Boston-based Eastern Bankshares (EBC -1.03%), which went public in October, surprised many with its recent announcement that it plans to purchase neighboring Century Bancorp (CNBKA). While many expected Eastern to make a big deal, given that it was sitting on a war chest of $1.8 billion following its IPO, I was surprised to see it take out Century, which is Massachusetts' largest family-run bank and an institution that didn't look particularly amenable to buyout offers.
The deal not only shakes up the banking scene in Boston, it also achieves a big goal that Eastern has had since it first announced plans to go public. But does it really make sense for Eastern, and does it make the company a better investment?
An expensive deal
Eastern will purchase Century for $642 million in cash, the equivalent of $115.28 per share. The deal values Century at 175% of its tangible book value (equity minus goodwill and other intangible assets), making it one of the larger deals in the Massachusetts banking scene in recent years. Eastern also announced it would raise its quarterly dividend by 33% in tandem with the acquisition.
Because it's an all-cash deal at a high premium, the deal will be fairly dilutive, reducing Eastern's tangible book value per share by about 9%. Eastern's management expects to recoup that lost value in about four years, which analysts these days would view as a somewhat lengthy earn-back period. I also think 175% of tangible book value is a fairly rich premium for a bank like Century. While its brand is relatively well-known in the Boston area, the bank is nothing special by any means.
When Century raised its dividend in 2020, it was the first payout hike since 2003. Its cost of deposits ended the year at 0.69%, which is not great considering the Federal Reserve's overnight bank lending rate (i.e., the fed funds rate) is practically zero right now.
Century is also not a big lender relative to its peers. It only lends out about 55% of its total deposits, investing the rest of its liquidity in securities. Some banks employ this strategy, and Century has generated a good return on equity in recent years, but it puzzles me as to why it wouldn't put at least a little more of its liquidity into higher-earnings assets if it could. Century has done a pretty good job of managing expenses in recent years, so perhaps the bank likes to run lean and keep its lending squad light, but it's hard to know.
Why Eastern paid up
Now, I am not sitting here pretending that I know something Eastern doesn't. The bank is run by a smart management team, and it doubtless had what it viewed as good reasons behind its choice to pay up for Century. Notably, Eastern has wanted to make an in-market acquisition from the get-go. That makes sense given its business model, and there simply aren't that many realistic targets in the Boston area that can accomplish for Eastern what buying Century does. The fact that it's taking out a direct in-market competitor also makes the deal more expensive right away.
But Century gives Eastern exactly what it is looking for with a similar branch footprint, and the deal will make it the leading local bank deposit holder in the Boston area. Furthermore, because their footprints have such strong overlap, Eastern expects to be able to eliminate 45% of Century's already somewhat lean expense structure.
Eastern expects the deal to reduce its efficiency ratio (expenses as a percentage of revenue, so lower is better) by 6%, a significant amount. I also think Eastern's cost savings estimate could be conservative, because 96% of Century's branches are within three miles of an Eastern branch.
Considering the pandemic has greatly accelerated digital banking trends and that Eastern has good technology for a bank of its size, I imagine that it will be able to close a majority of Century's branches. Ultimately, Eastern expects the deal to be accretive to its earnings by 55% in 2022, meaning that its earnings as a combined bank with Century will exceed its earnings on a stand-alone basis by 55%.
Also, while they are not modeled into the acquisition numbers, Eastern may be able to realize some revenue synergies with Century. For one thing, Eastern has a successful insurance business; following the deal, it will have new opportunities to cross-sell those products to former Century customers. And there may also be some wealth management cross-selling opportunities as well.
Additionally, Century is the biggest bank serving the marijuana industry in Massachusetts, so this could give Eastern inroads into a new lending segment. Century also did a nice job in 2020 of growing commercial and industrial loans outside of Paycheck Protection Program loans, and specializes in the healthcare and higher education segments.
Is it a good move?
While the deal is expensive, it enables Eastern to deploy its excess capital in a productive way. Additionally, because Eastern raised $1.8 billion in its IPO, the bank will have plenty of liquidity left to continue increasing its dividend, conduct share repurchases (once it's eligible to do so), and make more acquisitions down the line, although it will likely have its hands full for awhile integrating Century. Another thing to consider is that bank valuations are all pretty high right now, but they may not come down. Some analysts and pundits think the sector is poised to go on a multiyear run.
Eastern's stock price may suffer a little in the short term due to this pricey purchase, but the deal will accelerate the bank's growth and should make it much more profitable long term.