EBC - Eastern Bankshares Makes Cambridge Bancorp Look That Much Less Appetizing

2023-11-21 09:19:32 ET

Summary

• Cambridge Bancorp stock has outperformed the market since the announcement of its merger with Eastern Bankshares.
• Eastern Bankshares stock has performed worse than anticipated, with shares down 19.9%, due to weak deposit and profit figures.
• Financial data shows that Eastern Bankshares is struggling, warranting a downgrade to a 'sell' and Cambridge Bancorp to a 'hold'.

It's always interesting to see what transpires with investment prospects that I have looked at but ultimately decided not to purchase myself. Sometimes, I find myself wishing I had bought shares when I had the opportunity. In other cases, I find myself happy that I did not make a move. Every so often, I will also come across a scenario that I did not anticipate. At the end of the day, these scenarios often look logical. One example that I could point to regarding this would be the merger announced between Cambridge Bancorp ( CATC ) and Eastern Bankshares ( EBC ) back in September of this year.

Prior to that announcement, I had written about both companies. The first of them, Cambridge Bancorp I found to be a bullish prospect. I felt as though shares looked undervalued and the company offered attractive upside. Since then, the stock has outperformed the market, increasing in value by 3.8% at a time when the S&P 500 has risen only 0.4%. Then you have Eastern Bankshares, a much larger bank that I took a neutral stance on. At the time, I even recognized that there are better opportunities for investors in this market. But since the publication of that article, the stock has performed even worse than I anticipated, with shares down 19.9% compared to the 1% decline seen by the S&P 500.

In September, news broke that these two enterprises would be merging, with Eastern Bankshares essentially absorbing its much smaller rival. And since then, financial data for the most recent quarter for each business has come out. What this data shows is that Eastern Bankshares was right to seek out a transaction. It also shows that while Cambridge Bancorp continues to fare well, Eastern Bankshares is still struggling. Because the fates of these two firms are now intertwined, some revision to my prior view on each business is in order. Unfortunately, I have found it appropriate to downgrade both businesses, with Eastern Bankshares warranting a downgrade from a ‘hold’ to a ‘sell’ and Cambridge Bancorp deserving a downgrade from a ‘buy’ to a ‘hold’.

The picture has changed

According to the press release issued by both Cambridge Bancorp and Eastern Bankshares in September, both companies agreed to an all stock merger whereby investors in Cambridge Bancorp will receive 4.956 shares of Eastern Bankshares for each share of Eastern Bankshares they currently own. The combination of these companies might make sense to some extent. But it's important to keep in mind that the recent financial performance of each firm has been radically different. Consider, for starters, Cambridge Bancorp.

As you can see in the chart above, Cambridge Bancorp has experienced some downside when it comes to net interest income and net profits. Despite higher interest rates, the firm has been negatively affected by a decline in the net interest margin because of higher rates that it has to pay on deposits in order to keep them flowing into the institution. But in the chart below, you can see similar data for Eastern Bankshares. The only difference here is that Eastern Bankshares is substantially worse off because of securities losses incurred so far this year.

Of course, to have a better understanding of things, we need to dig deeper than this. We really need to dig into deposit data and other similar data. One of the good things about Cambridge Bancorp is that, after a short window of time, the institution began to show a recovery following the banking crisis that began earlier this year. You see, the value of deposits on its books fell from $4.66 billion in the first quarter of this year to $4.44 billion in the second quarter. But as it became clear that the institution is stable, deposits started flowing back in. By the end of the third quarter, they had grown to $4.57 billion. Over that same window of time, Eastern Bankshares has only seen continued weakness. Deposits went from $18.54 billion in the first quarter to $18.18 billion in the second quarter. From the second quarter to the third quarter, deposits plunged another $756.8 million to $17.42 billion.

A drop in deposits is very painful to see. After all, deposits are the lifeblood of many banks because they allow the aggregation of capital that permits loans to be written and securities to be invested in. Adding in net cash and securities, we find that while Cambridge Bancorp will ultimately own 19.5% of the combined business from an ownership perspective but it is bringing 21% of the net cash and securities to the equation. It also has to be bringing 21.1% of the deposits, though that will likely change if current trends persist.

When news of this transaction came out, investors in Eastern Bankshares didn't take matters well. I say this because, since the time of that announcement and as of this writing, shares of the enterprise are down 14.3%. The big hang up is likely due to the fact that, as opposed to deposits or net cash and securities, the market perceives the merger as one in which Eastern Bankshares is getting a smaller proportion of the net assets than it deserves. The fact of the matter is that, based on the most recent data available, shareholders of Cambridge Bancorp are getting 19.5% of the book value of the combined company but are bringing only 17.7% of the book value of the two companies individually.

Although I understand why the market might not be terribly enthusiastic, I think that this is a small price to pay for a bank that, despite being smaller, has proven itself this year to be superior to Eastern Bankshares. This is especially true on the deposit front. Now, based on the most recent fundamental data available, I would normally still be bullish on Cambridge Bancorp. After all, while earnings are down, the bank continues to exhibit positive deposit growth and loan growth at a time when debt has fallen, and cash and securities remains robust. But because its fortunes are now tied to Eastern Bankshares, I can really only be slightly more bullish on Cambridge Bancorp than I am on its suitor.

Takeaway

Fundamentally speaking, it seems to me as though the market has this wrong. Because of the most recent deposit data, Eastern Bankshares deserved to drop after financial results came out for the most recent quarter. And in general, it is a mediocre bank. But the data suggests to me that the market should have been more optimistic about the purchase of Cambridge Bancorp by it. The more recent data would normally make me keep my bullish stance on Cambridge Bancorp. But because of how connected it is now to Eastern Bankshares, I have decided to downgrade it to a ‘hold’ while downgrading Eastern Bankshares to a ‘sell’. The only things stopping a downgrade of Cambridge Bancorp to a ‘sell’ as well would be the hope that the deal could fall through and the extra 3% spread between where shares are currently trading and the implied buyout price of them by Eastern Bankshares.

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