Eastern Bank, which is gearing up to go public on the Nasdaq with the ticker "EBC," recently released its second-quarter earnings report in a filing with the Securities and Exchange Commission. Although its third quarter is already in the books, the Q2 disclosure from the institution, which holds assets of nearly $14 billion, is important because banks are harder than usual to analyze in the current turbulent environment.
I thought the bank's second-quarter results showed promise. Eastern got earnings back on track and reported deferral levels at the end of the second quarter that were smaller than several of its direct competitors. If those trend in line with most of the industry, then deferrals should be even lower now than they were. Along with the bank's strong performance in the Paycheck Protection Program and strong capital position, Eastern should be able to trade toward the higher end of its peer bank group.
Image Source: Eastern Bank 2018 Annual Review
How did Eastern do?
Eastern turned a profit of nearly $29 million in the second quarter. That may have been lower than its earnings of more than $35 million in Q2 2019, but it was much better than Q1 2020, when the bank reported earnings of $8.4 million. Total revenue of close to $150 million was down by about $8.5 million year over year, but that shouldn't be too big of a surprise considering that the Federal Reserve lowered the benchmark fed funds rate rapidly from 2% to zero in March. The bank's net interest margin -- the difference between what it makes on interest-earning assets such as loans and what it pays out on deposits -- fell by 54 basis points from 4.03% to 3.49% between the end of the Q2 2019 and the end of Q2 2020.
During the second quarter, Eastern Bank set aside roughly $8.6 million to cover potential loan losses, which was way down from the $28.6 million in credit loss provisioning the company made in the first quarter of the year. Generally, I prefer to see banks make their higher loss provisions in the first quarter, followed by lower provisions in subsequent periods -- especially at smaller banks that know their customers well -- because it often indicates that management is thinking conservatively. As of the end of the second quarter, the total amount that Eastern had set aside to cover potential loan losses was equivalent to 1.17% of its loan book. That's a lower ratio than a lot of other banks I have looked at, especially because Eastern is such a heavy commercial player. But Eastern has not adopted the new current expected credit losses (CECL) accounting method, which requires banks to project losses on a loan as soon as that loan is put on the balance sheet. When banks adopt CECL, they usually see an increase in their total reserves, which could explain the lower coverage ratio.
Digging into credit
Credit quality has been one of the most difficult aspects of banks to analyze this year because they have granted many borrowers deferrals on loans as a result of the coronavirus pandemic. That makes it harder to gauge how many borrowers are at serious risk of defaulting.
| Bank | Total Loans | Deferrals as of June 30 | Deferrals as a % of Total Loans | Deferral Update* |
|---|---|---|---|---|
| Eastern Bankshares | $10.014 billion | $946 million | 9.4% | ? |
| Berkshire Hills Bancorp (BHLB +0.00%) | $9.370 billion | 1.5 billion | 16% | $525 million |
| Independent Bank Corp. (INDB 0.33%) | $9.360 billion | $1.174 billion | 12.5% | ? |
| Brookline Bancorp (BRKL +0.00%) | $7.408 billion | $1.2 billion | 16.2% | $720 million |
*As of late August or September, Source: Bank financial statements
As a percentage of its loan book, Eastern had fewer deferrals than several of its peers as of June 30. Now, we don't have an update for Eastern about how its deferrals are trending, but based on what Berkshire Hills, Brookline, and other banks have reported, its quantity of loans in deferral should have declined since then.
This does not mean there still isn't a lot of risk in Eastern's portfolio. The bank saw "criticized loans" -- those that face some danger of default but aren't necessarily past due -- rise in certain segments of its commercial book between the first and second quarters, which could be a sign of pain ahead. But it still is a good sign that Eastern was in a better position on deferrals than its peers as of June 30.
PPP loans
Eastern Bank was also successful with its participation in the Paycheck Protection Program (PPP), originating $1.1 billion in total PPP loan volume to roughly 8,100 borrowers. By comparison, Independent Bank Corp. issued $800 million in PPP loans, Berkshire Hills issued $706 million, and Brookline originated nearly $566 million.
Eastern Bank is good with technology and has developed several fintech companies in house. One of those, Numerated, which it spun off, helps banks leverage artificial intelligence and machine learning to approve small-business loans more quickly, sometimes in as little as five minutes. Numerated developed a program specifically for PPP, which could be one reason Eastern was able to outperform its peers on PPP volume. PPP loans come with fees for banks, which will boost interest income when the loans are forgiven. That's expected to start occurring in the fourth quarter and continue through next year. That could be a nice lift for Eastern as its net interest income continues to suffer amid the low-rate environment.
What does this tell us?
Given that nearly 74% of Eastern's total loan portfolio is tied up in the commercial sector, you'll definitely want to watch those metrics that reflect its credit quality. Hopefully, the bank can release an update on deferrals before it goes public. But considering it had less in deferrals than its competitors at the end of the second quarter and has issued more PPP loans than they have, I would think Eastern should be able to trade at a valuation toward the higher end of its peer group. Berkshire Hills' stock is down by about 69% year to date. Brookline's stock is off by about 47%, and the bank is trading below both book value and tangible book value. Meanwhile, Independent is down by about 37% from where it began the year, but still trading way above tangible book value and around book value, and I would expect Eastern will trade at a level more like that of Independent.
