F. Morgan Gasior - Chairman and CEO.

Brian Martin - FIG Partners Kevin Reevey - D.A. Davidson.

Good day, ladies and gentlemen, and welcome to the BankFinancial Corporation Third Quarter 2016 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this conference call is being recorded.

I would now like to turn the conference call over to F. Morgan Gasior, Chairman and CEO. Sir, please go ahead..

Good morning. Welcome to our third quarter 2016 investor conference call. At this time, I’d like to have our forward-looking statements read..

The remarks made at this conference may include forward-looking statements within the meaning of the 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 word, believe, expect, intend, anticipate, estimate, project, plan, or similar expression.

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 declaration 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. At this time, all of our filings are complete. I’ll also note that we filed a national bank charter application during the third quarter and a related application with the Federal Reserve related to bank holding Company status. Those applications are pending. And we are hopeful to conclude that process during the fourth quarter.

Very good now our first question..

[Operator Instructions] Our first question comes from Brian Martin with FIG Partners. your line is open..

Just maybe want to touch on a couple things and that was, I guess, just as it relates to the filing of the charter. I guess, I was just going ask about your concentration levels and just how you guys are thinking about bumping up against those limits.

But I guess, maybe can you just give a little color on the loan growth in the quarter and then just your outlook.

I mean we’ve heard from quite a number of banks about some stagnation on the C&I side and just wondering if you are seeing the same type of things and if that has an -- is there any bearing on your concentration levels as we go forward here..

Well, I guess, the first thing I would say, as far as C&I is concerned is, it’s still extremely competitive out there, so I could see stagnation could be a function of competition for some organizations. Across the board, we’ve seen some compression of credit spreads, another indicator of competition.

But as I think you noted in previous reviews, we’re willing for the right quality of credit. For example, through the third quarter of 2016, 75% of our loan originations or lease originations and the lease portfolio have been investment grade. We’ll go where we need to go for those assets to maintain a diversified portfolio.

Having said that, we remain relatively optimistic on C&I growth. We have some good opportunities in all of our portfolios; the regional commercial portfolio, the healthcare portfolio, and commercial leasing portfolio.

In the commercial leasing portfolio, remember we see it on two dimensions; the discounted leases and then, the direct lessor exposures which flow through the C&I line. And as I said in the overviews, it’s always hard to predict exact volumes, but we do see continuing growth in the leasing area.

It’s really a function of what credit category and what structure comes at us in. So again, we’re pretty optimistic about that.

Towards that end, we were careful to manage exposures in the third quarter to stay well within the existing charter limits and we’re, as I said in the beginning, hopeful that as that charter process concludes here in fourth quarter, that we’ll be able to resume some growth in the fourth quarter and then on into 2017.

So I would tell you that the areas we’re in; healthcare, there continues to be investment in healthcare and the type of healthcare delivery we’re doing, there is a continuing demand. Obviously, the provider sometimes have challenges in their revenue streams and margins.

But there’s no question when we’re doing receivables lines that the healthcare is being delivered and it’s being paid for.

If and as rates increase, the general sense in the leasing industry, I obviously start meeting with lessors within the last week or so that general sense in the leasing industry is that it will be good for business and you could even see a little bit more business investment take place.

We’ve see more interesting hardware assets for distribution, forklifts, material handling, medical equipment is also getting a little bit stronger, a little bit of tech equipments, software is a more interesting that is somewhat newer on leasing software or firmware. So for all those reasons, we think we have some upside on this.

We’ll have a better sense when we get to the conference call in February about how we ramped up 2016 and what we really think the growth rates for 2017 are. But, as I said, we’re optimistic..

Okay. And I guess the payoffs this quarter look like they slowed from what -- at least what they’ve been in the past.

So I guess are you --I guess is that, when you look at your expectations and net growth going forward, does that give you a little bit more comfort that I guess getting to -- I mean, I don’t know what your targets are for loan growth and I guess it seems like it’s been more in the -- call it, mid-single-digit type of growth, type of range.

Does that seem achievable if pay downs lower or I guess are you seeing any trends in the pay downs that gives you more optimism on net growth, especially as it pertains to 2017?.

Well, I’d say two things. First of all, originations were fairly strong for the third quarter and we’re hopeful that the fourth quarter originations are at least as strong as they were in the fourth quarter of 2015. So getting that topline origination growth is important. The payoffs are, obviously, a little bit more wildcard.

First of all, as the portfolio grow, especially in the C&I portfolios, the payoffs can fluctuate just based on either scheduled amortizations or line usage and net draws.

So for example, if we’re doing more healthcare receivable lending and we see states where the receivable cycles are shorter than they are in Illinois, then you could see a little bit more payoffs.

Having said that, on the real estate side, it has started to slow down a little bit, I think part of that is a function of some borrowers are happy with the buildings they have.

They’re in various forms of improvement, but they don’t necessarily see a replacement building that they would want to reinvest in, if they were to sell the existing property.

We released a product, the 1031 Express that allows borrowers to coordinate both sides of the deal and then hopefully, stabilizes our portfolio so we might have some volatility in activity, but the net portfolio stays about the same.

So for next year, just penciling things out, we would say, if we could see net growth in the high single-digits for the entire portfolio, that to us would be a pretty good result that would take into account the fact that some markets are going to be more active than others in terms of real estate.

We should see some growth in C&I, but that could be offset by some faster amortizations. And again, if you’re looking at a GDP growth of may be 2% per quarter or something like that, nothing exciting, growing the loans at three or four times the rate of GDP is probably the right proportion.

Also worth nothing, once again that, unlike some of our peers we don’t really engage in construction lending, we have less than a $2 million exposure. That’s not going to be a factor for us going forward.

So when you compare us to peers, if you strip out their construction loan growth and really look at their net growth, we feel better about the areas of our growth rather than relying on a construction portfolio..

No, I agree. And just as it relates to that, kind of the growth for next year, you talked about maybe restricting a little bit of growth or managing at this quarter.

When you look next year, I guess, is the intent I guess -- as far as the expectation is, where does the greatest growth look like it’s coming from next year today and based on not having to manage to the constraints of the thrift charter any longer?.

Yeah. And I would say that, as I said earlier, the C&I portfolio, all three elements; the regional commercial banking, the healthcare portfolio and the commercial leasing and direct lessor portfolios will be the focus.

And one of the reasons for the focus is that probably gives us the best opportunity to grow yields and also maintaining asset sensitivity in what is likely or hopefully going to be something of rising rate biased environment and I know we’ve been saying that for three years, maybe it’ll happen.

But if it does, that type of asset generation will continue to position us well. On the real estate side, we’ll still see some growth but I expect it to be a little more muted based on market conditions.

In some markets, the capitalization rates and the debt service coverage ratios are just getting to the point where our underwriting is going to select us out of the markets. So markets that two years ago, we might have had a 10% growth rate. Next year, we might only see 2% or 3%.

But we’ve also started to open up other markets that are, shall we say, less overbought and less over invested that should replace some of that growth.

But for next year, we’re hopeful that C&I continues to be the leader of the loan portfolio, real estate will certainly contribute, but probably at a smaller growth rate and we’ll just have to see how the asset selection works.

We would have grown C&I considerably faster in this year if we had reduced our pricing margins on some of the healthcare equipment loans, but it got extremely competitive and really the profitability was so thin that we didn’t really want to put loans on for the sake of growing loans without a reasonable return..

Okay. No, that’s really helpful. And two other things, I’ll jump out and then I can come in if there is nothing else. But maybe, just the expenses were obviously a nice number in the quarter.

I guess, can you just talk about whether it’s the sustainability or just how you’re thinking about the expenses now that you’ve March have been down here and seem to be at a pretty good level, especially if you’re going to continue to invest in the Company.

But just in general, your thoughts on expenses? Where they’re at today and how you’re thinking about it going forward?.

Well, I think, we are at a level that is sustainable and we actually think there could be some modest improvements in expenses from this point forward. One of the focuses is going to be on getting a better return from some of the higher efficiency ratio operations we have right now.

We have invested a fair amount in the wealth management trust area in the last 12 months and it’s, I would say, been a reincubation phase at this point. Markets are markets, sometimes the markets present challenges in terms of good wealth management opportunities for the customers, for the investors.

But that’s one area that we were at a position now where we should hopefully see some better efficiency ratio improvement on the back because the investments have already been made.

Another area is as we look at other operations in the Company how can we optimize through further consolidation of functions, simplification of functions whether it’s in the deposits services area or whether it’s in the loan services area and any operation that the expenses are not really generating material growth or they present more risk than the income is really generating.

And with that in mind, we’ll see some, probably, net reduction in expenses and we’ll probably reinvest some of those expenses in other areas. So for example, we just added two C&I bankers here in the last three months, but that replaced two real estate bankers.

Where C&I is the focus, real estate, we have appropriate staffing right now and we want to devote more resource to that. We’d like to add more lease bankers to generate some additional lessors and diversify the portfolio, but we may reinvest some of the additional net savings expenses into that. So I think one sustainability is certainly feasible.

I think some net reduction is quite feasible. The net amount of reduction, I’ll have a better sense at the next call, because we’ll have finished our business planning and get a sense of where we can afford to make investments and get some profit..

Okay, perfect. That’s helpful and just the last thing and then I’ll jump out and I can come back in if need be.

But obviously the credit has been very strong and gotten better and I guess, can you just talk about how you’re thinking about -- seems like the credit cost next year will be a -- maybe a bit more of a headwind than a tailwind like we’ve seen lately absent the second quarter of this year, but how are you thinking about and I guess at this point, are you thinking it’s more about reserving for loan growth.

Is credit feels pretty good or is there, I guess, a better way to think about it prospectively?.

No, I think that’s a good way to think about it. I think reserving for loan growth would be the best outcome for us. We’ll get to an inflection point at some point. So as we diversify the portfolios, those being -- we grow the portfolio to see some reserve growth.

As we diversify the portfolio, you may reinvest -- shall we say, redeploy some reserve captured from one type of loan to another, but I guess I’m going to go with -- our likely scenario is that, to the extent that we have reserve growth next year, it’s from new growth and diversified loan growth where past-dues, non-accruals, classified loan, special mention, all look quite stable and favorable right now.

We remain extremely focused on that from an underwriting and on portfolio management annual loan review perspective.

You could even see some situations where if we didn’t get annual loan review financial statements or there is other issues with covenant compliance, we’ll take appropriate action to move that credit out of here because it’s not where we want to be in terms of the quality of portfolio management monitoring.

So bottom line on reserves, we would hope to see our net provisioning based on loan growth. That provisioning might be mitigated by redeploying some reserve recapture for some payoffs..

Thank you. Our next question comes from Kevin Reevey with D.A. Davidson. Your line is open..

Most of my questions have been answered, but I want to get a sense as to the economy in the various top markets you’re operating and how they are fairing thus far and what the outlook is for 2017 in those markets?.

Well, I would tell you right now that the Cubs are probably the best thing happening in Chicago and once that’s done then things will settle down rather considerably. Chicago just seems to be a very slow growth market and accordingly, it’s probably the most competitive market we see in terms of pricing and underwriting in all phases of the business.

If we go around the horn, if we look at the national commercial leasing markets, as I said earlier, those are starting to get a little more optimistic.

Even though volumes were down, leasing volumes were down in 2016, I think people are looking forward to the potential rising rate environment and seeing a little bit more business investment come in especially in the newer markets where they’re doing more with growth and development.

On the healthcare side, you’re seeing continued investment in equipment, you’re seeing continued investment in new smaller specialty hospitals, you’re seeing continued reinvestment in skilled nursing and assisted-living facilities and that creates opportunities for us on the working capital lines of credit and the equipment side.

So, on the real estate side, the markets we’ve seen, the Denver market in particular is performing well macro-economically. It had a little bit of a slowdown as a result of oil. They had some drilling and some pipeline stuff going on in Northern Colorado and that slowed down a little bit. But still, the market there is good, unemployment is low.

Our concern about that market though is that it’s just getting overbought. Cap rates well under 5% in some cases and you’re seeing material decreases in cap rates and shall we say tertiary areas where all of a sudden people are paying absolutely record-breaking prices for properties.

And as I said earlier, that is adversely selecting us out of those markets. Once it goes below a certain threshold, it’s not really a lendable asset for that. And a fair amount of that lending is being driven by Fannie and Freddie Mac and their small balance loan in their program.

They said they did 60 billion this year, they’re going to go 70 billion next year, so that fuel to that particular fire doesn’t seem to have an end of this juncture. When we look at Texas; Texas is kind of a balanced market, Dallas and Fort Worth continue to do well. The employment growth has slowed to some degree, but it is still positive.

Rental growth remains single-digits but it’s there and there is a fair amount of value-added investing going on there as people are taking older buildings and improving them and capturing a better quality tenants. There is still a shortage of units available for rental housing in Dallas in the B&C category especially.

Austin is doing very well, but again, you’re seeing a little bit of over-bought conditions in the central business area into the West and Southwest. The periphery though still have some opportunities.

And there some [indiscernible] growth and expansion going on in the San Antonio markets, possibly a little more resurgence as a result of things getting expensive in other places.

Huston is stable, but given oil conditions we would not expect employment to expand their materially, probably won’t get a lot worse, but it probably won’t get a lot better. So we’re approaching that market with caution. Florida continues to do well. The Tampa area has a diversified economy.

Orlando, of course, has a tourism and tourism-based economy, but it also has a significant support base, call centers, healthcare, lot of service businesses, in and around the Orlando area.

And the whole Central Florida, Northern Florida area seems to be doing well and our newest market in 2016 is South Carolina, the Greenville-Spartanburg area, with the expansion and continued reinvestment of the BMW plants. There is a new $1 billion plant for carbon fiber wings for the 787 as part of the Dreamliner supply chain.

We’ve seen some early interest -- good results in that market early. I will tell you though that others are discovering that market. We were recently down there and we’ll probably be working with somebody investing some money from California. So the movement eastward continues.

So little by little, I would say that we’re feeling okay about our markets in 2017. The big risk to those markets is I’ll say the continued over investment and aggressive investment which will probably limit some of our loan opportunities based on the underwriting issues that are presented by that..

And then -- and I apologize if you’ve mentioned this earlier in the call. I jumped on late. Salary and benefits, they were down about 7% linked-quarter.

Did you say you reduced headcount in your real estate business and that was the driver for the decline in that line item?.

Well, there is a mix there. The equity benefits have started to roll off and they’ll wrap up by the end of the year, so that was a benefit. And yes, we have redeployed the C&I during the quarter from real estate. That trend will probably stabilize a little bit. But to the extent we can continue to invest in C&I, we will.

So, going back to my earlier point, we feel very comfortable about expenses at this level. We actually think we can probably do some modest improvement on a net basis.

We’ll probably have more details on that the next time we’re able to talk because we’ll run our year-ends and get a better sense of where we can put new people and get some further growth in the C&I portfolio..

And then my last question is related to competition for hiring. How competitive is it to get new hires on the C&I side given the fact that that’s a talent pool with everyone is going after..

I will say that people that have good credit skills, but also good marketing skills are in absolute premiums. We’ve been fortunate in that regard to get some very good quality people aboard.

Sometimes, there will be groups that move because they have existing customer relationships and portfolios and if they can transfer those portfolios from one bank to another or that’s the perception anyways, then those people are in demand.

Our experience with that, we’ve tried to put forward is that the transfers from one bank to another sometimes don’t happen or it takes a long time for them to happen. So I would say, everybody is looking for good talent, we’re no exception. We’ll compete as hard as we can.

Our focus though is on people who have good marketing skills, who can take good products out there, define a target market, and just keep trying to hit it until we’re successful. So, we look at it this way is, set the target, aim and fire. If you didn’t hit the target the first time, fire again and keep firing until you hit the target.

And when we hit the right intersection of a person that has that skill-set and that mindset and also can analyze a customer’s business and see how he can be of service to him, we tend to succeed in that environment and we’ll do whatever we can to get those people aboard..

Thanks Morgan, that was great. Congratulations on a nice quarter. I appreciate it..

Thank you. And we have a follow up from Brian Martin with FIG Partners. Your line is open..

I am back. Just a couple of follow-ups Morgan, just the -- or maybe it’s for Paul. On the margin outlook, just kind of -- as far as rates staying the same versus rates changing.

I mean I guess how are you guys thinking about the margin? I mean, certainly I understand it depends on the mix of loans, But just in a big picture no rate change, what do things look like versus maybe getting some modest increase in rates here either late year or mid-next year?.

As you noted, there are so many variables to this, but let me try and tell you some directions that we’re trying to head. First off is, as we look at the 2017 originations, managing to continued stabilization of the loan yield or increase of loan yield even in a constant rate environment is a priority.

And also, continuing to focus on maintaining a good asset sensitivity or neutrality at the very, very least is the primary there. So we would hope to grow yield organically even in a constant rate environment or at least keep it at these same levels if we see further rate compression.

On the deposit side, it is really going to be a function of what happens in the markets and what happens with deposit betas. Our planning involves a number of scenarios. We think we absolutely have to respect the customers and the deposit base and if we’re going up, they should get the benefit of that.

They’ve certainly waited a long time for that to happen. But at the same time, market conditions may be that; one, very few competitors change their deposit rates and so we’ll enjoy some deposit growth and still keep customer’s happy or maybe that people get aggressive on deposit pricing.

So to us, the big variables are what happens with credit spreads in our various business categories and what happens with deposit betas in response to the market yield. So credit spreads compressed rather significantly in some of the areas, investment grade leases, strong healthcare equipment credits.

I think part of that is a function of money coming in from overseas and trying to escape negative yields. But that situation seems to be starting to roll back a little bit. German 10-year yields are now positive, I think, instead of being negative. There seems to be less emphasis on [QE and] Europe and Asia.

That might have a positive effect on spreads and give us a little bit better boost for next year..

Okay. So it sounds like -- I guess if your hope is to keep loan yields where they’re at, then the plan or the hope would be that the margin, absent any significant change on the deposit side, ought to be flat to maybe up to some extent, but that’s more the bias at this point.

I guess, is that fair?.

I think that’s a very good way to put it..

Okay, alright. And then, maybe just -- the last few things; the FDIC expense has come down in a lot of banks.

I mean, I guess is that something that you guys expect or are your numbers at a good level, I guess, here is your opportunity for that cost to go lower?.

Brian, there is a possibility that you will see a reduction in the fourth quarter in the FDIC expenses. They roll out the new formula for the smaller banks. Looking at that that may be a benefit to us and a reduction in the expense in the fourth quarter and into 2017..

Okay, perfect.

And then, the last thing for me Morgan was just, you guys have talked about or outlined what your profitability goals were and just wondering if you can give an update on maybe where you’re at or if anything has changed? The most recent kind of -- and I won’t say guidance, the most recent dialog you guys have indicated, as far as -- from an ROA perspective maybe or just -- how you guys are thinking about things? Can you just update us where you are on that and just maybe what are your thinking about it going forward?.

Sure. We’ve said that getting into the 75 basis point, 80 basis point range on a sustainable basis, given the relative risk allocations in our credit portfolio, and also the fact that we’re not a material player, in fact we’re not all a player in mortgage banking, is probably -- continues to be the goal we’re aiming for.

To the extent that we can grow the balance sheet, get a little bit better efficiency ratio out of that, we could even improve on that once we get to that level.

But realistically, when you look at the nature of the assets we’re invested in, in the absence of the mortgage banking revenues, the help will come from continued efficiency in the organization, a little bit of help from non-interest income and optimization of the credit portfolio.

Try to going beyond that would either take on considerably more risk in the credit portfolio at a point in time where it’s probably not justified either by U.S. economic growth or some of the areas you’d have to get yourself into. For example, we’re just not going to get into construction lending solely to exceed that benchmark. We’ve seen it before.

We just don’t believe in it. So I think right now, absent some large event that would significantly increase the balance sheet and create a larger spread on the core expenses, that’s probably the best guidance we can give you..

Okay. So in the 75% to 80% ROA number is that includes or excludes the provision. I guess that it includes credit cost. Just remind me on that. I just don’t recall what you guys are including in that number.

I mean is it a reported number or are you making changes to that?.

That really just exclude, our number would be on our core basis, which would exclude the smaller credit costs, because we’re not expecting to have much in credit costs and it would exclude the equity comp, but we’re not expecting to have much equity comp. So it’s a pretty narrow spread between the GAAP number and our core number..

Thank you. [Operator Instructions].

Okay. Well, it doesn’t appear there’s any more questions. We look forward to speaking to you next time when we’re officially a National Bank, after 90 plus years of having a thrift charter. In the meantime, we wish everyone a good fourth quarter and holiday season, go Cubs. And we’ll see you soon..

Ladies and gentlemen, thank you for participating in today’s conference. This does conclude the program and you may all disconnect. Everyone have a great day..