Rising Rates, Market Timing And Building Credibility: A Chat With Blue Hills Bancorp CEO Bill Parent
Deep value investor Tim Melvin had the opportunity to speak with Blue Hills Bancorp (NASDAQ: BHBK) CEO William Parent to discuss the current state of affairs at the bank and also the outlook for the future of the community and regional bank business.
Below is the full transcript and audio of the interview.
Tim Melvin: Okay. We're on today with Bill Parent, the CEO of Blue Hills Bancorp Inc up in Massachusetts. And, you guys just did a thrift to stock conversion last year, didn't you?
Bill Parent: We did. In July of 2014, we had made a decision to continue some of the growth, changing some of the growth prospects of the institution, so we converted and raised about $280M in July. So we're actually coming up on our first year anniversary.
Melvin: That's a big moment, your first year anniversary for a converted thrift, too. Opens up all sorts of capital choices.
Parent: Yeah. I think, as everybody- or, folks who are in tune to the conversion market, the first year there's a preclusion from buybacks, and the dynamics of conversions is that the converting institution does not determine how much they raise. It's a market-based, independent valuation-based kind of computation. We were fortunate to be over-subscribed with interest, so we raised the super max of a valuation range. So, today, even with a very strong growth over the past 9 months, we're sitting with 23% capital, which is healthy and invigorating on one level, but I don't think it's ideal from anybody's standpoint, if you're raising capital on a non-conversion basis.
Melvin: Yeah. It does tend to dampen the ROE just a touch, too.
Parent: Yeah, exactly.
Melvin: Now, your market area is described in your documents are eastern Massachusetts. It really looks to me like you're serving two separate and distinct marketplaces- one kind of suburban Boston, and then one down in the Nantucket area. Is that accurate?
Parent: I would say, from a retail perspective, that's a fair perspective to have. We have, in Eastern Massachusetts, we have a 7 branch network that stretches from Boston west along a Route 1 corridor, and in a relatively small geography from a branch network standpoint. And then, we have 3 branches down on Nantucket that we acquired from Sovereign there a little over a year ago. But, as many institutions are trying to do, we don't define a marketplace by solely where our retail branches are. Even on the retail side, we look to the opportunities to capture customers who are interested in a wide-ranging product array with a relationship orientation through both branch distribution channels and then online channels. So, we look at Eastern Massachusetts stretching down to Nantucket as really our core target market areas that we're looking to garnish new customer relationships. And now, on the commercial side, we certainly look at Massachusetts, and have an ability and willingness to look outside of Massachusetts into New England for corporate banking relationships where we either have core expertise in sectors of the economy that translate across the state line of Massachusetts, or have existing historic relationships from past lives within companies that transcend the state of Massachusetts. So, we're pretty open as to how we look at our marketplace overall.
Melvin: Now, do you find it necessary to visit the Nantucket branches more often in the summertime?
Parent: That is a trapping, and a good one, and I say that having just been there yesterday for a customer appreciation day. So, it is a nice venue to be at in the summer and in the fall, and in the wintertime, it's a little more stark. But it's a very dynamic marketplace that transcends through the seasonality of the calendar, which is actually kind of a lot of fun to work with, because it brings out a diverse set of banking needs in the marketplace. And we've got a great team down there. We've got a very strong brand in the markets hare that we're leveraging. So, we really like the market, we're really happy with how that acquisition has played out for us.
Melvin: Okay. Now, how would you describe the general economy, real estate and commercial loan conditions up in your part of the country?
Parent: Sure. I would say they're quite strong. We did not have the level of debt and downward pressure the economy had in areas such as the southeast in New England, and specifically in eastern Massachusetts. We are buoyed by the strength of hospitals and educational institutions that we have, along with biotech and technology that gives a pretty good breadth of economy marketplace. So, in the depths, they weren't as low as other regions in the country. And the recovery has been kind of equally as strong. So, this is a very vibrant market. Not overheated yet. But, there are some dynamics of the commercial real estate market that is warming up and is kind of hot. It's great for both borrowers and lenders. There's a lot of depth in the market for borrowers to seek financial institutions to fund either acquisitions or gamut growth or transitional ownership. And there's a lot of competition among the banks for that incremental customer that can allow us to grow. I think the challenge as a bank is not getting excessive exuberance in chasing business, where rates have gotten very aggressive, you wanna make sure that you stay aligned and disciplined with the alignment of credit, the embedded credit risk, with the return that you're able to get into the marketplace. So, it's a very dynamic marketplace, I would say.
Melvin: Now, before your conversion, you refocused your strategic plans and you decided you were gonna go after really more of the commercial marketplace. And I have to say that you've done a stunning job. Because commercial real estate levels were almost non-existent on your books 3 years ago, they're now 25% of the portfolio. How have you guys done that? I mean, that's phenomenal.
Parent: Well, thank you, and you're very kind. I think that there's a couple of things. One, it's always good to have good timing. We started the transition of our business model in 2010, and quite frankly, that was a time when the marketplace was interested in a new set of players coming into it to provide leverage opportunities. And in addition to that, we were able to recruit some top talent to come in and build what we think is a little different, a community bank orientation with the product sophistication of a larger institution, where customers can feel a real relationship orientation to it. Again, the market was receptive to that in both, from a consumer standpoint, and from some talented individuals willing to come into an institution looking to execute that strategy. So, it's really about recruiting top talent, empowering them to be in the market and combine that with strong capabilities to underwrite and win over top tier sponsors. So, we really like our portfolio. We like the customers and the sponsorship that's embedded in it. And we've been able to ride that market transition to get a good share of the marketplace that's been either transitioning, 'cause there's a lower rate environment created in a refinancing opportunity, and took some really top deals and put them into play in the marketplace, or some new acquisition. So, we've done a pretty good job of getting our share of that, and we're excited about it.
Melvin: Yes. And I've talked to a lot of bankers, a lot even in the similar situation such as your own, where they're growing commercial real estate. And we usually at least see a tick up in non-performing assets. That hasn't happened with you guys. And, again, can you comment on how you've achieved that? 'Cause that's impressive to me.
Parent: Well, again, I think timing in the market makes us all look really smart. We've had a good entry point. We entered without any baggage, so to speak, which was helpful. So, it allowed us to be selective and focused on growth and discipline and the underwriting of that growth. And quite frankly, we've led with credit quality being the utmost importance. And we've had quite frankly a willingness to cede some yields in exchange for credit quality, because we were building it from scratch. We knew we had to build credibility with all our constituents, those being on board, regulators in the marketplace. So, we knew that credit had to lead. With that, I think you see a portfolio that has performed well in a good market. Time will tell, cycles of more than 5 years. So, we're obviously optimistic that we'll perform well throughout a full cycle. But we haven't been through that full cycle yet. But we feel, like I said, really good about it. And it's reflective of our focus on credit as we've built the portfolio.
Melvin: Okay. Now, I was just reading the other day that net interest margins are now at pretty much historic lows for the banking industry. And even though there's some talk of an interest rate hike later this year, it's gonna be a small one. How concerned are you about continued pressure on net interest markets?
Parent: You know, that's the biggest concern I have, quite frankly. I think, as we've talked about, we feel good about credit. So, we've made a concerted effort to build our portfolio in a sound manner relative to interest rate risk. A vast majority of our commercial book has been swapped away, so it's LIBOR-based, so we're actually very short, very asset-sensitive. So, we're going to bed every night with hopes and wishes of a rising rating bar. Not everybody is playing it that way. We do see, in our marketplaces, folks taking extension risk on the asset side with short-funded deposits. That creates some dynamics in the competitive pricing arena in the marketplace, and certainly on a relative basis to peers. So, we have a low net interest margin. It's reflective of two things- one, the fact that we have swapped away most of our duration risk on the yield side of the assets, so we're very short. And, as a growing bank in a competitive market, our cost of funds are higher than certainly larger institutions as we look to get our share of core funding to match the asset growth. So, we've taken some compression in our margin relative to our peers, as part of the growth process. So, it would certainly help us from a competitive standpoint and from a profitability standpoint, to see rates rise and even, hard to believe, a banker wishing for a flat yield curve. For us, that is not a death spiral. So, rising rates is something we look forward to. I don't know how fast it's gonna happen, that's for other experts to prognosticate and for us to see.
Melvin: Okay. Now, a lot of bankers I talk to these days- 'cause I do mostly specialize in smaller banks- are really concerned about the increasing cost of compliance with, seems like, almost daily regulations between the consumer protection board and Dodd-Frank and all of that stuff. How much of a problem has that been for you guys?
Parent: Well, I think it's the industry cost of doing business that is meaningful, and certainly it hardens the dynamics of scale being a factor in our business. So, to me, it's just another factor, in that regard, in the dynamics and the rules that we have to abide by in order to operate our company. So, I don't think- we look at it as, obviously, a burden. It's one that gets lessened with scale and size, so we think a strong growth-oriented strategy is important, and one of the factors of it's importance is the ability to leverage those inherent costs of compliance and regulation across a bigger pool of assets and customers and deposits. So, it's something that we know what the rules are, we have to play by them, and in that regard, we have to do it in the most efficient way possible.
Melvin: Okay. Every time you talk to a banker these days, you go to the bank, various bank conferences, M&A's one of the first subjects that seems to come up these days. A lot of the smaller banks appear to almost have to merge. Do you see a merger and acquisition wave in the future? Do you see it accelerating, or just going along at, I'll call it a mildly elevated pace for a while?
Parent: Well, I think it's a market-to-market dynamic. Certainly in our market, consolidation should be part of the evolution of the marketplace. We have, in Massachusetts especially, a large number of financial institutions. Many people have versions of what size they think is scale-able and un-scale-able, but we certainly, wherever you pick, we have a number that are below that size. So, I think the dynamics of long-term viability for some in our marketplace would be questioned. And that obvious need for a nice M & A marketer should create a nice M & A market. The dynamic here that's a little different is a lot of them are mutuals who have different constraints, so that changes the marketplace. As a private stock-based companies, or even publicly-traded stock-based companies, there are a good number, but not an excessive number. So, I think the M & A market here will probably stay within a tight range of activity. I think it needs to happen still in our marketplace, but I'm just not sure how much more elevated it gets with the dynamic of mutuals who're here. From our standpoint, we obviously would like to be part of the consolidation as a consolidator. We have a track record of being an effective buyer and integrator, at least through our one transaction with Sovereign there on Nantucket. With the competencies of the folks we have on our team here, who bring that background from other institutions. So, we're interested, and we think we have a great platform that's leverage-able and would be an exciting platform for other institutions to join and be part of. So, we're excited about the opportunity. I think we're also realistic of the dynamics of the marketplace and how much that can really play out. Cuz, certainly on the banking side, and then when you get into the non-banking and more fee income businesses, whether it's a finance company, insurance, asset-management, wealth-management, I think there, it's a different marketplace with some real strong opportunities depending on the institution's appetite.
Melvin: Okay. And now, just as an aside, as a newly-converted thrift, you guys have a 3 year restriction on anybody taking a run at you, correct?
Parent: Yes, we do. Which is typical.
Melvin: Right. And that's got 2 years left. Now, one of the other concerns among smaller banks today is, if you let yourself get it all behind the 8 ball on the technology side, particularly with the younger generations- like, I'll go to a bank branch once a month, my kids haven't been in one in 5 or 6 years. How are you dealing with the technology cost? Do you feel like your mobile platforms and everything like that are being accepted by consumers?
Parent: Yeah. I think we're on the front edge of the curve, I call it the technology curve, we're not on the point, nor do I think institutions of our size should ever be on the point of the curve for technology and new technology adoption. I don't know that that's what our customers expect. They expect us to have a competitive product offering relative to the marketplace, and I think that we do that. And institutions of our size have to leverage third party service providers. I think the key, from our perspective, is to be very strongly tied with our service provider so that as products get rolled out, we're on the tip there for the new products. And I think we've been able to do that. I think our mobile banking product is strongly-rated in the marketplace. Our online banking and our bill pay, at the end of the day, the market for bill pay platforms is pretty narrow, we're all using some form of check free in most cases. So, the actual comparability is pretty tight, a lot of consumers don't know that and don't understand that. But that's the reality on the bill pay side. So, I think that we have a very strong product offering. Some of the bells and whistles are probably a little delayed in being rolled out, but that's okay, because I think adoption on those go at different paces. So, we're able to react where the market demand is and offer a competitive product.
Melvin: Okay. Now, how about cyber security? That's kind of an offshoot of the technology thing, but that's getting to be a big issue, and it's an expensive one. How are you guys approaching that?
Parent: Yeah. Again, part of it is a partnership with your third party service providers, which institutions of our size rely on, and having that strong partnership, that's a two-way partnership, not just they provide us a service and they take it, you really gotta understand how they're deploying the service to you, where your risk are through them, and directly through yourself. So, I think that we're focused on it the best we can. But there's a realistic dynamic of much larger institutions spending hundreds of millions of dollars to protect against this, and being as vulnerable as we are. So, that's a dynamic that we all worry about, and try to do our best to stay on top of. But it's an ongoing battle, and it's one that, again, partnering with your service providers and having some core expertise inside the house is your best bet to limit that risk. But, I think anyone's naive if they think they're eliminating that risk.
Melvin: Okay. Now, looking at your most recent 10K, looks like all of your officers and directors own some stock in the bank. The ESOP has 8%, and I assume that'll just continue to grow over the years. Do you find that that kind of skin in the game for employees, officers, and directors, maybe makes people a little bit more focused on profits and providing better service?
Parent: You know, we hope that the theory and the thesis that we're executing on- we like to look at ourselves as an employee-owned business. And I reiterate that to my employees on a consistent basis, that you're not just an employee here, you're an owner. And we want them to think as an owner, as an employee, and as a customer. And if they think along those three paths, then we think that there's an opportunity to deliver an outstanding customer experience to those who aren't in all three of those categories. And the good part about conversions are, and a lot of people are critical of mutual conversions, but the good part of it is, day one, we were 100% owned by our depositors. And we still have a significant portion of our ownership base that are depositors. And I'd like that to continue indefinitely. Over time, people make individual decisions, when to seek liquidity in this investment, and they've gotten a nice return from the $10 conversion price to the $13.50 range that we're trading at now. But my goal is to keep as many of those depositors as core investors, because there's a value component to that. So, it's part of our culture. I think that culture does add value to the customer experience and ultimately to the returns to investors. So, we're focused on maintaining, and love to be able to grow that over time.
Melvin: Okay. Now, you've been around banking and financial services for a considerable period of time. How do you see things going forward for Blue Hills Bancorp specifically, and the community bank industry in general?
Parent: Yeah, I think it continues to be an interesting opportunity. We are a unique story in that we're executing a strategy that has a major repositioning of a prior business model that was relatively narrow, where we would take deposits, a lot of them were single-product relationships, and turn it around and shift a majority of those deposits to Wall Street, and ran an investment portfolio with a very low efficiency ratio. And now we've migrated to what I like to call next-generation diversified community bank strategy, where we have a wide breadth of products and services that we're providing to the marketplace, with a level of sophistication that is equal to larger competitors, oriented to a better customer experience and overall relationship. So, we think that that demonstrated some opportunity by the growth we've been able to achieve, and we think there continues to be opportunity to have additional growth prospects. So, we're excited about that. We have a lot of the tools that are necessary to compete in that marketplace and execute that strategy. It's, from a financial performance standpoint, it's gonna be a long progression, and we're gonna need to demonstrate on a quarter over quarter, year over year progression on our financial performance to make our investors feel good about the return and the value that we're creating. And that's a very interesting opportunity of us, and the team has charged up to really go after it. And I think that that dynamic of change and embracing new aspects is what community banks will need to do in order to continue to capture younger customers, a wider range of commercial customers spread out geographically to new marketplaces vs just kind of competing in the same marketplaces they have traditionally, to be able to continue to have some growth and vibrancy in the marketplace, which is important. I mean, the community bank space is important to our economy nationally and locally, but I think that we can't take that for granted. We've gotta continue to challenge ourselves to deliver the best products, services, to those customers and win them over one by one, period over period. So that's exciting and challenging, and what gets my team really excited to participate in.
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