EBC - Eastern Bankshares: Lifting Our Sell Rating

2023-10-30 04:35:36 ET

Summary

• Eastern Bankshares' Q3 revenues were down from last year, but the company is making strategic moves that will be accretive to EPS.
• Margins are stabilizing and net income has increased compared to previous quarters.
• Asset quality remains strong, with a decrease in provision for credit losses and low net charge-offs.
• Return metrics are at one-year highs and a dividend increase to boot.

We continue our earnings season coverage of the many regional bank companies that we follow today with Eastern Bankshares ( EBC ) that we sell rated in January , and shares are down 27% from then. However, upon reviewing the just reported earnings , the key metrics we follow for the regional banks, and the strength of a 10% increase to the dividend in this climate, we lift our sell rating to a hold. While regional banks have taken it on the chin of late due to compressed margin power, difficulty in loan growth, competition for deposits, and pressure on asset quality, we think after this reset for Eastern Bankshares, we can lift our sell rating. Yes, this comes with the fear of a mild recession around the corner, but we believe that the hiking of rates is at an end, and moreover, whether we are higher for longer or not, the new normal will be adjusted to, and banks can better operate in a stable environment. In this column we cover the just reported earnings and review the key metrics which we think justifies the re-rating. Let us discuss.

Eastern Bankshares' Q3 sees mixed headline results

The top line was down from last year for Eastern Bankshares which was no surprised at all. The Q3 revenues were $156.4 million, dipping 20% from last year. This was a miss on estimates which at first caught us by a major surprise. So how could they increase the dividend? Either it was poor management, or there is more to the story. Well there are a few catalysts. First, they are selling off the insurance operations. Second, there is a pending merger with Cambridge Bancorp which will both combine to at 20% or more to EPS per management's projections, while improving efficiency by 10%. That is tremendous news.

Now, deposits did decline and loans were down, but the latter was due to the sale of $192 million of loans. Backing that out loans would have been up $150 million from the sequential Q3. Deposits were largely down due to timing of municipal deposits from seasonal issues, but brokered deposits were also down, a slight negative. Now here is the thing, margins are stabilizing. While they have been on a downward spiral like most of the sector, margins were 2.77%, just 3 basis points down from Q2. And, when considering the focus on operational expense control, the bank expanded its net income. Net income was $59.1 million, or $0.36 per share, compared to net income of $48.7 million, or $0.30 per share, in Q2. What is more impressive is that the net income was also a sizable increase from Q3 2022, which saw $54.8 million in net income, while EPS was $0.33. That expansion is impressive. Overall credit metrics also remained strong.

Eastern Bankshares' asset quality

Despite the pain for regional banking Eastern Bankshares continues to have very healthy assets. First, in Q3, Eastern Bankshares lowered its provision for credit losses to $7.3 million, down from $7.5 million in Q2, and down from $10.9 million to start the year. This is impressive. However, due to three specific Boston commercial real estate loans, Eastern Bank shares increased the allowance for credit losses to $155.1 million, or 1.12% of total loans compared to 1.06% to start the quarter. Net charge-offs were flat from Q3 at 0.01% of loans.

But folks, net-chargeoffs, actual written off loans, not just allowances, was just $0.1 million, or less than 0.01% of average total loans on an annualized basis, compared to $0.5 million or less than 0.01% of average total loans in Q2.

On top of this, the return metrics are all improving. The return on average assets are at a one year high now, hitting 1.18%, up from 0.81% last quarter. The same can be said for the operating return on average assets, hitting 0.97%, up from 0.75% last quarter, while the return on average equity was also at a one year high at 9.91%, rising a whopping 306 basis points from Q2.

Finally on a valuation basis, with the massive decline in shares, the stock is only slightly over tangible book value. At $11.22 per share we view this as attractive, relative to the tangible book value of $10.14 per share

Take-home

Eastern Bankshares' stock has reset. While the stock is up off its 52-week low, it is attractive relative to tangible book. Strategic moves being made will be accretive to EPS, which has been strong on its own. Net interest margin is stabilizing, while asset quality is at one-year highs. With a 10% increase to the dividend and the improving operations, we lift our sell rating.

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