Eastern Bankshares, Inc. Q4 FY2022 Earnings Call

Hello, and welcome to the Eastern Bankshares, Inc. Fourth Quarter 2022 Earnings Conference Call. Today's call will include forward-looking statements regarding Eastern's future financial and operating results, outlook, business strategies and plans, along with other opportunities and potential risks anticipated by management. These forward-looking statements are based on management's current estimates or beliefs and are subject to various known and unknown risks and uncertainties that could cause actual results or the timing of events to differ significantly from those expressed or implied. Listeners are encouraged to review the disclosures in the earnings press release under the forward-looking statements section as well as the risk factors and other important information found in the company's recent filings with the Securities and Exchange Commission for additional context about these risks and uncertainties. Any forward-looking statements made during this call reflect management's views and estimates as of today. Although the company may choose to update these statements in the future, it specifically disclaims any obligation to do so, even if management's perspectives or estimates change, and you should not depend on these statements as indicating management's views at any date after today. The company will also discuss certain non-GAAP financial measures during the call. To find a reconciliation of these non-GAAP financial measures to the relevant GAAP figures, please refer to the company's earnings press release available at investor.easternbank.com. Please note that this event is being recorded. All lines have been muted to minimize background noise. After the speaker’s remarks, there will be a question-and-answer session. I would now like to turn the call over to Bob Rivers, Chair and CEO. Please go ahead.

Thank you, Joanna. Good morning, everyone, and thank you for joining our fourth quarter earnings call. With me today is Jim Fitzgerald, our Chief Administrative Officer and Chief Financial Officer. We hope your new year is off to a good start, and I'd like to start this morning's call by thanking my 2,100 colleagues at Eastern for all of their good work in making 2022 such a successful year. Together, we posted record net income for 2022 of $199.8 million, 29% higher than our previous record in 2021. As always, this bottom line result is the product of a number of significant achievements, including the completion of the integration of Century Bank, record commercial loan and home equity originations, outstanding asset quality, the acquisition of two insurance agencies, the continued upgrade of our technology platforms as well as many other notable accomplishments. For example, Eastern was once again recognized by the Small Business Administration as the Top Small Business Lender in Massachusetts for the 14th consecutive year and was ranked among the top 10 most charitable companies in our region by the Boston Business Journal for the tenth time. All of this, along with the strength of our underlying franchise, is a testament to their hard work and tremendous commitment. In a moment, I'll turn it over to Jim for an in-depth financial review, but I wanted to first provide some high-level comments on our results for the fourth quarter and our near-term outlook. The fourth quarter of 2022 proved to be a more difficult environment than earlier in the year. Like the industry, we experienced deposit outflows and an upward repricing of deposits that quickly increased our cost of funds due to an aggregate 425 basis points of rate hikes by the Federal Reserve throughout 2022. It's been important for us to keep close to and respond to the needs of our customers with competitive pricing to attract and retain long-term customer relationships. We are watching our funding trends very carefully, but do not expect a reprieve from the more difficult competitive landscape over the near term. We saw a six basis point decline in our net interest margin in the fourth quarter, and we expect the margin to continue to contract. Given the current environment, as we look into 2023, we are prioritizing profitability over growth. We expect higher market interest rates and an overall softening in the economy to reduce loan demand. Coupled with our higher marginal cost of funds and taking into consideration our required returns, we expect the commercial loan growth rate in 2023 to be in the low single digits following an extremely successful year in 2022. We are proud of our diversified loan portfolio and the many commercial customer relationships we have built at Eastern over the years. We are carefully watching for any signs of credit deterioration, but remain very pleased with all of our credit metrics in Q4. Our reserves and capital levels are very healthy. We are taking many steps to realign and adjust to what we expect will be a more challenging year in 2023. As Jim will cover in more detail, we have significantly reduced our expense guidance. With the change in the environment and our growth outlook, we have pulled back across the board and reduced our expense budgets accordingly. We will continue to evaluate expenses as the next few months and quarters unfold. We have navigated our way through challenging times before and have successfully worked our way to the other side. I am very confident we will manage our way through this environment as well as the fundamentals of our company and our strong market position in Boston keep us poised for long-term success. And now I'll turn it over to Jim.

Great. Thank you, Bob, and good morning all. As Bob mentioned, our Q4 results reflect solid operating results, but also a very challenging and competitive environment. Net income was $42.3 million or $0.26 per diluted share, and operating earnings were $49.9 million or $0.31 per diluted share. As previously disclosed, we were required to use settlement accounting for our pension plan in Q4 and incurred a nonrecurring pretax expense of $12 million due to the unusually high number of lump sum payout levels in 2022. This expense is primarily responsible for the difference between our GAAP and operating results. Our operating net income of $49.9 million and $0.31 per share compares with $55.7 million and $0.34 per share in Q3. Net interest income was $150 million in Q4, down $2.2 million from Q3 or a decline of 1%. The net interest margin on a fully tax-equivalent basis was 2.81% in Q4 compared with 2.87% in Q3. The cost of interest-bearing liabilities increased from 18 basis points to 77 basis points in the quarter, which exceeded the increase in our interest-earning asset yield of 29 basis points. We experienced loan growth in all of our major portfolios in the quarter. Commercial loan growth was $313 million in the quarter or 13% on an annualized basis. Mortgage loan growth was $342 million, including $289 million from our Embrace relationship and annualized consumer loan growth was 4.8%, which was primarily in home equities. Asset quality continued to be very sound with net charge-offs of one basis point and nonperforming loans at a very low 28 basis points of total loans, both of which are consistent with Q3 levels. Our Board approved a dividend of $0.10 per share payable on March 15th to shareholders of record of March 3, 2023. We repurchased 1.5 million shares under our share repurchase program in the fourth quarter, most of these share repurchases were early in the quarter. I'll now make some comments on the balance sheet. Assets were $600 million higher in Q4 than Q3, and we ended the quarter with $22.6 billion of assets. Total loans ended the quarter at $13.6 billion, increasing $672 million from the $12.9 billion at the end of Q3. Total deposits increased $241 million in the quarter, which included an increase in brokered deposits of $929 million and outflows of approximately $700 million of customer deposits. Borrowings increased $318 million in the quarter and totaled $741 million at the end of the quarter. The increases in broker deposits and wholesale borrowings were used to fund the deposit outflows and the increases in loans. The securities portfolio was down $160 million as reductions from cash flows and sales were $210 million and offset by market appreciation of $50 million. Shareholders' equity increased $56 million in the quarter due to retained earnings and improved AOCI, offset by the share repurchases. Moving to the earnings review, as I mentioned, GAAP net income was $42.3 million or $0.26 per diluted share and operating earnings were $49.9 million or $0.31 per diluted share. Net interest income of $150 million was $2.2 million or 1% lower than Q3. The net interest margin was 2.81%, down six basis points as funding costs increased more quickly than asset yields. The cost of interest-bearing liabilities increased 59 basis points to 77 basis points due to deposit rate increases geared towards core customer retention as well as the use of FHLB borrowings during the quarter. The overall cost of total deposits, including demand deposits, was 37 basis points, up 27 basis points from the prior quarter. The graph on Page 12 of the presentation shows monthly detail on the rise of total interest-bearing liability costs and how the beta is evolving over the cycle. We've added some new tables on net interest income and net interest margin on Page 7 of the presentation that provide more detail on these changes as well. The provision for loan losses was $10.9 million in the quarter compared to $6.5 million in Q3. Similar to Q3, loan growth was the driver, attributing $7 million of the $11 million provision. The allowance as a percentage of loans increased a modest three basis points in the quarter. Noninterest income on an operating basis was $42 million in Q4. Insurance revenues were $22 million in the quarter, up 5% from the same quarter of 2021 and down $1.7 million from Q3. Other operating noninterest income line items were generally in line with either the prior quarter or the prior year quarter. As we disclosed in Appendix A and B in the presentation, there was a reduction in non-operating losses from the rabbi trust assets and security sales in Q4 compared to Q3. Including the pension settlement costs, noninterest expense was $132.8 million in Q4 compared to $116.8 million in Q3. On an operating basis, noninterest expense was $119.6 million compared to $117.4 million in Q3. Salaries and benefits, occupancy, professional services, and loan expenses were all down in the quarter from Q3, while data processing and marketing were higher. Other expense was higher due to the previously mentioned pension expense and an increase in the provision for credit losses on off-balance sheet credit exposures. I'll include some comments on our outlook for expenses later in the presentation. The tax rate in the quarter was 17% due primarily to some timing items, and the tax rate for all of 2022 was 22.1%. Asset quality continues to be very sound. Through the end of the fourth quarter, net charge-offs were very close to zero. NPLs are at very low levels, and our reserve coverage to NPLs is over 360%. We continue to carefully monitor all of our portfolios. We have several early warning signals as part of our credit review process, and based on those early warning signals, we don't see any significant items of concern at this point. As Bob mentioned earlier, we expect the economy to soften, and we will continue our credit and portfolio review processes diligently. I wanted to review our outlook page and make some additional comments. As mentioned, there's greater uncertainty in the environment, specifically related to expectations for liquidity in the net interest margin. We expect the challenging liquidity conditions to continue over the next few quarters, and this uncertainty makes our outlook subject to a wider margin of error than prior quarters. We are expecting commercial loan growth to be in the low single digits for 2023 due to the impact of higher rates on new originations. We would expect mortgage and consumer loan growth in a similar range. We experienced a net interest margin decline of six basis points in Q4 and expect further declines until the funding environment stabilizes. We added some new tables on Page 12, showing the increase in deposit costs and interest-bearing deposit costs as well as the total, including wholesale funding. We expect our noninterest income for 2023 to be between $170 million and $180 million. We expect reductions in deposit service charges due to changes in our overdraft practices, which you might recall us discussing in prior calls, as well as pressures on mortgage and interest rate swap fees due to market conditions and interest rate levels. We are lowering our operating noninterest expense guidance for 2023 and expect it to be in a range of $465 million to $475 million. This is a reduction of $30 million from the Q3 guidance of $495 million to $505 million. Given the uncertain environment, we're very cautious about adding expenses at this time and have undertaken actions to reduce all of our budgets. We'll continue to assess expense levels as we move forward. Most economic forecasts expect a softening economy that will likely turn into a modest recession, and we will continue to monitor all of our asset quality accordingly. The projected slowdown in loan growth is expected to have an impact on loan loss provision levels. As I mentioned earlier, $7 million of the $11 million provision in Q4 was due to loan growth. Share repurchase activity will depend on market conditions, capital, and liquidity levels. In particular, we'll be looking for liquidity conditions to improve before considering share repurchases at the pace we had earlier in 2022. In closing, we continue to focus on our core deposit customers and expect to find the appropriate balance between deposit retention and our short-term net interest margin. Over a long period of time, those relationships have been a great source of value for Eastern, and we're very confident they will continue to be in the future. Thanks. And Joanna, we're ready for questions.

Thank you. The first question comes from Janet Lee at J.P. Morgan. Please go ahead.

Hi, good morning.

Good morning, Janet.

I know there's a lot of uncertainty, it's hard to forecast, but I just want to get more color on your deposit cost. I think in the second quarter, you said you were modeling 150% higher than the prior cycle level of 20% for the interest-bearing deposit data. So I think that gets around 30%. Do you have any updated view on that due to cycle interest-bearing deposit beta?

So Janet, it's great to talk with you again and congratulations. In response to your question, we've learned that this cycle is different from what we expected based on past experiences, especially in the fourth quarter and parts of the third quarter. The pace of change has been quicker and a bit more challenging. Therefore, we are not using previous metrics to make predictions in this current environment. Instead, we've provided additional information through the end of the year to illustrate what we've encountered. As we've mentioned, we believe that challenges will continue moving forward.

Okay. So I mean, yes, I totally understand, totally on the same page that the cycle is very, very different from the prior cycle. But last cycle, you did better than your peer in terms of managing deposit costs lower than the industry, but in terms of your preference or planning lives, is it your plan to pay up on your deposits much closer to market rates and retain the deposits or stop that deposit outflows or are you still like trying to like manage your NIM and keep your deposit costs under peers in terms of your preference as you look out into the next few quarters?

It's a challenging question to address, as we're navigating a delicate balance. We have numerous long-term customers who are important to us, and we value those connections. Given the higher rates, we have adjusted many of those relationships and will continue to do so. We greatly appreciate the significance of these long-term deposits. We're closely monitoring our margin as well, balancing the considerations around how we price deposits. This process is similar to what we have experienced in the past.

Everyone is experiencing noninterest-bearing deposit outflows. In your case, if we exclude the broker deposits, the deposit outflows appear to be more significant. Is this primarily due to your customers seeking higher yields? Where exactly in your customer base are you observing the most deposit outflows? Are you planning to utilize brokered CDs in the future to address this issue, and will this be part of your strategy in the upcoming quarters?

Let me address a couple of questions in your inquiry. We've observed withdrawals from most of our customer segments, particularly in municipal and commercial areas. On the consumer side, deposits are somewhat more stable; however, we have noticed a transition from lower-cost deposits to higher-cost ones. To retain customers, we are offering higher promotional rates than in the past, which has helped keep deposits more stable, though it does come with an impact on costs. Moving forward, we are monitoring the situation closely and making pricing decisions as needed. It’s a balancing act between the important short-term net interest margin considerations and the long-term customer relationships.

Okay. I might give this a shot, but in terms of 2023, is there any range of guidance you can provide on the NII growth, I know you guys have pulled that off from the slide, is there any rough range that you can give us as well as sort of the goal in terms of your deposit growth or deposits decline for 2023?

I think what we put in the materials that you have is our outlook, Janet, which is that we do expect further contraction in the margin. As we said a number of times, it was six basis points in the third quarter, and we've given you, I think, pretty good information on the deposit costs in Q4 and throughout the year as well. So that's all part of our outlook and that's what we've provided.

Okay, alright, thanks for taking my questions.

Thank you, Janet.

Thank you. Next question comes from Mark Fitzgibbon at Piper Sandler. Please go ahead.

Hey guys, good morning.

Mark, how are you?

Good. Jim, just a follow-up to try to get at that margin question a little bit differently. Where does your modeling show the margin bottoming out, assuming the Fed kind of follows the forward curve?

Yes, Mark. As we've mentioned before, the market is very competitive and challenging. We believe the situation will remain difficult. Additionally, it's hard to provide further details. We've shared all the information available through the end of the year, and we do not anticipate things getting easier in the coming quarters.

Okay. And then secondly, when we see rallies in the bond market, are you guys selling or trying to reduce the size of the AFS book and is there any plans contemplated to take losses and shrink that book down?

No, Mark, thank you. It's a valid question. I believe we are in a constantly changing environment. We continuously assess the situation and respond to any changes we observe. The only way I can respond is that when we reach decisions, we will communicate them. Right now, we are carefully monitoring the situation. Given the current environment, it is challenging, and many factors are in play. We are certainly open to various options, but there are no plans at this moment.

Okay. And then just a couple of questions around M&A, it's been pretty quiet on the insurance M&A front. Any particular reason for that? And also, given sort of the dearth in bank M&A targets in Eastern Mass, are you guys getting a little more open-minded to extending your geographies a bit if a deal made financial sense?

Sure, Mark. We've focused on bank and insurance acquisitions in our current areas or nearby regions, and that strategy is ongoing. If opportunities arise outside of those regions, we will consider them, although we have historically been less inclined to pursue such options for various reasons. Regarding the pace of insurance acquisitions, it primarily comes down to pricing. We always have a robust pipeline of potential deals, but often the pricing does not meet our return expectations. Nonetheless, we continue to evaluate those opportunities.

Thank you.

Thank you. Next question comes from Laurie Hunsicker at Compass Point. Please go ahead.

Yeah, hi Bob and Jim. Good morning. Maybe just stick where Janet and Mark were, back on the margin, certainly, your core deposit franchise is very, very strong seeing the move in the money markets and the CDs, and the broker deposits obviously jumped to 5%. Can you help us think about how high you take those broker deposits and then maybe asking the margin question another way, can you refresh us maybe on where your December spot margin was?

Sure, Laurie. Good morning. So I think the broker deposit question, it's a challenging environment as we've said many times. Historically, we haven't used broker deposits, and we've had limited wholesale borrowings. In this environment, we've used them. So we continue to make decisions based on cost and balance sheet structure, etcetera. The margin at December was in the low 270s on an FTE basis.

Okay, that's helpful. And so nothing that you want to quantify in terms of how much to pull down of broker deposits?

I'm sorry, what was the question Laurie?

Just in terms of thinking about how big broker deposits could become, right, broker deposits are now 5% of your deposit base. Is there any thinking you cap it at 10% or how should we think about that?

Our preference is to utilize our own customer deposits significantly more than broker deposits. The market has been challenging, and we have adjusted our pricing while exploring alternatives with all our customers. We aim to grow our customer deposits to replace brokered deposits. The changes we experienced in the fourth quarter were notable, and as you mentioned, we did utilize brokers, and we have acknowledged this. However, we want to focus on developing pricing strategies and structures with our current deposits from existing customers as our main avenue for growth moving forward.

Got it. Got it. Okay. And then on expenses, your expense outlook is a dramatic change from where you were last quarter. So the $30 million reduction is substantial, can you take us through a very high leveу where that might come from, is that branch closures, or how are you thinking about that?

Sure. You're correct, Laurie, the reduction is quite significant. 2022 was a strong year for us, and we were on a solid growth trajectory. However, the environment shifted. The reduction is influenced by various factors. Some of it involves scaling back our growth plans, while other aspects relate to evaluating our current initiatives and determining that some are not as critical at this moment. We are implementing general cost-cutting measures, reviewing all expected areas such as branches and other real estate, along with other opportunities. The initial reduction primarily focused on scaling back, and as I mentioned, we noticed a substantial change in the environment during the fourth quarter, which prompted us to re-evaluate our expenses moving forward in light of this new reality.

Great, okay. That's helpful. Tax rate, how should we be thinking about that for 2023?

I think that's a good question. At the end of the third quarter, we are guiding for 22% to 23%, and that will be my updated guidance for you.

Okay. And then a question here in fee income, you had a drop in insurance revenue linked quarter. Maybe any thoughts around that and then I know March is typically your strongest month or strongest quarter rather for insurance, are we still thinking that we would see maybe a $4 million to $5 million build to increase or can you help us think a little bit about that?

Sure. I would recommend that we don't consider the linked quarter for insurance revenues due to seasonal changes. Instead, focus on the previous year. You're right that there was a significant increase in the first two quarters, especially the first quarter, which is when a lot of what used to be called profit sharing is realized, leading to a noticeable increase. So, it's better to look at last year's numbers and examine the growth rates from this year rather than relying on the linked quarter because of the seasonality.

Got you, okay. And I guess, any thoughts about the drop in the December quarter, I'm just looking again at a linked quarter, but any thoughts on that?

No. I think it was very much in line with our expectations, and it was 5% ahead of the prior year, which, again, I think is the appropriate benchmark.

Got it, got it, okay. And then just last question on loan loss provisioning. Was there anything that was a specific reserve set aside in that $11 million, I realize $7 million was growth, you had no charge-offs, anything specific the rest of it?

No, I would consider the changes in our ACL factors to be quite modest, with the provision as a percentage of loans increasing by three basis points. So it is very modest. I am aware that there were no specific issues or problems during the quarter.

Okay, great. Thanks for taking my questions.

Great, thank you.

Thank you. Next question comes from Damon DelMonte at KBW. Please go ahead.

Hey, good morning guys. Hope everybody is doing well today.

Good morning.

Great, kind of sticking on the margin topic because it's been pretty popular this morning. I wanted to comment a little bit differently. Could you provide a little color on the asset yield side of things, earning assets had only gone up 33 basis points with loans going up about 32 basis points, why wasn't there more lift in the loan yield this quarter?

I think it's interesting because we observed that loan yields increased by 32 basis points in relation to the rate changes during the quarter. We believed this was consistent with our expectations. The securities portfolio, being fixed rate, did not change, which is why the interest-earning assets are lower than the loan yields. Additionally, when we analyzed the fixed and variable components, along with the hedged variable amount, we felt that a 29 basis point increase was also in line with our expectations.

Could you provide an update on the Embrace Home loan relationship? Are you still active with them, or was this quarter just a one-time event?

Yes. At the end of the second quarter, we shared our objectives, aiming for about $400 million in residential mortgages. By the end of the third quarter, due to various factors, especially the shifting liquidity situation, we didn't fully execute that plan; instead, we paused it. The pipeline had accumulated, and we primarily closed those loans in the fourth quarter. There were a few lingering items into early Q1, but there are no new originations, and growth will be very modest in Q1.

Got it. Okay. And then just lastly, can you just provide an update as to what your exposure is with regard to office space and commercial real estate in the greater Boston area?

In total, this is consistent with previous calls on this topic. When you look at our entire office portfolio and exclude properties that are owner-occupied by commercial clients or have a retail element, the portfolio is just under $700 million. There is some exposure, but it is minimal in Boston itself, with most of it located outside the city. We are closely monitoring the portfolio, but as I mentioned in my earlier comments, our early warning indicators do not suggest any significant issues at this time.

Got it, okay. Well thanks, that’s all I had, everything else has been asked and answered. Thank you.

Great, thank you.

Thank you. There are no further questions at this time. I will now turn the call back over to Bob Rivers for closing remarks.

Great. Well, thank you for your interest and your questions this morning. We look forward to talking with you again at the end of April when we'll report our first quarter results.

Thank you. This concludes today's conference call. You may now disconnect.