Good day, ladies and gentlemen, and welcome to the BankFinancial Corp.'s Q2 2015 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I would like to introduce your host for today's conference, Mr. F. Morgan Gasior, Chairman and CEO. Sir, you may begin. .

Thank you, and good morning. Welcome to the second quarter 2015 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 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 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. As all filings are complete, we're pleased to answer questions. .

[Operator Instructions] Our first question comes from Brian Martin of FIG Partners. .

Morgan, can you just -- I guess maybe just start a little bit -- just talking about kind of the loan growth and I know that's been a focus and just kind of give us an update on how things went this quarter and just kind of where the pipelines are at and then maybe just a little bit on pricing?.

Sure. We were a kind of a little bit disappointed about loan growth this quarter, actually. We would like to be at a run rate on an average quarterly basis around $135 million, and we fell a little bit short of that this quarter.

If we do that run rate and we have a payoff rate that of vibrated our NPA payouts of about $95 million or $97 million a quarter then we get to our 10% annualized growth or better.

So it wasn't our strongest quarter but at the same time, as we said in the filing, we closed a fair amount of opportunities, especially in the C&I space that have some -- that are expected to draw in the third or the fourth quarter. And in fact, one of them we've had about $7 million or so draw even in the month of July.

So we're off to a good start there. The -- by business unit, the healthcare pipelines continue to do well, and we're seeing good diversity in that -- in those products out there. Real estate is starting to pick up, again, especially, and somewhat unusually for us the commercial real estate is picking up.

We just seem to be getting into a good spot on some good opportunities there. Still competitive, but the product diversity we have, you'll see commercial estate range from -- on a very strong deal right at, say, 3 7/8% on up to the 4 1/4%, 4 3/8% range. So a little bit over 4% as a yield. Multifamily also had a good quarter there at $28 million or so.

And we'll go to a little bit of a low now and then come out strongly in later August, early September. But we're still sitting on some decent pipelines for kind of this time of the year. So we are hopeful that we do the $30 million, $35 million plus going in on average for the next 2 quarters in multifamily.

The leasing side had a really good quarter for the second quarter, somewhat unusually for them. Again, we probably see a little bit of a drop off in the third quarter but maybe not by very much, $30 million, $35 million for the third quarter. But fourth quarter is usually our biggest and best.

So we are cautiously optimistic that equipment spending picks up a little bit. I would have to say though that the pricing and the leasing side continues to get competitive. And for investment-grade, a short duration of investment-grade deals, you'll see the spreads come under 100 points.

And you'll see spread compression across the curve even on, I would call, middle market to even lower middle-market deals. So we're kind of picking our way through that. I can see an environment where our volumes pick up a little bit but our yields trim down a little bit if we go to hit our volume targets for the year.

So I would say, as a going forward, we're -- as I said in the filings, we're reasonably confident we get to our 10% annual growth for this year, maybe a little work to do for the -- little bit of help on reduced payoffs. You're just seeing people moving assets around whether it was leases and repackaging equipment deals or payoffs due to sales.

Sometimes we keep those deals, sometimes they pay cash in a 1031. Sometimes they already got financing. So retention is just a case-by-case deal. And then, of course, the amortization of the loans are relatively seasoned.

And to mitigate risks, we tend to prefer somewhat shorter amortization where possible or necessary, so that kind of factors into the prepayments as well. But generally speaking, not saying it's a cakewalk out there but the prognosis for the pipelines, going forward, across all business lines is good.

Probably the toughest one of all is Chicago C&I more so in the underwriting than the pricing, although it's a pretty well underwritten loan. It's extremely competitive as well. But I would say there's a lot of people throwing money into C&I, where you're looking at 100% financing.

You're looking at working capital financing that really doesn't have any collateral whatsoever. And it just -- it causes pause to dive into that very deeply. So we're picking our way through those opportunities but of our main lines of business, that will be the slowest growing because we're seeing the least best opportunities there. .

Okay. And the -- and I guess being a little bit tougher than you thought this quarter, I mean the biggest contributor to maybe a little bit less growth this quarter. I guess, what would you put that at? I mean what's kind of the biggest... .

We had a couple of deals drop out. We had I think about $70 million in commitments going into quarter and we had 2 or 3 deals in $1 million to $5 million -- in fact, 3 or 4 deals in the $1 million to $5 million range that either deferred into third quarter or one guy didn't actually read his payoff statement.

Deals, approved, he wrote the check for the due diligence. Everything is ready to go. He then orders the payoff to send -- to get the closing schedule. And he figured out that he had misestimated his prepayment fee by a factor of 2. And just that made the deal uneconomic for this year. So he's got away.

We get -- we take a fair amount of deals away from agency deals Freddie or Fannie. Those fees and penalties could be rather steep, and they don't tend to fade over time. It's $300,000 today and it's $0 tomorrow.

And when he pulled that payoff statement, he said, "Oh my God, I can't do this now." And we asked him and he said, "No, it's only this amount." So you just have weird stuff like that happening.

But I think those 3 or 4 deals that I'm thinking about were probably the entire differential between multifamily and commercial real estate because we only needed about $12 million and one deal was $4 million and other deal was $4 million and other deal was $2.5 million, something like that.

So we would have gotten to our number pretty easily just on those 3 alone. I think the bigger factor was payoffs this quarter. We had a fair amount in leasing, and we had a fair amount in real estate, somewhat unusually so.

And there were a couple of payoffs where it was a transaction, actually, that the sellers came to us and said, "Would you like to keep the loan?" And we said, "What are you selling the building for?" They were selling the building for twice what they paid for. We had a loan of 60%, 65% of their original purchase price.

We would have had almost tripled our exposure to this building to keep the loan. We like the area. We like the building but we didn't like it that much to keep it. So that was one we got a payoff on. .

Got you. Okay. That's very helpful. How about just the -- one of the darker spots, the expenses.

Maybe just give us a little bit of an update on the kind of where you're at in there? And just how you're thinking about things prospectively as you continue to grow the business?.

I think we're pretty comfortable with expenses. It remains -- is and will remain a sharp focus of vigilance. One of the bright spots is then we're steadily reducing the NPA expenses, and we had some pretty positive results for past dues and non-accruals and REO.

We'll probably take those expenses and redeploy them, whether it's in the base comp, whether it's in the -- we need to pay incentive comp if the loan originations keep going and the company continues to perform well or marketing. So I'm hopeful that we can keep the expense levels at an absolute basis at these levels or lower.

Core expenses might move around a little bit on the comp side depending on where we are in this year and how much we have to accrue for after one incentive type program or another. But we're feeling pretty good about it.

And that's why I've been fairly consistent in our views that as we continue to aggregate the loan portfolio, you'll see the results drop almost directly to the bottom line. .

Okay. And so the $10 million type of level, that includes a couple of hundred thousand of credit-related costs still in the -- which are down considerably.

I guess the -- I guess that you're just viewing things today as the $10 million is kind of the base level as there's always going to be some level of credit in there and just kind of monitor how that goes going forward? Or I guess, is that the best way to think about it?.

I'd probably think about it, that the $10 million is a good absolute run rate. There might be some -- the core was running a little bit less than that, $9.7 million, $9.8 million. And I -- we would try to hold those levels. So if core goes up a little bit because of incentive plans, we, hopefully, pay for that through other means. .

Got you. Okay, that's helpful. And how about maybe just a little bit of thought on the margin. And just I guess your -- how you're you thinking about that as you grow loans here? I mean how -- it looked like the loan yields were up maybe a basis point from first to second quarter.

So just, I guess, maybe talk a little bit about your outlook on the margin. .

It's just a tough thing to give any kind of, what I would call, concrete guidance on. It is so dependent on the mix of credit that we bought. It's dependent on the utilization of the C&I lines.

For example, we think we'll have better C&I utilization in the third quarter for certain Illinois healthcare credits because the state funding mechanism and the budget issues might create a slowdown on the payment of the state payables. So you'll have greater utilization on some of those lines.

We had, for example, in the second quarter, greater utilization of some of the direct leasing credits. Even though the balances might not show at a quarter end, they were active for a good part of the quarter and that contributes an absolute level of interest income. So real estate is a function of which market, which product.

And I said, the range is, a goal away from 3.75 on one side to 4.5 on the other. Leases could be in high 1s, low 2s, all the way up to the mid-4s. So that's why I'm trying to be helpful as opposed to evasive.

I would say that our goal would be, if we have priorities, our goal would be to maintain the margin if we can, including any changes to funding cost. But we're probably more interested in growing the absolute level of net interest income because that will provide a better utilization on assets, and of course, a better utilization on return on equity.

So if we're getting the right quality loan at the right volume and we need to do it at a certain rate, it's pretty consistent with our philosophy, we'll do it, the best deal for the best deal. So we'll try to protect margin as best as we can, but we were more interested in growing the net interest income level and increasing the return on equity. .

Okay, perfect. That's I guess pretty much standard. The -- how about as far as -- just talking about the returns in profitability. I mean, I think the return on assets is about 55 basis points or so this quarter. I guess that's kind of the range it's running in.

I guess what's your -- I guess, expectation as that maybe it was I guess a little bit higher this quarter. I think it may be 60. But just the outlook going forward is kind of what you think is attainable as you continue to kind of execute here on growing the dollars of net interest income and kind of maintain... .

I mean if you kind of keep it with relatively simple math, let's just take a run -- let's just take -- we wave a magic wand and put $200 million of our quality loans on the books. And you'd say that comes in at maybe 4% on average. That might be high by 10 or 15 basis points, it might be low by 10 or 15 basis points. We'll just go with 4%.

So that's $8 million. Your funding costs might take that to a 3.5% or 3.75% margin depending on what it is, where it is. So you're dropping $7.5 million, $8 million -- somewhere between $7 million to $8 million in new income. We're not really going to have to spend much money to generate that income. So most of that drops to the bottom line.

And if you tax effect that, then you start to grow the balance sheet a little bit. But your return on assets, your return on equity improve consistently.

So that's why we always say that it's really a function of our continuing to execute both the loan growth as best as we can and we want it consistent with our safety goals because putting away loan loss provisions against loans is important, but we don't want to take any extra risks that aren't paid for.

And then the expense vigilance so that as that loan growth recurs, the results manifest themselves rather rapidly. And I'd say the third piece is the fee income side. It's with a variety of restrictions in Dodd-Frank, it's not the easiest thing to accomplish. But little by little, we are starting to see some improvement in those categories.

So at the end of the day, we haven't changed our views. We should be able to get 75, 80 basis points maybe even a little bit better out of it given our risk profile and with our commensurate return on equity. So we're comfortable with those views. The faster the better. .

Okay. And on a reported basis, I guess, the ROA, I mean I guess the acceptable level, I guess, if you will, for a more realistic level for kind of full year 2016.

I guess if you're in this 50 to 60 basis points range in the first half of the year, I mean, is getting to a 75 basis points ROA in 2016 something you view as attainable? Or is that -- sounds like if you put on the $7 million potentially that getting to that 75 basis point reported type of ROA should be achievable? Or is that... .

I would agree with it. If we see massive amount of yield curve spread compression, a very flat yield curve or something like that, that nobody is really modeling right now for '16, I think that could be a risk that forecast.

But absent something of that nature or something else coming out of left field that we don't really anticipate, that's exactly where we want to get to for '16 and the sooner or the better. If we have a pretty good second half, we could be nudging in -- nudging closer to that goal even at the earlier part of '16 rather than the latter part of '16.

So it really comes down to doing what we said. If we can have some reasonably consistent quarters like we did in the second half of '14, because we've done this before, and even in '13, the second half of '13, we can have some reasonably consistent quarters of 1 35 with payoffs around 95, 97. We finish '15 strong, and we start '16 strong. .

Okay, perfect. And then maybe just an update on capital and how you're thinking about deploying it. I guess, it looks like you were active on the repurchase front this quarter and just maybe as it pertains to further repurchases and/or dividends or sounds like from last quarter, you're still not interested in M&A.

It's more of dividend and the buyback but any change in capital or just kind of how you're thinking about things on that front?.

quarterly dividends, special dividends, share repurchase and mergers and acquisitions. And as of yesterday, the board has executed on 3 of those 4 tools. The dividend policy has progressed rather nicely on the quarterly basis from a year ago.

The board was comfortable with the special dividend given the company's overall liquidity and capital and earnings levels. And we -- as you point out, we started the share repurchase and were reasonably active immediately after it was adopted. So I think all those tools remain in the box.

At the Annual Meeting, we heard from shareholders who are continually interested in dividends given the relative tax efficiency that they present. So we've continued to make progress on that front. From a capital level, we feel very, very comfortable with our ability to grow the balance sheet and deploy the excess equity as we've outlined.

Our -- the relative efficiency of a multifamily portfolio using 50% risk-based capital treatment continues to improve. So you've seen where we've been able to grow those categories and still grow risk-based capital. So right now, we have the -- plenty of capital to grow organically.

We have some reserved capital for stress testing and unforeseen events. And we even have some excess capital if we saw a nice little acquisition come by that we really wanted to do that clicked all the buttons and didn't take any steps backwards. So we're feeling good about capital.

If it turns out that as we get towards the end of the year, circumstances are such that the share repurchase programs should be extended and/or expanded, I think that's a tool in the box that the board would consider and now comes off the table.

I also think further changes and improvements to the dividend policy, whether quarterly or specials, are also available to the board. And the better we do in dropping earnings to the bottom line further enables all of those tools. So I think we're looking -- we're in a pretty good shape today.

I think we have a pretty good focus on what's going on next. And I think the board's made it clear that they're willing to use any and all of those tools to continue to enhance shareholder return having checked all 3 of the 4 boxes that they said they would do. .

Okay. And as far as where you'd like to operate on a capital basis, I guess what's kind of the thinking there? I mean, you're at a 14.5% level of tangible common today, I guess.

As you kind of execute on the couple of items you'd mentioned, I mean, where do you see that heading over time? I guess, what's the board's outlook as far as where you want to maintain capital? I mean, obviously, it's at significantly above peer type of level today.

And even if you execute on a few of these things, I guess, it's not -- you didn't really mention a whole lot with M&A other than you'd look at one. I guess is that any more interest today or less interest or... .

It's why they're comfortable leaving the capital levels because it's certainly would enable M&A if we really saw something we liked. If organic growth really manifested itself, I think they'd probably prefer that because it potentially has fewer execution risks.

But in this regulatory environment, as everybody implements Basel III, and we look at the mix of credits, the 8, 12 levels of tangible and risk-based capital are pretty firmly the floors for now. It used to be 7, 11, and then there was the great recession. And now, I think it's 8, 12.

So I would say from a pure numerical perspective, 8, 12 is a number that if we start approaching those levels, we're going to be thinking about what to do about capital. We've got ways to go to that. We've got plenty of room.

So I'd say given that that's probably the learning track for capital for us, we have plenty of room to do if we need to do or what we're doing now and what we could do later. So we haven't -- we really haven't thought about targeting a level other than watching that floor and keeping our options open. .

Okay, that's helpful. And maybe just one last thing. And that's just how you are thinking about as far as kind of reserves and whatnot.

It seems like the health of the portfolio you mentioned had obviously gotten a lot better and I guess is the mindset today that you're kind of just providing to covered charge offs and there's still room to -- there's some additional credit leverage? Or is there -- is that not to thinking in prospectively? I mean, in the classifieds, I think we're down about 20% in the quarter on top of the reduction and a little bit better reduction in NPAs.

But just kind of additional credit leverage that you may have or may not have of how you're thinking about that?.

Yes. That's another topic that very much depends on the mix of originations in the portfolio. But let's talk about some trends and preferences. The first thing is we have been actively managing loan originations to look at the lowest risk categories from a reserve perspective.

If we've had your performance in those portfolios and those markets continue to perform well, then it benefits us to drop those earnings to the bottom line and stay out of historically higher risk areas.

So for example, we have virtually no exposure to construction and development lending because that would require among the highest of all possible loan loss provisions. And it just doesn't make economic sense, let alone market sense.

So the areas that we like in the healthcare lending and leasing and the multifamily, all present very favorable credit characteristics. The loss ratios continued to improve. The volumes in the markets continue to be stable. So we like that combination.

So I would expect that as the rest of the loss ratios continue to improve, you'll see some reserve release just because that's the nature of it. There's just very little left in those portfolios and the loss ratios continue to decline.

Best case scenario or one good scenario, I don't know about best scenario, but one good scenario would be where we have such strong loan growth that we can absorb any possible recapture and really have a negative to a -- neutral to negative provision but we grew our targeted categories very strongly.

So we're pretty happy with what's going on with loan-loss reserves. You'll also note that, as you point out, we did well with reducing nonaccruals and NPAs. We're down another $1 million as of today on nonaccruals, and we booked another couple hundred thousand on recoveries.

So we're focused on getting the benefits from that asset quality improvement, both from an ALLL side and from an earnings perspective. .

Okay. But certainly, I guess over time, I guess it sounds like you'd grow into the reserve, if you will, just I guess rather than further reserve releases especially if you're putting up good volume as you expect in the second half of the year and continuing that in '16. .

I think it would be choppy. I wouldn't -- but I still think it's possible to have net reserve recovery simply because the reserve requirements for the new production going forward are going to be less than the loss ratio provision of the stuff that's disappeared.

So I think as the overall quality of the portfolio evolves and the portfolio mix shifts a little bit, you're going to see inherently lower required reserves. So either we grow the volumes substantially to absorb those releases or you can still see a certain amount of release volume in the near term.

Now over time, if markets change, then obviously, provisions will be a different story. But we deliberately target these asset classes because we like the current, medium and long-term performance, and that is reflective of what we saw in the review mirror as well. .

[Operator Instructions] At this time, I see no other question in queue. I'd like to turn it back to Mr. Gasior for any closing remarks. .

Thank you, Vince. Well, going once, going twice. We appreciate your interest and all the questions from Brian. We hope you enjoy the summer, and we'll see you in the fall during football season. Thanks again. .

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may now disconnect. Everyone, have a great day. .

Thanks, Vince..