EBC - Eastern Bankshares: Loan Growth To Counter The Effect Of Margin Compression

2023-04-23 03:38:46 ET

Summary

• The net interest margin will face pressure in the first half of 2023 due to deposit re-pricing.
• Loan growth will slow down as the management is more focused on pricing than volume. Further, high borrowing costs will drag the loan growth.
• The year-end target price suggests a very high upside from the current market price. Further, EBC is offering a decent dividend yield.
• The risk level is high because of EBC’s large unrealized losses and a big balance of uninsured deposits.

Earnings of Eastern Bankshares, Inc. ( EBC ) will likely grow this year on the back of mid-single-digit loan growth. On the other hand, pressure on the margin in the first half of the year will drag earnings. Overall, I’m expecting Eastern Bankshares to report earnings of $0.33 per share for the first quarter and $1.34 per share for the full-year 2023. Compared to my last report on the company, I’ve reduced my earnings estimate because I’ve decreased my margin estimate and increased my provision expense estimate. The year-end target price suggests a high upside from the current market price. However, due to the high-risk level, I’m maintaining a hold rating on Eastern Bankshares.

Management’s Strategy, High Borrowing Costs to Drag Loan Growth

Eastern Bankshares’ loan portfolio size ballooned by 5.2% during the fourth quarter of 2022, which took the full-year loan growth to 10.4%. This exceptional growth beat my expectations given in my last report on the company. Loan growth will likely dip in 2023 due to the following reasons.

1. The management mentioned in the conference call that it is prioritizing profitability over growth.
2. The high-interest-rate environment will curb credit demand, especially for residential real estate loans which make up 18% of the total loan portfolio.

On the other hand, strong regional job markets indicate that business activity is currently strong, which bodes well for commercial loan growth in the near term. Eastern Bankshares operates in Massachusetts, New Hampshire, and Rhode Island. The unemployment rate in all three states is very low from a historical perspective.

The management mentioned in the earnings presentation that it is expecting commercial loan growth in 2023 to be in the low-single digits. Considering the factors given above and management’s guidance, I’m expecting the total loan portfolio to grow by 4% in 2023.

Margin to Face Pressure in the First Half of the Year

After growing at a decent pace in the second and third quarters of 2022, the margin took a downturn in the fourth quarter of the year. The reason was that the company had held down deposit costs for as long as it could, and these costs bounced up closer to market rates in the fourth quarter of last year. The management mentioned in the earnings presentation that it expects the margin to decline further until funding costs stabilize. In my opinion, funding costs won’t stabilize until after the up-rate cycle ends; therefore, the margin will likely continue to drop during the first half of 2023.

The results of the management’s rate-sensitivity analysis given in the 10-K filing show that a 200-basis points hike in interest rates can reduce the net interest income by 4.2% over twelve months.

Considering these factors, I’m expecting the margin to decline by six basis points in the first half of 2023 before rising by four basis points in the second half of the year. In my last report, I projected the margin to rise by eight basis points in 2023.

Revising Down the Non-Interest Expense Estimate

Eastern Bankshares’ non-interest expenses surged by 13.6% in the fourth quarter of 2022, which exceeded my expectations. The management mentioned in the conference call that it has reduced all budgets. Further, the disinflation has been faster this year than I previously expected. Therefore, it’s likely that the growth of operating expenses will slow down this year compared to the fourth quarter of 2022.

In my last report on Eastern Bankshares, I estimated non-interest expenses of $508 million for 2023. I’ve now reduced my estimate to $482 million, which is still higher than the management’s target of $465-$475 million given in the presentation.

Increasing the Provisions Estimate and Reducing the Earnings Estimate

The provisioning in the fourth quarter exceeded my expectations. Further, my outlook on asset quality is worse than before as the Federal Reserve has revised downwards its projection of GDP growth. Therefore, I’ve decided to revisit my provision expense estimate for 2023. In my last report, I projected the provision expense in 2023 to be 0.06% of total loans. I’m now raising this ratio to 0.09%, which is closer to the level for last year.

Due to my revisions of the estimates for provision expense and net interest margin, my earnings estimate for 2023 is now lower than before. I’m now projecting earnings of $1.34 per share for 2023, compared to my previous estimate of $1.57 per share.

The company is scheduled to announce its first-quarter results on April 27, 2023. I’m expecting Eastern Bankshares to report earnings of $0.33 per share for the quarter, up 8% from a year-ago period mostly due to the balance sheet growth.

The following table shows my income statement estimates.

Multiplying the average P/B multiple with the forecast book value per share of $14.2 gives a target price of $13.6 for the end of 2023. This price target implies a 15.9% upside from the April 21 closing price. The following table shows the sensitivity of the target price to the P/B ratio.

Equally weighting the target prices from the two valuation methods gives a combined target price of $14.5 , which implies a 24.0% upside from the current market price. Adding the forward dividend yield gives a total expected return of 27.4%. Normally I adopt a Buy rating when the total expected return is this high. However, due to the high-risk level, I’m going to maintain a Hold rating on Eastern Bankshares.

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