Hello, welcome to the Eastern Bankshares, Inc. first quarter 2023 earnings conference call. Today's call will include forward-looking statements, including statements about Eastern's future financial and operating results, outlook, business strategies and plans, as well as other opportunities and potential risks that management foresees. Such forward-looking statements reflect management's current estimates or beliefs and are subject to risks and uncertainties that may cause actual results or the timing of the events to differ materially from the views expressed today. More information about such risks and uncertainties is set forth under the caption Forward-Looking Statements in the earnings press release, as well as in the Risk Factors section and other disclosures in the company's periodic filings with the Securities and Exchange Commission.
Any forward-looking statements made during this call represent management's views and estimates as of today, and the company undertakes no obligation to update these statements as a result of new information or future events. During the call, the company will also discuss both GAAP and certain non-GAAP financial measures. For a reconciliation of GAAP to the non-GAAP financial measures, please refer to the company's earnings press release, which can be found at investor.easternbank.com. Please note this event is being recorded. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. If you would like to ask a question during this time, simply press star followed by the number one on your telephone keypad. If you would like to withdraw your question, please press star followed by two. Thank you.
I would now like to turn the call over to Bob Rivers, Chair and CEO. Please go ahead.
Great. Thanks, Joanna. Good morning, everyone, thank you for joining our first quarter earnings call. With me today is Jim Fitzgerald, our Chief Administrative Officer and Chief Financial Officer. Throughout our history, Eastern's balance sheet has been a great strength of the company with very strong capital, liquidity, and asset quality. This has served us well throughout challenging times in various economic cycles. In Q1, we took multiple steps to bolster our fortress balance sheet as we prepare for the future. As Jim will detail, we made the decision to sell 25% of our securities portfolio to enhance our liquidity and improve the earnings power of the company going forward. As a management team and with our board, we spent considerable time analyzing the sale and are very pleased with the outcome.
We closed on the sale just prior to the failures at Silicon Valley Bank and Signature Bank. We were glad to have $2 billion in cash on the balance sheet as the aftermath of those failures was playing out in our markets. We also quickly adapted to the uncertain environment by adding capacity to our backup facilities at the Fed and the Federal Home Loan Bank with a goal to cover 100% of our uninsured deposits with cash and immediately available funding sources. Importantly, we exceeded that goal and ended the quarter with coverage of 107%. One of the factors that we considered in deciding to sell securities was the strength of our capital position, which provided us with real flexibility to consider a broad range of options.
We had and still have some of the highest regulatory capital ratios in the industry, and our TCE ratio was in the top quartile of banks of our size at year-end, giving us a much greater opportunity to consider this action. As further evidence of that capital strength, we increased our TCE ratio by 50 basis points to 8.7% in the first quarter. The other factor in which we have a high degree of confidence is our depositor base. Throughout the quarter, and especially in the aftermath of the bank failures, we have experienced a very stable deposit picture. We have always had a very diverse and granular deposit base, characterized by long-standing customer relationships that provided a great deal of stability throughout the quarter.
Turning to our Q1 results, we delivered record operating earnings of $61 million, which were 10% higher than the prior record achieved in the third quarter of 2022. An impressive feat given the stress in the banking sector. Notably, we received only a marginal benefit in the quarter from the securities sale. The full benefit will come over the balance of the year as we have reset our earnings and provided a roadmap for earnings growth that is far greater than before the sale, which Jim will cover in more detail. Another driver of our Q1 results is asset quality. Although we are planning for a challenging economy and likely recession, we had another quarter with zero loan charge-offs and extremely low level of non-performing loans and very high reserve coverage for problem assets.
Although our loan growth has slowed compared with the record volumes of 2022, we are still very open for business and look forward to serving our customers throughout the year and into the future. We firmly believe that a more challenging environment will provide us a better opportunity to differentiate ourselves positively in the market. Once again, I am very pleased with our results this quarter and look forward to continuing to build upon our strong balance sheet over the coming quarters. It has been a difficult period for the banking industry over the past six weeks, I am very confident that our strengths and future prospects are very apparent in these results and look forward to sharing them with all of our shareholders and other stakeholders.
As always, my unending thanks goes to my 2,100 colleagues who continue to ensure that Eastern remains the strong and reliable financial and community partner we have been for the past 205 years, as well as to our customers for their continued business and support. Now I'll turn it over to Jim.
Great. Thank you, Bob. Good morning, everyone. As Bob mentioned, we took an important step this quarter to reposition the balance sheet to improve our liquidity and earnings outlook. We're pleased that we were able to do this while growing our TCE ratio by 50 basis points from 8.2%-8.7% and increasing both our book value and tangible book value per share by $0.60. The repositioning included the sale of $1.9 billion of low-yielding securities from our available-for-sale portfolio at a loss of $280 million after tax. We purchased these securities during the early part of the pandemic when interest rates were extremely low. Although they had excellent credit quality, the very sharp increase in interest rates over the last year caused a decline in their market value.
I'll discuss more on the sale shortly and the expected impact of the sale to our earnings outlook, which is very positive later in my remarks. The Q1 net loss was $194 million due to the repositioning. Operating net income was $61.1 million or $0.38 per share, which compares with $49.9 million and $0.31 per share in Q4. Asset quality remained very sound in the quarter with essentially no charge-offs, non-performing loans of $35 million or 25 basis points of loans, and reserve coverage of non-performing loans over 400%. As expected, loan growth slowed from 2022 levels. Total loans increased $100 million or 3% on an annualized basis in the quarter.
Our board approved a dividend of $0.10 per share payable on June 15th to shareholders of record on June 2nd, 2023. I wanted to go into more detail on our Q1 balance sheet actions. The security sales took place in early March, just prior to the failures of Silicon Valley Bank and Signature Bank. The strategy for the sale was generally to select the lowest-yielding securities in the available-for-sale portfolio in order to redeploy the proceeds in today's higher interest rate environment. The sale proceeds were $1.9 billion or approximately 25% of the total portfolio. We expect to use the proceeds to reduce our FHLB borrowings and broker CDs over time, though we are currently holding higher cash balances in the wake of the bank failures.
As we had mentioned in the past, our goal had been to reduce the size of the securities portfolio as a percentage of assets from approximately 30% to approximately 20%. This repositioning gets us to that goal. In addition to the liquidity and balance sheet cash generated from the sales, we quickly added to our backup borrowing facilities by pledging additional securities to the Fed's new Bank Term Funding Program and increasing our collateral at both the Fed discount window and the Federal Home Loan Bank of Boston. As we outline on page 7 of the presentation, the combination of balance sheet cash of $2.1 billion and available but unused facilities of $5 billion total $7.1 billion. One of our goals was to have enough liquidity coverage for all of our uninsured deposits.
As also outlined on page 7, we had just under $6.7 billion of uninsured deposits on March 31st. This uninsured deposit amount excludes intercompany deposits and deposit accounts that are collateralized. The $7.1 billion of cash and secured backup facilities is 107% of the uninsured deposits. Throughout the quarter, we experienced a very stable deposit picture. Excluding broker deposits, our deposits were $114 million lower at 3/31 than 12/31, a reduction of 0.6%.
We did experience a reduction in our uninsured deposits of $640 million in Q1 as we outline on page 8. This included the results of our working with customers to both provide large depositors Insured Cash Sweep options and steps we took to educate consumers on account ownership categories of FDIC insurance coverage. Despite the reduction in uninsured deposits, as I mentioned, core deposits in total were stable in the quarter. We provide more details on the deposit portfolio on page 10. We have very good diversification across our consumer, commercial, and municipal customer bases. We also have very diverse and very granular commercial deposit portfolio, as you can see from the breakout on page 10. There's no material concentration from any one sector in the portfolio.
Also, the average account age with Eastern ranges from 9-13 years, depending on the customer segment, which also provides evidence of our very strong customer relationships. We also include some additional data on our strong capital position on page 11. In addition to our regulatory capital ratios that greatly exceed well-capitalized requirements, we provide a breakdown of our tangible common equity ratio of 8.7% and further show the calculation, including the mark to market of our held-to-maturity portfolio. The size of our HTM portfolio is modest and the valuation impact would reduce TCE from 8.7% to 8.6%. Our near-term strategy on liquidity changed when the bank failures occurred.
We decided to retain a portion of the FHLB borrowings and brokered CDs that we had targeted to run off. We kept a larger cash position. We'll reevaluate that over time. I'll discuss that more during my comments in our outlook. I'll now move to re-review the balance sheet. As discussed, cash increased in the quarter by $2 billion and ended the quarter at $2.1 billion. Securities declined by $2 billion and ended the quarter at $5.2 billion. Total securities are 23% of total assets. Loans ended the quarter at $13.7 billion, increasing $100 million from the end of the year. Commercial loans were up $73 million or 3% on an annualized basis. Residential mortgages increased by $37 million, and consumer loans declined by $10 million.
I'll provide an update to our future loan growth expectations later in my remarks. This growth was in line with our prior guidance. Total deposits decreased $433 million in the quarter, which included a reduction in broker deposits of $319 million and a reduction of $114 million of core customer deposits. Borrowings increased $398 million in the quarter and totaled $1.1 billion at quarter end and were used to keep the cash balance at high levels as the impact of the bank failures played out. Shareholders' equity increased $107 million in the quarter, reflecting an increase in AOCI, partially offset by a reduction in retained earnings.
Moving to the earnings review, GAAP net income was a loss of $194 million due to the sales, partially offset by strong operating earnings. Operating earnings were $61.1 million or $0.38 per diluted share. This compares to operating earnings in the prior quarter of $49.9 million or $0.31 per share. Net interest income was $138.3 million in Q1 compared to $150 million in the prior quarter. The repositioning had a limited impact on net interest income in the quarter. I mentioned, we sold the securities in early March and subsequently elected to retain the high level of borrowings to keep cash at a very high level until the impact of the bank failures was better understood.
On the funding side, deposit costs were 92 basis points in the quarter, and our interest-bearing liability cost was 1.33%. Both of these levels are up from the prior quarter, but still very attractive in the current interest rate environment. We included our interest-bearing liability cost cycle beta on page 17. In the month of March, it had moved up to 34% from 24% in the month of December. Over time, the reduction in borrowing should help both interest-bearing liability costs and the related beta, although we expect overall funding costs to keep rising. Loan yields were up 31 basis points in the quarter, and the securities yield for the quarter was 1.61%. The securities yield at quarter end was 1.81%. I'll discuss our outlook for net interest income later in my remarks.
The provision for loan losses rounded to zero in the quarter compared to $11 million in the prior quarter. Loan growth was much lower in the quarter compared to the prior quarter and was responsible for most of the reduction in the provision. The allowance as a percentage of loans declined a modest 2 basis points in the quarter, which offset the impact of the increase in loans. Non-interest income was a loss of $278 million on a GAAP basis due to the repositioning and $52 million on an operating basis. Eastern Insurance had a strong quarter with $31.5 million of revenues, up 10% from the same quarter last year. As we have mentioned, there is a seasonal nature to insurance revenues, with the bulk of incentive payments from carriers being received in Q1.
The 10% increase from a year ago is due to higher incentive payments and higher commissions in commercial lines. The other line items were generally in line with either the prior quarter or prior guidance. Non-interest expense was $116.3 million on a GAAP basis and $115 million on an operating basis. GAAP expenses for the prior quarter included the one-time cost for the defined benefit plan settlement accounting charge of $12 million. On an operating basis, expenses were $115 million in Q1 compared to $119.6 million in the prior quarter. I'll provide some comments on the outlook for expenses later in my remarks. Tax expense in the quarter was a benefit of $62.2 million, due primarily to the loss on sale of securities.
Going forward, we would expect the tax rate for the next few quarters to be lower than the 2022 level at 18%-20%. Also provide some comments on that later in my remarks. Asset quality continues to be very sound. Similar to the prior couple of quarters, we experienced the nominal amount of net charge-offs in Q1 that rounded to zero. Non-performing loans of $35 million are at very low levels. Our reserve coverage to NPLs is over 400%. We are mindful of the potential for a recession and challenging times ahead for sectors like office. We have always worked hard to make sure we have good diversity in our lending approach and also to do business with very strong sponsors.
We've added some information on both our commercial real estate exposure by property type and our office portfolio on pages 21 and 22 in the presentation. I would note that in our classifications of office types, we do not consider any office building in the suburbs as Class A real estate. This helps explain the limited amount of Class A properties. The pages show the strong diversification in both portfolios and the lack of any specific concentration in either portfolio. We expect the office portfolio to experience some challenges and are monitoring the overall CRE portfolio very carefully as well, we're very comfortable with the customers we do business with and will partner with them as they work through any challenges. Total investor office loans were approximately $700 million or 5% of total loans on March 31st.
These loans are with customers we know well in our primary markets. The portfolio has been very carefully analyzed with a focus on rent rolls, lease rollovers, loan size, loan maturity dates, location, and valuation. We're very comfortable with the underwriting and the management of this portfolio, and we'll continue to monitor all of our portfolios carefully. I wanted to provide some comments on our outlook, which is included on page 24. We expect commercial loan growth to be in the low single digits and look for residential and consumer loans to be flat for the next few quarters. The growth rate for commercial loans is due to market conditions. As Bob said in his remarks, we believe we will outperform in more difficult environments and are very confident that our consistent underwriting and strong relationships will provide us a competitive advantage, especially when times are challenging.
We expect our insurance revenues to follow their normal seasonal pattern and for total non-interest revenues of $170 million-$180 million for 2023. We expect non-interest expenses to increase from Q1 levels but end the year between $465 million and $475 million. We expect a tax rate between 18%-20% over the next few quarters. This is lower than 2022, primarily due to strong activity by our community development lending group and their work with nonprofits on tax credit financing. We expect our net interest margin to improve over the rest of the year and to be between 275 and 285 basis points on a fully tax equivalent basis for the full year of 2023.
We expect overall net interest income in 2023 to be similar to the level in 2022. This is much higher than it would have been without the repositioning and was one of the key considerations in our evaluation of the repositioning. This net interest income and net interest margin guidance include our expectation we'll hold higher levels of cash on the balance sheet until we're comfortable that the impact of the bank failures is clearly in the rearview mirror. We do expect to pay off borrowings and let brokered CDs mature in the second half of the year. This is consistent with the original strategy of the repositioning. In closing, we're very pleased with our results for the first quarter and confident that the balance sheet positioning provides us a very strong foundation to continue to improve our financial performance over the short and long term.
Thank you. Joanna, we're ready to open a line for your questions.
Thank you. At this time, I would like to remind everyone, in order to ask a question, press star then the number one on your telephone keypad. We'll pause for just a moment to compile the Q&A roster. First question comes from Damon DelMonte from KBW. Please go ahead.
Good morning, everyone. Hope everybody's doing well today, and thanks for taking my question. Just wanted to start off on the margin commentary, Jim. The 2.75%-2.85%, that's for the full year. That's just not a, like, a fourth quarter level. Just wanted to clarify that.
It is for the full year. Yes, Damon.
Okay. And based on your commentary, it sounds like.
Sorry, just to clarify. On a fully tax equivalent basis.
Yes. Yes. Got that. It sounds like from your commentary, you know, you're probably gonna be sitting on this cash through, you know, probably the second quarter. It seems like maybe from a cadence standpoint, the margin kind of, you know, maybe bounces around this level a little bit, and then it kind of really accelerates in the back part of the year once you fully kind of get rid of the borrowings and let the brokered CDs mature. Is that a fair assessment?
I'd say it slightly differently, but I think I'd say the same thing, which is our original expectation was to shrink the balance sheet, pay off the borrowings. We felt like that was the right strategy. The failure sort of interrupted that, and as we've said many times, we're holding more cash than we would expect to long term. We do expect to hold it for a little bit longer. On your timing of, you know, Q2 and then, seeing improvements in the back half of the year, you know, we wouldn't argue with that. We'll see how that plays out, though.
Okay.
In terms of the bank failures and the cash levels is how I meant that.
Yeah. Right. Yeah. Hopefully, no more banks fail. Kind of just given the outlook for slower loan growth and, you know, just some kind of a more cautious tone on the economy a little bit, how should we think about, like, provisioning going forward? Do you feel, you need to kind of bolster reserves in anticipation of that? Or do you feel that because of the slower growth, and you feel good about your underlying credit, that you don't really need to add much in the way of provision every quarter?
Right. It's a very good question. It's a hard question to answer, as you know. You know, the couple of factors that go at, you know, in slightly different directions. Loan growth does have a big influence on the level of the provision in any one quarter. As you know, with CECL, you're providing reserves for the life of the loan, so new originations attract that reserve, you know, on day one. You can see that in our last 2. You know, the difference between our fourth quarter provision and the first quarter, right? Very strong loan growth in Q4, $11 million provision and, you know, effectively 0 in the first quarter. A lot of that was due to, you know, very modest loan growth.
We do, as part of the process, we review both the underwriting and also the portfolio management of all those portfolios and very comfortable with it. You know, I think like everybody, it's hard not to be concerned about the future and where the economy goes. You know, we'll obviously address that over time. I would just say, to answer your question the way I think it's intended, the slower loan growth does have a large impact on the provision level in any 1 particular quarter. All things being equal, which is very hard to, you know, we're not guaranteeing all things being equal going forward, but all things being equal, the provision would be much lower given the lower levels of loan growth than it was in 2022.
Got it. Okay, that's helpful. Then I guess just lastly, you know, no shares were repurchased this quarter. Now that you've kind of, taken some proactive measures to improve the flexibility on the balance sheet, what are your thoughts on buybacks, especially with where shares have been trading as of late?
Sure. No, good question. You know, I think what we've articulated over time is there's three considerations on the buybacks, and our strategies there. One is market conditions, which, your point on the share price is duly noted. Capital and liquidity are very important. As I said, there's, as I said last quarter and the quarter before that, I believe, there's, you know, certainly still some clarity to reach on the liquidity, on the liquidity front. That'll be a factor. I think over time, if you go back and look at our track record, we've found that to be a valuable tool. We'll consider and evaluate those, the liquidity and capital as we go forward and make appropriate decisions and keep communicating on that.
Okay, fair enough. That's all that I have for now. Thank you.
Thanks, Damon.
Thank you. The next question comes from the line of Janet Lee at JP Morgan. Please go ahead.
Hello, good morning.
Good morning, Janet.
I wanna start with your NII guidance. I mean, you sort of touched on this already. What is the ultimate level of cash you wanna maintain in the next several quarters after you pay down some of your borrowings and after reducing some brokered CDs?
Um, so I th-
If you want-
I'm sorry. Go ahead, Janet. I couldn't hear the last part of your question.
If you wanna quote it as a % of assets, that works too. Just wanna see, like, where the comfort level is in terms of the cash balances you wanna maintain.
I think, it's a very good question, first of all, and is probably different than an answer either we would've given you or any other of your banks probably would've given maybe six or nine months ago. Liquidity is obviously, very important. It's always been, but it's particularly important now. I would expect us to hold more cash than we have historically. If you look over the last couple years, we carried fairly modest levels of actual balance sheet cash, probably in a couple hundred million dollar range. I would expect this to hold more than that going forward. It's a little hard to give you a clear answer 'cause it's gonna depend on, you know, not just the economy, but also the banking environment and the state of those challenges if they continue.
I would expect it to be higher than it's been historically, but far lower than the $2 billion we're carrying now. As we tried to say, our original strategy for the reposition was to pay off somewhere between $1 billion to $1.5 billion to $1.6 billion of wholesale funding and leave a little bit of cash on the balance sheet. That was done in a time pre-bank failures, so we'll probably adjust that a little bit. We do expect to be paying off the wholesale borrowings as we get past the crisis in the second half of the year.
Okay, that's helpful. Now that your securities portfolio is around your target ranges of % of assets, is it your plan to continue letting those securities portfolio run off in the next couple of years, or do you have another plan in place?
I think... Yep, no. Another very good question, Janet. I think that's gonna we're not optimistic about deposit growth generally for Eastern or in the industry over the next 18 months, 24 months. We expect deposits to be continue, you know, to continue to be hard to not only grow, but to maintain at current levels. We do expect, you know, both a little bit of shrinkage in the overall deposit levels and also the continuing migration of low cost to high cost. You know, without deposit growth, I would anticipate that we would let the securities portfolio run off, over the next 18 months or so.
Okay.
We do provide some information about what we think cash flows are. Obviously, you know, those are dependent on prepayments which are pretty volatile in the current market. We would expect without deposit growth to use that cash flow to fund loan growth.
Right. Okay. Can you talk about in your NII guidance of Flattish NII versus 2022? What kind of interest-bearing deposit beta and non-interest-bearing deposit mix is assumed?
Sure. You know, a couple things. We do provide, I think, pretty good disclosure up until the end of the quarter on the deposit betas. I do get nervous, you know, sort of putting future deposit betas out there or projecting them. There's you know, mix shifts and things like that really do make it hard. We do expect the deposit betas to continue to grow from the March levels. We don't know exactly where they're gonna stop. We think the rate of growth will be slower than it's been over the last couple of quarters and ultimately will slow down a little bit, but we do expect those betas to continue to increase. I think we outlined in the presentation, we saw our checking accounts decline from 57% to 53% in the quarter.
We expect that trend to continue, but we expect it to slow down as well, meaning it won't be as fast a decline in the future. We've had like all banks, we've had pretty significant, that composition shift has been pretty significant up to this point. We think that slows down a little bit, but continues. The trend continues but at a slower rate.
Right. My last question, can you give us more color around what you're hearing from your customers on your commercial, on the commercial side, well, as well as on the consumer side? I get that, though, your loan guidance of low single digits for commercial and flattish for resi and consumer loans. Do you see the loan demand generally moderating, or is this guidance basically based on a situation around deposits getting a little bit harder to grow? Like, I wanna hear about, you know, how the loan growth demand dynamics is changing or maintaining.
Sure. I think I'll probably take it one kind of sector at a time, Janet. I'll start with the commercial because that's really our strategy, strategic focus, as you know. I'd forget that the commercial real estate is slower than commercial, and a lot of that is due to interest rate levels are much higher. Building valuations are harder for our customers and all customers, I think, to feel comfortable about. That sector's slowed down significantly. We had very strong growth there in 22 and 21 and, you know, a couple years prior to that and years prior to that as well. It has slowed down significantly. The interest rate levels, you know, number 1 reason that we hear from customers on that.
Commercial activity is also slower than it was in 2022, which is coming off a very high level, just to reinforce that point. you know, I think there it's customers are a little, just more cautious. We do have good traction. We had good, pretty good traction in the first quarter and had a pretty good April there. but caution would be the word I would use. On the residential side, it's a very difficult market. There's not a lot of activity. There's no refinance activity, and there's not a lot of home sales here. The mortgage business is very challenging, not just at Eastern, but everywhere. Just gonna make that very difficult to grow the portfolio.
Remember last year, a lot of the growth in the mortgage loans was from our Embrace relationship, which we had talked about. On the consumer, which is really home equity side, we had a very strong year in 2022. We saw that slow down at the end of 2022 and saw declines in the first quarter. That would be my color on that.
Great. Thank you.
There are no further questions at this time. I will now turn the call back over to Bob Rivers for closing remarks.
Well, thank you, for your interest and your questions today. We look forward to talking with you again at the end of July when we report our second quarter results.
Thank you. This concludes today's conference call. You may now disconnect.