Eastern Bankshares (EBC 0.17%)a Boston-based $22 billion asset bank, remains one of my favorite mid-cap stocks with good fundamentals.
Stocks have fallen more than 18% this year, and the banking sector in general has struggled. But it’s actually slightly better than the wider market. SPDR S&P Regional Banking ETFBank stocks may continue to struggle in the near term for a number of reasons: first, interest rates are still rising, and second, the market sees a potential recession next year. It’s woven into it.
Still, Eastern continues to improve financial returns and builds a franchise that delivers significant long-term value for shareholders. Here’s why:
great franchise
For a smaller bank like Eastern Bank, investors will want to focus on their core deposit and lending franchises. Both are very powerful.
The key to a bank deposit franchise is for the bank to have a sticky, low-cost deposit base that builds good customer relationships. Deposit costs will obviously rise as interest rates rise, but better deposit franchises can outperform the industry and peers on overall deposit costs.
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Eastern has one of the best deposit franchises in the business, with 62% of its deposits being checking account products, which are the stickiest and lowest cost form of deposit. Eastern deposit costs increased by only 4 basis points or 0.04% (1 basis point = 0.01%) in the third quarter, while the Federal Reserve increased its benchmark Federal Funds rate by 150 basis points . Deposit costs are expected to continue to rise, but most banks increased significantly more than the Eastern in Q3.
The Eastern has seen deposit outflows of about $900 million this year as the Fed shrinks its balance sheet, drains liquidity from the economy and drains deposits from the banking system. Eastern also brought $380 million of costly borrowing to its balance sheet in the third quarter.
In terms of loan growth, Eastern has a leading commercial lending franchise and posted record commercial loan growth in the third quarter. Credit quality is also untouched. In 2021, Eastern completes its largest-ever acquisition of Century Bancorp. Not only does this give him the fourth-largest deposit market share in the Greater Boston market, but the addition of Century’s lending expertise in healthcare and medical strengthens an already strong commercial lending franchise. I was. Higher education sector.
Better results despite headwinds
The strength of Eastern’s franchise and its sensitivity to rising interest rates has allowed Eastern to grow its Net Interest Margin (NIM) this year. This is essentially the difference between the weighted yield of an interest-bearing asset such as a loan and the yield. Incur deposits such as debts.
Eastern’s NIM rose from 2.54% at the beginning of the year to 2.87% at the end of the third quarter. This also boosted Eastern’s return on assets, a good measure of a bank’s profitability, to almost 1%. This is a strong number for the industry. Eastern’s efficiency ratio (lower is better), which expresses bank expenses as a percentage of revenue, is also headed in the right direction, below 60% in the third quarter.
Rising interest rates have been good for NIM, but have also been a headwind as they have crushed the bank bond portfolio. Bond values and bond yields are inversely related, so when bond yields increase, bond values decrease. These paper losses eroded the bank’s tangible book value, or net assets traded by the bank.
Data from YCharts.
But remember, these are just unrealized losses. If Eastern can hold onto bonds long enough, it’s likely to recoup its losses as interest rates fall and its bond portfolio recovers. The only way for Eastern to get into trouble is if they have to sell bonds during a losing trade, but I don’t think this is a problem as the banks have plenty of liquidity.
great outlook
Rising interest rates may continue to be a headwind for the banking sector, but I think it will ultimately show just how valuable Eastern’s low-cost deposit base is.
Early in the year, management expects commercial loan growth to grow at a mid-single-digit percentage, well ahead of gross domestic product growth next year.
Management also expects NIM to move to a low level of 3.0% by early 2023, which means continued strong growth. This is happening even as management is leading to a 9% to 10% increase in expenses next year. This is certainly not a small increase as management invests in technology and deals with higher salaries, but on average analysts expect strong earnings growth in 2023.
Ultimately, banks may face short-term difficulties, but Eastern Bank continues to generate earnings, positioning the bank for long-term success.