BankUnited: Reversing Loan Loss Provisions Results In A Profit Boost
- BankUnited reported excellent Q1 results.
- This was caused by reversing a portion of previous loan loss provisions.
- The amount of non-performing loans remains manageable and the LTV ratios low.
- I don't think we'll see additional substantial reversals, but that's fine: BankUnited seems to have a good grip on the situation.
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When the COVID pandemic hit last year, most banks had to aggressively increase their loan loss provisions, which weighed on financial results. Some bank were so cautious they now have to reverse some of those provisions. BankUnited (NYSE:BKU) for instance recorded a net loan loss provision of $178M in 2020 (including a small reversal in Q4 2020) but has now reversed almost $30M of those provisions, and whereas the provisions reduced the reported net income last year, they may provide a (non-recurring) boost to this year’s earnings. Time to have a closer look at this Florida-based bank.
An outstanding net income and EPS result
In the first quarter of the current year, BankUnited generated a total interest income of $245.2M, a slight decrease from the $251M generated in the final quarter of last year. However, as the interest expenses decreased at a faster pace (both in a relative as well as an absolute interpretation), the net interest income increased by 1.5% to $196.2M.
Source: financial statements Q1 2021
The total non-interest expenses during the first quarter were approximately $93M as the expenses remained stable (at a minus 0.1%) while the bank reported a lower non-interest income due to the lower gains on the sale of loans and investment securities.
The combination of the net interest income and the net non-interest expenses results in a pre-tax and pre-loan loss provision income of $103M. In line with the $105.4M in Q4 2020 (which included a higher profit on the aforementioned sale of loans and investment securities).
That being said, BankUnited’s pre-tax income increased to $131.3M because the bank was able to reverse some of the provisions for loan losses it recorded in 2020. In the first quarter of this year, the bank added $28M in previous provisions back to the income statement resulting in an exceptionally strong pre-tax income and net income of, respectively, $131.3M and $98.8M. The EPS in the first quarter came in at $1.06/share.
Can we expect more provision reversals this year?
And this shines a new light on the banking sector. Most banks were able to keep their loan losses and loan loss provisions relatively limited in 2020, and banks that took swift action, like BankUnited, are now in the position to reverse some of the provisions.
Source: company presentation
To understand why the bank feels sufficiently confident to reverse the provisions, we need to have a closer look at the structure of the loan book and the total amount of loan loss provisions. As you can see below, a large portion of the BankUnited loan book actually consists of residential mortgages. Those mortgages, and the PPP loans, could be considered low-risk assets. Sure, defaults are still absolutely possible, but as the economy is firing up again, job losses and thus mortgage payment defaults should remain relatively limited.
Source: quarterly update BankUnited
And keep in mind that even if a borrower defaults, it doesn’t mean the bank will lose its entire investment. As you can see on the image below, almost 60% of the residential loans has an LTV ratio of less than 70%.
Source: Company presentation
We see a similar situation in the Commercial Real Estate segment. The $6.7B in loans in this segment have an average LTV ratio of less than 60%. This means that the $6.7B in loans are backed by in excess of $11B in collateral. Does this mean the bank won’t make any losses when there’s a default? Obviously not. But it does mean those losses should be relatively limited given the relatively LTV ratio.
Source: company presentation
So we have established a large portion of the loans is backed by plenty of collateral. Let’s now have a look at how much of the loan book is actually past due at this point.
Source: quarterly update
As of the end of March, a total of $233.6M of the loans were deemed non-performing, an additional $126M were under short-term deferral regimes while an additional $636M of the loans is subject to CARES Act modification. The total amount of non-performing loans hasn’t really gone up much compared to the end of 2019 (pre-COVID) as you can see below:
Source: company presentation
That also likely is the reason why BankUnited seems to be fine with a loan loss provision of just over $220M, which represents approximately 95% of the total amount of non-performing loans. Given the more than acceptable LTV ratios of the loans, this should be sufficient although the short-term deferrals and the CARES Act modified loans could be the sword of Damocles.
That being said, BankUnited’s management obviously has a better idea of how "dangerous" those loans are and would not have reversed a portion of last year’s loan loss provisions if it wasn’t confident the loan losses would remain limited. Perhaps this also means we shouldn’t expect to see BankUnited reversing more provisions later this year until the dust has settled a little bit more.
In any case, it’s good to see some of the smaller banks are also now reversing earlier provisions, but that doesn’t make me a buyer of BankUnited yet. Trading at about 13 times its normalized net income and about 1.5 times its tangible book value, I’m on the sidelines for now. But the strong loan book intrigues me and I’ll for sure keep an eye on this bank.
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