One of my favorite mid-cap stocks is the regional bank Eastern Bankshares (EBC 0.38%) based in Boston. Since going public in October of 2020, the stock is up more than 70% and I think there is a lot of runway left. This is a stock that can go slow and steady and generate strong returns long term. However, one question I have right now is how Eastern will continue to use all of the excess capital it raised in its $1.8 billion initial public offering. While it used a portion of the proceeds on the acquisition, it still has a good amount left. Let's take a look at how it could use the remaining capital.
A large IPO
The $1.8 billion in capital that Eastern raised in its IPO was a lot for a bank that at the time was only $14 billion in assets. CEO Bob Rivers did not hide his intentions, saying that he planned to use part of the capital to make the bank more competitive when pursuing acquisitions. He also told a local publication that he thinks the bank will grow to $40 billion in assets over the next decade.
The bank got off to a good start on that goal, announcing in April that it would acquire the neighboring Century Bancorp (CNBKA), adding more than $6 billion of assets to its balance sheet. That acquisition is expected to close before the end of the year and should be good for the bank as a whole. Eastern paid $642 million in cash for Century, meaning that it still has $1.1 billion in remaining proceeds from the IPO.
In general, investors would rather see a bank with excess capital, but $1.1 billion is a huge amount for Eastern. After the acquisition of Century is completed, Eastern will still have a 20% common equity tier 1 (CET1) capital ratio, which is a bank's core capital expressed as a percentage of risk-weighted assets such as loans. Eastern's regulatory requirement is only 7%. Having this amount of capital in the near term will hurt Eastern's return metrics.
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How will the bank use the capital?
With so much consolidation occurring in the banking sector right now, the likely thought is that Eastern would use a portion of its remaining capital to make another acquisition, and management is certainly open to this. But the problem with this theory is that there may not be that many acquisition candidates left in Eastern's geographic footprint.
On an earnings call at the end of 2020, Rivers said the bank was focused on acquisitions in its "current footprint or immediately adjacent," which is Eastern Massachusetts and then a little bit in Rhode Island and New Hampshire. But there may not be that many potential acquisitions around, especially in its primary market of Boston and Massachusetts. When asked about mergers and acquisitions activity on its second-quarter earnings call, Paul Perrault, the CEO of Brookline Bancorp (BRKL -0.21%), an in-market competitor of Eastern, said: "there seems to be a lot less to think about. It really is getting pretty thin."
There's a few targets I can think of for Eastern, but many aside from Brookline itself are smaller than Century, which is not necessarily a bad thing. Eastern could also explore other New England states like Connecticut, which it may eventually look toward anyway if it keeps getting bigger. Also, Eastern likely wouldn't make a big acquisition right now, as it still hasn't closed on the Century deal and Rivers said at the end of the first quarter of this year, "we certainly wouldn't attempt to integrate two organizations at the same time."
So, in the meantime, it looks like Eastern will largely focus its capital on share repurchases, perhaps growing the dividend next year and using capital to support loan growth whenever it starts to pick up again.
Still bullish on Eastern
I still very much like Eastern's stock and plan to hold long term, as the bank has an exceptional deposit base, among many other strong fundamentals. With the acquisition of Century still in the process of being completed and loan growth likely to remain somewhat muted for the rest of the year, expect Eastern to be sitting on a good amount of excess capital for a while. Once the bank has integrated most of Century, I expect it to begin looking around for acquisitions, and management is likely fielding conversations as they arise.
My big question is, with not that many candidates left, who can Eastern acquire as an in-market bank that is also a strategic fit and not just an acquisition for acquisition's sake? I have faith that management will be disciplined, but if there is no acquisition out there, then they need to think about how to put all of that excess capital to work. Over the next several years, investors are likely going to want to see some of that capital put to work and to see Eastern's capital levels get down to a more normalized range.
