Eastern Bankshares: All Eyes On Merger With Cambridge Bancorp

seekingalpha06-13

Despite initial market skepticism, I believe the merger is a positive move due to the complementary strengths of Eastern and Cambridge.The Eastern Bankshares stock price has been stagnant due to an ...

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Shutter2U The price of Eastern Bankshares (NASDAQ:EBC) has been sideways for several months now, and the reason is attributed to the upcoming merger with Cambridge Bancorp (NASDAQ:CATC). Investors appear doubtful about the future of the resulting new bank and are not taking a position. I have covered both banks in the past and did not go beyond a hold rating. As for Eastern, I was concerned about the high unrealized losses on AFS securities, as they are bringing down TBV per share. In the case of Cambridge, a deterioration in profitability was evident. In both cases, these problems remain, but the prospect of a merger between these two banks is a game changer. Eastern's good profitability may offset Cambridge's difficulties. At the same time, Cambridge's rising TBV per share may help Eastern's underwhelming equity. Personally, I am quite optimistic and in this article, based on the latest quarterly reports released, I will explain why. However, before doing so, I think a recap regarding the main aspects of this merger is useful. Merger Highlights The merger announcement was made in September 2023, but due to numerous regulatory approvals it is expected to close in exactly one month, July 12, 2024. Until that date, the two banks will operate separately; after that date, there will be major changes:  The \"Wealth Management and Private Banking divisions of both banks will operate under the Cambridge Trust brand\". All other areas of the new bank will operate under the Eastern Bank brand.  As we will see later, this differentiation will be important. In addition, Cambridge CEO Denis Sheahan will be the CEO of the new Eastern. The merger will create a combined franchise whose total assets will amount to $27 billion, and it will have significant influence in Boston. Eastern plans to issue about 39.4 million shares of common stock based on its September 18, 2023 price per share to complete the merger, implying that the deal was valued at about $528 million. Simultaneously, Eastern sold its insurance business, Eastern Insurance, for $510 million. For those holding Cambridge common stock, each one will be exchanged for 4.956 shares of Eastern's common stock. Eastern and Cambridge complement each other Given the formal details of the merger, in this paragraph I will express my point of view on the matter. Since the announcement, Eastern's price per share has traded sideways while Cambridge has achieved double-digit returns, mainly due to its “premium” valuation in the deal. The market seems to find this situation more advantageous for Cambridge shareholders than for Eastern ones, but in my opinion, there are several aspects to consider. Certainly, Eastern is in an excellent position in terms of deposit quality and Capital Ratios, but Cambridge manages to cover its weaknesses. In a sense, it is as if the two banks together complement each other, which is why I value this merger positively. Let's start with the first aspect, which is deposits and net interest margin. Cambridge Bancorp Q1 2024 As you can see from this image, Cambridge is struggling a lot to find stability in deposits. In the last quarter, it managed to prevent a severe decline, but only because it allowed a higher yield on its deposits. In fact, the cost of deposits increased and reached 1.97%. At the same time, interest-earning assets failed to offset this increase, which is why the net interest margin dropped for the umpteenth quarter in a row. This trend does not seem to be stopping. Eastern Bankshares Q1 2024 On the other side, we have Eastern, a bank where the total cost of deposits is only 1.66% and the net interest margin has already stabilized. Incidentally, with a reduction in the Fed Funds Rate, it could return to growth rather quickly. There are no expensive-brokered deposits and borrowings have marginal value. In short, although Eastern is experiencing some difficulties due to the current macroeconomic environment, it is in a more stable income situation overall than Cambridge. If we based on this aspect alone, the merger would seem to be disadvantageous for Eastern, but other aspects need to be considered as well. Take a look at the TBV per share. Eastern Bankshares TBV, Seeking Alpha  Although Eastern is profitable every quarter and does not issue a high dividend, it has been unable to improve its TBV per share, which is quite serious since the latter is a key component of any bank's price per share. The reason for this stall can be attributed to the poor timing in the acquisition of fixed-rate securities.   Eastern Bankshares Q1 2024 Eastern's securities portfolio is worth $5.50 billion, about 24% of total assets. This is a huge amount and is causing a major problem. Although most of these securities are risk-free, after the rapid rise in the Fed Funds Rate they have generated large unrealized losses due to their low and fixed yields: the average yield of this portfolio is only 1.82%, the upper limit of the Fed Funds Rate is 5.50%. The unrealized losses of AFS securities should be accounted for in AOCI, an item located within equity. Since to date, these losses amount to $612 million after-tax, it is not surprising why the TBV per share is so low. There is a huge ballast carrying it down, and management can't do much to change the situation; it can only wait for the securities to gradually mature. Materializing all the losses by selling them before maturity would mean wiping out 20% of equity, a disastrous outcome. It's an entirely different discussion for Cambridge, whose TBV per share gradually continues to increase. Cambridge Bancorp Q1 2024 Although its profitability has deteriorated, it remains profitable and manages to increase equity without too much trouble. In fact, unlike Eastern, unrealized losses are quite negligible. Should there be a new shock in the banking sector as happened in early 2023, in order to increase liquidity, Eastern could be forced to sell some of its securities at a loss, while Cambridge would not. So, from an income perspective, Eastern has shown better performance, but from a balance sheet perspective, Cambridge is better positioned. Having said that, let us now turn to another important aspect, which is the dividend. Eastern Bankshares, Seeking Alpha There is little data available to Eastern since it has only recently been listed, but we can see that there is no clear dividend policy. In the long run it tends to grow, but there are many periods of stagnation. For a dividend-hunting investor, these results are certainly not exciting. Cambridge Bancorp Q1 2024 In the case of Cambridge, we are talking about a totally opposite situation; in fact, it is among the banks that most give continuity to the dividend. For 24 years in a row, the dividend has been increased, even during the Great Financial Crisis of 2008-2009. The new Eastern, run by Cambridge's CEO, may put more emphasis on the dividend policy, consequently attracting new investors. Finally, another strength of Cambridge is the brand it has managed to build over the years. In fact, its influence is important in wealthy Northwestern suburbs, something that Eastern has failed to do. In addition, its wealth management is quite competent, which is why the Wealth Management and Private Banking divisions of both banks will continue to operate under the Cambridge Trust brand. The ending AUM in Q1 2024 was $4.50 billion and 23% of total revenue comes from these divisions' fees. Thus, the new Eastern will have an added source of revenue disconnected from traditional banking. Conclusion In light of what has been discussed so far, my view on this merger is optimistic. The weaknesses of one bank are covered by the strengths of the other, which will make the new Eastern a more balanced and stable entity overall. By the way, this transaction occurred in conjunction with the sales of the insurance business, the proceeds of which almost entirely offset the value of the shares issued to complete the merger. Finally, there is one last aspect to consider, which is the degree of capitalization. Cambridge's CET1 is quite high, 13.30%, but Eastern's is on another level. Eastern Bankshares Q1 2024 As much as 18.50%, almost three times the regulatory minimum. Frankly, I don't recall a bank with such high Capital Ratios. Probably the choice to keep them so high is for precautionary reasons, given the large unrealized losses.  Once the merger is completed, management has already announced that it may purchase treasury stock. At that point, in addition to dividends, there will also be buybacks to remunerate shareholders. In short, I believe everyone gains from this merger except their competitors.","kind":"highlight","is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"0","news_tag":"","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.29.3","shortVersion":"4.29.3","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2443056775"}