BFIN - NASDAQ

Good morning, ladies and gentlemen, and welcome to the BankFinancial Corp. Q4 and Year-to-date 2020 Review. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to turn the conference over to your host, F. Morgan Gasior, Chairman and CEO.

Good morning. Welcome to the fourth quarter 2020 and Full Year 2020 investor conference call. At this time, I'd like to have our forward-looking statement read.

The remarks made at this conference may include forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934. We intend all forward-looking statements to be covered by the safe harbor provisions contained in the Private Securities Litigation Reform Act of 1995 and are including this statement for purposes of invoking these safe harbor provisions. Forward-looking statements involve significant risks and uncertainties and are based on assumptions that may or may not occur. They are often identifiable by use of the words believe, expect, intend, anticipate, estimate, project, plan or similar expressions. Our ability to predict results or the actual effect of our plans and strategies is inherently uncertain, and actual results may differ significantly from those predicted. For further details on the risks and uncertainties that could impact our financial condition and results of operation, please consult the forward-looking statements declarations and the risk factors we have included in our reports to the SEC. These risks and uncertainties should be considered in evaluating forward-looking statements. We do not undertake any obligation to update any forward-looking statement in the future. And now I'll turn the call over to Chairman and CEO, F. Morgan Gasior.

Thank you. We filed our 5-quarter supplement, along with our press release. The 2020 Form 10-K annual report will be filed on schedule later in the quarter. At this time, we have no further information opposed to provide. So we're happy to answer questions.

[Operator Instructions] Your first question is from the line of David Konrad with D.A. Davidson.

Just a couple of questions on NII. Obviously, a little bit of volatility there with some prepayment fees. And just help us out there in terms of maybe what's left in balances and unearned fee income in the PPP. And then maybe just -- I know prepayments in multifamily is hard to predict, but any sort of normalization on the loan prepayment fees as well would be great.

Well, let's do this. The -- your normal run rate for noninterest income, if you went back to '19, was somewhere closer to $6 million. And our goal for '21 is to do somewhere between $6 million and $7 million in noninterest income, inclusive of PPP fees. Right now, the PPP fees, we've received very little in terms of actual forgiveness. And the accounting doctrine has now emerged to essentially amortize the unearned fees over the life of the loan. And some of the loans are 2 years and some of the other loans are 5 years. Probably worth taking this opportunity to mention that right now, we've also done approximately -- it's about $6 million a little over in PPP round 2 loans in process. And those loans have started to fund. We also put a small marketing program behind PPP to make sure that we reach all parts of the community, especially low income, moderate-income census tracks where the participation of businesses in PPP 1 wasn't as strong. And certainly, that could drive more PPP loan volume. But probably the biggest uncertainty on PPP right now is the pace of forgiveness. We have submitted over $7 million to -- of our original $10 million for forgiveness, and we've received less than 15% of that forgiveness back. So I think that's what's going to make it a little bit choppy. We would hope to get a faster rate of forgiveness on PPP 1 in first quarter and then early second quarter. Then we'll have to see what the rules are for forgiveness on PPP 2, which could drive some further acceleration of income into the latter part of '21 and into '22. Obviously too, adds up to the borrowers who apply for forgiveness. So that's another aspect of this that has to be managed. In PPP 2, we're making sure we collect the gross receipts income upfront. So that we have the information necessary to apply for forgiveness when it's time. Prepayment income. Some of the prepayments we receive, borrowers and 90% of the prepayments were from markets outside of Chicago, principally due to appreciation in the property. Some borrowers had such strong appreciation in their properties. One property almost doubled in value in about a 3-year period that writing the check for the prepayment income was just a relatively minor transaction cost. In other cases, customers time the prepayment penalty very precisely. We had one customer that did a refinance one day after the prepay expired at a rate that was 50 points below where we were in talking to them. So it's really hard to predict prepayment income. We do think that there'll be continued prepays due to project sales. There are also people trying to get as much cash out of these properties as they can. So I'd say the prepayment income is hard to normalize. We did see some improvement in trust income, about 14% year-over-year. So we'd like to see that build a little bit. We picked up some assets under management during the course of '20, notwithstanding all the activity in the markets. We're probably going to be adding some resources to the Trust Department in '21 to further build AUM. So if we're lucky, we see another 10% to 15% improvement there. But that is completely dependent on getting the right trust officers in and seeing how they perform during the year. Obviously too, market influences that as well. And finally, we added the treasury services departments in 2020. They will begin operations more robustly in the latter half of the first -- in second quarter of '21. They'll probably contribute some additional interest income or noninterest income, I could say, maybe $50,000 to $100,000. But we're going to try to get them to a run rate of somewhere between $10,000 and $20,000 a month towards the latter part. So with all these things said, that's why we think we'll be somewhere -- we would hope to be around $6 million for the year in total noninterest income with PPP, maybe a little bit higher than they had, closer to $7 million. But then as we add more commercial finance capabilities, we'll try to sustain that going into 2022.

[Operator Instructions] Your next question is from the line of Brian Martin with Janney Montgomery.

On the comment, Morgan, you made about the PPP, is your expectation that flows through the noninterest income? Or is that flowing through the spread income?

Brian, that's going through net interest margin, not noninterest income.

Okay. So that's included in the spread. Okay. Perfect, Paul. And Morgan, I guess, maybe can you just talk a little bit about the size of the balance sheet today and just kind of how you're thinking about growth in -- in 2021, given the payoffs this quarter and just kind of the recent trends we've seen and kind of how you kind of get back to your targeted goals of where the earnings and kind of what not are -- but just the growth factor and how to think about that in '21? How you're thinking about it?

Well, right off the bat, we have some pretty good momentum in originations from -- in the second half of the year. Equipment finance for '20 did just under $200 million in originations, and that compared to about $127 million in '19. And that was without really the middle market department or the small ticket department contributing much because they got started relatively late in the year. So equipment finance will be our originations leader for '21. We expect to see some kind of growth in that, even notwithstanding the rapid amortization on that. But if we could do somewhere between $100 million and $125 million of growth for '21 in that portfolio, it builds on the momentum that we had at the end of '20. We did about $25 million of growth in the fourth quarter. Not every quarter is going to be exactly that number, but we think we can build on it, especially because we didn't see that much volume out of middle market and small ticket. Commercial finance, which is the other part of C&I, we are starting to see a little bit of activity on draws, both for the lessor credit side in funding new equipment prior to its -- prior to execution of the formal lease and discounting of the lease. And we also saw just a little bit of activity in health care. But we're expanding beyond the asset-based lending capabilities of health care in '21. We've added a number of producers for that, including one just this week. So there, we think in '20, we did about $95 million of originations in commercial finance. We'd hope to do better than that, maybe around $125 million. And so between the 2, if we do $100 million to $125 million of growth in equipment finance, another $25 million or more in commercial finance, and then real estate -- real estate is the wildcard. We are seeing stronger originations. We put new bankers' strength in Chicago. We strengthened markets outside of Chicago. So I think our -- a good scenario for us would be to see $65 million to $75 million of growth in multifamily. So all told, about $200 million with equipment finance leading the charge. And given our cash position and the fact that most of these expenses are already in the run rate, that gives us a pretty positive forward look in terms of operating leverage. Equipment finance with middle-market and small ticket contributing probably gets closer to a $5 million contribution in terms of interest income at $125 million. Depends on the mix. If we do more corporate and governmental, could be a little bit less. If we do more of a middle market and small ticket, could be that number is slightly higher. Multifamily yields are around 3.5% all in. So if you do $75 million on that, it's around $2 million. So -- and then add -- going back to David's question, you add in a little bit of noninterest income. So we'd like to see the total growth in the income side, somewhere between $7 million on the low side, $8 million on the high side for the year. And again, we won't expect that much change in expenses. So that's why we think we have a pretty good forward view in terms of operating leverage.

Got you. Okay. Let me -- and just to be clear, the growth -- the net growth, I guess, you're thinking growth of the $120 million -- $100 million to $120 million in the equipment group. And then you said the -- what was it, $25 million in the commercial finance and then $60 million to $70 million in -- I didn't catch the part that was more kind of $60 million to $70 million.

That'd be real estate, all total.

Okay. Real estate. Got you. Okay.

And that's principally because we can't -- we still can't really predict the prepayments in real estate. People are selling buildings, making a lot of money. And some of them are replacing the assets outside of multifamily. So one of our borrowers, who made a ton of money on his multifamily building, he turned around and bought a gas station, and he bought a single-tenant sporting goods commercial real estate building because the cap rates were in the 8s. Did not want to go back into multifamily in a 5% -- 4.5%, 5% cap range. Obviously, that's not our asset class. I couldn't replace that loan volume, but that's kind of an example of a little bit of sector rotation. Some of the professional investors are taking their money and moving on to other things. So that's why we think prepayments still could be volatile. In commercial finance, we can grow, but we also see right at the end of the year, we had about $25 million of line paydowns in the last 2 weeks of the year. That's typical. The lessor credit customers will then discount the leases that they have been putting in place. So you get the benefit of the income during the quarter, but you often see the balances decline right at the end of the quarter. So our average balances could increase, but the period-end balances might not show as much growth as you would otherwise see. And that's, again, a consistent theme, but we're growing the lessor base rather nicely for the first time in a couple of years. Adding 2 or 3 lessors a quarter in one context or another. We're working on 2 or 3 different new lessor proposals right now for almost $20 million. So that's why we feel optimistic about that particular segment. And equipment finance, our biggest challenge there is just the rapid amortization of the portfolio. Middle market tends to skew a little bit more 48 to 60 months. So it does cut down the amortization and the cash flows coming back. On the other hand, government tends to be shorter term. And so there's a balance that probably takes us around 36 months, maybe 40 months, all told. And so again, we see some growth opportunities there, but that's tempered in some cases by just the rapid amount of cash that comes back. And one other choppy part of this is government also tends to work on annual appropriations and annual payments. So you may have a relatively low quarter in terms of payments on the portfolio, and then you'll see a spike because you'll see one lease payment, an annual lease payment, come in all of a sudden at one month. We've tried to account for that, but as we do more of that governmental, it will get a little choppier quarter-over-quarter.

Got you. Okay. That's helpful. And just on the -- to the point on liquidity, Morgan, I think last quarter, you talked about kind of a combination of the loan growth as well as some -- putting some of the excess liquidity into some investment-grade leases. Just any change on how you're thinking about deploying the liquidity at this point? I mean, you kind of outlined the loan growth. But beyond the loan growth, are there -- is there anything else you're doing?

Yes. Our commercial finance numbers, our equipment finance numbers don't yet have the excess liquidity in there. We -- because we were busy enough in the fourth quarter, we didn't deploy the exit resources necessary to focus on excess liquidity. But it's still a priority for us. Now let's also say that the yields on those assets are not particularly exciting. I've seen yields as low -- under 2% for 36-month transactions. But nonetheless, it is certainly beneficial to overall income, and we will continue to pursue it. We're not the only ones pursuing it, but we will continue to pursue it. And until we actually start delivering that, I don't want to make predictions about what's going to go in there. I would have hoped we had a little bit better performance going into '21, but we did not. So it's now a focus for first quarter and in the second quarter. I'm hopeful to put some numbers up in the first quarter, and then we can talk more about a run rate once we get a better handle on flow in our next conversation.

Got you. Okay. And just the update on deferrals. I guess, can you provide some update on where the deferrals were at year-end?

It will be -- all the detail will be in the 10-K. But just as the preview, deferrals are really not an issue for BankFinancial. In fact, the 2 programs that we put out there, one was for larger real estate investors. One was for smaller real estate investors. And the plan was to have all the interest collected we were due for '20. In '20, we achieved that goal. And the plan was to collect as much of the principal due in '20 as we possibly could with given a little more flexibility to the smaller real estate investors with loans under $750,000. We achieved that goal. Total principal deferred in -- from -- that was due in '20 is $53,000 on a total loan balance of $10 million. So it's an absolutely de minimis amount. The customers are on ACH payments now. We don't really anticipate any problem collecting the rest of the money. And that actually just feeds into the fact that we continue to maintain a strong asset quality position during the year despite everything going on. And that gives us a very clear focus for growth in '21 as opposed to cleaning up problems in the portfolio.

Yes. Okay. I figured. And the criticized level, I guess, and just kind of how to think about, I guess, I'm assuming it's a preview that criticized assets were, I guess, kind of not much changed from what we've seen if you look back to third quarter based on the trends we saw this quarter, at least from the supplement material?

Well, we have one commercial customer that is not in compliance with their covenants. And we are working through that. I don't really anticipate it to be a problem, but we have to go through a process to deal with it. Beyond that, it's a Chicago C&I customer. And I don't think it has anything to do with the pandemic or anything else. They have just elected not to comply with their covenants deliberately so. But beyond that, the trends we had in the annual loan reviews were strong. We obviously could see as the annual reporting comes in, some customers where their rental income, their net operating income, their cash available for debt service weakened in 2020. And therefore, you could see some increase in classified or criticized assets just as a result of annual reporting. I wouldn't be surprised to see it. It's just the nature of what might have happened. At the same time, the portfolio underwriting was strong enough so that if, for example, a customer had a $160 million, $150 million debt service going into '20, and they had some vacancies, and they had some collection issues, but it recovered in the second half, they wouldn't necessarily be in danger of violating their covenants, and they certainly wouldn't be negative cash flow. So we're not anticipating a significant problem of this right now, but it will depend on how the annual reporting comes in. And it's worth noting, especially in the real estate portfolio, that borrowers continue to try to do what we'll call tax planning. And sometimes, it distorts some of the actual results. We tend to focus on making sure we validate the income that they're reporting. How they choose to report expenses of capitalized expenses or property expenses that should be capitalized versus expense may vary. But right now, we feel good about asset quality. We're not really seeing any trends in the portfolio. But we'll have to be mindful of the financial reporting we see and manage those results accordingly.

Got you. Okay. And just, Morgan, your -- last couple here, too -- was the -- on the capital, I guess, just capital deployment and then just reserves. The reserve level, as you look at the growth and the quality of credit quality, can you just talk about kind of how you see the reserve level trending with those kind of different components factoring in there and how you're thinking about it for '21?

Sure. Let's do ALLL first, and then we'll go into capital. As you noted throughout the year, and again, in the press release, we continue to take precautionary measures with respect to the inherent risks in the loan portfolio and particularly so in the real estate portfolio and particularly so in Chicago. Just because of some of the judicial restrictions on collections or evictions, it makes it harder. In some cases, almost impossible. But again, we don't sense the landlords are really seeing a huge impact right now. That could change. So we just decided to put more reserves away for those inherent risks. Therefore, as hopefully things normalize, they -- we will not need those for cautionary levels of reserves on those assets. And those reserves would then be available to fund growth. So it wouldn't surprise us that the overall balance of reserve stays about the same. And our goal is always to redeploy those reserves into loan growth. The general mix of equipment finance would have us put about the same amount of loan loss reserves, maybe a little bit more, maybe a little bit less. So fundamentally, we hope the balance will stay about the same, if everything goes the way we would like it to. To the extent we have precautionary reserves, we'd like to see those deployed to fund the equipment finance and the commercial finance growth. And then real estate might have a slightly lower reserve balance. But hopefully, we recovered some of the -- we've grown the real estate portfolio a little bit further. And therefore, the allocation of that portfolio stays about the same in dollar terms.

Got you. Okay.

As far as capital is concerned, obviously, for banks, especially and including this one, the Russell 2000 is looming ahead of us. The holding company ended the year in a good strong cash position. And obviously, we expect there to be some volume on the market as a result of Russell rebalancing. And we're going to do our best to position ourselves and take advantage of that as much as feasible. So we might not see very much share repurchase activity in the first quarter, kind of husbanding resources to get ready for Russell rebalancing. But we're certainly mindful it's out there. You have to pause and wonder when GameStop is the most valuable company in the Russell 2000 last week that the world has certainly changed. But nonetheless, we know it's out there. We're going to do our best to manage through it and devote resources as feasible to getting through it.

Got you. Okay. And the -- and just on the expense front, I mean, just any -- any puts or takes on what -- how the expenses look? I guess, as far as adding people or just the outlook for 2021 at this point from an expense standpoint?

Well, we added almost $3 million worth of new producers and production support whether it was originators or credit analysts or closing support in the -- in 2020. And we offset that with approximately $2 million worth of cost reductions. So again, it goes to my point about operating leverage. We've already made about 80-plus percent of the investments we need to generate this amount of asset growth. Just this week, we added a new department manager for middle-market equipment finance. We also added a general commercial, commercial finance banker who is focused on asset-based lending outside of health care here in Chicago. But we also have trimmed expenses in other places to keep this about neutral. So expenses, generally, for the first couple of quarters, especially because we are still in COVID health protocols with cleaning and security, I'd expect expenses to trend more like $9.75 million for first quarter, second quarter. We also have -- we're about 75% of the way through a complete revamp of our technology infrastructure. We put online business banking in, in fourth quarter. We just are in the process of moving over our digital data communications and our voice communications to a new carrier, but we're currently in overlap mode. So there's still going to be some expenses in the first half of the year. We're going to be looking at facilities during the course of the year. One unfavorable development is just the continued increase of real estate taxes on our properties in Chicago. But we're also seeing customers coming back to the branches and using the branches. So we're going to figure out ways that we can reduce the occupancy costs during the second half of the year and still do our best to deliver the services that the customers want when they want it. So I'd say first half of the year, expense is closer to $9.75 million for the first 2 quarters. We're going to try and work that back down to the $9.5 million range. So we're more about $38 million by the time we get to the fourth quarter. And if, Brian, you then take all these activities, you take the momentum we have going into '21 in asset generation, the additional resources we've already deployed and are in the run rate, the ability to provide the operating leverage, a little bit more help from income, whether it's from PPP, whichever column it's in, net interest margin or net interest income, the trust side, the treasury services side. Our goal is to see if we can get to EPS results and a run rate by the end of the year back into a $0.20 range or better. And that is just going to be pure execution on our part on all these fronts. But we like the momentum going into the year. We're glad that we don't have the asset quality challenges that we thought we might have at the beginning of the year -- of the beginning of 2020 when the pandemic hit. Still, that story is not completely finished yet, but we're feeling good about it. So that's why we think we're able to go back to our original goals, try to get to something with a 2 in it at the end of the year and then build on that in 2022.

Got you. That's all really helpful, Morgan. And I think just last one for me was just on the -- on the share -- on the Russell rebalancing and kind of the timing of all of that. I guess, it didn't change your outlook as far as the expectation of the share repurchases you were hoping to accomplish in '21, kind of where the -- I guess, where you kind of talked about last quarter kind of getting the share count down, I think it's somewhere around the 14 million range. Is that still the target? Just maybe the timing changes a little bit with some of the dynamics with the Russell?

It is certainly a target. It wouldn't completely surprise me that we go beyond it. That's been a recent discussion at the Board level. I wouldn't want to commit to it right now. But obviously, the Russell rebalancing does create a different dynamic than we're originally planning, and the Board is taking that into account.

Got you. Okay. Perfect. I appreciate all the color and look forward to catching up with you in a couple -- in 90 days.

We appreciate all the questions and thought processes, Brian. Thanks very much.

I am showing no further questions at this time. I would now like to turn the conference back to F. Morgan Gasior, Chairman and CEO.

Well, assuming no other questions, we thank everybody for their interest in our call and your continued support of BankFinancial. We'll continue to build on the momentum we had at the end of '20 into '21, and we look forward to talking to you next quarter.