BankUnited Posting Good Loan Growth, But Margin Pressures Loom (NYSE:BKU)

BankUnited (NYSE:BKU) goes into 2023 with an interesting mix of positives and negatives. On the positive side, the bank’s core South Florida operating footprint is an attractive one, and organic expansion efforts into Georgia (Atlanta) and Texas should help growth. On the negative side, competition for deposits is likely to intensify and I expect to see pressures on spread and operating margins squeeze core pre-provision profit growth and a materially worse credit environment would only add to the profit pressures.

I wasn’t that fond of the value offered by BankUnited shares last quarter and the shares have slipped about 7% since then, modestly lagging their peers (though a move after earnings has helped). I do see BankUnited shares as a little more interesting from a valuation perspective now, but I think there’s more risk to management’s outlook now and I don’t think this is one of the better banks to own in a period of rising funding costs.

Weak Results Across The Board

There weren’t too many positives on the income statement line items for BankUnited in the fourth quarter, and while core pre-provision results weren’t as bad as the $0.27/share core miss would suggest, they still weren’t particularly good.

Revenue rose more than 15% year over year and 4% quarter over quarter, beating expectations by less than 1% and about $0.01/share. Net interest income rose almost 18% yoy and 3% qoq (FTE basis), missing by about $0.02/share as better earning asset performance (up 1.4% qoq) was offset by a modestly weaker than expected net interest margin (2.81%, up 37bp yoy and 5bp qoq). Non-interest income fell 2% yoy and rose more than 15% qoq on an adjusted basis, beating by about $0.03/share.

Operating expenses rose 15% yoy and 7.5% qoq, missing by a wide margin (about $0.11/share, or 370bp on efficiency ratio). Opex misses have been fairly common this reporting season, with banks absorbing higher wage costs, as well as higher costs for items like FDIC insurance.

Pre-provision profits rose about 16% yoy and just slightly qoq, missing by about $0.10/share. Loan loss provisioning was considerably higher than expected (about $40M versus close to $17M, or about $0.24/share), as the company is taking a more conservative stance in light of a slowing economy. Taxes added back about $0.075/share.

Mixed Loan Growth Trends, And Higher Funding Costs

Looking at BankUnited’s balance sheet, there were some curious mixed trends in the quarter. Overall lending was a little better than expected, but weaker than the broader market and C&I lending growth slowed more noticeably, while funding is getting more challenging.

Loans rose 2.6% qoq on an end-of-period basis, with strong growth in C&I lending (up nearly 11%), but relatively weak CRE lending (up 0.6%, combining owner-occupied and investment CRE lending). Residential lending grew modestly from the prior quarter. Softer CRE lending does make some sense in the context of management seeing reasons for caution with office and retail (something that has been echoed to varying degrees by other banks like Eagle Bancorp (EGBN) in the D.C. area and Metropolitan (MCB) in NYC).

Loan yields continue to climb in response to higher Fed rates, with the average loan yield climbing 122bp yoy and 61bp qoq to 4.72%. Credit quality remains fine, with non-performing loans down 33% qoq (to 0.42% of loans from 0.64% in the third quarter) and criticized loans down 10% (to 3%).

On the deposit side, BankUnited saw period-end deposits decline about 1% and average deposits decline more than 3%, with non-interest-bearing deposits down about 11% at the end of the quarter. Deposit costs jumped 124bp yoy and 65bp qoq to 1.43%, with cumulative deposit beta now over 30% and likely to continue heading higher. While management expects further increases in the deposit beta, they believe it will stay below the 61% level of the prior cycle. I believe that’s a plausible expectation, but I do think BankUnited will see above-average cumulative beta for this cycle (likely in the high-40%’s to low-50%’s).

The Outlook

I’m concerned that management’s targets for 2023 may be too optimistic. I think mid-single-digit loan growth is achievable, and likewise with mid-single-digit deposit growth, but I think funding costs are a bigger risk. Management is getting a margin spread tailwind from its growing C&I loan book, but I think guidance for net interest margin expansion throughout 2023 (when many banks are likely to see peak NIM in Q4’22-Q2’23) could prove optimistic.

With opex growth in the mid-to-high single-digits, I think there’s a very real possibility that BankUnited shows little-to-no growth in pre-provision profits from 2022 to 2024, and that’s not going to be positive for sentiment. On a more positive note, the growth in C&I lending looks impressive (I say “looks” because we need to see how credit quality evolves here), and I’m bullish on the company’s efforts to organically expand into Atlanta (done), Dallas (underway), and eventually North Carolina, South Carolina, and Tennessee.

I’m expecting pretty weak core earnings in FY’23 and FY’24, and my medium-term core earnings growth rate only ends up at around 2% (I expect a rebound in FY’25). My longer-term core earnings growth rate ends up at around 3%, and I do expect healthy capital returns to shareholders over time. Between discounted core earnings, ROTCE-driven P/TBV, and P/E, I believe BankUnited’s near-term fair value is in the high-$30s ($38 to $39).

The Bottom Line

I could be wrong about BankUnited and the bank may see better net interest income growth and operating leverage than I expect, driving a better growth rate. Still, I just don’t see the upside here as being all that impressive, particularly when considering the risk of funding costs exceeding management’s expectations (as well as my own) and the ongoing risk of elevated competition in South Florida, Dallas, and Atlanta lending markets.