we could do is to dilute our private client strategy."

Banyan was founded in 2006 and has largely grown through several acquisitions. Although Boston Private has become proficient in integrations, Deutsch said making sure Banyan didn't look like the Boston Private he took over in 2010 was a "big part of our due diligence."

"They have been doing additive acquisitions, but we've found it to be a highly integrated company and management team," Deutsch said. "We didn't want to acquire an unintegrated assortment of companies."