Eastern Bankshares Inc. said it is cashing out on the high valuation of its insurance brokerage business to capitalize on the lower valuations in the bank space.
Eastern is selling its insurance agency Eastern Insurance Group LLC to Arthur J. Gallagher & Co. for roughly $510 million in cash and will acquire Cambridge Bancorp in an all-stock deal valued at $525.5 million at announcement — the second-largest bank deal of the year, according to S&P Global Market Intelligence data. The company struck the simultaneous deals in order to capitalize on climbing insurance valuations and depressed bank valuations, executives said on the deal call.
"The decision to sell Eastern Insurance was made to capitalize on its strong valuation and allow us to focus on the growth and strategic initiatives of our core banking business, such as the merger with Cambridge," Bob Rivers, Chairman and CEO of Eastern Bankshares, said on an investor call.
Price-to-earnings (P/E) ratios of the insurance brokerage industry have been trending upward, currently sitting at 23.7x this year from 16.6x in 2013, according to an investor deck. In comparison, banks' valuations have declined, with Cambridge trading at 0.86x price to tangible book value right now, compared to 1.49x in 2013, according to the deck.
The $510 million valuation of Eastern Insurance represents a 35x P/E based on the insurance agency's expected net income of $14 million in 2024. Eastern expects to earn a net gain of about $260 million on the sale.
The net gain will improve Eastern's overall liquidity position and help unlock the value of the insurance unit, which Eastern has not been able to fully take advantage of in the past, CFO, Chief Administrative Officer and Treasurer James Fitzgerald told investors on the call.
Piper Sandler analyst Mark Fitzgibbon was not surprised by Eastern's decision to sell its insurance arm given the company's slowdown in insurance acquisitions in recent quarters. Eastern was a top bank acquirer of insurance companies, striking 11 deals since 2016, according to an S&P Global Market Intelligence analysis in February.
"Our view in recent quarters was that Eastern was not as focused on this line of business. They had not done a single insurance agency acquisition over the past several quarters, which was not typical," Fitzgibbon said.
Strategic rationale
With the insurance arm sale, Eastern Bankshares can redeploy that capital into the Cambridge acquisition to improve its earnings and profitability, Fitzgerald said.
Eastern will mark Cambridge's balance sheet to fair value through the acquisition, which will improve the combined entity's earnings outlook and net interest margin, Fitzgerald said.
The company estimates the transaction will boost its net interest margin by 25 basis points, improve its efficiency ratio by about 10% and increase net income by about 50% — estimates Piper Sandler's Fitzgibbon thinks are "optimistic," the analyst wrote in a note.
Eastern is also exploring the possibility of restructuring its available-for-sale securities portfolio in conjunction with the deal, Fitzgerald said. Changes would be more likely to happen on the Cambridge side because of the purchase accounting method, he added.
"Purchase accounting, quite honestly, as you know, it gives you some advantages," Fitzgerald said. But "there's a lot of things that will happen between now and then in terms of rates and other market conditions."
With the transaction, Eastern can more aggressively sell assets without negative capital impacts, Janney analyst Jake Civiello wrote in a note.
Other benefits of the bank transaction include bolstering Eastern's Boston presence and bulking up its wealth management arm, executives said.
The combined bank will have $23.1 billion in deposits, making it the fourth-largest bank by deposits in the Boston metropolitan area, according to the investor deck. The combined wealth management business will operate under the Cambridge Trust brand, with $7.6 billion in assets under management and administration.
The company expects the Cambridge deal to close around the end of the first quarter of 2024, a timeframe it feels comfortable with even as many banks face longer deal closing timelines due to outstanding regulatory approval.
"We've always had very strong relationships with our regulators, and we've continued to update them throughout this process," Fitzgerald said. "That good communication that we've had over time, plus the preparedness that we've got to begin the regulatory approval process as soon as practical puts us in good stead there, but we'll continue to communicate as we go through the process."
