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January 9, 2024
VIA EDGAR
United States Securities and Exchange Commission Division of Corporation Finance, Office of Finance Washington, D.C. 20549 Attention: Sarmad Makhdoom Michael Henderson Madeleine Joy Mateo James Lopez
Re: Eastern Bankshares, Inc. Form 10-K for the year ended December 31, 2022 Form 10-Q for the quarter ended September 30, 2023 File No. 001-39610
Ladies and Gentlemen:
Reference is made to your letter, dated January 5, 2024 (the “Comment Letter”), regarding comments made by the Staff (the “Staff”) of the U.S. Securities and Exchange Commission (the “Commission”) with respect to the above referenced Annual Report on Form 10-K for the year ended December 31, 2022, Quarterly Report on Form 10-Q for the quarter ended September 30, 2023 and our prior response letter dated December 20, 2023. This letter repeats the comment in the Staff’s Comment Letter in bolded typeface followed by a response prepared by Eastern Bankshares, Inc. (the “Company”) together with our legal representatives. We have also sent to your attention via email courtesy copies of this letter.
Response Letter Dated January 5, 2024
1. We note your draft disclosure references management’s belief that interest rate derivative financial instruments provide significant protection against falling interest rates. In light of increases in interest rates during the periods covered by your annual and quarterly reports, please revise your draft risk management discussion to further clarify whether and how derivatives are used to manage risk due to other interest rate environments, including any material adjustments to the strategy due to recent increases in interest rates. Additionally, please clarify whether the simulation and EVE model outputs reflect such use of derivatives.
Company Response:
In response to your request for additional disclosure dated January 5, 2024, we plan to include additional language substantially similar to the language contained in Exhibit A for the Company’s upcoming Form 10-K for the year ended December 31, 2023. This language clarifies that the $2.4 billion in notional value of receive-fixed interest rate swap agreements on floating-rate loans to limit our exposure to downward rate scenarios constitute the entirety of our current hedge portfolio and also describes other hedging strategies that we may evaluate as a result of changes in market rates or our risk exposure. The Company has not made any material adjustment to its strategy regarding the use of derivatives to manage risk due to other interest rate environments, such as a rising rate environment similar to what the Company experienced generally beginning in March 2022 and continuing through July 2023. In addition, the revised disclosure on Exhibit A clarifies that the simulation and economic value of equity (“EVE”) model outputs reflect the impact of our interest rate derivatives designated as hedging instruments.
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Should you require additional information, please do not hesitate to contact me at 781-598-7831.
Sincerely,
James Fitzgerald Chief Financial Officer Eastern Bankshares, Inc. 265 Franklin Street Boston, MA 02110
Enclosures (Exhibit A) |
Management of Market Risk
General. Market risk is the sensitivity of the net present value of assets and liabilities and/or income to changes in interest rates, foreign exchange rates, commodity prices and other market-driven rates or prices. Interest rate sensitivity is the most significant market risk to which we are exposed. Interest rate risk is the sensitivity of the net present value of assets and liabilities and/or income to changes in interest rates. Changes in interest rates, as well as fluctuations in the level and duration of assets and liabilities, affect net interest income, our primary source of income. Interest rate risk arises directly from our core banking activities. In addition to directly impacting net interest income, changes in the level of interest rates can also affect the amount of loans originated, the timing of cash flows on loans and securities, and the fair value of assets and liabilities, as well as other effects.
Governance. The primary goal of interest rate risk management is to attempt to control this risk within policy limits approved by the Risk Management Committee of our Board of Directors, and within the Risk Appetite Statement formally adopted by the Board of Directors and described further below. These limits reflect our tolerance for interest rate risk over both short-term and long-term horizons, are designed to encompass market rate shocks that would take place with both gradual and immediate effect and encompass a range of scenarios from mild to extreme market shocks. More specifically, and as further described below, our policy limits govern:
| • | The maximum amount of acceptable earnings loss due to market risk in year one of a two-year earnings simulation, determined by net interest income analysis. |
| • | The maximum amount of acceptable earnings loss due to market risk in year two of a two-year earnings simulation, determined by net interest income analysis.; and |
| • | The maximum amount of acceptable decline in the present value of equity due to market risk, determined by economic value of equity analysis. |
| • | The maximum acceptable size of the investment portfolio relative to total assets. |
| • | Concentration limits on investment asset type to ensure appropriate portfolio diversification. |
| • | Maximum maturity and weighted average life per security at time of purchase in both a base case and a shocked rate scenario to measure extension risk. |
| • | The maximum acceptable duration of the investment and hedging derivatives portfolio.; and |
| • | Guidelines on accounting classification of securities including held for trading, available for sale and held to maturity. |
Policy limits are tested quarterly, and the results are reported to the Asset and Liability Management Committee (“ALCO”) and to the Risk Management Committee of the Board of Directors (“RMC”). RMC advises the Board of Directors with respect to the adequacy of capital allocated based on the level of risk as well as risk issues that could impact liquidity and/or capital adequacy. From time to time, we expect we will exceed policy limits, in which case we may seek corrective action after considering, among other things, market conditions, customer reaction, and the estimated impact on profitability. A remediation plan will be presented to ALCO, Enterprise Risk Management Committee (“ERMC”) and RMC that carefully outlines the proposed corrective action.
We attempt to manage interest rate risk by identifying, quantifying, and where appropriate, hedging our exposure to market risk. If assets and liabilities do not re-price simultaneously and in equal volume, the potential for interest rate exposure exists. Our objective is to maintain stability in the growth of net interest income through the maintenance of an appropriate mix of interest-earning assets and interest-bearing liabilities and, when necessary and within limits that management determines to be prudent, through the use of off-balance sheet hedging instruments including, but not limited to, interest rate swaps, floors and caps.
Our asset-liability management strategy is devised and monitored by our ALCO, a subcommittee of the ERMC, in accordance with policies approved by the RMC. ALCO operates under a charter developed and approved by the ERMC. ALCO meets at least monthly, or more frequently as needed, to review, among other things, our sensitivity to interest rate changes, loan pricing and activity, investment activity and strategy, hedging strategies, deposit pricing and funding strategies with respect to overall balance sheet composition, as well as earnings simulations over multiple years. ALCO may meet more frequently if there are changes in the economic environment, such as rapid increases or decreases in interest rates due to or as a result of exogenous or unknown factors so that ALCO can make any necessary strategic adjustments to ensure risk is well-managed. ALCO’s membership is comprised of executive management of the Company, and representatives from various lines of business are in regular attendance, including representation from Enterprise Risk Management (“ERM”). ALCO reports regularly to RMC on these risks and objectives with independent oversight and reporting from our Financial and Model Risk Management group within ERM.
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As a company offering banking and other financial services, certain elements of risk are inherent in our transactions and operations and are present in the business decisions we make. We, therefore, encounter risk as part of the normal course of our business, and we design risk management processes to help manage these risks. In its oversight of our risk management framework, the Board of Directors has adopted a formal Risk Appetite Statement (“RAS”) which defines the aggregate level of risk and the types of risk the Company is willing to assume to achieve its corporate strategy and objectives. The Board ensures that approved policy limits, as described further above, conform to stated risk appetite. The Board monitors, on at least a quarterly basis, a set of key risk metrics, including those, but not limited to those, pertaining to market risk. Monitoring these metrics ensures that management is operating within the Board’s stated risk appetite, can help to identify trends in risk profile or emerging risks over time, and where applicable, determine where adjustments may be required to business strategy or tactics. Within our risk management framework, the functional responsibilities of risk management are divided into a tiered model, involving three lines of defense:
| 1. | The Finance Department to which primary market risk ownership belongs including monitoring and tracking of risk, model development and maintenance, and execution of strategy and tactics to mitigate market risk. |
| 2. | The ERM Department which conducts independent risk and controls assessments to ensure appropriate risk identification, management, and reporting. The Model Risk Management group (“MRM”) within ERM is responsible for independent oversight of models used to measure market risk, including model and assumption implementation, development, and effectiveness.; and |
| 3. | The Internal Audit Department which independently assesses the operating effectiveness of the first- and second-line processes and controls. |
Comments on Recent Developments. As noted in the earlier section titled “Outlook and Trends” and the later section titled “Liquidity, Capital Resources, Contractual Obligations, Commitments and Contingencies” in this Item 7, we completed a balance sheet repositioning during the first quarter of 2023 by selling a portion of our AFS investment securities portfolio for total proceeds of $1.9 billion. Such securities were lower-yielding U.S. Agency bonds and government-sponsored residential and commercial mortgage-backed securities which were purchased when interest rates were historically low. In addition, as noted in the earlier section titled “Outlook and Trends” within this Item 2, we completed the sale of our insurance agency business in the fourth quarter of 2023 for net proceeds of $499.7 million. Prior to the sales of securities and of our insurance agency business, we placed greater reliance on wholesale funding, including brokered deposits, to meet our loan-growth needs which have a higher cost than deposits originating within the markets we serve and are not our preferred sources of funding. Subsequent to such sales, a portion of the proceeds of which were used to reduce our wholesale funding balances, our reliance on such funding sources is lessened as we believe we have a stronger liquidity position.
As noted within the section titled “Outlook and Trends” within this Item 7, beginning in March 2022, the Federal Open Market Committee (“FOMC”) voted to increase the federal funds rate multiple times from a range of 0.00% to 0.25% to a range of 5.25% to 5.50% on July 26, 2023, when the FOMC stated that it will continue to assess additional information and its implications for monetary policy. Our market risk management framework is designed for the potential for such rapid changes in interest rates, by establishing policy limits on such rapid shocks and periodically back-testing modeled to actual results. Back-testing of top-line results as well as key assumptions is performed against established thresholds as part of our ongoing monitoring governance of our models and results are reported to ALCO and MRM. Should back-testing results exceed established performance thresholds, the model and underlying assumptions will be reviewed for recalibration.
Net Interest Income Analysis. We analyze our sensitivity to changes in interest rates through a net interest income (“NII”) model. We model our NII over a 12-month and 24-month period assuming no changes in interest rates and a static balance sheet, where cash flows from financial assets and liabilities are replaced with new business of similar terms at current rates. The impact of our interest rate derivatives designated as hedging instruments are included in the model results. We then model NII for the same period under the assumption that market rates increase and decrease instantaneously by certain basis point increments, which vary by period depending upon market conditions, with changes in interest rates representing immediate and permanent, parallel shifts in the yield curve. A basis point equals one-hundredth of one percent, and 100 basis points equals one percent. An increase in interest rates from 3% to 4% would mean, for example, a 100 basis point increase in the “Changes in Interest Rates” column in the table below.
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Many assumptions are made in the modeling process for both NII and economic value of equity (“EVE”, discussed further below), including but not limited to the repricing and maturity characteristics of existing and new business, loan and security prepayments, administered deposit rate betas, duration of deposits without stated maturity dates, and other option risks. Management believes these assumptions to be reasonable for the various interest rate environments modeled, however, differences in actual results from these assumptions could change our exposure to interest rate risk. The models assume that the composition of our interest-sensitive assets and liabilities existing at the beginning of a period remains constant over the period being measured and assume that a particular change in interest rates is reflected uniformly across the yield curve regardless of the duration or repricing of specific assets and liabilities. Additionally, the model requires that interest rates remain positive for all points along the yield curve for each rate scenario which may preclude the modeling of certain falling rate scenarios during periods of lower market interest rates. We do not model negative interest rate scenarios.
Because of the limitations inherent in any modeling approach used to measure market risk, including NII and EVE sensitivity analysis, and because, in the event of changes in interest rates, management would take active steps to manage interest rate risk exposure among its financial assets and liabilities, modeling results, including those discussed in “Interest Rate Sensitivity” and “EVE Interest Rate Sensitivity” below, should not be relied upon as a forecast of actual NII or EVE, nor should they be interpreted as management’s expectations of actual results in the event of such interest rate fluctuations. The tables provide an indication of our interest rate risk exposure at a particular point in time, and actual results may differ.
The tables below set forth, as of December 31, 2023 and 2022, the calculation of the estimated changes in our net interest income on an FTE basis that would result from the designated immediate changes in market interest rates:
Interest Rate Sensitivity
| As of December 31, 2023 | ||||||||||||
Change in Interest Rates (basis points) (1) | Net Interest Income Year 1 Forecast | Year 1 Change from Level | Policy Limit | |||||||||
| (Dollars in thousands) | ||||||||||||
400 | $ | — | #DIV/0! | (20 | %) | |||||||
200 | — | #DIV/0! | (12 | %) | ||||||||
100 | — | #DIV/0! | (10 | %) | ||||||||
Flat | — | #DIV/0! | ||||||||||
(100) | — | #DIV/0! | (10 | %) | ||||||||
(200) | — | #DIV/0! | (12 | %) | ||||||||
(400) | — | #DIV/0! | (20 | %) | ||||||||
| As of December 31, 2022 | ||||||||||||
Change in Interest Rates (basis points) (1) | Net Interest Income Year 1 Forecast | Year 1 Change from Level | Policy Limit | |||||||||
| (Dollars in thousands) | ||||||||||||
400 | $ | 528,247 | (8.4 | )% | (20 | %) | ||||||
300 | 539,739 | (6.4 | )% | (16 | %) | |||||||
200 | 552,231 | (4.2 | )% | (12 | %) | |||||||
Flat | 576,477 | — | % | |||||||||
(100) | 585,728 | 1.6 | % | (10 | %) | |||||||
(200) | 586,771 | 1.8 | % | (12 | %) | |||||||
| (1) | Assumes an immediate uniform change in interest rates at all maturities. |
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As of December 31, 2023, our model, as indicated above, shows a decline in our net interest income in rising rate scenarios. In the rising rate scenarios, funding costs are modeled to rise faster than income on earning assets, due, in part, to the mix of funding which has shifted towards higher rate paying deposits and wholesale funding in recent quarters. As shown in the table above, the model generated similar results as of December 31, 2022. That is, the model showed a decline in our net interest income in the rising rate scenarios as funding costs were modeled to rise faster than income on earning assets, due, in part, to the shift in our mix of funding. The simulation results are within policy limits and management therefore does not expect a material change to our current strategy over the near term. The rate scenarios that we model at each period end are dependent upon market conditions, which is why the rate scenarios that we model may differ from period-to-period. As such, we did not previously model an instantaneous 400 basis point decrease in interest rates at December 31, 2022 given the lower level of interest rates compared to December 31, 2023.
Management may use investment strategy, loan and deposit pricing, non-core funding strategies, and interest rate derivative financial instruments, within internal policy guidelines, to manage interest rate risk as part of our asset/liability strategy. Hedging strategies such as, for example, receive-fixed and pay-fixed swaps, interest rate caps, floors, or collars, and may be used to protect against benchmark interest rates either rising or falling. The type of derivatives we primarily use to hedge market risk are interest rate swap agreements designated as cash flow hedging instruments. When the Federal Reserve began raising interest rates in March of 2022 from very low levels, management began evaluating a derivative strategy designed to limit our exposure to downward rate scenarios. In 2022, management executed a total of $2.4 billion in notional value of receive-fixed interest rate swap agreements on floating-rate loans. These swaps are designated as cash flow hedges and management believes these derivatives provide significant protection against falling interest rates. These receive-fixed swaps constitute the entirety of our current hedge portfolio. Management may, from time to time, due to actual or projected changes in market rates or our risk exposure, evaluate other hedging strategies, although we believe our current Net Interest Income and Economic Value of Equity simulation analyses support maintaining the current derivatives strategy. For additional information related to our interest rate derivative financial instruments, see Note 18, “Derivative Financial Instruments” within the Notes to the Consolidated Financial Statements included in Part II, Item 8 in this Annual Report on Form 10-K.
Economic Value of Equity Analysis. We also analyze the sensitivity of our financial condition in interest rates through our economic value of equity (“EVE”) model. This analysis calculates the difference between the present value of expected cash flows from assets and liabilities assuming various changes in current interest rates. The impact of our interest rate derivatives designated as hedging instruments are included in the model results.
The tables below represent an analysis of our interest rate risk as measured by the estimated changes in our EVE, resulting from an instantaneous and sustained parallel shift in the yield curve (+100, +200, +400 basis points and -100, -200, and -400 basis points) at December 31, 2023 and (+200, +300, +400 basis points and -100, -200 basis points) December 31, 2022. The model requires that interest rates remain positive for all points along the yield curve for each rate scenario which may preclude the modeling of certain falling rate scenarios during periods of lower market interest rates.
Our earnings are not directly or materially impacted by movements in foreign currency rates or commodity prices. Movements in equity prices may have a modest impact on earnings by affecting the volume of activity or the amount of fees from investment-related business lines and by affecting the amount of unrealized gains and losses from securities held in rabbi trusts, the latter of which are partially offset by a corresponding but opposite impact to the amount of employee benefit expense associated with the change in value of plan assets.
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EVE Interest Rate Sensitivity
Change in Interest Rates (basis points) (1) | Estimated EVE (2) | As of December 31, 2023 | EVE as a Percentage of Total Assets (3) | |||||||||||||||||
| Estimated Increase (Decrease) in EVE from Level | ||||||||||||||||||||
| Amount | Percent | Policy Limit | ||||||||||||||||||
| (Dollars in thousands) | ||||||||||||||||||||
400 | $ | — | $ | — | #DIV/0! | (30 | %) | #DIV/0! | ||||||||||||
200 | — | — | #DIV/0! | (20 | %) | #DIV/0! | ||||||||||||||
100 | — | — | #DIV/0! | N/A | #DIV/0! | |||||||||||||||
Flat | — | — | #DIV/0! | #DIV/0! | ||||||||||||||||
(100) | — | — | #DIV/0! | N/A | #DIV/0! | |||||||||||||||
(200) | — | — | #DIV/0! | (20 | %) | #DIV/0! | ||||||||||||||
(400) | — | — | #DIV/0! | (30 | %) | #DIV/0! | ||||||||||||||
Change in Interest Rate (basis points) (1) | Estimated EVE (2) | As of December 31, 2022 | EVE as a Percentage of Total Assets (3) | |||||||||||||||||
| Estimated Increase (Decrease) in EVE from Level | ||||||||||||||||||||
| Amount ($) | Percent (%) | Policy Limit | ||||||||||||||||||
| (Dollars in thousands) | ||||||||||||||||||||
400 | $ | 3,691,963 | $ | (691,696 | ) | (15.8 | )% | (30 | %) | 18.48 | % | |||||||||
300 | 3,834,512 | (549,147 | ) | (12.5 | )% | (25 | %) | 18.72 | % | |||||||||||
200 | 4,007,265 | (376,394 | ) | (8.6 | )% | (20 | %) | 19.04 | % | |||||||||||
Flat | 4,383,659 | — | — | 19.66 | % | |||||||||||||||
(100) | 4,527,743 | 144,084 | 3.3 | % | N/A | 19.74 | % | |||||||||||||
(200) | 4,620,994 | 237,335 | 5.4 | % | (20 | %) | 19.61 | % | ||||||||||||
| (1) | Assumes an immediate uniform change in interest rates at all maturities. |
| (2) | EVE is the discounted present value of expected cash flows from assets, liabilities and off-balance sheet contracts. |
| (3) | Total assets is the net present value of expected future cash flows. |
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