Good day, ladies and gentlemen, and welcome to the First Quarter 2014 BankFinancial Earnings Conference Call. My name is Britney, and I'll be the operator for today. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. And at this time, I would now like to turn the presentation over to your host for today, F.

Morgan Gasior, Chairman and CEO. Please proceed. .

Thank you. Welcome to the first quarter 2014 investor conference call. At this time, we'll read our forward-looking statement. .

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 and the actual effect of our plans and strategies is inherently uncertain, and actual results may differ significantly from those predicted.

For further details of the risks and uncertainties that could impact our financial condition and results of operations, 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. Well, all of our filings are complete. We're ready for questions. Please excuse my voice, I'm not quite up to my usual standards, so our CFO, Paul Cloutier, might answer some questions on topics as necessary if my -- lose my voice. But please proceed, anyone who'd like to ask a question. .

[Operator Instructions] And your first question comes from the line of Jon Burke. .

Morgan, you got 4 quarters of profitability here now in a row, what's that say for the possibility of the DTA coming back, and then also for capital return back to shareholders?.

We -- right now, we're on track for the DTA in '14. We're having discussions with the auditors and going through the documentations rule [ph] on that right now, so I don't know if it will be a second, third or fourth quarter event, but it's going to be in that time frame. The shareholder return issue is a somewhat broader issue than that.

The first thing that the board has been focused on has been evaluating our quarterly dividend policy, and that process is just about wrapped up.

Then after that, and as soon as that policy is decided, obviously, with a view towards increasing the quarterly dividend, and the question is, to what levels and when? Then the issue is along the line of a special dividend, a share repurchase program, we haven't had one for a number of years, but given where we're trading, it would make a certain amount of sense to look at it, unlike 4 or 5 years ago when we were trading significantly above book [ph] when it might not.

But at these levels, it very much might. And then, of course, mergers and acquisitions. But I would say, first of all, quarterly dividends is the near-term issue.

And as we wrap up the DTA analysis and we look at a dividend capacity from the bank and also, therefore, at the holding company, that some of the other shareholder return issues will start getting decided on. .

Okay.

So we should expect a press release maybe by the next quarter about the recurring dividend?.

Yes, they're going to make that decision coming up soon, so I would expect the first moves on dividends will be near term, possibly as soon as the end of this quarter. .

Okay. And then shifting over to expenses. At year end, you put out some guidance for different line items and on expenses, you had, had core expenses down to $10 million by the third quarter.

Is that still achievable?.

Paul?.

John, we're on pace. We're taking measures to reduce compensation and benefits and you're starting to see that line trend down. There's other expenses, depreciation that's starting to roll off. So we are on pace right now and that is the goal, to get it down to a core of $10 million a quarter.

We will keep you updated each quarter as we continue to make progress towards that goal. .

Yes, I don't -- I think that is a pretty achievable number, and we might even beat it, get there before the end of fourth quarter. Trends are moving in the right direction. We have a few open posts here in the smaller expense category for brand services and things like that.

But generally speaking, we're pretty comfortable with that number, absolutely no later than the end of the year, but it could quite possibly be sooner. .

And when you say core, is that stripping out the OREO cost and nonperforming costs?.

Yes, that's x the nonperforming and OREO-related costs. .

Okay. And then last one for me. In the Q, you had a comment about loan renewals peaking out in the first quarter.

Does that mean you're expecting the payoffs to start to slow down?.

That'll be one function of it. Payoffs are a cash event, where we got cash for a loan. And sometimes, payoffs are created because a loan, an existing loan pays off and a new loan is booked, but the borrower took additional funds or sought a larger commitment.

So we pay off the loan, book the new loan and you'll see -- it kind of grosses those volumes up a little bit. But the reason I made the point on the renewals is, in terms of yield stability, we're still seeing resetting in that -- in the loan portfolio as loans come in for either out of prepay or they just come up for maturity.

And the first quarter renewals were the kind of the high watermark for the maturity dates for this year. So we put that in the 10-Q. Whereas we're hoping to see a little more stability in the yield because those repriced loans are masking the improvements from the loan growth [ph] a little bit. .

Okay. So you've been -- I mean, for a few quarters now, you've been marching down 14, 15 basis points on the loan yield.

So what you're trying to say there is that's going to start to slow down?.

Yes, we're hoping so. We ran the yield distribution analysis as we prepared that, and the bulk of the portfolio has repriced. It's not to say that it's all repriced. For example, the loans that were acquired from Citibank is still a reasonably sizable percentage, and those are some very attractive yields.

We had our initial slug of prepayments on that in the end of '12 and the early part of '13, but that has slowed considerably down. We remain in touch with those customers, and I would say, right now, that's probably the largest pool of loans that could present a repricing risk. It's about $85 million to $90 million.

But the rest of the portfolio has repriced at least once, and most of the prepayment penalties are now expired or expiring, so you're going to see -- we're planning out of the position where yield resets are a factor.

It's not over, but I think it's, to use your word, I think slowing down at least, is what we hope to see happen in the next 3 quarters. .

And what's an average new loan coupon coming on at?.

Yes, it will depend on the product. The multifamily product will range from 3.5% up to 4%, depending on the term of the loan and the role of credit risk. Commercial leases would go on the books in the low 3s on up, it could even be slightly south of 3% if it's a very short-term lease, [indiscernible] to an investment grade company.

C&I is going on the books. Usually, somewhere around prime plus 0.25%, on average to prime plus 0.50%. So again, 3.5%. Again, sometimes a little stronger depending on what the nature of the product is, whether it's a line of credit versus a term loan.

So I think if you add it all up, somewhere between 3.50% to 3.875% is a pretty good range, and it will really depend on the mix of assets that we book during a given period of time.

The focus is to continue to improve the C&I lines of credit and some of the equipment -- fixed equipment loans and that should help push the yield a little bit north as we go forward. C&I is still pretty competitive, but prime plus 0.5%, for the type of borrower we typically talk to, should be a reasonably good average. .

[Operator Instructions] And your next question comes from the line of Brian Martin. .

Morgan, can you just talk about -- you mentioned some of the comments on the capital.

As far as dividends and special dividend buyback, where is the, longer term, an optimal capital structure as you guys look at it in kind of bigger picture, with whatever actions you do decide? And where is ultimately, how you'd like to run the bank? What type of capital?.

I think I might be front running a firm answer on that a little bit, Brian, so I don't think I'm at a point where I can be specific as we would otherwise be in the not too distant future. But let's just take a couple of points to keep in mind.

It's our view, that under the Basel III and the current views of regulators, the new minimum capital ratios are 8%, 12%. 8% tangible, 12% risk base. We are still polishing the model on Basel III to look at the different factors.

But once upon a time, we would've been comfortable running the bank with a minimum capital of 7%, 7.5% and 11% to 11.5% on risk based and 100 points over the well-capitalized thresholds. But we really think, from a regulatory perspective right now, that the new threshold is 8%, 12%.

If you go much south of that, I think the regulators are going to have concerns. So that's probably the floor for capital in terms of ratios. But I think part of the answer for us is looking at the allocation of assets and managing what is likely to be the more restrictive value, which is risk-based capital.

And towards that end, we're careful about originating multifamily loans so that the vast majority of the loan production becomes eligible for a 50% risk weighting when the standards are met. There's documentation standards and there's a seasoning standard.

We had a pretty good quarter in multifamily originations even in the first quarter when we were defrosting people, but that's one of the reasons we like that product, is it gives us some additional capital flexibility.

So I think that a number of 8%, 12% is a base capital level at the bank level, and then keeping an eye on managing risk-based capital with asset allocations are the 2 key metrics we're looking at. Anything else is a function of when we allocate capital, what is the better return.

Is a special dividend a better return? How does that address the needs of the shareholder base. Is a buyback a better return? What's feasible to do? And if you do it once or you do it over a period of time? And as far as mergers and acquisitions are concerned, we're pretty cognizant of the state of the Chicago market.

There's certainly institutions for sale.

But given the fact that many of these institutions still have some fairly elevated legacy asset quality issues, and we just literally got done moving the vast majority of the Downers Grove stuff out, I think we're less likely to look, at least in '14 and early '15, we're less likely to look at a merger and acquisition as the capital leverage.

We're more likely to look at the dividend policy and the share repurchase in the near term.

After that, if a really great merger and acquisition opportunity were to arise that would materially complement the balance sheet, provide good synergies, a pop on efficiency because of the end market cost saves, we'd look at that, but it's more of a longer-term thought for us than a shorter-term thought.

The dividend and the share repurchase analysis are a little more upfront in terms of our priorities. .

Okay. That's helpful.

And as far as the DTA, Paul, I guess, maybe what's the amount -- what's the add if and when that does come back, today?.

Well, as we reflected in the K, we have about $35 million of deferred tax assets that are fully reserved for currently. So that's what's at stake in terms of a recovery. .

Okay. And in timing of that, you said some time this year was the expectation, just a little bit uncertainty as the exact time. .

But we've started discussions with our outside accountants -- auditors on that topic. .

Yes, it could be as soon as second quarter. We don't -- we still -- and we anticipate it to be a '14 event in any event. .

Okay, perfect.

And then just as it relates to the margin and kind of your outlook there with the excess liquidity you're still carrying, what's the -- and then the yield is still being under pressure as far as on the new lending? What's your expectation kind of on the margin and, I guess, in net interest income? I guess the NII dollars were down a little bit this quarter, despite the margin being a little bit higher just, I guess, given fewer days in the quarter? So I guess what's your thought as far as deploying that liquidity and moving the margin higher perspective?.

Yes. We had a -- if you look at our loan originations payoffs table, we had an okay, low okay, quarter. We knew that after -- that having a strong quarter in the fourth quarter, we'd be kind of lighter on originations, overall, but it was still respectable.

And we also got rid of a fair amount of things that we like to get rid of in the quarter as well. But if you go through the rest of the year, if we're growing $25 million each quarter in the loan portfolio and those yields are averaging in the 3.5 range, as I said earlier, that would be the low end of a good quarter for us.

And I would say the high end of a good quarter for us is if we were to grow $50 million to $60 million in a quarter, like we did in fourth quarter. So divide by -- average those out, if we're doing $40 million a quarter, that'd be $120 million for the year, net, and we would be -- we would think that would be a good result for the year.

So then take that $120 million times an average of 3.5 and you kind of get a sense of where that number is going to head. And that's why we're kind of keeping an eye on renewals, too, because the -- you still -- we're glad to see that we got through the bulk of the renewals in the first quarter, it'll take a little pressure off of rate versus volume.

There's still some out there, but I'd say, like I said earlier, the bulk is behind us at this point. .

Okay. In the originations and kind of loan outlook at this point, no real change to your comments on the last couple of quarters as far as what your expectations are.

I guess at some point, when do you expect to see -- if the originations hold, I guess at a level that's, maybe this quarter, a little bit higher, when do you start to see a drop in the payoffs as you go forward?.

Again, part of those numbers are affected by a customer refinance and [indiscernible] an additional loan. So to a certain level, it's gross up. But I would also say that the trend line continues to work down if you look at longer-term trend on payoffs, generally.

So I think we're probably more focused on when we're looking at raw originations and producing the originations total every quarter. There's a limited amount of control we're going to have on payoffs. And if we lose deals, we typically lose it because the borrower wants a larger cash out than we are comfortable with.

It is typically a situation where when you analyze the cash-out request, the borrower's attempting to extract virtually all of their cash equity out of the business or out of the asset involved, and we're just not interested in essentially segueing to being an equity partner in those assets.

So if -- there are more aggressive competitors than we are in terms of property valuation and advance rates on real estate, but if we like the deal and it's a strong deal, we almost never lose that deal based on pricing. So that's why it's a little hard to predict the payoff side.

I can say, though, that we're kind of focused on the origination side being the key to the ballgame as far as improvement in net interest margin. .

Okay.

In the origination trends, like you said, they were down off of last quarter's elevated level, but somewhere in the $70 million type of quarterly level, does that seem more along the lines of how you guys are looking at that line?.

Like I said, it was on the low end. The total for the quarter was on the low end of what we like to see. We're thinking that, again, growing the loan portfolio $25 million a quarter is at the low end of acceptable, $60 million a quarter is on the high end, so midpoint around $40 million.

With about the same at the distribution we're having, we're seeing a little bit of pick up in pure C&I stuff in the healthcare area and on a direct lessor category. So our numbers could improve. But sometimes those numbers are also a little bit opaque. We had better utilization during the quarter.

For example, on lines of credit on the direct lessors, but then the leases funded right at the end of the quarter and you didn't see it result in end-of-period balances. So greater line utilization will certainly help the absolute level of net interest -- of interest income, even though the period-end balances may not reflect it. .

Okay, perfect. And just the last 2 things.

I guess as far as the deposit trends, what are your expectations as far as the longer term in boosting the component of the non-interest-bearing areas? Is there initiatives that you have, you're working on there that you can give any color on?.

Deposits are a topic that there are so many moving parts that it's hard to predict. I think we're going to be back in the deposit market towards the latter end of the year as we absorb the remaining part of available cash.

Remember, too, non-interest-bearing deposits are a little bit of an anachronism in a sense that you can pay interest on business deposits.

So we continue to market that for those deposits at a lower level, but I think when we start talking in the third quarter, we'll have a better talk -- a better opportunity to talk more about the direction of the deposit portfolio.

One, we have not engaged in a great amount of cross-selling on deposits to existing customers because we have been sitting on so much liquidity. But particularly in the context of some of the Downers Grove customers, there may be some opportunities there. On noninterest income, the -- we've reconfigured a variety of products on the retail side.

We were not really -- we were not at all in the deposit advance market, so our noninterest income numbers did not have the same issue as some of our competitors who were very aggressive on the deposit advance products, so it certainly boosted their noninterest income, but when those products were basically outlawed, they're paying for it.

But what we did do is there are certain parts of our market that the products that the federal -- that the government has approved in terms of being suitable for retail consumers are something that we've released those products. The sales process is just now getting started.

So I would say the key to our noninterest income is doing more account development at the retail side and then smaller -- small businesses around the branches. We're not really out there doing small business lending and small business deposit as a market line of business all by itself.

We looked at that in the context of SBA and we just couldn't get comfortable with it. So our focus will be improving the retail-based cross-sell, improving the noninterest income results from retail and getting a better penetration of small business around our branch -- our existing branch network. .

Perfect. Okay. And just the last thing, there was a couple of comments recently from some of your competitors about the Chicago market and the multifamily market, maybe getting a little bit frothy or a little bit overheated.

I guess, with the growth you put on this quarter, I guess is it fair to say, not a lot of concerns on your end in that market? Are you seeing any concerns that's from that element of the loan portfolio?.

Yes, I would say a little bit, but I would also extend that comment to nonresidential real estate, and to some degree, even more so in nonresidential real estate. The market is probably divided into 2 pockets.

Very, very strong -- well, maybe 3, very, very, very strong; and then okay, plus; and then, oh my God, where the markets have not recovered, occupancies haven't recovered, valuations haven't recovered. In the multi-space, we tend to be in the smaller end of the market to begin with.

So for example, in Lincoln Park, you're seeing a 6 flat trade for well over $1 million. But we have minimum capital [ph] rate requirements when we underwrite loans and we also do stress testing on both the debt service, vacancy and valuation to make sure we're not over advancing into a frothy market.

And as I said, that does affect our payoffs from time to time because a borrower who heard about a friend who got an appraisal on his building says, "Hey, let's do a cash out." Very little of our -- well, we can't say very little. Most of our originations are purchases or rate and term refis.

We will do cash outs, but we're doing it off of a very, very strong equity position in the multi-side. We're doing very little in the way of cash outs on nonresidential real estate.

And just as an example, it's timely, we saw a property recently that was a simple 3-tenant commercial space, probably about, I don't know, 8,000 square feet, and it was being valued at $457 per square foot. That's just a tough deal to do in a 70%, 75% advance rate.

And on top of that, that transaction, the tenants involved have above-market leases that are going to reset here in the next 2 years. So I would agree with competitors who are saying real estate can get a little frothy. Multi in some of the very strong markets, commercial real estate, with strong markets.

We're sidestepping that to some degree by focusing on markets where valuations are a little more reasonable and staying in [ph] close on smaller deals. And we also have some underwriting stresses built into this. So we're not over-advancing into, shall we say, a mini- or micro-bubble, on a case-by-case basis. .

At this time, there are no further questions in the queue. I'll turn the call back over to F. Morgan Gasior for further remarks. .

Well, thank you again for some excellent questions. I hope it was informative. We look forward to talking to you, and especially with a better voice, at our next opportunity, either at the Annual Meeting or for second quarter results. For those of you who are actually having a spring, enjoy it. The rest of you in Chicago, we hope it warms up soon.

Thanks, and have a good day. .

Ladies and gentlemen, that concludes the presentation for today's conference. You may now all disconnect, and have a wonderful day..