BankUnited, Inc. Q2 FY2024 Earnings Call

Good morning, and thank you for joining us today for BankUnited, Inc. Second Quarter 2024 Results Conference Call. On the call this morning are Raj Singh, Chairman, President and CEO; Leslie Lunak, Chief Financial Officer; and Tom Cornish, Chief Operating Officer. Before we start, I'd like to remind everyone that this call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 that reflect the company's current views with respect to, among other things, future events and financial performance. Any forward-looking statements made during this call are based on the historical performance of the company and its subsidiaries or on the company's current plans, estimates and expectations. The inclusion of this forward-looking information should not be regarded as a representation by the company that the future plans, estimates or expectations contemplated by the company will be achieved. Such forward-looking statements are subject to various risks and uncertainties and assumptions, including, without limitations, those relating to the company's operations, financial results, financial condition, business prospects, growth strategy and liquidity, including as impacted by external circumstances outside the company's direct control, such as adverse events impacting the financial services industry. The company does not undertake any obligation to publicly update or review any forward-looking statement, whether as a result of new information, future developments or otherwise. A number of important factors could cause actual results to differ materially from those indicated by the forward-looking statements. These factors should not be construed as exhaustive. Information on these factors can be found in the company's annual report on Form 10-K for the year ended December 31, 2023, and any subsequent quarterly report on Form 10-Q or current report on Form 8-Q, 8-K, which are available at the SEC's website, www.sec.gov. With that, I'd like to now turn the call over to Mr. Raj Singh.

Thank you for joining our earnings call. This quarter has been outstanding. There's always some variability as we approach the end of a quarter, and this time everything went well for us. Whether it’s loans, deposits, NIDDA, cost of deposits, margin, expenses, credit, capital, or liquidity, I couldn't have asked for a better quarter. We even celebrated India winning the World Cup on the last day of the quarter, which was the cherry on top. Let me share a few numbers before Tom and Leslie provide more details. Our EPS came in at $0.72, whereas the consensus was around $0.65. As we anticipated, our margin grew from 2.57% last quarter to 2.72% this quarter, thanks to our success in transforming our balance sheet. On the right side, deposits saw a decrease in costs for the first time, dropping from 3.18% to 3.09%. A significant portion of this decline can be credited to phenomenal DDA growth. Interest-bearing deposit costs did rise slightly from 4.21% to 4.26%, but are also starting to plateau. We are pleased to report that non-broker deposits grew by $1.3 billion this quarter, with $826 million being non-interest DDA, which is a solid figure. For the first half of the year, NIDDA is up $1.2 billion. We have paid down more of the brokered deposits than we had originally planned, leading to a net growth of $736 million. We also reduced our wholesale funding by $1.2 billion this quarter, reaching levels not seen since early 2022. Asset mix improved as well, although resi declined by $212 million; areas like corporate, commercial, small business, and CRE saw growth. Overall, credit trends remain solid, and we've seen a slight decline in criticized and classified loans. We experienced some migration in office CRE, but we're fully reserved for this. Leslie will discuss expenses soon, but I want to underline our investments over the last couple of years. While not noticeable initially, our efforts with commercial cards and capital market products are beginning to yield results. Capital and liquidity are robust, and tangible book value continues to grow. In terms of guidance, we’re maintaining our strategy and focusing on DDA growth, which is crucial for our success. The recent $1.2 billion growth in DDA largely stems from attracting new customers. We've seen significant success in New York, Florida, and across our national businesses. However, we expect some seasonality effects, which may affect DDA growth in the second half of the year. I also want to highlight our approach to attracting like-minded individuals for organic growth, recently welcoming Ernie Diaz from TD Bank. He brings a wealth of experience and fresh ideas, and we're excited to have him on board. Now, I’ll turn it over to Tom to go over the numbers in more detail.

Thank you, Raj. As he mentioned, total deposits increased by $736 million for the quarter, even after accounting for a decrease in brokered deposits. Non-brokered deposits grew by a total of $1.3 billion, with NIDDA rising by $826 million, marking an 11% increase quarter-over-quarter. Looking ahead, our pipelines appear robust across all operating teams, and new account business looks promising for the quarter. While the back book is subject to seasonality and other issues, the new relationship pipeline is strong as we approach the third quarter, and we are monitoring opportunities extending into the fourth quarter. We are strategically reducing rates on some higher-priced deposits that we had increased during the financial disruptions last year. With continued growth in deposits and a decrease in the cost of funds, we see this as a good time for adjustments. On the loan side, overall loans increased by $402 million quarter-over-quarter, with the core C&I and CRE segments together growing by $589 million—$475 million for C&I and $114 million for CRE. The mortgage warehouse experienced an $83 million increase, consistent with our strategy, while residential loans fell by $212 million, along with declines in leasing and municipal finance subsidiaries. The growth we observed in C&I and CRE was broad-based, with seven or eight of our largest C&I segments experiencing growth. For CRE, the strongest growth occurred in industrial, multifamily, and core retail sectors. The overall distribution of the CRE portfolio remained stable compared to the previous quarter, except for a decline in the office segment. We anticipate high-single-digit growth in core commercial portfolios for the year, consistent with our previous guidance, focusing more on C&I than CRE. Resi, municipal, and equipment finance segments will continue to decline. The operating lease equipment portfolio decreased by $62 million this quarter as we selectively sold some assets and reduced our lease exposure from $702 million two years ago to $266 million now. We will maintain this strategy moving forward. The loan-to-deposit ratio improved from 89.6% to 88.7%. In light of that, let's take a closer look at CRE and specifically the office segment. In our supplemental deck, you can find detailed slides about this area. Overall, our CRE exposure remains modest at 24% of total loans and 165% of total risk-based capital, well within our risk parameters. As of June 30, the weighted average LTV of the CRE portfolio was 56%, with 56% of the portfolio located in Florida and 27% in the New York Tri-State area. In our analysis of office loans, we monitor each one by submarket, and this quarter showed improved credit statistics in nine out of 16 submarkets, particularly where we have significant exposure. Occupancy across the portfolio has generally remained strong, aided by improving abatement periods seen recently. Our office loan portfolio totals $1.8 billion, with a substantial portion in suburban Florida and the New York Tri-State area. The medical office segment shows distinct dynamics in terms of debt service coverage ratios. The construction portfolio has an additional $87 million in office-related exposure, mostly for renovations in Manhattan. The stabilized office portfolio's weighted average LTV is 66%, with a debt service coverage ratio of 1.59 as of June 30. A portion of office loans is maturing soon, with relatively low rent rollover in the upcoming year. In the New York Tri-State area, a significant percentage is in Manhattan, showing strong occupancy rates and manageable lease rollover proportions. Early signs in the Manhattan market indicate a 9% increase in total leasing activity, predominantly in Class A spaces, though it's still below pre-pandemic levels. In contrast, we have seen some challenges in certain markets like Orlando, but generally, the market is performing well across Florida, with positive absorption and modest rent increases in the majority of markets. Non-accrual CRE loans reached $51 million this quarter, and the total criticized and classified loans increased in the office segment. Despite these increases, our portfolio remains strong, characterized by reliable sponsors and sound asset management. We believe that the ultimate loss potential from this portfolio will be manageable. Now, I’ll turn it over to Leslie.

Thanks, Tom. Just a quick summary of the quarterly results. As Raj said, net income for the quarter was $53.7 million or $0.72 per share. Net interest income was up $11.2 million this quarter, and the NIM increased 15 basis points to 272. The most significant contributor to this increase in margin was obviously an $888 million increase in average NIDDA. Average NIDDA grew to 27.5% of average total deposits, and that's compared to 24.7% for the prior quarter. The yield on loans was up from 5.78% to 5.85% as new production came on at higher rates and the portfolio composition continues to shift into higher-yielding assets. The yield on securities, as expected, was essentially flat quarter-over-quarter. We are very happy to see the average cost of total deposits decline to 3.09% for the second quarter compared to 3.18% last quarter, along with a slower pace of increase in the cost of interest-bearing deposits. On a spot basis, the cost of interest-bearing deposits is stable quarter-over-quarter. The average cost of FHLB advances did go up this quarter to 4.28% from 4.18%. That's really just due to the expiration of a couple of cash flow hedges. From a guidance standpoint, we continue to expect the NIM to expand over the back half of '24, although I don't think we'll see 15 basis points per quarter. I would love that, but it's not what I'm expecting, but still continue to expect NIM to end the year in the high 2%s. And given that we're already at 2.72%, I guess now you have a little better idea of what I mean by the high 2%s, higher than that. So, we do and we expect net interest income to be up mid single-digits to low high double-digits year-over-year. Provision in reserve. The provision this quarter was $20 million, and the ACL to loans ratio continued to increase from 90 basis points to 92 basis points. The commercial ACL ratio, which includes C&I, CRE, franchise and equipment finance stood at 1.42% at June 30. This quarter's provision and the increase in the ACL were driven by risk rating migration and increase in some specific reserves, new loan production, changes in portfolio characteristics partially offset by some improvements in the economic forecast. The reserve on CRE office was 2.47% at June 30. That's up from 2.26% at March 31. This build was prompted by some of the risk rating migration that you see and changes in commercial property market forecast. You might recall that last quarter, we put up a pretty large qualitative reserve on CRE office over $20 million in anticipation of the fact that we were likely to see what we saw this quarter, some of that negative risk rating migration. And this quarter, you saw some of that move from the qualitative reserve to the quantitative reserve and getting picked up in the quantitative calculation. We do expect the ACL to gradually build as a percentage of loans over the rest of 2024, likely getting closer to 1%. And some of that's going to be driven by the expected shift in portfolio composition. As Raj mentioned, criticized and classified assets declined by $52 million overall this quarter with the $69 million increase in CRE being offset by a decline of $121 million in other commercial categories. A few comments on noninterest income and expense. Noninterest expense was pretty much flat quarter-over-quarter. Lease financing income is down about $5.8 million. That's due to two things; just the reduction in the size of the asset portfolio, as well as fluctuation in residual income, which was a small loss this quarter compared to a small gain last quarter. Other noninterest income, we did have an increase in income this quarter from our customer derivatives business, our commercial card business and syndication fees. Going forward, I'd expect an overall gradually increasing trend in that line item. But there are some things in here that can cause some quarterly volatility. I'll reiterate our mid-single-digit guidance for the year-over-year increase in noninterest expense, excluding the FDIC special assessment. This does include some railcar refurbishment costs that we're expecting in the back half of the year, and that's one of the things that's going to drive that increase. I'll make a brief comment on the year-over-year increase in compensation expense. Most of what you're seeing in the P&L is really driven by some fluctuations in liability-classified share awards that are driven by changes in volatility in the company's stock price and some reversal of expense in the prior year for awards that didn't vest. Core salary expense is really only up about 2%. The ETR, I'd expect to be around 26.5% going forward, excluding discrete items. CET1 from a capital perspective, CET1 was stable at 11.6% this quarter compared to last quarter and TCE to TA increased to 7.4%. That's all I have. I'm going to turn it over to Raj for closing comments, and then we'll take your questions.

I think, listen, like I said at the beginning of the call, I couldn't be happier with the way the quarter turned out and looking forward, very optimistic when I look at the pipeline. So, all is well and happy and we'll be glad to take questions. We'll turn it over to the operator for Q&A.

Thank you. Our first question comes from Will Jones from KBW.

Hey, great. Good morning, guys.

Good morning, Will.

So first of all, congrats on the nice quarter. I just wanted to start on deposits. I mean, it's impressive what you guys are doing on the noninterest-bearing front. Growth was really nothing but spectacular this year. It sounds like there's continued optimism that the pipeline still looks good, but maybe in the second half of the year, we might see a little bit of seasonality kind of dampen that. And maybe the easier way to think about noninterest-bearing for the year, maybe just a full-year growth rate. If you look at what you guys have already done, you're already approaching 20% growth for the year. Is there just a broader target for what you see noninterest-bearing do this year in terms of just maybe a growth rate?

I believe our target for non-interest DDA is comfortable double-digit growth, but not in the range of 20% or 30%. Taking into account seasonality and the fluctuations from quarter to quarter, achieving mid-teens growth is quite challenging, particularly in the current environment. However, if the conditions remain stable and our pipeline continues to be strong, we anticipate DDA growth between 13% and 16%. This is our long-term projection. It's important to note that interest rates will fluctuate, and these changes can significantly affect our performance. For example, in our title business, a surge in mortgage refinancing can greatly boost growth. Currently, our growth is primarily from gaining market share, as the broader market is quite depressed with historically low originations. Once mortgage originations increase, which could be in a year or even a decade, we expect to see average account balances rise, allowing us to benefit from that growth without much additional effort. Setting aside interest rate fluctuations, our focus is on achieving double-digit DDA growth. We are aiming to regain our previous peak of 30%. We currently stand at 29%, up from 27% last quarter, indicating that we are making progress toward our goal and moving closer to our all-time high watermark of 34%. This is an objective we aim to reach sometime next year.

Yes. And just to recap, from here through the rest of the year, I would expect just modest growth given the seasonal headwinds.

Okay. Well, that's very helpful. Well, great work on the non-DDA front. And Leslie, I appreciate that the margin guidance is still kind of unchanged in the high 2% range, but as we look at the loan side, in particular, you can kind of see the remakes happening where core C&I and CRE is seeing strong growth and we had that runoff and one-to-four family is still happening. As you grow that core C&I and you runoff mortgage, what is kind of that trade-off and yield? I guess, in other words, what is the new loan yield you guys are receiving versus what's running off?

I mean call it, around 8%, 7.5% to 8% on most of the new production and the resi portfolio yields in the mid-3%s. So, there you go.

And as you guys continue to target that high single-digit range for kind of core loans, is it fair to assume that we will continue to kind of see maybe that 5 basis points to 10 basis point increase in loan yields going forward?

I mean that seems reasonable, yes.

I want to emphasize the deposit growth we've achieved. This growth is the result of five years of hard work and is not something we accomplished in the last quarter or even last year. It represents years of effort in developing our products and technology and successfully bringing them to market, which is now yielding results. We didn't simply hire a large team last quarter to drive this business; that wasn't our approach. While I mentioned bringing in Ernie, he wasn't responsible for generating new business by knocking on doors. We noticed many potential producers over the last year from familiar names, but we chose a different path. This has been a long-term strategy spanning four to five years that is finally coming to fruition and benefiting us.

Well, I would also add on the loan yield side, if we look at the pipeline going forward and we kind of look sort of opportunity by opportunity between what's approved, what's accepted, term sheets and things of that nature, I think that the pricing market remains fairly good. We're not seeing too much differential in terms of yields. Obviously, virtually all banks are trying to put more emphasis on growing the C&I business versus growing other parts of their book. But I think as we look at a good quality pipeline, Q3 and into early Q4, we're seeing a fair bit of firmness in the yield on loans right now.

Yeah, okay. That's great. And job well done, guys. That's it for me.

Thank you. One moment for our next question. Our next question comes from the line of Timur Braziler from Wells Fargo.

Hi, good morning.

Good morning.

Good morning.

Maybe just following up on that line of questioning for DDA, Raj, you kind of alluded to the future opportunities within the title business. And I apologize if I missed this in the prepared remarks, but can you just kind of go through where the DDA growth has been coming from in the first half of the year? And then maybe frame what the opportunity in the title business might look like if we do get some rate relief and increased mortgage activity?

Predicting the impact of a refinancing boom is challenging. It could result in a 20% to 30% increase in average deposit balances, but that's just an estimate. The growth this quarter was widespread, with the title business being the largest contributor and benefitting the most from seasonal trends. It's worth noting that the HOA business has also performed well. We established that as a separate business line about three or four years ago and invested in technology over the last two years. They are reaping the rewards of that investment. We added a few members to the sales team last year, which has also contributed positively. The HOA business is significantly exceeding its budget for the year, much like our national title businesses. Additionally, we are seeing positive developments in New York, where market disruptions have allowed us to capture some core business. Florida's market remains strong, contributing to our growth this quarter as well. While there were some declines this quarter—primarily due to seasonal trends in the municipal money market business, which typically grows in the fourth quarter and shrinks in the following three quarters—overall, the growth was broad-based. The title business was likely the largest contributor and will be the most affected by seasonal changes in the fourth quarter.

I would add that we also saw a good increase in the corporate banking deposit business in the quarter, which is virtually all kind of transactional business and it was across all of the geographies that we're in. So, it was a combination of both kind of specialty businesses and broad geography businesses.

Okay. Great. And then just, again, a follow-up on the title business specifically. What are those balances today that are sitting in DDA? And then, just to kind of rate the opportunity, maybe what was the balance?

We don't disclose detailed information about deposit balances by line of business. However, I can say that the title business is approximately $4 billion, mostly in DDA, though I don’t have the exact figures on hand, and we generally do not share this type of information publicly.

Understood. Okay. And then just one last one for me. Just looking at some of the degradation in the office portfolio over the last couple of quarters, and I appreciate the comments on the qualitative reserve last quarter moving into quantitative this quarter. I guess, is it really just the lease abatements that's the biggest issue right now that you're seeing within the office book? And as you sit here today, assuming other commercial categories kind of stay stable, how should we think about the reserve on the office portfolio maybe relative to what you're seeing for the trends in the last couple of quarters?

I'll comment on the reserve, and then Tom will provide additional insights on the book. Nothing we are observing is unexpected. For several quarters, we have indicated that some of these loans would encounter difficulties. While we weren't certain which loans would be affected, we now have a clearer understanding. This aligns perfectly with our projections for the office book, and we believe that a reserve of approximately 2.5% is sufficient.

I would say that the overall performance of the office portfolio, including occupancy, debt service coverage, and debt yield, indicates that the portfolio is doing well. However, there are specific assets facing challenges, mainly due to lease-up rent abatement issues that affect the debt service coverage ratio in the early stages. During the abatement periods, while the building is physically occupied, it is not generating net operating income. One of the buildings Raj mentioned in New York has undergone renovation, and we have two renovated buildings there that need to complete a lease-up period before the abatement period begins. While there are a few asset-specific issues within the portfolio, when I review all 98 loans in front of me, the majority are performing very well.

Great. Thanks for that color. I appreciate it.

Thank you. Our next question comes from David Bishop from Hovde Group.

Good morning.

Hey, Dave.

Good morning, Dave.

Hey, Raj and Leslie, specifically, we talked about this before, but there's been quite a bit of concern regarding the commercial CMBS market, and I know you have some exposure there. I'm curious about your thoughts on that portfolio these days in light of what's been reported in the news. Are you seeing any potential risk of impairment? I'm interested to know how that's overall holding up.

Yeah. So yes, collateral losses have increased in the CMBS market, but we are seeing no risk of impairment whatsoever in our portfolio. All of our holdings are extremely well enhanced. We rigorously stress test each and every one of those securities on at least quarterly basis, and we don't see any potential signs of impairment at all at this time because of the level of credit enhancement that we have. And we do monitor it on a deal-by-deal basis, very rigorously.

And you guys avoid the single asset, single tenant investment...

Correct. Yeah, thank you for asking. We have no single asset, single borrower exposure.

Got it. Leslie, I think I missed the operating expense guidance. How should we view that for the second half of the year? It seems like there will be an increase in expenses.

Yeah, still mid-single-digit increase year-over-year in the aggregate. So, no change to our guidance. And I just made the point that one of the things that's going to drive that is some railcar refurbishment that will happen. But no change in our overall guidance.

Great. Thank you.

Thank you. One moment for our next question. Our next question comes from the line of Steven Alexopoulos from JPMorgan.

Hey, good morning. It's Alex Lau on for Steve.

Good morning, Alex.

I have a question, a follow-up on the DDA and the title solutions business. In terms of the seasonality for that business, is last year's seasonal trends a good period to model after? Or has anything changed in that business that would result in last year in not being a good data point to refer to?

I think you could use that. Probably the best year that you could probably feel that would be last year.

Yeah.

And yeah, I would say that, yeah. Last year is probably as typical a year.

Yeah. Barring, as Raj said earlier, something happening in the rate market...

Yeah.

Got it. And how much of the growth in the title solutions business this year has been from gaining market share versus some seasonality?

I would say that the business is growing at a mid-teens level if you account for seasonality. Considering the new relationships we are establishing and the balances adjusted for seasonality, we're seeing a growth rate of about mid-teens. We're acquiring approximately 40 to 45 clients each quarter.

And that would equate to about a 15% to 18% increase in the overall client base.

Great color. Thank you. And then, my last one. How big is your deposit pipeline for treasury management at quarter-end? And how does that compare to the prior quarter?

It's very similar. From the beginning of this year to now, as we are bringing in new items into the pipeline and closing deals, it really hasn't changed that much.

That pipeline has actually been pretty consistent for some time. It tends to get replenished at about a pretty constant rate.

Okay. Thanks for answering my questions.

Thank you. One moment for our next question. Our next question comes from the line of Ben Gerlinger from Citi.

Hey, good morning.

Good morning.

Hey, Ben.

I apologize for the confusion. There were a lot of calls this morning, so it seems you all had a solid quarter. I agree with what was mentioned in the transcript, but have you provided any insights regarding your overall capital deployment strategies, such as share repurchases or the potential for significant loan growth in the future? I'm trying to understand your approach to capital, especially considering that your share price is still somewhat low. It has rebounded well, and you've also experienced strong growth, particularly in the Southeast, which seems to have a more favorable economic environment.

Leslie and I were working on the Board agenda for August just yesterday, and I asked her to include a section on capital discussions. We’re looking at a favorable situation with growth opportunities and capital build-up. My first choice is to deploy the capital and grow it profitably. If we cannot sustain that over time, we will consider buybacks. We also need to be mindful of whether the environment is suitable for buybacks. Additionally, we are very conscious of our stakeholders, particularly the rating agencies, who are sensitive to capital returns. We will discuss this in August, and I don't want to preempt any decisions that require Board authorization. Our discussion will follow the pattern we’ve established previously. For now, we’re on the sidelines, but we may take action in August or later this year. Currently, I see a solid pipeline, and deploying this capital would yield the best outcome.

Got you. Are you...

This year, we have stated that our balance sheet will not grow from the beginning to the end of the year, and I believe we will end up at that level. However, I do want to eventually grow. Not growing is not enjoyable. I shouldn't discuss next year yet, as Leslie would have my head, but I want to return to a growth phase.

Got you. Are you able to say what day the Board meeting is, so I know what date...

No. If anything happens, there'll be a press release.

Yeah, it sounds good. I'm just trying to get in front of it by about four minutes. I appreciate the time. Thank you.

Like I said, India winning the World Cup was the big cherry on a pretty decent Sunday. We're very happy with the way the quarter turned out. We're very optimistic as we look to the future. And thank you for your time this morning, and call us if you have any more detailed questions. Otherwise, we'll see you or talk to you again in three months. Bye.

This concludes today's conference call. Thank you for participating. You may now disconnect.