BankUnited: Valuation And Deposit Costs Offset Growth Investments (NYSE:BKU)

There are certainly things to like about BankUnited (NYSE:BKU). This bank has significant operations in an attractive fast-growing market (Florida) and is using an organic growth strategy to expand into attractive markets like Atlanta and Dallas. The bank has also been focused on addressing past deficiencies in its core deposit base, while also returning meaningful capital to shareholders.

Despite those positives, the shares have lagged the larger regional bank group since my last article (up about 9% versus up 25%), as my concerns about the bank’s deposit costs and valuation have played out. At this point, BankUnited shares do look undervalued, but so do many other bank stocks, and without more meaningful differentiation in loan growth, spread margin, and/or operating leverage, I don’t see what really ought to drive a “buy this, not that” call for BankUnited.

A Core Miss In Q3 Driven By Expenses

While BankUnited did report better-than-expected earnings at the bottom line, the market tends to ignore beats that are driven by “below the line” items like provisioning and taxes, and that was the case for BankUnited in the third quarter. Still, as misses go, a miss driven by higher opex at a time when the company is investing in organic growth is arguably more forgivable.

Revenue rose 17% year over year and 5% quarter over quarter on a core adjusted basis. Net interest income rose 21% yoy and 5% qoq on a core FTE basis, beating expectations by close to $0.02/share. Net interest margin improved 43bp yoy and 13bp qoq to 2.76% – better than expected, but below peers/comps in the 3.5% range – while average earning assets decreased by almost 1% sequentially and missed expectations.

Fee income isn’t a large part of the revenue mix here; fee income declined 12% yoy and rose 5% qoq, a tiny miss versus expectations.

Operating expenses rose 17% yoy and 8% qoq, higher than what most banks have seen, and driving a $0.05/share miss versus expectations. The good news, though, is that I believe BankUnited is overspending largely on growth investments and the efficiency ratio (52.5%) still compares satisfactorily to its peer group.

Pre-provision earnings rose almost 17% yoy but only 1% qoq, a weak result in a quarter where many banks have reported double-digit sequential growth and about $0.04/share below expectations. Provisioning expense was $0.11/share better than expected, driving the earnings beat. Like many banks, BankUnited saw declines in tangible book value per share (down almost 8% yoy and 7% qoq) due to mark-to-market losses.

Healthy Loan Growth, But Deposit Costs Remain A Worry

BankUnited once again did well with its loan portfolio. Loans grew almost 4% sequentially (up 3.8% on an end-of-period basis), which was nicely above the overall average for comparable banks (around 3%). Multifamily lending was curiously soft (down 5% when the group was closer to +6%-7%), but core C&I was up close to 7% (versus 2%). Core CRE grew a little less than 2% qoq, which was a bit below the average 2% of the peer group.

Loan yields continue to improve, helped by strong loan growth in C&I and CRE categories where the “vast majority” of originations are for variable-rate loans. Loan yield improved 66bp yoy and 52bp qoq to 4.11%, which is lower than average, but the rate of improvement here was a little better. A higher mix of residential lending (over a third of loans) can explain some of that difference.

Management did say that they expect a “significant” economic slowdown next year, and the mid-single-digit loan growth forecast for the next quarter is consistent with an outlook for a slowing economy. Even if the economy does slow (which I expect it will), BankUnited goes in with decent credit quality, including an adjusted NPA ratio basically in line with peers.

Where I’m less pleased with BankUnited is with the deposit evolution. As I wrote in that prior article, BankUnited has had higher deposits than peers in past cycles, and I was concerned about how that would limit BankUnited’s performance during this next phase of the banking cycle. Likewise, I was concerned earlier this year that banks would see higher deposit betas through this next phase of the cycle than bank managements and sell-side analysts were expecting, and thus far that has been the case.

BankUnited saw a 4% qoq decline in total deposits and a 9% decline in non-interest-bearing deposits. Not only was that considerably worse than the average “slightly down” performance of the peer group, it was one of the worst results I’ve seen. Even allowing that half of the decline in non-interest-bearing deposits was driven by title insurance customers (at least partly on seasonal moves), the reality is that BankUnited’s total cost of deposits rose 48bp, almost triple the qoq peer average, and ended up at 78bp, about two and a half times the peer average.

The cumulative interest-bearing deposit beta is now 43%, or about double the average, and I’m concerned it will head higher still. It’s possible and plausible that BankUnited will simply see a different path in its deposit beta and that its full-cycle deposit beta will still end up better than the prior cycle (and more comparable to peers), but I’m still concerned about the role that higher deposit costs will play in the bank’s profitability.

The Outlook

I like the bank’s decisions to open lending offices in Atlanta and Dallas, and I likewise agree with management that expansion into Tennessee, South Carolina, and North Carolina would make sense over time. I’m not in such strong agreement with management where M&A is concerned; management continues to be pretty adamant that they’re not interested in bank M&A, but I think a deal for a bank with strong core deposits in an attractive market could be worthwhile.

I do see a risk that BankUnited could see core earnings declines in both 2023 and 2024; a lot depends on just how quickly the economy slows in 2023 in response to higher rates. It is plausible, for instance, that 2023 could be worse than I expect, but see a more meaningful rebound in 2024. In any event, I do expect solid mid-single-digit core earnings growth after that, as well as robust capital returns to shareholders.

Between discounted core earnings and ROTCE-driven P/TBV, I believe BankUnited is undervalued below $41, though a roughly 9.5x P/E on my ’23 EPS estimate doesn’t exactly screen out as particularly cheap at the moment. I also believe there are multiple attractive attributes to the bank that could make it a M&A target in its own right.

The Bottom Line

I want to like BankUnited shares more than I do, as I largely agree with the approach management is taking to drive growth and improved long-term results from the bank. In a market with many undervalued banks, though, I don’t see many attributes here that should push these shares to the top of my list, as I see less opportunity for spread leverage, outperformance on deposit costs or loan growth, or operating leverage relative to many names. With that, I consider this is a solid hold and a name to reconsider if the shares sell off and/or evidence of slowing deposit beta emerges.