The bottom line of BankUnited, Inc. (NYSE: BKU) rebounded in the second quarter after the first quarter’s loss. The company reported earnings of $0.80 per share in the second quarter, which brought the first half’s earnings to $0.47 per share. The recovery in the bottom line was attributable to a plunge in provision expense, gains on sales of securities, and cost savings. The accelerated booking of fees under the Paycheck Protection Program will likely drive earnings in the second half of the year. Further, a growth in revenues from the management’s initiatives will support earnings in the last quarter. For the full year, I’m expecting BKU to report earnings of $1.92 per share, down 39% from last year. The June 2021 target price suggests a limited upside from the current market price; hence, I’m adopting a neutral rating on BKU.

BankUnited 2.0 to Drive Revenues

BKU’s non-interest expense declined by 11% quarter over quarter in the second quarter because of management’s initiatives, collectively called ‘BankUnited 2.0’. While BKU is ahead of schedule in achieving cost-savings under BankUnited 2.0, it is facing delays in achieving revenue targets. As mentioned in the second quarter’s investor presentation, the management now expects the BankUnited 2.0 revenue stream to increase in the second half of 2020. The revenue initiatives include the launch of a commercial card program, a new fee-generating partnership with Goldman Sachs (NYSE:GS) that will offer investment advisory, and the launch of an automated underwriting platform later this year.

On the other hand, non-interest income will face downward pressure from the normalization of gains on the sale of securities. BKU reported gains on sales of investment securities of $6.8 million in the second quarter of 2020 as opposed to $4.1 million in the corresponding period last year. Considering the impact of BankUnited 2.0 and the normalization of gains on sales of securities, I’m expecting non-interest income to decline by 5% sequentially in the third quarter and then increase by 0.5% sequentially each quarter through the end of 2021.

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Accelerated Booking of Paycheck Protection Program Fees to Lift Net Interest Income

BKU originated over 3,500 loans totaling $876 million under the Paycheck Protection Program, as mentioned in the presentation. Assuming fees of 2.7% and funding cost of 0.35%, PPP will likely add an estimated $21 million to net interest income over the life of the loans. The management mentioned in the second quarter’s conference call that it doesn’t expect much forgiveness of PPP loans before the fourth quarter. Hence, I’m expecting a majority of the loans to get forgiven in the fourth quarter, leading to an acceleration in the booking of the remaining PPP fees.

The forgiveness of PPP loans will likely reduce the loan balance in the remainder of this year. Excluding the impact of PPP, I’m expecting loan growth to be low as the uncertainties related to the COVID-19 pandemic will keep commercial loan demand lackluster. However, low interest rates will likely boost the demand for residential mortgages. Overall, I’m expecting the year-end loan balance to be 1.5% lower than the balance at the end of the last quarter, and 0.7% higher than the 2019-end balance. The following table shows my estimates for loans and other balance sheet items.

BankUNited Balance Sheet Forecast

Deposit Cost Decline Likely to Keep the Margin Stable

BKU’s net interest margin, NIM, increased by around 6bps in the second quarter from the first quarter of 2020. NIM will likely face pressure from asset repricing and origination of new loans in a lower interest rate environment in the year ahead. However, the management mentioned in the second quarter’s conference call that it expects the cost of deposits to decline this year and the next, which will counter the yield pressure. Moreover, BKU considerably improved its deposit mix in the second quarter, which will help ease the pressure on NIM. The non-interest-based deposits made up 18.7% of total funds at the end of the last quarter, as opposed to 15% at the end of the first quarter of 2020. Overall, I’m expecting NIM to remain unchanged in the third and fourth quarters of 2020. My expectation is more or less in line with management’s guidance given in the conference call. The following table shows my estimates for yield, cost, and NIM.

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BankUNited Net Interest Margin

Portfolio-Specific Factors to Drive Provision Expense

BKU’s provision expense plunged to $25 million in the second quarter from $125 million in the first quarter of 2020. Future loan loss reserve builds will depend on a change in the economic outlook and portfolio-specific factors. The economic forecasts the management used to determine the provisioning requirement are already very stressed; hence, I don’t expect the economic outlook to worsen any further. As mentioned in the presentation, the existing reserves incorporate an unemployment rate of 13% in the mid of 2020, which declines to 9% by the end of 2020 and 7% by the end of 2021. Further, the existing reserves incorporate a recovery in GDP growth in the third quarter of 2020 and a return to pre-recession levels in 2023. As I’m not expecting the outlook to worsen, I believe pressure on the provision expense from economic factors will likely remain subdued in the year ahead.

On the other hand, portfolio-specific factors will likely keep the provision expense above normal. BKU has high exposure to COVID-19-sensitive industries that pose credit risks. According to details given in the presentation, vulnerable industries, including hotels and franchise finance, made up 13.9% of total loans at the end of the last quarter. Moreover, BKU had to accept deferral requests on 15% of total loans, which shows the extent of debt servicing problems customers are facing.

BankUNited COVID Sensitive Industries

Considering the economic and portfolio-specific factors, I’m expecting BKU’s provision expense to remain above normal in the remainder of 2020. For the full year, I’m expecting a provision expense of $211 million, up from $9 million in 2019.

Expecting Full-Year Earnings of Around $1.92 per Share

The accelerated booking of fees under PPP and the increase in revenues from BankUnited 2.0 will likely support earnings in the year ahead. For the full year, I’m expecting BKU to report earnings of $1.92 per share, down 39% from last year. The following table shows my income statement estimates.

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BankUNited Income Forecast

Earnings may differ materially from estimates because the COVID-19 pandemic can lead to negative surprises in provision expense. BKU’s high exposure to vulnerable segments will magnify the impact of any worsening of the pandemic on the provision expense.

Limited Price Upside Justifies a Neutral Rating

I’m using the historical average price-to-tangible book multiple, P/TB, to value BKU. The stock traded at an average P/TB multiple of 0.83 in the first half of 2020. Multiplying this P/TB ratio with the projected tangible book value per share of $31.3 for June 2021 gives a target price of $25.9. This target price implies an upside of only 7% from BKU’s September 3 closing price. The following table shows the sensitivity of the target price to the P/TB multiple.

BankUNited Valuation SensitivityApart from the price upside, BKU is also offering a modest dividend yield of 3.7%, assuming the company maintains its quarterly dividend at the current level of $0.23 per share. There is little threat of a dividend cut because the earnings and dividend estimates suggest a payout ratio of 31% for the fourth quarter of 2020 and 33% for 2021, which is easily sustainable.

The limited price upside shows that the market has already priced in the positive earnings outlook. Based on the limited upside, I’m adopting a neutral rating on BKU.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Disclaimer: This article is not financial advice. Investors are expected to consider their investment objectives and constraints before investing in the stock(s) mentioned in the article.