BFIN - NASDAQ

Good day, and thank you for standing by. Welcome to the BankFinancial Corporation's Q3 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today's conference is being recorded. And I would now like to hand the conference over to your speaker today, Mr. Morgan Gasior. Sir, please go ahead.

Thank you. Good morning, and welcome to the third quarter 2022 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 the 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 effects 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 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 statements in the future. And now I will turn the call over to our Chairman and CEO, Mr. F. Morgan Gasior.

Thank you. At this time all filings are complete. The only additional information we provide at the outset is that we have issued branch closing notifications to customers in two locations, our Hazel Crest branch in the Southern suburban area of our market, and the Naperville branch in the Western suburbs. The Naperville branch will be consolidated with our new Flossmoor branch, and we believe we can adequately support our Naperville customers through our Downers Grove branch, particularly since those customers are already well adapted to the electronic banking online environment. So we can discuss the impact of those changes later. Both branches will close in January of 2023 after the holiday season, and then we will be able to proceed with the liquidation of those facilities and cost savings. With that, I would open it up for questions.

Thank you, sir. [Operator Instructions] First question is coming up, and we have a question from Manuel Navas of D.A. Davidson. Your line is open.

Hey, good morning.

Good morning.

Hey. Can I just start with the loan growth? It seems like our originations were matched by payoffs, and I just wanted to get a firmer grasp of – on trends in the past quarter and kind of your outlook going forward?

Sure. Well, the loan growth in the quarter was actually about what we expected and was our second best quarter of the year and actually was a pretty respectable increase in origination activity, if you look year-over-year. In terms of payoffs, we had a larger amount of payoffs in the multi-family portfolio. One of our customers sold their entire portfolio during the quarter and paid everything off. So that was probably the biggest negative variance to loan growth, almost exactly. We were hoping to get to $1.175 billion, and that was almost the entire difference. We also had a higher than usual scheduled amortization in the equipment finance portfolio, particularly government because that's the fourth quarter of the government's fiscal year. It's typically a busy time for us. So that was a contributing factor as well. But we felt good generally about originations in the third quarter. It just wasn't enough to overcome the – almost doubling of the payoffs and the real estate portfolio for the third quarter. Going into fourth quarter, we like the pipelines going into fourth quarter pretty much across the Board. We were hoping to get to $1.175 billion at the end of third quarter, which would set up hopefully somewhere between $1.2 billion and $1.25 billion at the end of the year. But given the lower starting point, our goal is just to get to $1.2 billion. As you saw during the quarter, we had growth in the commercial and industrial portfolio that has continued here into the fourth quarter. And we have reasonably good pipelines going into the fourth quarter and even into 2023, particularly in the healthcare portfolio and the commercial finance portfolio. We're even seeing some pick-up in activity in the lessor finance portfolio with some new opportunities. Probably what's most noteworthy is we're seeing greater draw activity in the healthcare portfolio that is also some higher coupon average yield credits. So all things considered, we feel fairly positive about the pipelines in the C&I portfolio for 2022 fourth quarter and even going into next year. As market liquidity ebbs a bit and the inflationary environment continues also in the winter, the healthcare credits tend to be more active to begin with. So all those I think are positive trends for greater line utilization, particularly in the healthcare portfolio for fourth quarter and into 2023. And on top of that, as I said, we have a reasonable pipeline for new originations, which will expand commitments. In the equipment finance portfolio, fourth quarter is typically one of our stronger quarters, and we have a pretty good pipeline going into fourth quarter. We expect funding activity to ramp up rather considerably here in November, and the first couple weeks of December before it tails off. So again, we'll see – we have a somewhat higher than average scheduled amortization because fourth quarter is usually the strong quarter historically. But if we can do somewhere in the $60 million range for equipment finance, we'll get some growth out of that portfolio. And if we can do a little bit better than that, if a couple of the larger credits actually fund this quarter, then we'll get a little more meaningful growth out of the equipment finance portfolio. And then real estate has a good pipeline going into fourth quarter. We've seen a couple of nice larger credits come in, lower risk, people looking for a very good rate and term deal. So all-in-all, we see it's feasible to get to $1.25 billion for the fourth quarter of 2022. A number of factors have to drop into place, but we believe it's feasible. If we come a little short or go a little over, I think that's a reasonable range. But our primary goal here is to put as much aboard in the fourth quarter to set up 2023 to be in the strongest possible position, and particularly so in our commercial finance side then followed by equipment finance because that sets up a higher coupon environment and a higher interest income environment for 2023.

That was helpful. Is there any [straight line] to – I guess you talked about the amortization for the equipment finance, but any other straight line for paydown activities. Should it come down a little bit just because of higher rates?

Yes. I agree with that at least and so far as real estate. I want to temper that comment by the fact that quite a bit of our payoffs are due to sales. The customers that paid off their loans in third quarter, I think just on the numbers we saw in their portfolio, they enjoyed almost a 300% return on their investment, and there are still purchases in the pipeline, there's still activity in the market even with rates a little bit higher. So we feel that there's still maybe some customers that opportunistically sell their properties, and so we'll see some payoffs. But having said that, we do expect the payoff activity to diminish, so for example, in the apartment and commercial real estate portfolio, the payoffs are more in the 20 million a quarter range as opposed to the 50 million a quarter range, then naturally that helps us with some growth, or at least a reduced risk of payoffs. The commercial portfolio still could be volatile. We still have some customers with some substantial liquidity on deposit here. So we see them drawing on the lines, but then once the liquidity is restored, they pay it back down. But we also know that that liquidity is starting to trend out, which did generally speaks to a higher utilization and a greater percentage utilization month-by-month. So I think we're seeing a little bit less risk in the real estate portfolio as far as payoffs, probably a little less volatility over time in the commercial, and the equipment finance portfolio is 90%, 95% of the activity is scheduled activity. Every once in a while we'll get an early termination because they're repositioning equipment or rewriting a deal, but those numbers are fairly consistent.

That's helpful. Just switching over to the – some of your deposit trends. You had a slight decline on end of period basis. Can you just talk about trends there? You still have plenty of liquidity, but just kind of seen broader trends there and thoughts on like deposit pricing competition?

Yes. Well, as far as third quarter goes, we saw some seasonal activity, some public funds activity, some of our higher balanced retail and commercial customers with some activity in and out. Somebody – could you please mute, please? If we're seeing a trend, we saw a handful of customers starting to shop rates and really to more brokerage solutions. So we have those solutions as well. So that's a training issue. We're making sure people know that's an option, if that's something they're interested in. We maintained our competitive position in the market throughout the quarter. We're ready to do so again, even this week. So I do expect our cost of funds to accelerate. There's no question about it. But right now, we're priced to maintain our position in the market and retain deposits, and so far that's been successful. We will see some broader trends in liquidity going down, people just consuming liquidity. One of the more interesting things that happened is we'll see real estate taxes being paid here in the fourth quarter of 2022 instead of third quarter, and we typically seasonally see some declines in deposits as people write checks on for real estate taxes. Third quarter, we saw money going out for tuition. So right now, we don't see any broad-based trends, but we are watching it very carefully. And our mission here is to price where we're at in the market and play really good defense to the best of our ability. We want to retain these deposits to fund loans and make the growth story continue to be viable.

Bringing that together, yet a nice margin increase. Can you just talk about that kind of thoughts in the next couple quarters?

Yes. First of all, our mission is to maintain it. If we can grow it a little bit, that's even better. The path to growing it is probably a big step more favors our commercial finance deals and lines of credit than real estate. So if we look ahead into 2023, our marketing focus, our growth focus is going to be on the commercial finance, healthcare finance, government finance, lessor finance portfolios will still be active in real estate, but on a relative basis, we're going to put more emphasis on the C&I portfolio. And then, of course, equipment finance will continue as before. We think that's got the best chance of helping us maintain margin. If we improve it, that's good, but maintaining is the key. And obviously too, that is a wild card on what happens with deposits. But just looking at where we're at now, we feel that it's feasible to maintain the margin, it will depend on doing more with commercial finance to just to give you a simple example. Next year, we have approximately $60 million in securities maturing throughout the year at roughly a 260 average yield. If we simply grow and simply is a loaded word, but if we can grow the commercial portfolio by that $60 million, you're picking up almost 600 points on that money right there. And then the re-pricing of cash coming off of the equipment finance portfolio and of the multifamily portfolio even with a reduced amount of prepays, Paul told next year we have approximately a little over $700 million in assets repricing next year. So we feel that if there is not a huge interruption to demand then we ought to be able to ride the curve and protect the margin.

I appreciate that. I can step back into the queue.

Thank you. [Operator Instructions] Our next question comes from Brian Martin of Janney. Your line is open.

Hey. Good morning, guys.

Good morning, sir.

Yes. I just wanted to touch base, Morgan, just on – just one follow-up on the margin. I guess just given the – what you just outlined there as far as what's repricing and the fact that you expect to kind of continue to grow here, it seems like it in – the deposit betas have been very low. Certainly, they go up, understood your comments there, but it seems like there's room to expand this margin, I guess a fair amount if you talking about and just re-pricing what's in the portfolio. I guess, is there – and you guess – it seems like you're talking more about maintaining it, so just try and understand how optimistic you are that you could, if things fall together the way you expect, how much margin or if you could get more margin expansion than kind of just holding stable here?

I think it turns primarily on the cost of funds, which is not something we have a great deal of control over. There's so many different scenarios for interest rates next year for federal reserve action next year, competition next year for funds. That's why I think the base case is to protect the margin in the 350, 360 range. If we can expand it, that's obviously a great result for everybody. But I wouldn't want to promise it until we have greater visibility on deposit trends and it's just getting started now. We will see a greater volatility and an upward trend in deposits. We are planning for it and we're ready to the best of our ability. The fact that we have as much repricing as we do gives us some flexibility. But like I said, our first thing is to protect the margin. We'll probably have a better sense of where we stand on this when we talk next at the end of the fourth quarter of how we look at this. And then again, what's the mix going to be in loans. Obviously the real estate portfolio will reprice, but the upward delta on that is less than it is in say, the equipment finance portfolio, and certainly less than if we reposition securities into commercial finance credits. So all those pieces are a factor. I would agree with you that there is potentially more upside to margin. I just wouldn't want to promise it to anybody. We feel comfortable with the high-20 – mid to high-20s for fourth quarter. We will have some costs involved in these branch closures for fourth quarter that we have to deal with, but then next year, we'll get to enjoy the benefit of the cost saves. And then next year we still feel we are protecting the margin that the low-30s remain feasible, but it's going to be a function of what happens on deposits and then how we can redeploy the cash and particularly the securities as we've outlined.

Got it. And your thought right now about just deploying the remaining cash, the thought is that that's primarily, I know you did some securities this quarter, but given the pipeline it's primarily going to go into loans at this point?

That would be our hope because you can certainly pick-up some margin from that. You're going to pick-up some margin in securities, but obviously you'll do much better in the commercial finance and the equipment finance side of it. Even a little bit in the real estate, but mostly in the commercial finance and equipment side. So that would be our priorities for next year. Securities are useful if, for example, we get more payoffs than we're expecting in real estate, and real estate demand is down, then securities are an attractive alternative to that. You'll probably have a shorter duration. You'll protect the interest income from that. You might even pick up a little bit. And it's obviously a safe asset to be. So we see security as just an alternative potentially to real estate. It's not necessarily an alternative to other types of credits. So more defensive than offensive, I should think right now.

Yes. And Morgan, can you – just a high level. I mean, the breakdown or just ballpark of that $700 million that is repricing, I guess, what's kind of the mix of that? Just so we can kind of think about that as we think about the margin going forward.

Let me turn you over to Paul for that.

Okay.

Brian, the $700 million represents the $200 million in cash, interest-bearing cash at the quarter end. $35 million in – well, in the next 12 months, $35 million. But then if you extend into the fourth quarter of 2023, it's $59 million of securities and then the rest is a loans and that breaks down about half, and half is cash flow versus assets repricing.

Okay. So I guess more on the loan side, I guess just kind of on the yield side more on the real estate that's coming versus other areas that are – maybe I'm just trying to understand the lower yields versus higher yields of what's repricing loans for next year?

Well, there's about a $170 million of cash flow coming off of the equipment finance portfolio, and that's at a weighted average coupon of around 4%.

Got you. Okay.

Yes. It's a nicely balanced set of cash flows. I mean, this is what we have been building all these years in anticipation of an environment, maybe not quite this extreme in terms of rate increases, but an upwardly biased rate environment. We didn't want to get trapped in lower-for-longer interest-bearing assets. So this gives us the flexibility to meet an environment like this. And also, one of the goals here is if in fact, monetary policy changes suddenly next year and all of a sudden the Fed starts cutting rapidly, which in history has been known to happen, this also gives us the ability to add some duration in a flexible way during the course of the year and protect against a sudden change in policy to the downside so that we can have a more balanced earnings stream and not be subject to a sudden change in policy on the downside.

Got you. No, it sounds like there's opportunities just like you said on the funding side. And just remind us, I mean, I guess your thought on the funding costs today or just kind of the deposit betas, however you're thinking about it? What are your expectations? I mean, it sounds like the – I guess if the Fed does pause in December, would your expectation be after – how the margin behaves after that pause? I mean, is it likely to maybe compress a little bit just as the deposit betas catch up, like you're outlining? Or I guess – is that a fair way to think about it?

I think we have a pretty good chance of keeping it steady. If we have enough repricing and if the mix works out even reasonably close to what we're thinking, we should be able to keep it steady. The betas are interesting, right? Even if the Fed pauses, the treasuries are still in the force. Now maybe they decline because all of a sudden the market sees the Fed pausing and maybe their next thing is a pivot downward. And [erratically] that takes a little bit of pressure off of funding, but there's really no way to know. During the course of 2022, there's been two episodes, one was last summer and one very recently where people think all of a sudden though Fed is going to stop what they're doing and pivot. That does not seem to be supported by the inflation data or the labor market data at this point. But nonetheless, you see the 10-year retracing from [4.30 down to 4.04]. And something like that happened in the summertime, when the trend was below 4. So there's just way too much volatility to project this and what depositors might do, what competitors might do. But bottom line, when we look at a variety of scenarios, we say that we have a very good chance of protecting the margin in the [350, 360] range. Yes, it might dip a little bit in any given quarter depending on the timing of assets repricing and fundings, and whether we had to act more aggressively to protect deposits. But we feel pretty good about steady as you go as the base case scenario, 60% of probability.

Got it. That's helpful. Thanks for all the color Morgan. I know it's hard. How about just jumping the expenses for just a minute, a little bit better than we thought, and then you kind of the branch closers, just kind of how we should be thinking about the near-term on the expenses, and then as you get some benefit or I guess I'm thinking you get some benefit or not, maybe you're reinvesting that in the business. So just kind of how you're thinking about the branch closings impact on the expense run rate?

Well, if when fully realized the branches together will create about an $800,000 cost saving. Our Flossmoor branch is up and running and so far early read is that customer acceptance has been good. And that is taking over 16,000 square foot facility and serving customers that actually help bridge us into adjacent markets in a more efficient way down to a 4,000 foot facility with a significant amount of cost saves, real estate taxes, bricks-and-mortar. If it's going to work out very well for us, at least that's the current size. So of that $800,000, our focus for next year is to do the best we can to control non-compensation expenses. But we still need – there's – we have to take care of our people, just like we have to take care of our depositors. Inflation is still a factor for those folks, and we have to make sure that we're competitive for people just so we have to make sure we're competitive for deposits. Our marketing focus will continue to be on the commercial finance side. I can see us pivoting some effort into commercial finance and real estate, just given the profitability or relative profitability of those assets. But our focus will be on maintaining controls on the non-comp expenses and then putting money into the marketing for the assets we need, including business deposits. That's going to be a continuing focus for us. We've had some early success with it, there's more work to be done. But if we can continue to grow our commercial deposits, which both create credit and income opportunities, even trust and wealth management opportunities as well as an overall lower cost of funds with higher average balances, that is actually – that's a great place to be in any rate environment, but particularly this one.

Got you. Okay. All right. And then maybe just one or two final ones. Just on the buyback, Morgan, I guess there was a few shares you guys repurchased this quarter just given kind of valuation levels and just the outlook for growth here. I guess can you just talk about how you balance that or how you think about buyback?

It's a little more expensive to buy shares back starting next year due to the excise tax. So I expect that we'll have a reasonable amount of activity here in the fourth quarter, maybe not quite the same extent as the third quarter, but still healthy. And then next year, we'll see. We have enough to take us through April of next year, and the Board has taken this pretty much a quarter at a time, but making sure we have capacity over a six-month period. So if you said we're going to do somewhere between 150 and 200 in the fourth quarter, that sounds like a reasonable place to be. And then if you said maybe 100 to 150 for the four quarters next year, we will be throwing off some extra cash so there will be some opportunity to share repurchases. But obviously, hopefully, share prices improve as the consistency of earnings improves, and it's a little less accretive to buy shares back. So I would say still interested in the share repurchases, maybe not quite to the same level as in the third quarter in 2023. But given the excise tax that takes place in 2023, it makes more economic sense to do more in 2022 while that tax is still not being assessed.

Got you. Okay. And then just maybe lastly, just – I know you talked a little bit about your goal as far as loan growth goes, as far as where you get to maybe by end of year. But just broadly, what you're hearing from your customers and just thinking about next year? I mean, I guess, are you more cautious today on the growth outlook given what we're seeing with the economy or, I guess, your customers? Do you get the sense that maybe growth is a little bit better, a little bit worse as you were thinking about for next year? Or I don't know if you can give any color on [indiscernible] on that?

If we're able to get to $1.2 billion at the end of 2022, that meant we get roughly a 14% loan growth in 2022, which we consider to be a good solid achievement. A considerable amount of that growth was real estate, somewhat better than we thought actually at the beginning of the year. Next year, we would look closer to probably 10% as a starting point, and again, with a focus on the commercial finance and equipment finance side. Typically, in this rate environment where liquidity is getting tighter and rates are going higher to make equipment finance demand increases, lessees look at it and say, I'd like to pay over time. I'd like to conserve cash. Cash is no longer the enemy of the equipment finance world as it's been in a zero rate high liquidity environment. So historically, and just cyclically, a rising rate, higher rate environment is usually good for equipment finance. And obviously, in our government finance portfolio, the government is going to continue to spend money, somewhat recession-proof. So generally, we would expect to continue in that portfolio. If, however, the economy substantially slows down and production slows down, things of that sort, maybe you don't get that type of equipment finance growth. But I suspect we probably will. Companies are going to be interested in modernizing their operations. Companies are going to be interested in automation. Anything that can raise efficiency, potentially reduce the reliance on labor and upgrade their equipment so that it's consistent with operating systems that are about to deprecate, Windows 11 as opposed to Windows 7. So I think our bias right now is a 10% growth is feasible. We're assuming that equipment finance trends stay in place, and there's a greater – there's a continued interest in equipment finance going forward because it's economically efficient from a cash perspective as opposed to paying cash for it, and that's usually good for us.

Got you. Okay, and then I'll – let me ask this last one and I'll step back, but just on the two things. I know you talked about hiring people recently and looking at more people to add. But just – any update there? And then just on the – how to think about given the growth you've outlined, just how to think about the reserves? So those last two, and then I'll step back. Thank you.

We're in pretty good shape on people. There is a little bit more work to do. I would not expect the addition of people to have a huge impact on expenses. Again, we may – we'll find ways to economize our shift priorities a little bit to make sure we get what we need. I mean, obviously, if a sudden opportunity shows up with a great group of people, we won't hesitate, but we're not necessarily planning for it. As far as reserves are concerned, we, again, will have CECL starting next year, and we'll obviously talk more about that right now. We don't see it as a massive change in the reserve ratios or the approach. But again, given the mix that might move higher and more towards commercial finance, then I'd say that 75, 80 basis point per quarter reserve ratio is a little more likely. But again, if the growth is in the government finance credits, if it's in healthcare credits with extremely strong account debtors, then that might be a little bit lower. So somewhere between 70 and 80 seems reasonable if we get the mix that we want, and obviously a little bit less if it's a lower risk mix.

Perfect. Thanks for taking all the questions, Morgan.

Appreciate your interest, Brian. Thanks.

Thank you. I am seeing no further questions in the queue. I would now like to turn the conference back to Mr. F. Morgan Gasior for closing remarks.

Well, we thank everybody for their interest in BankFinancial. We look forward to continuing progress here in the fourth quarter. We wish everyone a happy holiday season and safe holiday season, and we will speak to you in 2023.