Good day, ladies and gentlemen, and welcome to the BankFinancial Q3 2014 Earnings Conference. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to turn the conference to our host, Mr. F. Morgan Gasior, Chairman and CEO. Sir, you may begin. .

Thank you, and good morning. Welcome to the third quarter '14 results investor conference call. At this time, I'd like to have our forward-looking statement read. .

Okay. 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 these statements 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 the 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 the 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. As all filings are complete, we're certainly prepared to answer questions. So please proceed. .

[Operator Instructions] And our first question comes from Jon Burke of Amica Insurance. .

Morgan, for the last 12 to 18 months, you've spoken about getting or exiting 2014 fully tax ROA of about 75 basis points, and we're 2 months from year-end. And correct me if I'm wrong, but on my numbers of kind of normalized earnings taken out something like the provision this quarter, you're somewhere like 40, 50 basis points.

And so just given that, given the lack of execution, really the question to me is how much more patience does the board have to allow the company to operate these levels of returns, given the M&A market is offering attractive exit multiples for sellers?.

Well, Jon, I think the first thing about our projection was that was a position we wanted to be for a run rate starting in '15. So we've certainly made progress towards that goal. And as we track further on loan originations, cost savings and, to a lesser extent, noninterest income improvement, we think we're making good progress with that goal.

We'll see if we get there, exactly to that number, in the fourth quarter, or as of fourth quarter, I should say, going into '15. But if we do get at or near that number, it sets up a good base to improve on in '15. As far as the board is concerned, they're very cognizant of the position we're in, the progress. They're also monitoring market conditions.

And I think once we get to the end of '14 and we look at the '15 business plan, we'll be benchmarking to see what those results look like, how well we did execute to our projections and then start making decisions about what we should do next. .

All right. I'm interested in seeing some execution because from the standpoint of myself, and I would imagine a lot of other shareholders, the level of profitability here is just not cutting it. .

Understood your position, Jon. .

Our next question comes from Brian Martin of FIG Partners. .

We'll continue to just talk about -- you just talked about -- I guess a little bit to Jon's question on the -- on getting your profitability goals, maybe just give us an update on the loan originations and kind of how those are tracking relative to what you're thinking.

And then same thing on the efficiency front, kind of what -- has there been any change in your position on where you can get to? And maybe just remind us where that is on the loans and the efficiencies.

And the other question maybe just what's the kind of the capital plan? We talked a little bit last quarter about that, and just kind of an update on where you are there would be -- those couple of things would be helpful. .

Okay. Well, first on loan originations. We picked up some momentum on the loan pipelines as we got through third quarter. And our goal for the year was to end loans right around $1.225 billion.

And based on the pipelines that we have right now, we see a range of about $1.2 billion, and it's still possible for us, based on the pipelines we have, to get close to $1.225 billion. But those are what pipelines are. The question is will they all close. So I think getting close to $1.2 billion, right at a $1.2 billion, is very feasible.

And it's still possible, based on the pipelines we have, to get to $1.225 billion. And that would be pretty consistent with what we thought. I'm seeing a little more yield compression in the existing portfolio than we had thought, that was putting a little bit of a damper on the interest income side.

Yields picked up a little bit in loans for the third quarter, but obviously market rates dropped a little bit for new originations in the fourth. Expenses. We're still tracking towards that $40 million to $42 million range.

I think we're at, Paul, $10 million?.

$10.250 million. .

Yes, $10.250 million, as we ended up on core expenses for the third quarter. And I think we'll be in pretty good shape to get to that $10 million to $10.250 million for the fourth quarter. So going into fourth -- going into '15, a $40 million run rate, plus or minus, looks feasible.

On capital, obviously we've just -- the board saw fit to raise the dividend again. So we're now running at $0.03. And when we get to the first quarter of '15, once we do all of our stress tests and look at the overall capital, look at the growth plan for '15, I can tell you the board is looking at all the different options.

There's been an extensive discussion on share repurchases and what would be appropriate to do in that context. There's a range of views on that, but certainly, there's some range of views that say that it could be a benefit to reducing the share counts and improving EPS.

And if it all works out as we like, there will be a capability to execute, to some degree, on that starting in the first quarter of '15 or second quarter, if conditions are appropriate. There's still some thought about a special dividend. We've done some research on that. We haven't made any commitment to it, but it's also a possibility.

So I think there's a variety of ways that the capital plan can move forward. We're not really modeling an acquisition for '15 right now. That's not to say we wouldn't look at one later, but it's not something that we're presently incorporating in the projections. .

Okay.

And the share repurchase program, if something were to happen on that front, it wouldn't happen until '15 is your sense, or there's something that could potentially happen sooner?.

I would not expect any activity until '15. .

Until '15, okay.

And then maybe just kind of an update on the DTA, kind of where that stands?.

Well, we've done our first analysis and consulted with Crowe and others on this. The audit committee has reviewed it and reported to the board on that matter. And just to review, the key elements are the 3-year cumulative loss and the continued quarterly GAAP earnings.

And at 12/31 of '14, the goodwill impairment is no longer a factor, but the impact of the bulk sales still remains. But if current earnings and asset quality trends continue, and there are no adverse developments, then these positive factors should overcome the trailing impact of the bulk sale.

So as you can see, our next measurement point is the end of the year. It helps greatly that the goodwill is dropping off. And if things remain stable, then that's the next inflection point to take a look at DTA. .

Okay. That's helpful. And then maybe just back to loans for a minute. The payoffs continue to be pretty consistent here in this, I guess -- well, if you net out the construction, I guess, the commercial stuff is probably $60 million -- $50 million, $60 million a quarter. Is there -- what's your sense on payoffs going forward.

I mean, if you get the originations stabilizing or going up, are you still going to expect an elevated level of payoffs?.

You have to take that by portfolio. Home equities continue to decline. I think that's kind of an industry thing, at least for most, if not all. But we're not really originating enough in home equity to offset the consolidation of home equities in the first lanes. So that's probably been a significant change in balances.

We've had some prepayments on leases, which is unusual for us. But year-to-date, we've had about $16 million in prepays. The good news about that is we collect prepayment fees for that, so it helps noninterest income a little bit. But there's no question you lose the earning assets and you have to replace them.

So -- and there's no real predicting those things. If the lessor and the lessee decide they're going to rewrite a deal and pay the prepay, there's not much we can do about that. And we've also had some cases where customer wanted to do a small cash out and -- on the real estate loan.

So what happens is the old loan gets paid off and the new loan is originated. But there's a very small delta in the actual outstanding amount. So you kind of hit the parts, what's going on there.

And we've also had some property sales, both in the nonresidential and the multi-family where people are taking advantage of market appreciation and selling the buildings. There's 1 case that we got paid off on a $3-plus million loan. The borrower paid cash for it. There was no loan opportunity there to keep that asset.

So I would say it's fairly opportunistic, and we're seeing payoffs, we'll still see some payoffs as we exit certain relationships. But overall, our retention has been pretty good, other than the situations where the borrower's actions are driving volume in one context or another. .

Okay. In the excess liquidity that still sits out there, if you talk about, when you look at '15, I know you haven't commented about your loan growth outlook, but the loan growth outlook you do see in '15, I guess, is your expectation you still fund most of that with this excess liquidity and the balance sheet really isn't growing all that much.

Is that kind of big picture kind of how we should be thinking about things?.

I would actually say we'll start growing the balance sheet. If we have the upper end of our range for fourth quarter on loan growth, we'll have to start funding now based on our liquidity -- our balance sheet liquidity parameters. So we're very much looking at '15 as a way to grow the fundings, which obviously is another way to consume capital.

But we're at or near the point where we need to start funding with deposits. We're pretty close to where we want to be on minimum or target liquidity. .

Okay. So that $100 million that we see out in this quarter, a touch more than that is kind of what you want to maintain. .

It's close. I mean, those are all -- those are primarily CDs that have staggered maturities. And depending on the loan mix, we're seeing some more C&I growth. So we'll be holding some unused lines. And so that's part of the contingency funding analysis.

Also, it will -- it depends on if we're originating more leases where they have relatively short durations. So that all goes into our cash flow analysis. But I would generally tell you that of that $100 million, you might see a decline by $25 million. But we're going to keep a very healthy liquidity position.

There's been discussions in the market about surge deposits and what happens when rate goes up. Nobody is really expecting rates to go up materially any time soon, and we've done an analysis that says our exposure is relatively modest in that front.

But still, nobody really knows, and the board thinks that it's a good idea to keep some excess liquidity on the balance sheet. And so therefore I think we might look at some of that $100 million going into shorter duration loans, but we won't really look to have -- dive deep into that to fund, say, term loans. .

Okay. All right.

And I guess looking at -- just remind me, your target that you had out there for -- in ROA in the fourth quarter, was that on core expenses? And I guess, or is that inclusive of all expenses that are out there? And what was the target for an ROA for the fourth quarter, kind of a run rate?.

Brian, that goes back to the presentation in May. And the core ROAA off of the balance sheet that we projected as of 12/31 was a core ROAA of 70 basis points projected out to 2015. .

Okay.

Then when you say core, Paul, what are you stripping out, or I guess, what are you backing out of that to make it core versus just reported?.

the provision, the NPA expenses and the OREO operations. .

Okay. All right. And I guess just maybe back to Morgan for a minute. Just kind of if you look to '15, and I realize you're not necessarily giving any guidance, but just for me, it sounds like the expenses will have been essentially rationalized, getting down to a baseline type of level.

And credits been cleaned, where you can't really bleed the reserve a whole lot further, so the provisioning ought to be more stable and more consistent at whatever level.

And then two, to take profitability higher in 2015, what -- kind of big picture, what's the focus? Is it just getting the loan growth that you expect? Is that the key driver? I'm just -- maybe just talk a little bit about kind of what the board is prioritizing for 2015. .

Yes. I mean, if you look at the fundamentals, of noninterest -- net interest income growth is going to be the key. We've said that consistently. It certainly would help if rates picked up a little bit. It would cut down on refinance opportunities in the existing portfolio. But to your point, the expenses are about as good as they're going to get.

There might be some smaller opportunities for economies of scale, but to maintain what we have in terms of the structure of the company, branch operations, compliance, technologies, security, all of those things we're at are factored in that run rate on expenses.

We think we'll see a little bit more improvement in noninterest income as account structures are changed. We're working through all the various compliance functions on that and making sure that we are careful in how we manage those customer relationships and don't paint with a broad brush.

So as that stuff rolls out this quarter and into next, we'll see some improvements in noninterest income. They won't be going from 45 basis points to 90 basis points in noninterest income, but there are some room for improvement there. But at the end of the day, it's going to be leveraging the excess capital into loan growth.

And we get to $1.2 billion, $1.225 billion, we're going to have about 9% loan growth this year.

And if we can continue 9% to 10% loan growth into '15, especially in a better mix of assets, adding a little more C&I to the portfolio and shortening up the durations, then we'll have a pretty good rate -- run rate going into '15, getting close to those market ROAs that we've been trying to hit. .

Okay.

And then just remind me, your asset sensitivity, where do you guys stand there? And how -- I guess, maybe what percentage of your loan book has floors on? What do you have to burn through to start getting a benefit if the run rates go up?.

You can look at different measures. We're mostly focused on a plus 100, plus 200 instantaneous shock. And then we also look at a projection of interest rate risks based on global insights, just on a most-likely scenario because the 100 and 200 seem very consistent with industry practices, but they potentially are less likely.

So we kind of look at the plus 200 as the worst case scenario. And then the most likely -- and the plus 100 as a more likely scenario. And in those regards, we are slightly liability-sensitive on current net interest income in the plus 100 to plus 200 scenario. And we're slightly asset-sensitive in the most likely scenario.

So I think the goal is as we start to net fund, we'll start to layer on maturities and address the gap on the new originations on more or less a duration-matching basis. And that should serve to keep the organization pretty close to neutral in terms of interest rate risk in a most likely scenario, plus 100 scenario.

We might be slightly liability-sensitive still on a plus 200 scenario, but it's not very likely we're going to see that any time soon. .

Right.

And the amount of floor -- I guess, the amount of floors, what percentage of the portfolio has floors on it today?.

I don't have that number readily available. Some percentage do, competitively. That's a harder thing to put in these days, especially since most customers are keenly aware of where things are. Some credits have them, some don't. C&I is more likely to have them at the base rates there are now. Real estate, obviously, does not.

So I wouldn't -- if rates declined further, we wouldn't see much improvement in interest income. Just like if rates go up, we won't see much decline in interest income. So there's not a lot of help from floors, there are some. We put them in when it's possible on the C&I side.

The real estate side, when you're putting on ARMs, they're fixed for 3, 5 or 7 years anyway so that's the floor right there. .

Okay. All right. And then maybe just the last two.

Just a -- how about just staying on the margin, I guess, would your expectation be that the margin could go lower but the dollars of net interest income go up as you grow a bit, I guess, or is it a sense that both could go up? I guess, you're more focused on dollars of net interest income, I guess, is my sense.

But just kind of how -- your take on the margin, kind of where it's at today and how it holds up relative to the growth you're looking at. .

I think it's a fair point or a fair statement to say we're focused on the dollars and especially when you're focused on the fact that we like the multi-family assets because they're 50% risk-weighted, so it enables a greater utilization of excess capital. And for that, you give up a little coupon to get that benefit.

So is it possible that we would see some net interest margin as a percentage compression as we get into the latter '14 and '15 based on asset mix? Sure. Especially if the mix skews to higher-grade leases, for example. The market is very competitive there, but they're very safe assets.

So on the flip side, as our C&I grows, you get a little bit of improvement in interest rate -- variable interest rate, interest rate risk protection. Some credits go on to books at prime, some credits go on to books at prime plus. So you pick up a little margin enhancement there and you pick up some improvement in interest rate risk if rates go up.

So I think it's kind of a careful balance. The ideal scenario for us is if we can maintain margins about where they are now as a percentage and still grow interest income, then that is probably the ideal scenario for us.

But if we have the opportunity to grow loans and put that excess equity to work, we'll accept -- for good quality loans, we'll accept those yields and continue to grow and not be as concerned about maintaining a specific percentage margin. .

Okay, perfect. And I think you answered my last question.

Just as far -- it sounds like the -- as far as the opportunities on the loan growth front, the areas you're focus on are the leasing and multifamily and commercial, those are the 3 categories we'd expect to see the most benefit from as you look to '15?.

Yes, that's correct. We're just -- we're not really focused -- I mean, we're here to take care -- we market for home equity loans and we're here to take care of our home equity customers and our deposit customers interested in residential ARM products and home equity loans.

But that's not been -- home equity has not been really too much of a growth for most institutions, partly because of market conditions on home equity. So we're not anticipating much growth there.

But the multifamily product, C&I, whether it's lines of credit, equipment or a limited amount of owner-occupied real estate, and -- which also includes direct lessor relationships, as well as the growth in discounted lease purchases, are the key asset growth parameters for us. Nonresidential real estate, we will grow it from time to time.

But as I said before, very opportunistic. .

Okay. And did you say something about a bulk sale? I guess maybe I missed that or... .

It's just -- we're not doing any bulk sales. The one we did is still a factor in the DTA analysis. .

[Operator Instructions] And I'm showing no further questions at this time. I'd like to turn it back to Chairman and CEO, F. Morgan Gasior. .

Well, I thank everyone for their questions, and enjoy your holiday season. We will talk to you next year. .

Ladies and gentlemen, that does conclude today's conference. Thank you for your attendance. You may now disconnect. Everyone, have a great day..