Good day, ladies and gentlemen, and welcome to the BankFinancial Fourth Quarter and Year-To-Date 2016 Review Conference call. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference, Mr. F. Morgan Gasior, Chairman and CEO. Sir, you may begin. .

Good morning. Welcome to the first quarter 2017 investor conference call. At this time, I'd like to have our forward-looking statement read. .

The remarks made at this conference may include forward-looking statements within the meaning of Section 21-E of the Securities Exchange Act of 1934.

We intend all forward-looking statements to be covered by the safe harbor provision contained in the Private Securities Litigation Reform Act of 1995 and are including this statement for purposes of invoking this safe harbor provision..

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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.

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And now I'll turn the call over to Chairman and CEO, F. Morgan Gasior. .

Thank you. All filings are complete. We'll be ready for questions. Just one informational note, this first -- this 5-quarter supplement we published now includes some concentration data on our 50% risk-weighted multifamily loans and our composition of the commercial lease portfolio.

Also worth noting, this is our first partial quarter as a national bank. And with that, we're ready for questions. .

[Operator Instructions] Our first question comes from the line of Kevin Reevey with D.A. Davidson. .

So first question is related to the $55 million in borrowings that you took on in order, and obviously, this was before you converted to a commercial bank charter.

What's your timing as far as paying off or paying down those borrowings?.

It'll be a function of how our loan originations work and our deposit originations work for the first 6 months of the year. The cash flows from the related lease portfolio, the $55 million of commercial leases, are a very rapid amortization.

So our goal, of course, is to take those leases that are at an average, 2.30% or so yield and reposition them in higher-yielding leases in the high 3s or low 4s.

If that's the case and the durations remained short, we may just leave those borrowings in place or we may replace them with retail deposits, or we may replace them with some limited amount of wholesale that we're trying to balance the ALM. So it's a little bit of an open question of what's going to happen with that.

We did it, obviously, to make sure we were in full compliance with the former thrift charter requirements. And it also helped to have some fairly low-cost funding in place for year-end closings.

If we closed, for example, the $22 million that's currently, potentially in the pipeline for the remainder of the lease portfolio, that'll probably hang around a little while longer because we'll need it for the shorter-term funding to close. .

Okay. And then with that said, how should we think about the margin going into 2017? It looks like with the borrowings and the additional leases that you picked up that kind of pushed the margin down in the fourth quarter. .

Yes, that's an entirely accurate observation. The lease portfolio acquisition will have a -- certainly had a depressive effect in the fourth quarter, and if we do the extra $22 million, it might have a somewhat depressive effect on the first quarter. Having said that, the normal originations that we see have been on a continuing uptrend.

They were -- the yields in the third quarter -- the yields in the fourth quarter were stronger than the yields in the third quarter, and at least so far in '17, the yields on the first quarter originations are stronger than fourth quarter. So I really think it comes down to we should see a rebounding of the net interest margin in the first quarter.

Again, the $22 million if it closes will be have a temporarily dilutive effect on that. But we have a pretty good chance with the movement in yields to recover that original margin and potentially, even expand on it, depending on how the funding works out. .

Okay.

And then my final question, and I'll let somebody else jump on, is why did your competitor decide to exit the commercial leasing sector?.

I think they were kind of a passive investor in this industry. They were down to a very minimum staffing level, and I think they just got to the point where it wasn't making any, what we call, economic and volume sense. They're a large company out of New York.

They do somewhat complementary things to what we do, but leasing was just not one of their priorities. So it gave us an opportunity to strengthen the relationships out there with some of the lessors. We've already picked up some new business from some of them.

And in a couple of different dimensions, in the short run, it helps us increase the return on equity. In the longer -- medium to longer term, it will help us return or increase the return on average assets.

And let's also face it, at some level in the past, that competitor was competing for us for the same exact assets, and now we've taken one competitor off the board in terms of yield pressure. .

Our next question comes from the line of Brian Martin with FIG Partners. .

Morgan, or maybe just -- whether it's you or Paul, just the margin and kind of just the impact, can you just give some color around -- I mean what was kind of the core margin at versus when those transaction came on? I mean as far as the -- can you just kind of quantify the impact of the lease transaction versus the core margin, kind of what did that -- how much of impact did that actually had on the declining margin? And then maybe just kind of the -- where the monthly level is at starting out the beginning of the year here? I mean, I guess it's just hard to tell the exact closing time and kind of where the starting point is on for 1Q '17?.

There were really 3 impacts to margin, Brian, in the fourth quarter. One was there was a slight dilution to the margin just with the repricing of deposit CDs and the short pricing up. We didn't really move core deposits with the Fed rate hike, but just normal CDs maturing and repricing.

So there was a slight reduction in net interest margin due to that. Then you have the reduction in net interest margin due to the purchase of the portfolio, and then the impact of the short-term borrowings for the period of time so that we met our regulatory compliance levels.

Starting in 2017, you'll see net interest margin moving back to its normal levels, but it'll probably take a couple of quarters to get there. Because as Morgan said, if we do the add-on purchase of $22 million, that will have a slightly dilutive effect in the short term.

So from a forecasting standpoint, as you're looking at it, think about it over a few quarters, returning back to its normal level. .

Okay.

And, I guess, a specific impact of the -- I mean, if you're down 20 basis points-or-so in the fourth quarter, I mean, the piece that is -- the lion's share of that, Paul, related to this transactional leasing? Or is it the other 2 factors you've talked about, I mean, just in general terms?.

I would take the 2 together, the short-term funding and the lease portfolio, would make up the majority of the drop. .

Okay. And when the transaction occurred, did you guys tell -- say when it occurred or just... .

The purchase?.

Yes, the purchase. .

The purchase... .

It happened right at the end of November, and again in mid-December. So that was the tough part about this because we have to take the funding out and didn't have much in the way of assets to put it in because we had to wait for the charter conversion. Then we had the first chunk close right about the same time as the charter conversion.

We got the second chunk close in late December, third week of December. So it's -- all these assets diluted the margin, but we have virtually no income to offset that. And obviously, that's how things will change in '17 because now we'll have a full working period to get those assets working. .

Yes, okay. That's helpful, perfect. And then just, I'll go back to the margin for a minute. So that's the piece related to the acquisition here.

And as far as rates go and the increase in December and potentially more for this year, I mean, can you give some thoughts on I guess maybe the impact of that 25-basis point increase and maybe the kind of talk about this piece of portfolio that's floating versus fixed.

Just in general, how you would think about the rate increases or potential for more of the impact it could have on margin?.

Well, that part of our portfolio, which is a variable, which basically reprices when the index moves, represents about 10% to 15% of our assets. So you saw that come in right at the end of the year. So that impact will start to manifest itself in net interest margin in the first quarter.

As I said, we're not seeing the competition move on core deposits, we have not moved on core deposits, so that should help strengthen net interest margin at the beginning of 2017. Now we'll see what happens as the year goes on if there's future rate hikes and what the response to those rate hikes will be.

But as I said, about 15% of the assets are variable and repriced when the index reprices. Then you've got the adjustable loans, such as your residential portfolio that are tied to like CMT, and they reprice over the course of the year. So that will work itself in as each of those loans reprice throughout the year.

So that will help our net interest margin as time goes on. And as Morgan mentioned with originations, we're seeing some margin expansion with our originations starting the year. So that should have a positive impact on net interest margin going forward also. .

it certainly creates a higher yield on originations; two, it allows us to reposition cash flows into a higher yield once they come off from the last 2 or 3 years from a very low yield curve; and the three, to some degree, it will inhibit refinances, and essentially, prematurely, repricing assets at a lower yield for longer.

So I would say, of the 3 impacts, the rate resets are helpful. The fact that -- and it gives us the opportunity to work the core deposit portfolio to our favor. But the greater impact is the ability to reprice assets at a higher yield as time goes on. .

That's very helpful. And maybe just a couple other things that I can hop off is the -- just the outlook. I appreciate the color on the commercial real estate concentrates, and that's helpful.

When you look at the organic growth this quarter, I mean I guess just the organic growth in general in '16, I know there's -- you talked about it over the quarters kind of what's transpired. But when you look to 2017, I mean, I think the outlook was, I don't know, maybe mid- to high-single digit growth in 2017.

I guess, are you still kind of comfortable with that where you are today? Or is it more or less comfortable, and just kind of what can you just point to, I guess, where you see the most opportunity and where you expect to now that you've got the charter change?.

Yes, I'd say, it's kind of interesting that there's a couple of different things going on.

For starters, with the National Bank Charter now in place, we have significantly more flexibility on the origination of the larger commercial leases and larger commercial loans, either in the healthcare space, direct lessor space on the national commercial leasing front, or even in just regional commercial banking.

Our regional commercial banking got off to a good start this quarter, one of their best starts ever. And we added a new commercial banker in the fourth quarter that -- from Bank of America, that we think has got promise.

So we're looking forward to getting stronger growth in the commercial lending portfolio, the C&I portfolio, than we are in real estate. I mean, that is going to be the priority for '17. So at the end of the day, we expect the multifamily portfolio to continue to do mid to -- low to mid-single-digits, 5% to 7% net growth.

Some of the markets will just not grow that fast given the conditions of the market, and we're being as selective as we usually are. Some of the other markets have better growth opportunities. But with repayments and building sales and things like that, I'd say 5% to 7% growth in the multifamily portfolio is a pretty good place for us.

It's a little better because there's opportunities out there that's terrific, but we would expect it to be in that area.

Worth noting that year-over-year, commercial real estate, if you add up multifamily commercial real estate and construction, which is obviously not a focus for us, actually went down a little bit year-over-year because we've been, again, selective in that commercial real estate portfolio.

Leases will be an interesting story because we put on so much in terms of assets during '16 that the focus will be on repricing the cash flows to better yields and diversifying the portfolio. So the lease portfolio might only grow by 1%, 2%, 3%, 5% this year.

But the thing to watch is the allocation between investment grade and other, and then just the improvement in yields as we go through the course of the year.

That's -- to us, what we thought the benefit of the Lumi [ph] portfolio was, in that we were able to get the assets working for us, we're able to improve return on equity very slightly, but now we can have an opportunity to reposition those assets forward.

So if we -- if we everything works for us, we'd see 10%-plus growth in the C&I portfolio, including leases, and 5% to 7% to 8% growth in the real estate portfolios, with, again, the emphasis being the 50% risk-weighted assets -- 50% risk-weighted capital assets. .

Okay, Perfect.

And just remind me, the concentration levels where you guys are operating at today, is there's room to move those up? I guess, where is your comfort level with the concentration levels and kind of how are you thinking about as you manage this year, will those numbers shake out, or I guess what the outlook is there?.

Well, that's why we broke out the concentration data on the real estate portfolio. You'll notice there's been a significant increase in the 50% multifamily risk-weighted assets, and we expect that to continue. And as long as that continues where we're getting good quality assets on a diversified basis, we're comfortable with growth.

But at the same time it's really a function of how the markets do. If we see deterioration in the market, we'll pull back. And in some cases, we already have. Some of these markets are very, very strong, maybe too strong and they're just not meeting our underwriting standards, and therefore, we're not doing us many deals.

So the problem tends to solve itself. So I wouldn't expect, for example, like a huge jump in the concentration if we were slightly over $400 million, I wouldn't expect that number to get 10% or 15% or 20% larger. But it might go up by single digits. .

Okay. That's helpful. And maybe just the last couple of things, just the expenses, it looked like they were kind of as you guys expected generally. Do you have any thoughts on your initiatives you guys have? I mean, I know you've talked about potentially hiring some folks or making some investments.

But as it stands now, the levels is a good level and absent any significant initiatives or hiring that you guys would anticipate?.

Yes. The guidance we had last quarter, I think, pretty much remains intact. Fourth quarter, we, all of a sudden, had strong loan originations for the quarter. They were double what they were in the previous quarter, so we had to put accruals away for the related incentive programs.

Where the stock price closed at 12/31, we had to put a provisional way for increased ESOP expense. And this was also our last quarter for option expense recognition. So if we have -- we'll have no option expense in '17, at least not that we're projecting at the moment.

The ESOP, if the ESOP accruals come down at a lower level, hopefully, we'll absolutely find putting away loan incentive because that means we're growing the loans like we'd like. So I'd say on the comp side, our core trend should remain pretty much intact.

The only other area I'd probably caution is, you will probably see a little bit of drift-off in information technology. We're putting some new capabilities in for our commercial business banking software, our new lockbox software. We're going to be spending some money on additional cyber security and information security technology.

It's just what you have to do in this environment. We're going to be taking a look at office occupancy and seeing what we can do there to get a little more efficient in space usage. So maybe in the second half of the year, we might have some developments on that, that would be positive.

But again, to the extent that we can keep the efficiency ratio moving down, take the benefit of hopefully rising income and get the organization more efficient. And to your point, we do have room to add 1 or 2 more bankers in different spots, whether it's leasing, regional commercial banking or healthcare.

So if we do see opportunities, we will take advantage of them. We don't have anything immediately pressing, but we'll keep you posted if something develops. .

Okay.

And I assume, with regard to the provisioning, reserving, the growth expectations, I guess at some point, you'd probably hit inflection point as far as more positive provisioning or just that type of outlook, I guess is anything sort of unusual with regard to that, or I guess the negatives that we've seen, given the improvements in credit, I guess, is that the outlook going forward that's returning to a somewhat of a positive number?.

Well, if you look at the trends in the fourth quarter, right, we had pretty good loan growth, but it was extremely high-quality loan growth, whether it was the strength in the multifamily, 50% risk-weighted assets coming on board, or just the local originations, the investment-grade leases, I mean, those are 2 assets that are going to command a pretty low reserve ratio.

So we got the benefit of that in the fourth quarter. And you also had, I will just say, very, very strong asset quality, so you got the benefit of that.

If you look at '17, as we reposition the commercial lease portfolio, given the fact that they're not all going to go reinvested in the investment-grade leases, you will definitely see a positive provision on that repositioning. The 100% risk-weighted C&I, you will definitely see positive provisioning on that.

Even the multifamily that goes on the books goes on initially as it's 100%. To some degree, it may be offset. There's about $90 million to $100 million of multifamily loans that should qualify for a 50% risk-weighting during the course of the year, so the number was $305 million at the end of '16.

It should be close to around $400 million at the end of '17 if the reviews clear and the loan portfolio remains stable. So that could have a slightly offsetting effect on positive provisioning, but we think we either add or maybe have slightly passed the infection point at this point.

And again, going back to a consistent theme, provisioning is a good thing if you're growing the right assets in the right way. So we have no problem with -- we'd look forward to that type of an expense. It means that things are going the right direction. .

Okay, that's fair. And then I don't know if you -- I guess just bigger picture, Morgan, I mean you've talked about the profitability and just kind of where you see, directionally, where things heading.

I guess, can you give some thoughts on '17 now, I guess, just to kind of update on -- is there any update on where you think the ROA capabilities of the firm are, maybe later in '17, '18 as you progress basically with the new assets here?.

We're very focused on trying to earn into a -- earn in the trading off of earnings. I mean, that's the thing that we have yet to accomplish. A lot of other things have been accomplished, and they've been accomplished in a low-risk way. But that is the one thing that's left to do.

It's -- we have a little bit of uncertainties, obviously, but I'd say the goal would be, is we'd like to climb ourselves into a run rate very firmly into the 70s for ROA by the end of the year, and trending into the 80s for next year.

If we execute on the asset side and we get some pop on the yields, if the cost of funds remained relatively stable given the current projected federal reserve movements, then the expansion of the balance sheet, and if we get a little more expansion, it would be even better.

The expansion of the balance sheet should start to drive that ROA in that target zone. Once you start thinking about getting beyond 80, 85 points, you really start thinking about taking on more risk. And I think we need to get there first before we look about -- how far -- how much further we'd like to push the risk portfolio.

We don't have, on the other hand, some of the headwinds that others might have. We're not dependent on residential mortgage banking revenues, so to the extent -- we have more of a growth upside story, and relatively little downside.

We don't have an exposure to construction loans, so to the extent that some markets don't perform as well on construction loans, we don't appear to have a headwind or a tail risk on that.

So I'd say the path for us is pretty clear, and the key for us is going to be how well we do on the C&I originations, repositioning the leasing portfolio and continuing to really optimize the multifamily portfolio for better yields with about the same credit risk that we have now.

And if cost of funds stays relatively stable of these marches, along with the increases in interest income and we can continue to optimize the core operating expenses, we have a very good chance of getting to the 70s, by the end of '17, and then start to get into the 80s for '18, and that would be a very firm goal for us. .

Yes, that sounds fair. And just maybe one thing I wasn't clear on, the leases. The leases you acquired, I guess, it sounds like that they are, whatever -- you'd get the average yield, 2.3% or whatever it was in the quarter.

I mean, I guess, the thought if those leases renew or you, I guess, put those assets -- the money back to work, I guess the current rates on that product, if you were to redeploy it, I guess, what's the differential in rates today versus what you're picking up? So you're picking up at 2.30%.

As that stuff pays off and you redeploy it, what are the current market rates for that type of product?.

We'd hope to do 100 to 200 points better, depending on the -- depending on the credit quality of the lessor -- the lessee that comes in and where we position it. It won't all stay in investment-grade and it won't all stay with these lessees.

We're already at or near concentration at the lessee level with a couple of these, so we'll be letting that run off. But if you're looking -- if you look at what we've done, we're seeing pretty good high 3s average yield on leases in the latter part of the quarter, and we're hoping to keep that up through a better distribution of the portfolio. .

Okay. And the retention of this portfolio you bought, I guess, your expectation is you'll retain the bulk of it.

Or I guess, what's kind of the assumption as you -- it sounds as though -- I guess you didn't state that, but I guess it sounds as though you want to keep most of these customers, is that the plan?.

Well, I think you have to draw distinction between lessees and lessors. The nice part about this is it gave us an opportunity to strengthen our relationships with the lessors. So in that context, we'll be doing more business with the lessors even if it's involving different lessees.

Those lessees themselves are going to be a function of concentration risk, pricing, the cash flows. And so the underlying lessee composition may change, but we're really looking forward, and there's already been some activity on it, is we should hope to do more business with the lessors themselves. .

[Operator Instructions] And I'm showing no further questions at this time. I'd like to turn the call back to Mr. Gasior for closing remarks. .

Thanks, everyone, for their interest in BankFinancial and very insightful questions. We look forward to making continued progress in '17. In the meantime, enjoy the remainder of the winter and early spring, and we'll see you on second quarter. Thanks again. .

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