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Edited Transcript of BKU earnings conference call or presentation 23-Oct-19 1:00pm GMT

Q3 2019 BankUnited Inc Earnings Call

Coral Gables Nov 11, 2019 (Thomson StreetEvents) -- Edited Transcript of BankUnited Inc earnings conference call or presentation Wednesday, October 23, 2019 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Leslie N. Lunak

BankUnited, Inc. - CFO

* Rajinder P. Singh

BankUnited, Inc. - Founder, Chairman, President & CEO

* Thomas M. Cornish

BankUnited, Inc. - COO

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Conference Call Participants

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* Alex Lau

JP Morgan Chase & Co, Research Division - Research Analyst

* Brady Matthew Gailey

Keefe, Bruyette, & Woods, Inc., Research Division - MD

* Christopher William Marinac

Janney Montgomery Scott LLC, Research Division - Director of Research and Banks & Thrifts Analyst

* David Jason Bishop

D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst

* David John Chiaverini

Wedbush Securities Inc., Research Division - Senior Analyst

* Ebrahim Huseini Poonawala

BofA Merrill Lynch, Research Division - Director

* Jared David Wesley Shaw

Wells Fargo Securities, LLC, Research Division - MD & Senior Analyst

* Lana Chan

BMO Capital Markets Equity Research - MD & Senior Equity Analyst

* Tyler Stafford

Stephens Inc., Research Division - MD

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Presentation

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Operator [1]

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Welcome to the BankUnited, Inc. 2019 Third Quarter Earnings Conference Call.

On the call this morning from BankUnited are Raj Singh, Chairman, President and CEO; Leslie Lunak, Chief Financial Officer; and Tom Cornish, Chief Operating Officer.

Before we start, the company would like to remind everyone that this call contains forward-looking statements within the meaning of the U.S. securities laws. Forward-looking statements are subject to risks, uncertainties and assumptions and actual results may vary materially from those indicated in these statements. Additional information concerning factors that could cause actual results to differ materially from those indicated by the forward-looking statements can be found in the company's earnings release and SEC filings. The company does not undertake any obligation to update or revise any such forward-looking statements now or at any time in the future.

With that, I'd like to turn the call over to Mr. Singh.

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Rajinder P. Singh, BankUnited, Inc. - Founder, Chairman, President & CEO [2]

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Thank you so much. Welcome, everyone, to our earnings call. Thank you for joining us.

We've had another strong earnings quarter with very strong earnings from EPS growth. We reported this morning $76.2 million of net income, $0.70 per share EPS. I think this time last year, we had EPS of $0.90, but that included loss share, and if you've carved out loss-share earnings, we were at $0.64. So $0.64 last year compared to $0.77 this year represents about 20% growth in these earnings, which I'm very happy about. Given the environment that we're in, that's pretty good progress.

Happy to announce the increase in cost of funds that curve has now turned, officially turned. Cost of deposits came down 3 basis points this quarter to 167 basis points. And this is a small amount payment on what we expect to be a meaningful acceleration in the downward trajectory of deposit cost. And I say that not even taking into account more rate cuts, which we are pretty sure -- the market is pretty sure there will be at least one more later this month and probably a second one in December. But even if those don't happen, we expect deposit cost to come down meaningfully based on the actions that we've already taken.

Let me -- usually, I start these calls with a comment about the environment. So let me just go back and talk a little bit about things we don't control, i.e. the environment. The economy stays -- from our record point stays healthy. So I -- there's -- or maybe there's a 2-part way to look at this. When we look at mainstream, i.e. look at our loan portfolio, things look pretty solid. When you look at Wall Street, there are obviously a lot of signs to be concerned about as we head into the next year. So we're paying attention to both those things and being cautious and not trying to take on excessive risk, but that's sort of the way we're seeing the landscape right now.

The interest rate environment remains challenging. I sound like a broken record, but for the last, God knows how many quarters, it's been challenging and it keeps getting more challenging. Right now, the -- I think this entire quarter, the curve was inverted. Now the Fed has moved twice already, it's about to move another time in the next few days, and that will probably, at best bring us back to a flat curve, but nevertheless, it's a challenging environment for margin interest rate.

In light of what we're seeing with the short end of the curve coming down, we have been taking a very defensive view of trying to grow money market and savings as is evident in our growth numbers. Deposits grew only marginally this quarter. And if you look at for the entire year, all of our growth really came from DDA, which obviously is, at the end of the day, what this game is all about.

Loan growth was at $253 million and there -- Tom will walk you through. Some parts of the bank came in very, very aggressively, other parts of the bank sought run-off enough, but that's -- again, just changes quarter by quarter. But $253 million of loan growth for the year, I think we're at about a little over $1 billion, taking into account that we did sell $168 million in Pinnacle loans that we told you about last quarter.

In terms of BankUnited 2.0, I wanted to give a quick update on that as well. We had come back -- come to you, I think, in April and laid out plans for the next 2 years as to what 2.0 would be about and given you some targets. We are very comfortable where we see them today. We still think it's a $60 billion (sic) bogey, $40 million in cost and $20 million in revenue lift. The update that I would have for you now 6 months into implementing this is that on the expense side, we are probably just a tad bit ahead in terms of timing. And on the revenue side, we're probably a tad bit behind. Overall, if you combine it, we're right on where we said it would be that 2021, the total benefit would be about $60 billion. So I -- we feel even more comfortable today than we did 6 months ago as we were just embarking on this journey. Today, we're pretty far down and feeling pretty good about it. Again, Tom, you can feel free to give more color around that.

But margin contracted, like I said, given the interest rate environment came down from 2.52% last quarter to 2.41%. I'll let Leslie to talk a little bit about that and talk in terms of what happened to deposit cost, which she'll walk you through the asset yield side of it. Credit, NPAs, NPL ratios, all fairly steady. I think they were down. NPLs were down 1 basis point, NPAs were down 2 basis points. Charge-offs stayed at about 6 basis points. There was a $73 million uptake in criticized and classified loans. $42 million of that is one relationship in C&I Florida. It's not an industry-wide issue. It is an issue that is unique to that particular borrower, and that loan is in the workout. The rest are a bunch of other loans, but it's that one $42 million loan that I wanted to mention.

We did finish our $150 million buyback and announced -- another $150 million buyback was announced in August, and we will be working on that over the course of next few weeks or few months. With that, I will turn it over to Tom.

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Thomas M. Cornish, BankUnited, Inc. - COO [3]

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Okay. Thank you, Raj. I wanted to give you just a little bit more detail on some of the BankUnited 2.0 initiatives that Raj mentioned. We have essentially completed our realignment of the commercial lending and credit and support teams into a more customer-centric and less geographic-centered silo. We expect this to be an excellent go-to-market strategy for us, giving us an ability to better leverage our specific areas of expertise across the company, our practice group strategies and whatnot across the entire organization and also to develop a great deal of more operational efficiencies.

Despite the challenging environment that Raj mentioned, continuing investment in strengthening of the sales teams across our industry verticals and business segments is really helping us deliver good-quality production in the areas that we are really focused on from a growth perspective. We're also seeing, as part of the revenue initiatives in 2.0, very early strong progress as it relates to treasury management sales, deepening relationships, expanded number of products per client and our revenue trends in that area have been ahead expectations, and we're very happy about that.

One of the major things we did in these past quarters is we launched a new commercial lending team in the Atlanta market. We think Atlanta's got great prospects for us. It's a wonderful middle market, one of the largest middle-market segments in the U.S. We traditionally had some lending corporate banking business in the Georgia market, and we've hired a team in Atlanta that opened up an office a few weeks ago. And we're very optimistic about the opportunities for us both from a loan and deposit side in the Atlanta market.

A little bit of more color on the loan and lease growth. As Raj mentioned, loan growth of $253 million for the quarter was driven by growth of $341 million in mortgage warehouse outstandings. They really had a grand slam quarter. It was a great quarter for that team, both in terms of overall growth and growth in commitments. The residential portfolio grew by $308 million, $182 million of which was in the Ginnie Mae early buyout portfolio. In some of our core commercial areas, we did see runoff in most of these areas. In CRE, we were down in multifamily $162 million. Most of that was in the New York multifamily market and a good portion of it was in the rent-regulated market that's going through a significant amount of change recently. We're down $120 million in other CRE and our C&Is businesses, we're down $84 million.

Overall, the production for the quarter was good. It was in line with what we expected, but we're continuing to see a great deal of pay-offs in some of these segments. In BFG, we're up modestly, and we had some moderate runoff in the Pinnacle portfolio. Deposits grew by $34 million for the quarter, as Raj mentioned, $27 million of which was noninterest DDA. At the end of the quarter, we had a bit of atypical volatility in a few large commercial DDA accounts by quarter end.

But I would say, just sort of in closing, as we look at the next couple of quarters, we think that the loan and deposit pipelines look good and actually October started out well in terms of new fundings and transactional volume that we've seen.

So with that, I'll turn it over to Leslie.

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Leslie N. Lunak, BankUnited, Inc. - CFO [4]

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Thanks, Tom. I'll start by taking a few minutes to talk about net interest income. Net interest income declined by $66.3 million compared to the third quarter of the prior year while the NIM decreased to 2.41% from 3.51%. These decreases were expected given the termination of the loss-share agreement and final portfolio sale of covered loans in Q4 of 2018. The NIM declined 11 basis points from 2.52% for the prior quarter ended June 30 to 2.41% this quarter. This is mainly due to declines in the cost of deposits lagging declines in yields on interest-earning assets, to some extent LIBOR, front-leading Fed funds in terms of the rate of decline. The impact of accelerated prepayments on residential loans purchased at a premium and on mortgage-backed securities impacted the NIM by 7 basis points for the quarter. So 7 of the 11 basis points in decline were due to that, and most of that came from the residential portfolio accelerated premium amortization there.

The yields on loans was 4.43% this quarter, down from 4.52% for the immediately preceding quarter. The most impactful driver of that decline was coupon resets on floating-rate loans, most of which were tied to 1-month LIBOR. Although pay-offs of loans at higher rates than the portfolio average also contributed to that. The yield on loans for the third quarter of the prior year was 5.47%. The decline from the prior year, as you would expect, is primarily attributable to the expiration in loss-share agreement and the covered loan sale. The yields on the investment portfolio was flat compared to the third quarter of the prior year, but decreased to 3.40% from 3.61% linked quarter. That decline was due to a combination of coupon resets, lower reinvestment rates and retrospective accounting adjustments, which accounted for 6 basis points of the decline. Duration of the portfolio remains low at 1.41%. Our current expectation is that the NIM will stabilize next quarter, maybe down 1 basis point or 2, but we shouldn't see the kind of decline we saw this quarter. For the full year, we think we'll land somewhere between 2.45% and 2.50%. Obviously, all of that is dependent on assumptions we're making about deposit repricing. And our estimates are based on the consensus forward curve, which, at that time we put this together, called for a high probability of a cut in October and a more modest probability of another cut in December, which would have a minimal impact on the quarter in any case.

A couple of comments on unusual items included in noninterest income and expense for this quarter. The gain on sale of loans for the quarter included about $2.4 million in gains related to the sales of Pinnacle loans that we moved to held for sale at the end of last quarter. We took a loss of $3.8 million this quarter related to the extinguishment of some higher-cost FHLB advances as those FHLB advances had a weighted average rate of 2.72%. And we also had a $2.4 million loss on the sale of one commercial OREO property this quarter. So all of those a little bit unusual.

I want to take a couple of minutes to talk about CECL and give some guidance about what we expect the impact of CECL to be. So we're currently in parallel run. And based on our current portfolio mix, our economic forecast and other assumptions, we expect the reserve to increase a range of 15% to 30%, so we expect a 15% to 30% increase in the allowance for credit losses. And that will lead to us having a ratio of the allowance to total loans in the range of 55 to 62 basis points compared to the current 47 basis points. We also expect a few million increase in the reserve for unfunded commitments, probably $5 million to $7 million. The increase in the reserves is primarily related to the transition from an incurred loss model to an expected loss model and providing for lifetime losses rather than incurred losses, which we estimate today generally using a 12-month loss emergence period.

Obviously, all of these estimates are dependent on economic conditions at the time of the implementation. Any updates to our economic forecast, changes in portfolio mix and further review and refinement of our models and methodologies over the course of the first -- fourth quarter. We do expect increased volatility in our allowance estimates and our provisioning after implementation.

A couple words on expenses. Noninterest expense for the quarter and 9 months ended September 30 included $2 million and $14.5 million, respectively, of costs specifically related to BankUnited 2.0. Most of that's professional fees as well as some severance and branch closure costs. For the full year 2019 compared to 2018, we expect total operating expense to be down about 3% to 4%. To remind you, BU 2.0 was in the implementation phase. If we have not done BankUnited 2.0, that probably would have been a 4% to 5% increase in OpEx. So in total, that's about an 8% swing on $500 million worth of expenses. So we're pretty happy about that. To be clear about how I'm calculating those numbers, my numbers exclude the onetime costs related to BU 2.0 implementation, they exclude FDIC asset amortization for 2018 and I also am not including depreciation of the equipment under operating lease, which we don't really view as an operating expense and that will fluctuate with the size of the portfolio. We also do expect noninterest expense to continue to decline from 2019 to 2020. We are in the middle of the budgeting season right now, so we'll about specific guidance about the pace and amount of those expected declines on our next call.

And with that, I will turn it back over to Raj for any closing remarks.

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Rajinder P. Singh, BankUnited, Inc. - Founder, Chairman, President & CEO [5]

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All right. Before turning it over to questions, I'll again say, very happy with the way the earnings came out. I think it's -- we're a few cents ahead of consensus estimates, which is always good. 20% increase in core earnings from last year to this year -- for this particular quarter is not bad given the environment. And sort of leaning in and growing aggressively, we're choosing to wait it out, especially on the deposit side. And when rates were going up, the mantra and the bank used to be let's try and get in front of the Fed rate hike that is coming. And until very recently, that -- everybody used to be scrambling, trying to be a month or 2 ahead and say let's put on deposits now because the cost is going up. And that sentiments has totally reversed itself and now everyone in the bank is talking about let's just wait this out because we know rates are going to be lower next month or next quarter and the focus totally is on DDA growth. The fact that we grew deposits $482 million for the year -- for 9 months of the year, and $506 million of that $482 million is DDA says it all that our focus is totally on DDA growth, which is eventually a long-term success driver.

So with that, I will turn it over for Q&A. Operator, let's start.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Brady Gailey with KBW.

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Brady Matthew Gailey, Keefe, Bruyette, & Woods, Inc., Research Division - MD [2]

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I wanted to start -- thank you for the CECL guidance, Leslie. But I wanted to ask, do you still have a fairly elevated yield of over 30% on those -- your previously FDIC-covered loans? I know, CECL, for some banks can impact that level of accretion. For BankUnited, do you expect any sort of impact to the yield on those previously covered loans?

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Leslie N. Lunak, BankUnited, Inc. - CFO [3]

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I do not expect the impact to be material.

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Brady Matthew Gailey, Keefe, Bruyette, & Woods, Inc., Research Division - MD [4]

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Okay. And where did those loans stand in the third quarter? I know they've been shrinking, they were around $180 million last quarter.

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Leslie N. Lunak, BankUnited, Inc. - CFO [5]

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Yes. I believe the number at the end of the third quarter -- I have it in my notes here, I'm just going to check, I believe it's $171 million and a yield of 35.49% for the third quarter.

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Brady Matthew Gailey, Keefe, Bruyette, & Woods, Inc., Research Division - MD [6]

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Okay. And then Raj, I heard in your opening comments, you talked about how classified and criticized were up a little bit. You mentioned the $42 million loan. What -- can you just go over with? How much did that increase by? And where are those levels as of the end of the quarter?

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Rajinder P. Singh, BankUnited, Inc. - Founder, Chairman, President & CEO [7]

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I think we're at 1.9% for the bank.

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Leslie N. Lunak, BankUnited, Inc. - CFO [8]

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Yes.

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Rajinder P. Singh, BankUnited, Inc. - Founder, Chairman, President & CEO [9]

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So overall number is pretty modest, but it did increase by a little over $70 million, mostly had to do with that one loan, which we've had on our books for -- this client has been with us for...

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Thomas M. Cornish, BankUnited, Inc. - COO [10]

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7 years.

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Rajinder P. Singh, BankUnited, Inc. - Founder, Chairman, President & CEO [11]

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7 years -- 7, 8 years something like that. And just made a bunch of bad decisions over the last 1.5 years, and they're paying for it and so are we.

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Brady Matthew Gailey, Keefe, Bruyette, & Woods, Inc., Research Division - MD [12]

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And is that a credit that you're concerned about? Do you think there's potential loss there?

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Leslie N. Lunak, BankUnited, Inc. - CFO [13]

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Performing now.

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Rajinder P. Singh, BankUnited, Inc. - Founder, Chairman, President & CEO [14]

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It's still performing, but the performance of the company itself is not looking good, which means that we'll probably end up taking some credit action on this in the fourth quarter or maybe first quarter. We're in the middle of it right now. We moved it from the line to the workout group and are basically working on the credit. We'll -- there probably will be some provision cut out for it this coming quarter.

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Brady Matthew Gailey, Keefe, Bruyette, & Woods, Inc., Research Division - MD [15]

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Okay. And then last for me is just on the margin. It was nice to hear that you expect some stability in the fourth quarter. As we look towards 2020, your margin is already barely below peer average. Do you think it can maintain that 2.40% next year? Or do you think we'll see some continued slippage?

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Thomas M. Cornish, BankUnited, Inc. - COO [16]

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It's really hard to say.

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Leslie N. Lunak, BankUnited, Inc. - CFO [17]

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I think there's so much, Brady, that's going to impact that. Our success in growing noninterest DDA, what the Fed does, what the yield curve does. It's very, very premature, I think, to try to prognosticate that. But we will give some guidance on our fourth quarter call after we get through budgeting season. There's just a lot of variables there.

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Operator [18]

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And our next question comes from Jared Shaw with Wells Fargo Securities.

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Jared David Wesley Shaw, Wells Fargo Securities, LLC, Research Division - MD & Senior Analyst [19]

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I guess, maybe looking at loan growth, without -- obviously, it was a great quarter for mortgage warehouse, but without that, it looks like it would have been a little bit of contraction in the loan portfolio. Are you waiting to sort of get the lower deposit cost opportunity before we should really see a ramp-up in loan growth? Or was that more particular to third quarter and that we could see loan growth accelerate even without the deposit growth accelerating?

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Rajinder P. Singh, BankUnited, Inc. - Founder, Chairman, President & CEO [20]

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I would say this, production has been in line with last year. The lower level of net loan growth that you're seeing is almost completely attributable to the early pay-offs that we're seeing, and that's a very hard thing to try and guess. So this quarter was particularly painful. Actually, first quarter was pretty decent. We were actually happy in the first quarter because we saw much lower run-off. And this quarter, it kind of all caught up and everyone we found were going to pay-off in the first quarter, they finally by the third quarter were doing that. So from a production perspective, which is what the pipelines refer to are, they are very healthy and very much in line with what we've seen over the last year or so. It's just very hard to predict where they also come from. And it's -- in both C&I and CRE, we're seeing a lot of that. The warehouse business, obviously, they had an unbelievable quarter and they continue to do very well, but that's coming both from the utilization and from growth in commitments too. So it's not just as the utilization went up. And yes, utilization was up, but we also put on a whole lot of new business, new clients, and -- which is all very healthy growth and coming in at decent margins. So on the deposit side, I will say again, we will continue to choose quality over quantity and keep a very strong line on deposit pricing. So that's why I feel so comfortable in saying that deposit cost will come down quite meaningfully, not like the 3 basis points, which we see here, but a hell of a lot more next quarter, which is what goes into, Leslie saying that we feel pretty good about margin being somewhat stable next quarter. So you could have, again, a quarter where you see more loan growth and deposit growth next quarter.

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Thomas M. Cornish, BankUnited, Inc. - COO [21]

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I would add one thing on the production side too. If you -- if we went back and we looked at the last 12 quarters of production and correlated that to growth in any 1 quarter, the variability of the production numbers is relatively small. 85% of the variability in ultimate net growth really is from pay-offs, refinancings, private equity takeouts and other capital market activities that tend to impact your growth levels off of gross production. So when we're happy or unhappy, it doesn't usually tend to be around production, it usually tends to be around pay-offs and refinancings and asset sales.

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Leslie N. Lunak, BankUnited, Inc. - CFO [22]

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The other thing I would say, Jared, in this environment with the inverted yield curve and the challenge that, that presents to us, on both sides of the balance sheet, we are a lot more focused on the optimizing of the mix of what's on the balance sheet and a little bit less purely growth-focused right now.

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Rajinder P. Singh, BankUnited, Inc. - Founder, Chairman, President & CEO [23]

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Yes. The lowest-yielding asset at a highest-yielding liability, the spread between those...

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Leslie N. Lunak, BankUnited, Inc. - CFO [24]

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Is small.

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Rajinder P. Singh, BankUnited, Inc. - Founder, Chairman, President & CEO [25]

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Is at a historically low level, right? There are loans out there getting done at 3%, sometimes even under. And there are deposits that were being generated in the system at over 2%. That's not a lot of spread to put 8% capital against. You're much better off letting that go and using that capital either at a later date when there is better curve and better margin or just buying back stock with it. And especially when your stock is trading at 1.1x, the math is pretty straightforward. You don't need a high-flying MBA to figure that out. So it's -- we're looking eventually at capital usage and what's the best way. And putting on 3% asset and funding over 2% liabilities and holding 8% capital is not a very smart thing to do.

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Jared David Wesley Shaw, Wells Fargo Securities, LLC, Research Division - MD & Senior Analyst [26]

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Okay. And then just on the margin. I appreciate the thoughts around the deposit pricing decline. Do you feel -- as you look at the timing of that, do you need the potential October cut to accelerate the pace of that deposit pricing decline? Or are you already seeing that serving the quarter right now?

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Rajinder P. Singh, BankUnited, Inc. - Founder, Chairman, President & CEO [27]

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It's -- so internally, we look at deposit pricing almost on a daily basis. I'll tell you that the numbers already come down meaningfully. Even if there is no cut in October and the Fed surprises us, I still expect deposit cost for fourth quarter to be meaningfully lower than third quarter. Now fourth quarter, when it goes in, it takes a month to sometimes 2 months before operationally we can actually have it trickle into deposit numbers. So October will help further take that down, but October will actually help partially the fourth quarter and it'll help more in this -- in the first quarter. So we're still working on the September rate cut. So October will certainly help. But if October doesn't happen, it will still be of meaningful drop in deposit cost.

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Operator [28]

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And our next question comes from Ebrahim Poonawala with Bank of America.

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Ebrahim Huseini Poonawala, BofA Merrill Lynch, Research Division - Director [29]

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I guess, this is the first question around -- I'm sorry if I missed it, but did you provide what the new loan origination are coming on at in terms of the yield?

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Leslie N. Lunak, BankUnited, Inc. - CFO [30]

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I'm sorry, can you repeat that?

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Ebrahim Huseini Poonawala, BofA Merrill Lynch, Research Division - Director [31]

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Yes. The new loan origination yields, like what are the new loans getting booked at?

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Leslie N. Lunak, BankUnited, Inc. - CFO [32]

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Mid-4s this quarter on average.

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Ebrahim Huseini Poonawala, BofA Merrill Lynch, Research Division - Director [33]

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Got it. And I guess just moving separately, talking about Atlanta, Raj, for you. It is a very good market, also highly competitive. Just if you could give some color around the thought process of why Atlanta? Was it just an opportunistic timing from acquiring a team at that time? And should we expect you to do more of these over the coming months or quarters and going into new metro markets that have strong growth prospects?

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Rajinder P. Singh, BankUnited, Inc. - Founder, Chairman, President & CEO [34]

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Yes. So we've been looking at Atlanta for a while, but I would say we're looking at it from a distance. What really got us to take an even harder look was the announcement of the SunTrust BB&T deal, which is going to create a lot of chaos in the Atlanta market over the next 2 or 3 years. So we see an opportunity, both on acquiring business, also acquiring good people. And when the right thing comes along, you move on it, right? And we found the right team and we acted on it. And we think over the next 2 or 3 years, this will be a nice piece of business. Just like a few years ago, we did this with Jacksonville. We don't have any branches in Jacksonville. Our footprint really -- there was no branches beyond Orlando, but we found a team a few years ago in Jacksonville and we built a business around it. And I don't recall the exact numbers, but it's a few hundred million dollars in loans and deposits that we've built, and we're very, very happy with what we've done. We're trying to replicate the same thing in Atlanta. We're always looking for good teams that will fit the culture, that will fit the businesses we're trying to build. And not just in Atlanta or in Southeast, but also in the Northeast. We've been in discussions with some teams in Northern New Jersey as well. That hasn't yet panned out, but we're looking over there too.

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Ebrahim Huseini Poonawala, BofA Merrill Lynch, Research Division - Director [35]

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Understood. That's helpful. And just in terms of -- I would love to get your thoughts on how you think about M&A and consolidation for the sector. I mean, on the one hand, the revenue challenges would imply that we should see more dealmaking, but again there's been significant dislocation in stocks like. I would love to get your thoughts in terms of how you think about it and what you're hearing in terms of when you're talking to other bankers around potential for any sort of dealmaking over the near term?

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Rajinder P. Singh, BankUnited, Inc. - Founder, Chairman, President & CEO [36]

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Yes. I think that there are obviously a number of reasons why there should be deals, whether it's scales and the regulatory environment that we're in, which might change couple of years down the road. But then there are a lot of hurdles also, right? The biggest hurdle being that everybody's stock price is depressed. Now you can say it's a relative gain in a stock-for-stock deal, but human nature doesn't quite work like that. People always look at their stock price and feel like it's down more than everybody else's and why would I want to use this, I'd rather just do a buyback or just wait it out. So that is getting in the way of doing deals. And then deals -- a vast majority of deals that have been announced over the last 3 or 4 years have not been received well, and the stock of the acquirers are not doing quite as well. The couple of deals that have been announced more recently, which were termed merger of equals, they have their own set of issues. While the numbers might look a little easier to digest, they will have a lot of integration issues and they're not easy to pull off. So M&A has always been a difficult game and I think it will continue to remain. So I would think there is still something some -- there are -- I mean, I talked with bank's CEO, and there is still talk about, if we got to get a deal done in sort of this quarter and next quarter are the times to get it announced, you want to not take the risk of an election in getting your deal approved. But if -- to the extent deals aren't announced by April or May of next year, I think there will be even less deals after that in the second half of the year.

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Operator [37]

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And our next question come from Steven Alexopoulos of JPMorgan.

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Alex Lau, JP Morgan Chase & Co, Research Division - Research Analyst [38]

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This is Alex on for Steve. So on BKU 2.0, you mentioned that you're on track for the $60 million pretax by mid-2021. So when you provide the initial guidance, you also provided ROA target of 1% and ROE targets of 11%. Are you on track to achieve this under the same time line as well? Or if not, can you give us a sense of when this could be achieved?

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Rajinder P. Singh, BankUnited, Inc. - Founder, Chairman, President & CEO [39]

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Yes. So I will ask you to go back and listen to that call. What we said at that call was you take $60 million of benefit, which we feel pretty good about achieving, and you add that to the numbers we had announced that quarter. I don't remember the numbers off the top of my head, but if you took the ROA, ROE that we announced that quarter and you added $60 million to it, it gets you over 1% ROA and it gets you over, I think where we said 11%.

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Leslie N. Lunak, BankUnited, Inc. - CFO [40]

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11%.

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Rajinder P. Singh, BankUnited, Inc. - Founder, Chairman, President & CEO [41]

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11% ROE. The -- of course, keeping in mind that the underlying premise, which is sort of the core earnings of the company, are dependent on the environment, right? What happens to the rate environment? What happened to the economy? We're going through an interest rate environment right now and that is weighing down on margin. This is not -- so it was not a goal, a target set that risk -- the target was always $60 million in benefit, which we will get there and that we'll get probably a little better than that we'll do. But what happens with the core franchise, what happens to the environment, God forbid if there's a recession next year. It's -- that will not solve to the 11% to 1%. But if the curve gets better and the economy stays healthy, then we will do that and we'll do probably better.

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Alex Lau, JP Morgan Chase & Co, Research Division - Research Analyst [42]

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Got it. Thanks for clarifying that. And also early, you mentioned some runoff in the New York rent-regulated multifamily. Have you -- do you have any observations there in terms of the marketplace with valuation or credit quality in this portfolio?

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Rajinder P. Singh, BankUnited, Inc. - Founder, Chairman, President & CEO [43]

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I'll let Tom take this one.

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Thomas M. Cornish, BankUnited, Inc. - COO [44]

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Yes. I think it's still clearly early in the process to say that. I mean what you are seeing is evidence of a lesser appetite on investors to buy, obviously, into rent-regulated apartments. When you look at what's happening in valuations, we saw some data the last few days on what's happening with valuations in the free market area, which is increasing more sharply. As you would expect, people are tilting their investment strategy towards free market versus rent regulated. It's early to say what's happening with valuations. We think that there will be consolidation among the property owners and I think asset owners that have significant critical mass in infrastructure will be able to manage through this process better than more fragmented investors and I think we will expect to see sort of consolidation within the rent regulated market. But right now, other than a expected lesser appetite for acquiring properties, there is not a lot of trading in the market today to be able to grab a hold of and say this is sort of a trend line in what you see in valuations other than free market valuations, are clearly, I think, going to move upwards as investors going to tilt strategy over the next 12 to 24 months.

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Leslie N. Lunak, BankUnited, Inc. - CFO [45]

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The other thing I would add to that is -- I agree with Tom's comments about valuations. But I would add to that, that these loans are cash flowing and performing and that has not changed.

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Thomas M. Cornish, BankUnited, Inc. - COO [46]

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Correct.

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Operator [47]

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And our next question come from Tyler Stafford with Stephens.

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Tyler Stafford, Stephens Inc., Research Division - MD [48]

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You guys clearly sound positive on the funding and deposit cost improvements. I was just curious if you could give us an update, Raj, where deposit cost stood at the end of the quarter to give us a sense of just the magnitude of improvement you guys have seen so far? And just any comment on where kind of new CD rates are at this point?

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Rajinder P. Singh, BankUnited, Inc. - Founder, Chairman, President & CEO [49]

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We have not disclosed that in the past, so I don't want to start a precedent. I will give you CD pricing. So CD pricing, our typical 12-month CDs, we're back up to the 125, 150 range. We are still running a special, but we are not really pushing and advertising it at an 8-month at 2%, but I'd rather take it down -- take that down as well. Money markets are in the 150-ish range. I will give you a piece of information. I asked yesterday just to look at the month of June for deposit pricing and the month of September. So this is not even October. So just looking at what the deposit costs were, the month of June versus September, the decline was 9 basis points. So that doesn't really include anything that happened post September and certainly, it doesn't include what will happen in October. So I think that the overall decline you will be even higher than that number.

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Tyler Stafford, Stephens Inc., Research Division - MD [50]

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Okay. Very helpful. And then just lastly for me. I was just curious if you could make any credit trend comments around the Bridge energy portfolio and the restaurant franchise division, what you guys are seeing there?

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Rajinder P. Singh, BankUnited, Inc. - Founder, Chairman, President & CEO [51]

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So let me talk about franchise. So our franchise portfolio, it's -- the largest concentration is to quick service restaurants, but we also have exposure to the fitness industry. We feel very good about the fitness industry, the trends are very, very solid. I have no issues over there. On the restaurant, the quick service restaurant side, we are seeing pressure on labor costs given unemployment being as low as it is. And we're also seeing some pressure on gross margins coming from changing customer sort of preferences. Delivery is becoming a big deal and delivery tends to not include drinks and desserts, which is high-margin items. And probably getting too much of the detail over here, but that's some of the trends that we are monitoring over there on the franchise side. On the fitness side, it's pretty good actually. Very, very solid. Energy, Leslie, do you want to talk about energy?

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Leslie N. Lunak, BankUnited, Inc. - CFO [52]

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Yes. Our energy exposure, obviously, is on the Bridge portfolio. On September 30, we had about $305 million of exposure to energy in the Bridge equipment portfolio. The majority of that, $211 million is in the operating lease equipment portfolio, $199 million of that is railcar, $60 million is vessel, $46 million is helicopters and some other. That's where the exposure is. We did have a little over $40 million in assets off-lease at 9/30 that we're looking to re-lease. All of those leases though now -- with that exception, all of those leases are performing right now. We haven't had any impairment charges that we've had to take. But that's what they are, that's where the exposure is.

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Rajinder P. Singh, BankUnited, Inc. - Founder, Chairman, President & CEO [53]

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Yes. We're not looking to grow that. We're looking to grow the energy exposure and we're also taking a fairly conservative view on the restaurant franchise business as well.

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Thomas M. Cornish, BankUnited, Inc. - COO [54]

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And maybe just a little bit more detail to support that. Our overall franchise book is roughly around $600 million. That's 68% of it is in quick service food. It's pretty diversified among a number of concepts in a number of states. About 28% is fitness and the remainder would be non-franchise fitness or food businesses, which were typically things like Jiffy Lube and other franchise concepts. And the stress areas in the business that Raj mentioned are predominantly on the 68% that's in the food service, less on the remaining 32% that's in the other parts of the portfolio.

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Operator [55]

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And our next question comes from David Bishop with D.A. Davidson.

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David Jason Bishop, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [56]

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Quick question for you, Raj. I guess in the past from demand deposit, noninterest-bearing deposits, you've sort of said to focus on the year-over-year growth. I know there's some volatility in the quarter. Is that 20%, 21% growth rate, sort of the number to key on -- that your keying in on a go-forward basis?

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Rajinder P. Singh, BankUnited, Inc. - Founder, Chairman, President & CEO [57]

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Yes. I would say so. Yes. I mean over the last 12 months, we've had about $700 million of DDA growth and about $1.7 billion of total deposit growth. And it's especially hard to predict deposit growth unlike loan growth. Loan growth is a lot easier. But looking at the pipeline, do I feel the pipeline is as strong as it was 6 months or 9 months ago? Absolutely.

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David Jason Bishop, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [58]

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Got it. And then it looks like the pace of share buybacks may be backed off a little bit this quarter. Is that just related to the growth you were seeing in the mortgage warehouse, preservation of capital, just curious sort of what drove that lower?

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Rajinder P. Singh, BankUnited, Inc. - Founder, Chairman, President & CEO [59]

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No.

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Leslie N. Lunak, BankUnited, Inc. - CFO [60]

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We completed the $150 million initial authorization that we had from our Board. They gave us another $150 million authorization, but we didn't get that until September, so we've now started buybacks under that new $150 million authorization. So it was really just the timing between the completion of the one authorization and then granting of the next.

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Thomas M. Cornish, BankUnited, Inc. - COO [61]

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It is a few weeks in between.

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Leslie N. Lunak, BankUnited, Inc. - CFO [62]

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That's what is going on there.

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David Jason Bishop, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [63]

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Got it. And then I guess on the narrative, it looks like the deposit service charge is nice growth on the year-over-year basis. As part of BankUnited 2.0, I know there's the $20 million revenue enhancements. I guess that falls over that purview. Anything else you can give us to hang our hats on in terms of what else could drive that $20 million on the revenue side?

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Rajinder P. Singh, BankUnited, Inc. - Founder, Chairman, President & CEO [64]

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So some of it -- the early hits you're seeing already, which is you are absolutely right that it's in service charges, it's in treasury management revenue. It was basically not waiving what we don't have to waive and collecting on it. Better cross-sell and better penetration into existing customer base. The new products that we are launching, those are the things that will take time. This is the commercial card program, for example, that's going to take a full year to develop. I don't think we sell our first commercial card until probably third quarter of next year. So that will be the second piece of it, which just takes time to develop and it will be fully launched and running into 2021. Same thing on the small business side. We're making some pretty heavy investments in small business as well. And -- but for the next 12 months, it's more about investing rather than harvesting the benefit of that.

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Operator [65]

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And our next question comes from Christopher Marinac with Janney Montgomery Scott.

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Christopher William Marinac, Janney Montgomery Scott LLC, Research Division - Director of Research and Banks & Thrifts Analyst [66]

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I want to drill down on deposit cost and sort of kind of rate specials that either you need to do or they are being done in your backyards either in South Florida or New York as you execute the 2.0 strategy.

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Rajinder P. Singh, BankUnited, Inc. - Founder, Chairman, President & CEO [67]

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Deposit competition is still very much clear, both in New York and Florida and both in commercial and consumer. We are actually seeing, even today, 2% plus rates for CDs. And if you want to grow money market, the rate is still in the high 1s, if not close to 2%. Where we're priced at the 1.50%, you actually see runoff, which is what is in front of you for this quarter. We're hoping next week when the Fed moves that numbers comes down by 25 basis points, but competitors have been slow to move. There's still a fairly high level of irrationality in deposit pricing.

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Christopher William Marinac, Janney Montgomery Scott LLC, Research Division - Director of Research and Banks & Thrifts Analyst [68]

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Raj, does that make it more challenging to execute next year? Or again, do you think the Fed sort of takes care of that for us with these changes?

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Rajinder P. Singh, BankUnited, Inc. - Founder, Chairman, President & CEO [69]

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It all depends on, eventually not just what the Fed does, but what the long term does too. Long term, after having come down over the summer, has been somewhat stable. It's in 10 years at 1.80%. I'd love for it to stay there as the Fed reduces and we get some, if not an upward sloping curve at least a flat curve and that will be helpful. But last quarter, we had a fairly severely inverted curve.

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Christopher William Marinac, Janney Montgomery Scott LLC, Research Division - Director of Research and Banks & Thrifts Analyst [70]

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Got it. And then follow-up just on credit quality for Tom or whoever is -- with the classified numbers, we've seen in the Q kind of track the stability we've saw in NPAs this quarter?

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Leslie N. Lunak, BankUnited, Inc. - CFO [71]

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No. I think, as Raj mentioned, you're going to see about $70 million uptick in classified and criticized and Raj spoke to that earlier and that will come up to about 1.9% of total loans.

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Christopher William Marinac, Janney Montgomery Scott LLC, Research Division - Director of Research and Banks & Thrifts Analyst [72]

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Okay. So no offsets to that was where I was going?

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Leslie N. Lunak, BankUnited, Inc. - CFO [73]

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No. That's in that. That's in that.

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Rajinder P. Singh, BankUnited, Inc. - Founder, Chairman, President & CEO [74]

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It's in that number. There were some offerings there.

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Operator [75]

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And our next question comes from Lana Chan with BMO Capital Markets.

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Lana Chan, BMO Capital Markets Equity Research - MD & Senior Equity Analyst [76]

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I've got 2 questions. One on the CRE multifamily portfolio. Given sort of maturities that are coming up through this year into next year, how much of a headwind do you think prepayments could be on the growth of that business? In other words, do you expect balances to continue to move down in the -- in those portfolios?

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Thomas M. Cornish, BankUnited, Inc. - COO [77]

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Yes. I would say, within multifamily portfolio, specifically in New York, we would expect to see it continue to come down. I don't think it'll be prepayments per se because you have -- 2020 has a significant amount of maturing loans because the bulk of the portfolio was 5-year loans in 2015 was sort of a big vintage year. So there's a significant amount of maturities coming up in 2020 and a good portion of that portfolio is within the rent-regulated market. Although, we have, at this point, very little exposure around repositioned type loan. So we would expect to see a lot of competition in that market, particularly from the government-sponsored lenders, which are taking out a lot of the existing real estate loans now in the long-term markets. So I think that we will continue to see that particular segment of the New York portfolio go down in 2020.

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Lana Chan, BMO Capital Markets Equity Research - MD & Senior Equity Analyst [78]

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Okay. And just related to that, in terms of the margin this quarter, were there any elevated prepayment penalties in 3Q?

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Leslie N. Lunak, BankUnited, Inc. - CFO [79]

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I don't think particularly elevated. No, there were some, but I don't think it had an outsized impact on the margin for this quarter compared to the last several quarters. A little more, but not material to the margin, Lana.

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Lana Chan, BMO Capital Markets Equity Research - MD & Senior Equity Analyst [80]

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Okay. Just one more question, Leslie. In terms of the stock buyback, should we think about the pace to be similar to the last couple that you've done in roughly 3 quarters?

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Rajinder P. Singh, BankUnited, Inc. - Founder, Chairman, President & CEO [81]

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I would say, it depends on the stock price. We don't try and phrase this on a day-to-day basis. We generally give our brokers some guidelines and they execute and we get a report every few weeks or so. So if the stock is lower, it's going to go faster. If the stock is higher, it's going to go a little slower. But at the end of the day, we're not thinking like traders or investors do where it is thinking and this is the return of capital and it will just happen over the course of the next few weeks and months.

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Operator [82]

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And our next question comes from David Chiaverini with Wedbush Securities.

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David John Chiaverini, Wedbush Securities Inc., Research Division - Senior Analyst [83]

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So first on the -- on the Atlanta team, could you size the opportunity, and perhaps say how much they were overseeing at their prior firm?

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Rajinder P. Singh, BankUnited, Inc. - Founder, Chairman, President & CEO [84]

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I'd rather not. But again, we're not -- we're going to measure their success over the course of 3 years, not just silver, what they do over the next 10 to 12 months. But it is a commercial team, I will say that. It's a C&I team and they are going to be responsible for not just lending, but also deposit generation in that market.

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David John Chiaverini, Wedbush Securities Inc., Research Division - Senior Analyst [85]

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And you alluded to Jacksonville earlier in that team, should we think of it as similarly sized in terms of a few hundred million over the next few years?

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Thomas M. Cornish, BankUnited, Inc. - COO [86]

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Yes. I think that's -- that's hard to say. We've done well in Jacksonville over the last 3 years. Atlanta is a great market to be in. We benefit by being, fortunately, our franchises in excellent markets and Atlanta is a good market. It's one of the biggest middle markets. It's a lot bigger than Jacksonville, certainly, it's one of the biggest middle market segments in the entire country. So our hope is, obviously, that we do well, but it would be far too early to kind of throw out targets.

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Leslie N. Lunak, BankUnited, Inc. - CFO [87]

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Premature to give specific guidance on anything.

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Thomas M. Cornish, BankUnited, Inc. - COO [88]

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Yes.

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David John Chiaverini, Wedbush Securities Inc., Research Division - Senior Analyst [89]

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Got it. And then shifting to your liability. So looking at the $5 billion of FHLB advances. I saw in the second quarter, the rate was 2.41% that came down 5 basis points in the third quarter. How long will it take for these to reprice down more meaningfully?

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Leslie N. Lunak, BankUnited, Inc. - CFO [90]

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At least a couple of years. So let me back up and explain the strategy around FHLB advances. We use FHLB advances, obviously, as a funding sources. But one of the other things that we used that instrument for is to hedge interest rate -- our interest rate risk exposure on the balance sheet. So for example, we recently entered into some hedges to protect us against a protracted downturn in rates because our analysis showed a pickup in sensitivity if rates were to go down materially from here and so we purchased some insurance against that. So we do use that as a hedging tool. So you won't see the cost of that move on a dime because most of it is hedged out and is used as a hedging tool.

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David John Chiaverini, Wedbush Securities Inc., Research Division - Senior Analyst [91]

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So even if we get a couple more rate cuts, it'll still be in this, say 2.30%.

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Leslie N. Lunak, BankUnited, Inc. - CFO [92]

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A lot of it is hedged. The portion of it that isn't will come down, sure, but a lot of that is hedged and it's hedged out over some duration. So effectively, it's like fixed rate paper in some cases. So it doesn't move as quickly as, say a LIBOR-based loan because of the hedging strategies that we've employed.

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Operator [93]

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I'd like to turn the call back to Raj Singh for any closing remarks.

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Rajinder P. Singh, BankUnited, Inc. - Founder, Chairman, President & CEO [94]

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Thank you, again, for joining us. Once again, we're happy with where we came out on earnings, 20% growth over last year is no mean feat in this environment and we look forward optimistically to next quarter and to next year. We'll talk to you again in 90 days. Thanks so much. Bye.

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Operator [95]

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Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.