Eastern Bankshares, Inc. Q1 FY2023 Earnings Call

Hello, and welcome to the Eastern Bankshares, Inc. First Quarter 2023 Earnings Conference Call. Today's call will include forward-looking statements, including statements about Eastern's future financial and operating results, outlook, business strategies and plans, as well as other opportunities and potential risks that management foresees. Such forward-looking statements reflect management's current estimates or beliefs and are subject to known and unknown risks and uncertainties that may cause actual results or the timing of events to differ materially from the views expressed today. More information about such risks and uncertainties is set forth under the caption forward-looking statements in the earnings press release as well as in the Risk Factors section and other disclosures in the company's periodic filings with the Securities and Exchange Commission. Any forward-looking statements made during this call represent management's views and estimates as of today, and the Company undertakes no obligation to update these statements as a result of new information or future events. During the call, the Company will also discuss both GAAP and certain non-GAAP financial measures. For a reconciliation of GAAP to the non-GAAP financial measures, please refer to the Company's earnings press release, which can be found at investor.easternbank.com. Please note that this event is being recorded. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. Thank you. I would now like to turn the call over to Bob Rivers, Chair and CEO. Please go ahead.

Great. Thanks, Joanna. Good morning, everyone, and thank you for joining our first quarter earnings call. With me today is Jim Fitzgerald, our Chief Administrative Officer and Chief Financial Officer. Throughout our history, Eastern's balance sheet has been a great strength of the company with very strong capital, liquidity, and asset quality. This has served us well throughout challenging times in various economic cycles. In Q1, we took multiple steps to bolster our fortress balance sheet as we prepare for the future. As Jim will detail, we made the decision to sell 25% of our securities portfolio to enhance our liquidity and improve the earnings power of the company going forward. As a management team, and with our Board, we spent considerable time analyzing the sale and are very pleased with the outcome. We closed on the sale just prior to the failures at Silicon Valley Bank and Signature Bank, and we were glad to have $2 billion in cash on the balance sheet as the aftermath of those failures was playing out in our markets. We also quickly adapted to the uncertain environment by adding capacity to our backup facilities at the Fed and the Federal Home Loan Bank, with a goal to cover 100% of our uninsured deposits with cash and immediately available funding sources. Importantly, we exceeded that goal and ended the quarter with coverage of 107%. One of the factors that we considered in deciding to sell securities was the strength of our capital position, which provided us with real flexibility to consider a broad range of options. We had and still have some of the highest regulatory capital ratios in the industry. Our TCE ratio was in the top quartile of banks of our size at year-end, giving us a much greater opportunity to consider this action. As further evidence of that capital strength, we increased our TCE ratio by 50 basis points to 8.7% in the first quarter. The other factor in which we have a high degree of confidence is our depositor base. Throughout the quarter, and especially in the aftermath of the bank failures, we experienced a very stable deposit picture. We have always had a very diverse and granular deposit base characterized by longstanding customer relationships that provided a great deal of stability throughout the quarter. Turning to our Q1 results, we delivered record operating earnings of $61 million, which were 10% higher than the prior record achieved in the third quarter of 2022, an impressive feat given the stress in the banking sector. Notably, we received only a marginal benefit in the quarter from the security sale. The full benefit will come over the balance of the year as we have reset our earnings and provided a roadmap for earnings growth that is far greater than before the sale, which Jim will cover in more detail. Another driver of our Q1 results is asset quality. Although we are planning for a challenging economy and likely recession, we had another quarter with zero loan charge-offs and an extremely low level of nonperforming loans and very high reserve coverage for problem assets. Although our loan growth has slowed compared with the record volumes of 2022, we are still very open for business and look forward to serving our customers throughout the year and into the future. We firmly believe that a more challenging environment will provide us a better opportunity to differentiate ourselves positively in the market. Once again, I am very pleased with our results this quarter and look forward to continuing to build upon our strong balance sheet over the coming quarters. It has been a difficult period for the banking industry over the past 6 weeks, but I am very confident that our strengths and future prospects are very apparent in these results and look forward to sharing them with all of our shareholders and other stakeholders. As always, my ending thanks goes to my 2,100 colleagues who continue to ensure that Eastern remains the strong and reliable financial and community partner we have been for the past 205 years, as well as to our customers for their continued business and support. And now I'll turn it over to Jim.

Great. Thank you, Bob, and good morning, everyone. As Bob mentioned, we took an important step this quarter to reposition the balance sheet to improve our liquidity and earnings outlook. We're pleased that we were able to do this while growing our TCE ratio by 50 basis points from 8.2% to 8.7% and increasing both our book value and tangible book value per share by $0.60. The repositioning included the sale of $1.9 billion of low yielding securities from our available-for-sale portfolio at a loss of $280 million after tax. We purchased these securities during the early part of the pandemic when interest rates were extremely low. Although they had excellent credit quality, the very sharp increase in interest rates over the last year caused a decline in their market value. I'll discuss more on the sales shortly, and the expected impact of the sale on our earnings outlook, which is very positive later in my remarks. The Q1 net loss was $194 million due to the repositioning. Operating net income was $61.1 million, or $0.38 per share, which compares with $49.9 million and $0.31 per share in Q4. Asset quality remained very sound in the quarter with essentially no charge-offs, nonperforming loans of $35 million or 25 basis points of loans, and reserve coverage of nonperforming loans over 400%. As expected, loan growth slowed from 2022 levels. Total loans increased $100 million or 3% on an annualized basis in the quarter. Our Board approved the dividend of $0.10 per share payable on June 15 to shareholders of record on June 2, 2023. I wanted to go into more detail on our Q1 balance sheet actions. The security sales took place in early March, just prior to the failures of Silicon Valley Bank and Signature Bank. The strategy for the sale was generally to select the lowest yielding securities in the available-for-sale portfolio in order to redeploy the proceeds in today's higher interest rate environment. The sale proceeds were $1.9 billion, or approximately 25% of the total portfolio. We expect to use the proceeds to reduce our FHLB borrowings and brokered CDs over time, though we are currently holding higher cash balances in the wake of the bank failures. As we had mentioned in the past, our goal had been to reduce the size of the securities portfolio as a percentage of assets from approximately 30% to approximately 20%. This repositioning gets us to that goal. In addition to the liquidity and balance sheet cash generated from the sales, we quickly added to our backup borrowing facilities by pledging additional securities to the Fed's new bank term funding program and increasing our collateral at both the Fed discount window and the Federal Home Loan Bank of Boston. As we outlined on Page 7 of the presentation, the combination of a balance sheet cash of $2.1 billion and available but unused facilities of $5 billion totaled $7.1 billion. One of our goals was to have enough liquidity coverage for all of our uninsured deposits. As also outlined on Page 7, we had just under $6.7 billion of uninsured deposits on March 31. This uninsured deposit amount excludes intercompany deposits and deposit accounts that are collateralized. The $7.1 billion of cash and secured backup facilities is 107% of the uninsured deposits. Throughout the quarter, we experienced a very stable deposit picture. Excluding brokered deposits, our deposits were $114 million lower at $331 than at 12.31, a reduction of six-tenths of 1%. We did experience a reduction in our uninsured deposits of $640 million in Q1 as we outlined on Page 8, but this included the results of our working with customers to both provide large depositors insured cash sweep options, and steps we took to educate consumers on account ownership categories of FDIC insurance coverage. Despite the reduction in uninsured deposits, as I mentioned, core deposits in total were stable in the quarter. We provide more details on the deposit portfolio on Page 10. We have very good diversification across our consumer, commercial, and municipal customer bases. We also have a very diverse and granular commercial deposit portfolio, as you can see from the breakout on Page 10. There is no material concentration from any one sector in the portfolio. Also, the average account age with Eastern ranges from 9 to 13 years, depending on the customer segment, which also provides evidence of very strong customer relationships. We also include some additional data on our strong capital position on Page 11. In addition to our regulatory capital ratios that greatly exceed well-capitalized requirements, we provide a breakdown of our tangible common equity ratio of 8.7% and further show the calculation, including the mark-to-market of our held-to-maturity portfolio. The size of our HTM portfolio was modest, and the valuation impact would reduce TCE from 8.7% to 8.6%. Our near-term strategy on liquidity changed when the bank failures occurred. We decided to retain a portion of the FHLB borrowings and brokered CDs that we had targeted for runoff and kept the larger cash position. We'll reevaluate that over time, and I'll discuss that more during my comments on our outlook. I'll now move to review the balance sheet. As discussed, cash increased in the quarter by $2 billion and ended the quarter at $2.1 billion. Securities declined by $2 billion and ended the quarter at $5.2 billion. Total securities are 23% of total assets. Loans ended the quarter at $13.7 billion, increasing $100 million from the end of the year. Commercial loans were up $73 million or 3% on an annualized basis. Residential mortgages increased by $37 million, and consumer loans declined by $10 million. I'll provide an update to our future loan growth expectations later in my remarks, but this growth was in line with our prior guidance. Total deposits decreased $433 million in the quarter, which included a reduction in brokered deposits of $319 million, and a reduction of $114 million of core customer deposits. Borrowings increased $398 million in the quarter and totaled $1.1 billion at quarter end, and were used to keep the cash balance at high levels as the impact of the bank failures played out. Shareholders' equity increased $107 million in the quarter, reflecting an increase in AOCI, partially offset by a reduction in retained earnings. Moving to the earnings review. GAAP net income was a loss of $194 million due to the sales, partially offset by strong operating earnings. Operating earnings were $61.1 million or $0.38 per diluted share. This compares with operating earnings in the prior quarter of $49.9 million or $0.31 per share. Net interest income was $138.3 million in Q1 compared to $150 million in the prior quarter. The repositioning had a limited impact on net interest income in the quarter. As I mentioned, we sold the securities in early March and subsequently elected to retain the high level of borrowings to keep cash at a very high level until the impact of bank failures was better understood. On the funding side, deposit costs were 92 basis points in the quarter, and our interest-bearing liability costs were 1.33%. Both of these levels are up from the prior quarter but still very attractive in the current interest rate environment. We included our interest-bearing liability cost cycle beta in Page 17. In the month of March, it had moved up to 34% from 24% in the month of December. Over time, the reduction in borrowing should help both interest-bearing liability costs and the related beta, although we expect overall funding costs to keep rising. Loan yields were up 31 basis points in the quarter, and the securities yield for the quarter was 1.61%. The securities yield at quarter end was 1.81%. I'll discuss our outlook for net interest income later in my remarks. The provision for loan losses rounded to zero in the quarter compared to $11 million in the prior quarter. Loan growth was much lower in the quarter compared to the prior quarter and was responsible for most of the reduction in the provision. The allowance as a percentage of loans declined a modest two basis points in the quarter, which offset the impact of the increase in loans. Noninterest income was a loss of $278 million on a GAAP basis due to the repositioning and $52 million on an operating basis. Eastern Insurance had a strong quarter with $31.5 million of revenues, up 10% from the same quarter last year. As we have mentioned, there was a seasonal nature to insurance revenues, but the bulk of incentive payments from carriers were received in Q1. The 10% increase from a year ago is due to higher incentive payments and higher commissions in commercial lines. The other line items were generally in line with either the prior quarter or prior guidance. Noninterest expense was $116.3 million on a GAAP basis and $115 million on an operating basis. GAAP expenses for the prior quarter included the one-time costs for the defined benefit plan settlement accounting charge of $12 million. On an operating basis, expenses were $115 million in Q1 compared to $119.6 million in the prior quarter. I'll provide some comments on the outlook for expenses later in my remarks. Tax expense in the quarter was a benefit of $62.2 million, due primarily to the loss on sale of securities. Going forward, we would expect the tax rate for the next few quarters to be lower than the 2022 level at 18% to 20%, and also provide some comments on that later in my remarks. Asset quality continues to be very sound. Similar to the prior couple of quarters, we experienced a nominal amount of net charge-offs in Q1 that rounded to zero. Nonperforming loans of $35 million are at very low levels, and our reserve coverage to MPLs is over 400%. We are mindful of the potential for a recession and challenging times ahead for sectors like office. We've always worked hard to ensure we have good diversity in our lending approach and to do business with very strong sponsors. We've added some information on both our commercial real estate exposure by property type and our office portfolio on Pages 21 and 22 in the presentation. I would note that in our classifications of office types, we do not consider any office building in the suburbs as Class A real estate. This helps explain the limited amount of Class A properties. The pages show the strong diversification in both portfolios and the lack of any specific concentration in either portfolio. Although we expect the office portfolio to experience some challenges, we are monitoring the overall CRE portfolio very carefully as well, and we are very comfortable with the customers we do business with, and we will partner with them as they work through any challenges. Total investor office loans were approximately $700 million, or 5% of total loans on March 31. These loans are with customers we know well in our primary markets. The portfolio has been very carefully analyzed with a focus on rent rolls, lease rollovers, loan size, loan maturity dates, location, and valuation. We're very comfortable with the underwriting and the management of this portfolio, and we'll continue to monitor all of our portfolios carefully. I wanted to provide some comments on our outlook, which is included on Page 24. We expect commercial loan growth to be in the low single digits and look for residential and consumer loans to be flat for the next few quarters. The growth rate for commercial loans is due to market conditions. As Bob said in his remarks, we believe we will outperform in more difficult environments, and we are very confident that our consistent underwriting and strong relationships will provide us a competitive advantage, especially when times are challenging. We expect our insurance revenues to follow their normal seasonal pattern, and for total noninterest revenues of $170 million to $180 million for 2023. We expect noninterest expenses to increase from Q1 levels but end the year between $465 million and $475 million. We expect a tax rate between 18% to 20% over the next few quarters. This is lower than 2022 primarily due to strong activity by our community development lending group and their work with nonprofits on tax credit financing. We expect our net interest margin to improve over the rest of the year and to be between 275 and 285 basis points on a fully tax-equivalent basis for the full year of 2023. We expect overall net interest income in 2023 to be similar to the level in 2022. This is much higher than it would have been without the repositioning and was one of the key considerations in our evaluation of the repositioning. This net interest income and margin guidance include our expectation that we will hold higher levels of cash on the balance sheet until we're comfortable that the impact of the bank failures is clearly in the rearview mirror. But we do expect to pay off borrowings and let brokered CDs mature in the second half of the year. This is consistent with the original strategy of the repositioning. In closing, we're very pleased with our results for the first quarter and confident that the balance sheet positioning provides us a very strong foundation to continue to improve our financial performance over the short and long term. Thank you. And Joanna, we're ready to open the line for your questions.

First question comes from Damon DelMonte from KBW. Please go ahead.

Good morning, everyone. Hope everybody is doing well today. And thanks for taking my questions. Just want to start off on the margin commentary, Jim. So the $275 million to $285 million, that's for the full year. So that's not like a fourth quarter level. Just wanted to clarify that.

It is for the full year, yes, Damon.

Okay. And based on your commentary, it sounded like …

Damon, just to clarify, on a fully tax-equivalent basis.

It seems like from your commentary, you're likely going to hold onto this cash through the second quarter. The margin seems to fluctuate around this level a bit, and then it really picks up in the latter part of the year, especially once you completely eliminate the borrowings and allow the brokered CDs to mature. Is that an accurate assessment?

I'd say slightly differently. But I think I have said the same thing, which is, our original expectation was to shrink the balance sheet, pay off the borrowings. We felt like that was the right strategy. The failure sort of interrupted that. And as we've said, many times, we're holding more cash than we would expect to long-term. We do expect to hold it for a little bit longer. So on your timing of Q2 and then seeing improvements in the back half of the year, we wouldn't argue with that. We'll see how that plays out, though.

Okay. Fair enough. In terms of the bank failures and the cash levels, is how I meant that. Yes, right. Yes, hopefully, no more banks fail. And then, kind of just given the outlook for slower loan growth, and just some kind of a more cautious tone on the economy a little bit. How should we think about provisioning going forward? You feel you need to kind of bolster reserves in anticipation of that? Or do you feel that because of the slower growth and you feel good about your underlying credit that you don't really need to add much in the way of provision every quarter?

It's a great question, and it can be challenging to answer. There are several factors at play that influence the provision level in any given quarter. Loan growth significantly impacts this provision level. With CECL, reserves are established for the entire loan duration from the moment of origination. This is evident in the contrast between our provision in the fourth quarter and the first quarter; we had strong loan growth in Q4 with an $11 million provision, while in the first quarter, the provision was effectively zero due to modest loan growth. We regularly review our underwriting and portfolio management practices and feel confident about them. Like others, we are concerned about future economic conditions, but we will address that over time. To directly answer your question, slower loan growth indeed affects the provision level in specific quarters. While we cannot guarantee that all conditions will remain constant going forward, a lower loan growth would typically lead to a significantly lower provision compared to 2022.

Yes, okay. That's helpful. And then I guess, just lastly, no shares were repurchased this quarter. Now that you've kind of taken some proactive measures to improve the flexibility on the balance sheet. What are your thoughts on buybacks, especially with where shares have been trading as of late?

Sure, that's a great question. We've highlighted three key factors regarding our buyback strategies. First, we consider market conditions, and I appreciate your mention of the share price. Second, capital and liquidity are crucial. As I mentioned in previous quarters, there is still some clarity to achieve regarding liquidity, which will influence our decisions. Historically, we've found buybacks to be an effective strategy, and we will continue to assess our liquidity and capital as we move forward, making decisions accordingly and keeping everyone informed.

Okay, fair enough. That's all that I have for now. Thank you.

Thanks, Damon.

Thank you. The next question comes from the line of Janet Lee at J.P. Morgan. Please go ahead.

Hello. Good morning.

Good morning, Jen.

Good morning, Janet.

I want to start with your NII guidance. So, you sort of touched on this already, but what is the ultimate level of cash you want to maintain in the next several quarters after you pay down some of your borrowings and after reducing some brokered CDs?

I'm sorry, go ahead, Jen, I couldn't hear the last part of your question.

If you want to vote, please share the percentage of assets you believe would indicate your comfort level regarding the cash balances you prefer to maintain.

That's a very good question, and it's likely different from what we would have answered or what any of your banks might have said six or nine months ago. Liquidity is extremely important now, perhaps more than ever. I expect us to maintain more cash than we typically have. In recent years, we've held fairly modest cash levels, around a couple hundred million. I anticipate that we will hold more than that going forward. It's difficult to provide a precise figure since it will depend on both the economy and the banking environment, as well as ongoing challenges. However, I expect our cash levels to be higher than historical amounts, but still significantly lower than the $2 billion we currently have. Our initial strategy was to pay off between $1 billion and $1.6 billion in wholesale funding while keeping some cash on the balance sheet. This strategy was designed before the recent bank failures, so we will likely adjust it. Nevertheless, we expect to reduce our wholesale borrowings as we move past the crisis in the latter half of the year.

Okay, that's helpful. And now that your securities portfolio is around your target range as a percentage of assets, is it your plan to continue letting those securities portfolio run off in the next couple of years? Or do you have another plan in place?

I think that's a very good question, Janet. We are not optimistic about deposit growth generally in Eastern or in the industry over the next 18 to 24 months. We anticipate that it will be challenging to not only grow deposits but also to maintain them at current levels. We expect to see some shrinkage in overall deposit levels, along with a continuing shift from low-cost to high-cost deposits. Therefore, without deposit growth, I would expect that we will allow the securities portfolio to run off over the next 18 months or so.

Okay.

We provide some information about our expectations for cash flows, which depend on prepayments that are quite volatile in the current market. However, we expect to use that cash flow to fund loan growth without relying on deposit growth.

Right, okay. And can you talk about in your NII guidance of flattish, NII versus 2022, what kind of interest-bearing deposit data and noninterest-bearing deposit mix is assumed?

Sure. We provide good disclosure on deposit betas until the end of the quarter. I'm cautious about projecting future deposit betas due to mix shifts that complicate predictions. We expect deposit betas to continue growing from March levels, although the growth rate will be slower than in the previous quarters and will eventually taper off. In our presentation, we noted that our checking accounts declined from 57% to 53% this quarter, and we anticipate that trend will continue, albeit at a slower pace. Like other banks, we have experienced a significant shift in composition so far, which we believe will slow down but continue at a reduced rate.

Right. And for my final question, can you provide more insight into what you're hearing from your customers on both the commercial and consumer sides? I understand your loan guidance indicates low single-digit growth for commercial loans and a flat outlook for residential and consumer loans. Do you see overall loan demand easing, or is this guidance primarily influenced by the challenges in growing deposits? I'm interested in understanding how the dynamics of loan growth demand are evolving or remaining stable.

Sure. I'll break it down by sector, starting with commercial, which is really where our strategic focus lies. Commercial real estate is currently slower than other commercial areas, largely due to high interest rates. Building valuations have become more challenging for our customers, and many feel uncertain about this sector, which has significantly slowed down. We experienced strong growth in 2021 and 2022, but that's not the case now. High interest rates are the main concern we hear from our customers. Commercial activity has also decreased compared to last year, which was a particularly strong period. Customers are showing more caution now. We did see decent traction in the first quarter and a good April, but caution remains key. On the residential side, the market is quite tough, with minimal activity, no refinancing, and low home sales, making it difficult for the mortgage business to grow. This challenge is not just specific to us; it's pervasive across the board. Last year, much of our mortgage loan growth came from our established relationships. In terms of consumer loans, focused mainly on home equity, we had a solid year in 2022, but we noticed a slowdown at the end of the year and declines in the first quarter. That's my insight on the situation.

Great. Thank you.

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

Well, thank you for your interest and your questions today. We look forward to talking with you again at the end of July when we report our second quarter results.

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