Eastern Bank (NASDAQ: EBC) is gearing up to go public in mid-October in what will be one of the few bank IPOs of the year. This should be interesting to watch not only because it's going public in an extremely uncertain environment for the banking industry, but also because it's a mutual savings bank -- and not just any mutual, but the biggest one left in the country. Let's look at what we can expect from this IPO and whether it can be successful.
Image source: 2018 Eastern Bank annual review.
Mutual institutions are different
As a mutual bank, Eastern has a unique corporate structure in that it's technically owned by its depositors. While the bank is still run by a standard management team, retail depositors with as little as $50 in an account get to participate in its IPO.
The bank plans to sell anywhere from roughly 175.4 million shares to more than 201 million shares of common stock in its IPO. But before it converts to a public company and gives up its mutuality, insiders including depositors, employees, officers, directors, as well as the unique bodies of a mutual including the trustees and corporators get first dibs on shares. For this reason, management at mutuals want to price shares as low as possible before the market prices the stock, so stakeholders can hopefully enjoy a nice bump as soon as it hits the public markets. Eastern is pricing its IPO at $10 per share, which is common for mutual IPO conversions.
If you are a depositor at a mutual bank when it goes public, I am almost always going to recommend purchasing shares, because these offerings almost always fill up. Not only do many depositors, employees, and other stakeholders purchase shares in the initial subscription because of how cheap they are, but there is also a group of people who know about mutual offerings and open bank accounts at mutual institutions hoping for them to go public.
So these subscriptions are usually oversubscribed and typically open on the public markets higher than $10 per share. Eastern's subscription offering was not oversubscribed, raising $1.8 billion, but that's still toward the higher end of the range, and most mutuals don't attempt to raise billions of dollars like Eastern has.
While going through Eastern's prospectus, I came across this independent appraisal done for the bank. It says that if Eastern is able to sell the maximum number of the shares in its IPO (roughly 175.4 million) at $10 per share, it would be trading at a price-to-book-value ratio of 57.57%.
| Share Range | Shares (millions) | P/E Multiple | P/B Value Ratio | P/TBV Value Ratio |
|---|---|---|---|---|
| Adjusted Maximum | 201.7 | 23.91x | 61.77% | 69.44% |
| Maximum | 175.4 | 20.14x | 57.57% | 65.32% |
| Midpoint | 152.5 | 17.05x | 53.39% | 61.12% |
| Minimum | 129.6 | 14.12x | 48.64% | 56.27% |
Source: Eastern Bank S-1
That means the bank's book value is somewhere around $17.50 per share ($17.50 x 0.57 = ~$10) in this range. At this level, Eastern also trades at a price-to-earnings multiple of roughly 20. This doesn't mean Eastern will start trading at book value, especially right now while many banks are trading below it. But it does show the potential of the stock. Before the pandemic hit, most of Eastern's competitors were trading well above book value.
What about for the public?
Even if you are not a depositor, mutual banks are still typically good investments. Mutual banks are not start-ups -- in fact, they are the opposite. Many are extremely old (Eastern was founded more than 200 years ago), and therefore are often profitable and have established themselves in their respective markets. Eastern turned a profit of more than $135 million in 2019 and has built up more than $1.6 billion in retained earnings. Furthermore, most of these mutual banks were not making complex derivative trades during the Great Recession, and are considered fairly safe.
The issue right now is that the pandemic has made all banks risky, primarily because they are closely linked to the economy and very sensitive to interest rates. The economy is currently struggling because of the pandemic, and rates could be low for a while, which hurts loan margins.
With the economy struggling, many banks have been forced not only to increase the amount of cash they are setting aside for potential loan losses, but also to grant loan deferrals to many customers. With roughly 70% of its loan book tied up in the commercial sector, Eastern has not been immune, modifying roughly 9.4% of its total loan book in terms of volume at the end of June. But that's actually a smaller amount of deferrals than some of Eastern's direct competitors, and given the way lots of community and regional banks have been trending, I would expect that deferrals have come down more by now.
Additionally, the bank has a lot of capital built up. Its common equity tier 1 (CET1) capital ratio, a measure of core capital expressed as a percentage of risk-weighted assets, is 12.42%, a big number for a bank of Eastern's size. This money can be used to absorb unexpected losses if need be.
Another thing I like about Eastern is that unlike most small mutuals, this bank is actually strong when it comes to technology. It developed the fintech company Numerated, which can approve some small-business loan applications in just minutes. Eastern also hired a chief digital strategist in 2018 and has a fintech incubator at the bank.
Technology is going to be one of the most important aspects for banks, and having a culture that fosters technology and looks to innovate is important. Eastern showed some of its tech prowess when it originated roughly $1.1 billion in Paycheck Protection Program loans, more than several of its direct competitors.
One caveat
Mutual savings institutions are often seen as good investments because they are frequently acquisition targets, which often result in a nice premium. While you never know, Eastern appears to be more of an acquirer than a target.
In its prospectus, the bank said it intends to use proceeds from the IPO to "pursue opportunities to acquire banks in our existing and contiguous markets that create attractive financial returns." CEO Bob Rivers also told The Boston Business Journal that he thinks Eastern can become a $40-billion-asset bank over the next decade. Additionally, I think one of the reasons Eastern is charging ahead with its IPO during the pandemic is because it wants capital available to make a big acquisition sooner while many banks are still trading at lower tangible book values.
The problem with bank acquirers is that their stock prices tend to get dinged up after an acquisition, and then the banks can come under a lot of pressure to make that acquisition accretive enough to earnings to make up for all the money they just spent. While certainly exciting, acquisitions are more difficult to pull off than many realize, and the ends often don't justify the means.
Worth the risk
It's a risky time to be a bank, and it may be a bit of a bumpy ride in the beginning, but I believe Eastern is a good long-term investment -- certainly for current depositors that get to buy shares early, and for the public. Mutual savings institutions have a history of performing well, and Eastern has been around for more than two centuries.
The key will be watching to make sure that Eastern is making the right acquisitions that fit in with its strategic plan, and that it doesn't overpay.
