This stock will see revenue rise with higher interest rates and has been growing its dividend as well.

This stock will see revenue rise with higher interest rates and has been growing its dividend as well.

Members of the Federal Reserve are widely expected to raise the agency’s benchmark overnight lending rate (the federal funds rate) at their upcoming March meeting, leaving behind the ultra-low-rate environment that has persisted since the start of the pandemic in 2020. And the Fed may proceed to raise the federal funds rate several times this year. While much uncertainty remains in the market, many banks are expected to benefit from rising interest rates.

One I like in particular, though, is Eastern Bankshares ( EBC 0.94% ), a $23.5 billion asset bank in Boston that went public in 2020. Here’s why. Good asset sensitivity

The reason banks benefit from interest rates is because most of them are asset sensitive, meaning the yields on more of their loans reprice higher with the federal funds rate than the yields on their deposits and other funding sources. If loan yields are rising and deposit yields are staying stable or rising much less, banks can widen their margins and make more money. Image source: Getty Images. Eastern is a very asset-sensitive bank, largely because most of its loans are commercial loans, which tend to be variable-rate loans that rise with the federal funds rate. Eastern also has a very strong, sticky deposit base. In its annual filing for the period ending Dec. 31, 2021, management estimated that if the Fed instantly raised the federal funds rate to 2%, Eastern would see its net interest income, the profit it makes on loans and securities, rise by more than 15% over the next year.

Now, the Fed is not going to instantly raise interest rates by 2% all at once. On its most recent earnings call, Eastern Bank CFO Jim Fitzgerald said that for every 25 basis-point (0.25 percentage point) increase by the Fed, Eastern will add about $8 million to $10 million of net interest income annually. He also said that 40% of Eastern’s loan portfolio will adjust immediately with a Fed rate hike, although a more significant impact from rate hikes will be felt in 2023.

Furthermore, Eastern has a superb deposit base. At the end of the fourth quarter of 2021, the bank’s cost of deposits was a mere 0.06%, which is among the best in the industry. Excess liquidity and low deposit costs have been the norm in banking for two years, but that will likely change toward the end of 2022 and in 2023. Deposit costs will rise, and banks with the lowest, stickiest deposits will reign supreme.

Roughly 60% of Eastern’s deposits are in checking accounts to normal retail customers. These tend to be very insensitive to rate hikes because people with a few thousand dollars in a checking account aren’t too worried about a very small amount of extra yield. Business looks well positioned

In Q4, Eastern closed on the acquisition of neighboring Century Bancorp and also completed the systems conversion. It was the bank’s largest acquisition ever. Century wasn’t a cheap acquisition and diluted Eastern’s tangible book value, or net worth, by about 9%. However, Century will complement some of Eastern’s lending and deposit businesses, adds 56,000 new customers to the bank, and creates a nice moat in the Boston area.

There aren’t that many banks that could give Eastern the kind of scale in the Boston market that Century could, so I think making the acquisition was the right move. Eastern has now taken most of the merger charges and is expecting to realize the 45% of cost savings on Century’s expense base in 2022, which is ahead of schedule.

The acquisition also hasn’t stopped the bank from returning capital to shareholders. Not only has Eastern been repurchasing shares, but it has initiated a dividend and now increased that dividend twice since. In Q4, the bank’s board of directors authorized a 25% hike to the quarterly dividend, which will now be $0.10 per share. That gives Eastern an annual dividend yield of about 1.9%. The bank’s payout ratio is now toward the higher end of what banks generally pay, around 35%, but Eastern also has plenty of capital and will start generating higher earnings in coming years, so I certainly think the bank can continue to grow the dividend. The stock offers good value

Even after the significant dilution from the Century deal, Eastern still only trades at about 140% tangible book value. Considering its strong deposit base and commercial lending division, I definitely think Eastern is a bank that will steadily rise to a higher valuation, especially as loan growth returns, rates […]

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