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| BKU > SEC Filings for BKU > Form 10-K on 25-Feb-2013 | All Recent SEC Filings |
25-Feb-2013
Annual Report
The following discussion and analysis is intended to assist readers in understanding the consolidated financial condition and results of operations of BankUnited, Inc. and its subsidiaries (the "Company", "we", "us" and "our") and should be read in conjunction with the consolidated financial statements, accompanying footnotes and supplemental financial data included herein. In addition to historical information, this discussion contains forward-looking statements that involve risks, uncertainties and assumptions that could cause actual results to differ materially from management's expectations. Factors that could cause such differences are discussed in the sections entitled "Forward-looking Statements" and "Risk Factors." We assume no obligation to update any of these forward-looking statements.
Overview
In evaluating our financial performance, we consider the level of and trends in net interest income, the net interest margin and interest rate spread, the allowance and provision for loan losses, performance ratios such as the return on average assets and return on average equity, asset quality ratios including the ratio of non-performing loans to total loans, non-performing assets to total assets, and portfolio delinquency and charge-off trends. We consider growth in the loan portfolio and trends in deposit mix. We analyze these ratios and trends against our own historical performance, our budgeted performance and the financial condition and performance of comparable financial institutions in our region and nationally.
Performance highlights include:
º •
º Net income for the year ended December 31, 2012 was $211.3 million or
$2.05 per diluted share, compared to $63.2 million or $0.62 per
diluted share for the year ended December 31, 2011. Earnings for 2012
generated a return on average stockholders' equity of 12.45% and a
return on average assets of 1.71%. Results for 2011 reflected a
one-time charge of $110.4 million recorded in conjunction with the
Company's IPO.
º •
º Net interest income for 2012 was $597.6 million, an increase of
$98.4 million over the prior year. The net interest margin, calculated
on a tax-equivalent basis, decreased to 6.04% for 2012 from 6.21% for
2011. The decline in the net interest margin resulted from a decrease
in the average yield on interest earning assets, partially offset by a
decrease in the average rate paid on interest bearing liabilities. The
primary driver of the decrease in the average yield on interest
earning assets was a shift in the composition of the loan portfolio
away from higher yielding covered loans into new loans originated at
lower current market rates of interest. The decrease in the average
rate paid on interest bearing liabilities resulted from declines in
market interest rates and a continued shift in deposit mix into lower
cost deposit products. The following chart provides a comparison of
net interest margin, the interest rate spread, the average yield on
interest earning assets and the average rate paid on interest bearing liabilities for the years ended December 31, 2012 and 2011 (on a tax-equivalent basis):
[[Image Removed: GRAPHIC]]
º •
º We completed the acquisition of Herald on February 29, 2012 for a
purchase price of $65.0 million. At the date of acquisition, Herald
had total loans of $306.0 million, total investment securities of
$161.0 million and total deposits of $435.5 million.
º •
º Strong loan growth continued. New loans increased by $2.0 billion in
2012 to $3.7 billion. New loan growth in 2012 outpaced the resolution
of covered loans, resulting in net growth in the total loan portfolio.
New loan growth was concentrated in the commercial portfolio segment,
commensurate with our core business strategy. The following charts
compare the composition of our loan portfolio at December 31, 2012 and
2011: [[Image Removed: GRAPHIC]]
º •
º Total deposits grew by $1.2 billion to $8.5 billion while demand
deposits increased to 22% of total deposits at December 31, 2012. The
following charts illustrate the composition of deposits at
December 31, 2012 and 2011: [[Image Removed: GRAPHIC]]
º •
º Asset quality remains strong. At December 31, 2012, 97% of the new
commercial loan portfolio was rated "pass" and 99% of the new
residential portfolio was current. The ratio of non-performing,
non-covered loans to total non-covered loans was 0.43% at December 31,
2012. Credit risk related to the covered loans is significantly
mitigated by the Loss Sharing Agreements.
º •
º The Company's capital ratios exceed all regulatory "well capitalized"
guidelines. The charts below present the Company's regulatory capital
ratios compared to regulatory guidelines as of December 31, 2012 and
2011: [[Image Removed: GRAPHIC]]
Management has identified significant opportunities for our Company, including:
º •
º Our capital position, market presence and experienced lending team
position us well for continued organic growth in Florida and the
Tri-State market. In addition to our core commercial banking
franchise, we are building an in-house residential origination channel
and have entered the indirect auto and taxi medallion lending
businesses.
º •
º Planned expansion of our branch footprint, including three branches in
Manhattan scheduled to open in the first quarter of 2013.
º •
º Potential growth through strategic acquisitions of financial
institutions and complementary businesses.
º •
º The potential to take advantage of lower market interest rates and the
ability to shift deposits into lower cost products to further reduce
our cost of funds.
º •
º The continued enhancement of our infrastructure and technology
platforms will enable us to expand product offerings to our customers
and increase operational efficiency.
We have also identified significant challenges confronting the industry and our Company:
º •
º The current low interest rate environment is likely to put pressure on
our net interest margin, particularly as higher-yielding covered
assets are liquidated or mature and are replaced with assets
originated or purchased at current market rates of interest.
º •
º Economic conditions in the Florida market, while improving, remain
under stress. Continued economic stress may lead to elevated levels of
non-performing assets or impact our ability to sustain the trajectory
of new loan growth.
º •
º Management expects that the Company and the banking industry as a
whole may be required by market forces and/or regulation to operate
with higher capital ratios than in the recent past.
º •
º Uncertainty about the full impact of new regulation may present
challenges in the execution of our business strategy and the
management of non-interest expense. For additional discussion, see
"Regulation and Supervision."
Impact of Acquisition Accounting, ACI Loan Accounting and the Loss Sharing Agreements
The application of acquisition accounting, accounting for loans acquired with evidence of deterioration in credit quality since origination ("ACI" or "Acquired Credit Impaired" loans) and the provisions of the Loss Sharing Agreements have had a material impact on our financial condition and results of operations. The more significant ways in which our financial statements have been impacted are summarized below and discussed in more detail throughout this "Management's Discussion and Analysis of Financial Condition and Results of Operations":
º •
º Under the acquisition method of accounting, all of the assets acquired
and liabilities assumed in the FSB Acquisition were initially recorded
on the consolidated balance sheet at their estimated fair values as of
May 21, 2009. These estimated fair values differed materially from the
carrying amounts of many of the assets acquired and liabilities
assumed as reflected in the financial statements of the Failed Bank
immediately prior to the FSB Acquisition. In particular, the carrying
amount of investment securities, loans, the FDIC indemnification
asset, goodwill and other intangible assets, net deferred tax assets,
deposit liabilities, and FHLB advances were materially impacted by
these adjustments, which continue to affect the reported amounts of
such assets and liabilities;
º •
º Interest income, interest expense and the net interest margin reflect
the impact of accretion of the fair value adjustments made to the
carrying amounts of interest earning assets and interest bearing
liabilities in conjunction with the FSB Acquisition;
º •
º The estimated fair value at which the acquired loans were initially
recorded by the Company was significantly less than the unpaid
principal balances of the loans. No allowance for loan and lease
losses was recorded with respect to acquired loans at the FSB
Acquisition date. The write-down of loans to fair value in conjunction
with the application of acquisition accounting and credit protection
provided by the Loss Sharing Agreements reduces the impact of the
provision for loan losses related to the acquired loans on the results
of operations;
º •
º Acquired investment securities were recorded at their estimated fair
values at the FSB Acquisition date, significantly reducing the
potential for other-than-temporary impairment charges in periods
subsequent to the FSB Acquisition for the acquired securities. Certain
of the acquired investment securities are covered under the Loss
Sharing Agreements. The impact on results of operations of any future
other-than-temporary impairment charges related to covered securities
would be significantly mitigated by indemnification by the FDIC;
º •
º An indemnification asset related to the Loss Sharing Agreements with
the FDIC was recorded in conjunction with the FSB Acquisition. The
Loss Sharing Agreements afford the Company significant protection
against future credit losses related to covered assets;
º •
º Non-interest income includes the effect of accretion of discount on
the indemnification asset;
º •
º Non-interest income includes gains and losses associated with the
resolution of covered assets and the related effect of indemnification
under the terms of the Loss Sharing Agreements. The
impact of gains or losses related to transactions in covered loans and other real estate owned is significantly mitigated by indemnification by the FDIC;
º •
º ACI loans that are contractually delinquent may not be reflected as
nonaccrual loans or non-performing assets due to the accounting
treatment accorded such loans under Accounting Standards Codification
("ASC") section 310-30, "Loans and Debt Securities Acquired with
Deteriorated Credit Quality."
These factors may impact the comparability of our financial performance to that of other financial institutions.
Critical Accounting Policies and Estimates
Our consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles and follow general practices within the banking industry. Application of these principles requires management to make complex and subjective estimates and judgments that affect the amounts reported in the consolidated financial statements and accompanying notes. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable and appropriate under current circumstances. These assumptions form the basis for our judgments about the carrying values of assets and liabilities that are not readily available from independent, objective sources. We evaluate our estimates on an ongoing basis. Use of alternative assumptions may have resulted in significantly different estimates. Actual results may differ from these estimates.
Accounting policies are an integral part of our financial statements. A thorough understanding of these accounting policies is essential when reviewing our reported results of operations and our financial position. We believe that the critical accounting policies and estimates discussed below involve a heightened level of management judgment due to the complexity, subjectivity and sensitivity involved in their application.
Note 1 to the consolidated financial statements contains a further
discussion of our significant accounting policies.
The allowance for loan and lease losses ("ALLL") represents management's estimate of probable loan losses inherent in the Company's loan portfolio. Determining the amount of the ALLL is considered a critical accounting estimate because of its complexity and because it requires significant judgment and estimation. Estimates that are particularly susceptible to change that may have a material impact on the amount of the ALLL include:
º •
º the amount and timing of expected future cash flows from ACI loans and
impaired loans;
º •
º the value of underlying collateral, which impacts loss severity and
certain cash flow assumptions;
º •
º the selection of peer banks used to calculate loss factors;
º •
º estimated losses based on risk characteristics and risk rating of
loans; and
º •
º our assessment of qualitative factors.
Note 1 of the notes to our consolidated financial statements describes the
methodology used to determine the ALLL.
A significant portion of the covered loans are ACI Loans. The accounting for ACI loans requires the Company to estimate the timing and amount of cash flows to be collected from these loans and to
continually update estimates of the cash flows expected to be collected over the lives of the loans. Similarly, the accounting for the FDIC indemnification asset requires the Company to estimate the timing and amount of cash flows to be received from the FDIC in reimbursement for losses and expenses related to the covered loans; these estimates are directly related to estimates of cash flows to be received from the covered loans. Estimated cash flows impact the rate of accretion on covered loans and the FDIC indemnification asset as well as the amount of any ALLL to be established related to the covered loans. These cash flow estimates are considered to be critical accounting estimates because they involve significant judgment and assumptions as to their amount and timing.
Covered 1-4 single family residential and home equity loans were placed into homogenous pools at the time of the FSB Acquisition; the ongoing credit quality and performance of these loans is monitored on a pool basis and expected cash flows are estimated on a pool basis. At acquisition, the fair value of the pools was measured based on the expected cash flows to be derived from each pool. For ACI pools, the difference between total contractual payments due and the cash flows expected to be received at acquisition was recognized as non-accretable difference. The excess of expected cash flows over the recorded fair value of each ACI pool at acquisition was recognized as accretable yield. The accretable yield is recognized as interest income over the life of each pool.
We monitor the pools quarterly by updating our expected cash flows to determine whether any changes have occurred in expected cash flows that would be indicative of impairment or necessitate reclassification between non-accretable difference and accretable yield. Initial and ongoing cash flow expectations incorporate significant assumptions regarding prepayment rates, the timing of resolution of loans, frequency of default, delinquency and loss severity, which is dependent on estimates of underlying collateral values. Changes in these assumptions could have a potentially material impact on the amount of the ALLL related to the covered loans as well as on the rate of accretion on these loans. Prepayment, delinquency and default curves used to forecast pool cash flows are derived from roll rates generated from the historical performance of the ACI residential loan portfolio observed over the immediately preceding four quarters. Generally, improvements in expected cash flows less than 1% of the expected cash flows from a pool are not recorded. This threshold is judgmentally determined.
Generally, commercial loans are monitored and expected cash flows updated at the individual loan level due to the size and other unique characteristics of these loans. The expected cash flows are estimated based on judgments and assumptions which include credit risk grades established in the Bank's ongoing credit review program, likelihood of default based on observations of specific loans during the credit review process as well as applicable industry data, loss severity based on updated evaluations of cash flows from available collateral, and the contractual terms of the underlying loan agreements. Changes in the assumptions that impact forecasted cash flows could result in a potentially material change to the amount of the ALLL or the rate of accretion on these loans.
The estimated cash flows from the FDIC indemnification asset are sensitive to changes in the same assumptions that impact expected cash flows on covered loans. Estimated cash flows impact the rate of accretion on the FDIC indemnification asset.
Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at the fair value of the collateral at the date of foreclosure based on estimates, including some obtained from third parties, less estimated costs to sell, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed, and the assets are carried at the lower of cost or fair value less estimated costs to sell. Significant property improvements that enhance the salability of the property are capitalized to the extent that the carrying value does not exceed estimated realizable value. Legal fees, maintenance and other direct costs of foreclosed properties are expensed as incurred. Given the large number of OREO properties and the judgment involved in estimating fair value of the properties,
accounting for OREO is regarded as a critical accounting policy. Estimates of value of OREO properties are typically based on real estate appraisals performed by independent appraisers. In some cases, if an appraisal is not available, values may be based on brokers' price opinions. These values are generally updated as appraisals become available.
Prior to the consummation of the IPO, BUFH had issued equity awards in the form of Profits Interest Units ("PIUs") to certain members of management. Compensation expense related to PIUs was based on the fair value of the underlying units on the date of the consolidated financial statements. At the time of the IPO, the PIUs were exchanged for a combination of vested and unvested shares and vested and unvested options. The fair value of PIUs and options issued in exchange for PIUs was estimated using a Black-Scholes option pricing model, which incorporated significant assumptions as to expected volatility, dividends, terms, risk free rates and, prior to the IPO, equity value per share. Changes in these underlying assumptions would have had a potentially material effect on the values assigned to these instruments. Determining the fair value of the PIUs and the options issued in exchange for the PIUs is considered a critical accounting estimate because it requires significant judgments and because of the potential materiality of the amounts involved. See Notes 1 and 17 to our consolidated financial statements for further information about equity based compensation awards and the techniques used to value them.
The Company measures certain of its assets and liabilities at fair value on a recurring or non-recurring basis. Assets and liabilities measured at fair value on a recurring basis include investment securities available for sale, derivative instruments and, for periods prior to the IPO, the liability for PIUs. Assets that may be measured at fair value on a non-recurring basis include OREO, impaired loans, loans held for sale, intangible assets and assets acquired and liabilities assumed in business combinations. The consolidated financial statements also include disclosures about the fair value of financial instruments that are not recorded at fair value.
Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. Inputs used to determine fair value measurements are prioritized into a three level hierarchy based on observability and transparency of the inputs, summarized as follows:
Level 1-observable inputs that reflect quoted prices in active markets,
Level 2-inputs other than quoted prices in active markets that are based on observable market data, and
Level 3-unobservable inputs requiring significant management judgment or estimation.
When observable market inputs are not available, fair value is estimated using modeling techniques such as discounted cash flow analyses and option pricing models. These modeling techniques utilize assumptions that we believe market participants would use in pricing the asset or the liability.
Particularly for estimated fair values of assets and liabilities categorized within level 3 of the fair value hierarchy, the selection of different valuation techniques or underlying assumptions could result in fair value estimates that are higher or lower than the amounts recorded or disclosed in our consolidated financial statements. Considerable judgment may be involved in determining the amount that is most representative of fair value.
Because of the degree of judgment involved in selecting valuation techniques and underlying assumptions, fair value measurements are considered critical accounting estimates.
Notes 1, 4, and 20 to our consolidated financial statements contain further information about fair value estimates.
Recent Accounting Pronouncements
See Note 1 to our consolidated financial statements for a discussion of recent accounting pronouncements.
Results of Operations
Net interest income is the difference between interest earned on interest earning assets and interest incurred on interest bearing liabilities and is the primary driver of core earnings. Net interest income is impacted by the relative mix of interest earning assets and interest bearing liabilities, the ratio of interest earning assets to total assets and of interest bearing liabilities to total funding sources, movements in market interest rates, levels of non-performing assets and pricing pressure from competitors.
The mix of interest earning assets is influenced by loan demand and by management's continual assessment of the rate of return and relative risk associated with various classes of earning assets. The mix of interest bearing liabilities is influenced by management's assessment of the need for lower cost funding sources weighed against relationships with customers and growth requirements and is impacted by competition for deposits in the Company's markets and the availability and pricing of other sources of funds.
Net interest income is also impacted by the accounting for ACI loans and to a declining extent, the accretion of fair value adjustments recorded in conjunction with the FSB Acquisition. ACI loans were initially recorded at fair value, measured based on the present value of expected cash flows. The excess of expected cash flows over carrying value, known as accretable yield, is recognized as interest income over the lives of the underlying loans. Accretion related to ACI loans has a positive impact on our net interest income, net interest margin and interest rate spread. The impact of accretion related to ACI loans on net interest income, the net interest margin and the interest rate spread is expected to continue to decline as ACI loans comprise a declining percentage of total loans. The proportion of total loans represented by ACI loans will decline as the ACI loans are resolved and new loans are added to the portfolio. ACI loans represented 29.1%, 50.8% and 76.3% of total loans, net of premiums, discounts, deferred fees and costs, at December 31, 2012, 2011 and 2010, respectively. As the impact of accretion related to ACI loans declines, we expect our net interest margin and interest rate spread to decrease.
Payments received in excess of expected cash flows may result in a pool of ACI residential loans becoming fully amortized and its carrying value reduced to zero even though outstanding contractual balances remain related to loans in the pool. Once the carrying value of a pool is reduced to zero, any future proceeds from the remaining loans are recognized as interest income upon receipt. The carrying value of one pool was reduced to zero in late 2011. Future expected cash flows from this pool totaled $105.6 million as of December 31, 2012. The UPB of loans remaining in this pool was $213.9 million at December 31, 2012. The timing of receipt of proceeds from loans in this pool may be unpredictable, leading to increased volatility in the yield on the pool.
Fair value adjustments of interest earning assets and interest bearing liabilities recorded at the time of the FSB Acquisition are accreted to interest income or expense over the lives of the related assets or liabilities. Generally, accretion of these fair value adjustments increases interest income and
decreases interest expense, and thus has a positive impact on our net interest income, net interest margin and interest rate spread. The impact of accretion of fair value adjustments on interest income and interest expense will continue to decline as these assets and liabilities mature or are repaid and constitute a smaller portion of total interest earning assets and interest bearing liabilities.
The impact of accretion and ACI loan accounting on net interest income makes it difficult to compare our net interest margin and interest rate spread to those reported by other financial institutions.
The following tables present, for the years ended December 31, 2012, 2011 and 2010, information about (i) average balances, the total dollar amount of taxable equivalent interest income from earning assets and the resultant average yields; (ii) average balances, the total dollar amount of interest expense on interest bearing liabilities and the resultant average rates; (iii) net interest . . .
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