Good day, ladies and gentlemen, and thank you for standing by. Welcome to the BankFinancial Corporation First Quarter 2017 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. .

Now I would like to welcome Mr. F. Morgan Gasior, Chairman and CEO. Please, 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 21E 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 the safe harbor provision.

Forward-looking statements involve significant risks and uncertainties and are based on assumptions that may or may not occur. They are often identifiable by use of the words believe, expect, intend, anticipate, estimate, project, plan or similar expressions.

Our ability to predict results 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. All filings are complete. We're ready for questions. .

[Operator Instructions] And our first question is from the line of Brian Martin with FIG Partners. .

Morgan, I was wondering, I guess I have a handful of questions for you.

But just maybe one where you could start on just the commentary about the ESOP, and just kind of walk through the decision to make that changes and just kind of the impact on this quarter's earnings as it related to the reported number, and then just the benefits going forward?.

Well, the impact for the quarter was about $1.1 million in additional expense. The annual run rate on that is, depending on your share price, between $1.3 million and $1.5 million. So for the remainder of the year, you've now eliminated that expense. We also made some other progress on expenses during the quarter, the course of the first quarter.

So all told, as we said, if you compare, for example, second quarter to first quarter, we’d expect about $0.04 or $0.05 improvement in earnings for the second quarter compared to first quarter. So the second quarter results would be $0.14 to $0.15. Maybe if loan yields and loan volumes continue to progress, slightly better than that.

But reasonably, $0.14 to $0.15 earnings per share, both in terms of the cost saves we have been able to achieve and the reduced share count compared to $0.10 in the first quarter. And that run rate should continue throughout the remainder of the year and into next year. .

Okay. And I thought that there was also, when I looked at the queue, some commentary about a tax benefit, and some other things with regard to options, so just kind of in the whole picture, the impact. .

Yes, for the first quarter, there was activity in share -- in stock option exercises. And at the end of the day, we received -- we generated a tax benefit that was a positive, but then there were some additional employment taxes that were an offset. So about -- I think about $800,000 was the net impact, a positive impact on the first quarter.

But since the vast, vast majority of all the stock options have been exercised at this point since the plan and the options expire in June, that was kind of a one-time positive impact of about $800,000 against a $1.1 million negative impact from ESOP. .

Okay. So little bit of a positive -- little bit of a negative when you net the 2 out. So couple hundred thousand dollars, $300,000 or so was the net impact of all the kind of the stuff with regard to ESOP and the options. .

Yes, that's a reasonable number. .

Okay. All right. That is helpful.

And I guess, as far as just kind of looking at the update on kind of the leasing portfolio on that acquisition, can you just give us kind of an update on what -- I guess what transpired this quarter as far as purchasing your remaining leases out there, and then what you're seeing on transitioning these into higher-yielding leases.

I guess if you -- any early indications, can you offer any insight there?.

Sure. First, on the portfolio purchase, we ramped up the remaining purchases, about $21 million, comparable yield to the last time in low to mid 2s. Again, a fairly aggressive amortization schedule on that so the cash comes back pretty quick. But that competitor is now out of the business.

On the originations front, volumes were actually fairly respectable for first quarter, especially given how slow the industry has been as a whole. That kind of malaise on capital investments from fourth quarter has continued into first quarter. But nonetheless, our origination volumes were fairly respectable for the first quarter.

But probably the more important thing is that the yield improvement continues to deliver. We -- the yield on lease originations for the first quarter was 3.96%, which was an improvement over fourth quarter and the current lease pipeline, which is tracking our internal originations projections pretty much on the nose is now at 4.30%.

So again, we're continuing to pick up yield as we change the mix of the portfolio. And as that mix continues, I would expect continued improvement in those yields.

And that is actually happening in the real estate portfolio as some of the loans that were made in the 14, 15 range at lower yields, some of those payoffs occur and those are relatively low yields and we were able to replace that volume at higher yields. So you might pick up 50, maybe even 100 points on some of those transactions.

You're picking up over 200 points redeploying some of the purchased lease portfolio proceeds. And then the C&I area, we're seeing yields in the low to mid 4s on average, and in some of the healthcare stuff, over 5. So again, we're -- right now, we're reasonably pleased with the yield performance both in the leasing portfolio, the C&I portfolio.

We'll see what happens now that the curve has come down in real estate. But we had positive trends in real estate originations for the first quarter in terms of yield performance. And right now, we think we can continue that. If the curve continues to come down, the 10-year touched 2.20% and the 5-year went all the way down into the 1.7s.

If that were to continue, those trends might start to flatten out. But if we can get a little recovery in yields, we would expect it to continue. .

Okay.

And as far as how much of those -- what's the timing of -- when did you -- the $20 million in leases you added, were those early in the quarter or late in the quarter and then how much?.

Right at the end of the quarter. .

Okay. So right at the end of the quarter. So no real impact.

And how much of the -- how does the -- how -- this portfolio is pretty quick as far as the amortizing the lease portfolio acquired? How do we think about that as far as the timing of when it reprices, maybe just kind of even throughout the -- I thought you said these are 2-year lifes on most of these leases, or is that?.

Yes. I think you're probably over focused on that portfolio. It's just -- it's a small acquisition and the cash flows have come back really quickly on that. It's probably a 28 to 30-month average. The larger point is the entire lease portfolio throws off somewhere in the neighborhood of $30 million to $40 million a quarter.

So keeping that cash working is important. But as I said, that's why we're focused on the overall yield of the portfolio on the new originations. And the good news for us is we're able to pick up, anywhere between 100 points on the normal portfolio that's running off, and 200 points on the proportional part that was the purchase portfolio. .

Okay. That's helpful. Perfect. And as far as pressure on the -- or any look at the funding cost side, now that you've, had, I guess, 2 rate increases, one fully for a quarter and now the new one.

Have you felt any pressure on the funding side?.

Really -- we made some modest adjustments in our pricing, as I said before, to keep faith with customers and manage their expectations. But externally, we haven't seen a tremendous amount of response on a broad basis. There are always a handful of institutions that are running specials for their own corporate purposes that provide some competition.

To the extent that we have repricing, it's mostly because we're balancing interest rate risk. So in some of the fund liquidity management and funds management we'll extend some duration out. For example, you might see a little of that this quarter since we've had a little of a dip in yields on the shorter end.

And see if we can lock in some funding and just kind of balance out the ALM. But on the retail side, other than some competitors offerings some specials, which tend to affect more new money than existing money, we haven't seen a broad-based response to the Fed changes. .

Okay, helpful. And maybe just 1 or 2 others and I'll step back and let someone else chime in, maybe can you just talk about -- I think in the past you've kind of talked about the -- to improve profitability, the focus was really, given you're a spread bank and improving the loan growth.

I mean, this quarter, it looked like the loans were up $6 million or $7 million in the quarter, but that included the acquired $20 million. So I guess, on an organic basis, maybe down a little bit. Just your outlook -- I think you've talked about is kind of a mid-to-upper single digit loan growth in 2017.

Just trying to understand if that's inclusive of -- is that organic or acquired and just kind of what trends are you seeing on loan growth in the first quarter versus some seasonality or payoffs or how did it play out relative to how you are thinking about things going forward?.

I think probably, let's just take it from this point forward rather than looking backward to first quarter. So from this point forward, we're seeing some pretty nice opportunities in C&I inclusive of healthcare. So it is feasible for us that we could see double-digit growth in C&I using first quarter balances as a base.

I always want to temper that with line usage can be volatile and especially in the healthcare side, if all of a sudden we get some state payments in. We might enjoy the benefit of balanced growth throughout the quarter, but at the very end of the quarter, you'll see the cash come in and reduce the period end balances.

We had fairly muted line usage for leasing in the first quarter. Again, kind of that malaise that we saw even a little bit in the first quarter, but in the second quarter, we've seen some stirrings of some bridge line usage already in April, which is usually a good sign of additional volumes to come.

Because the lessors use that funding to acquire equipment that then gets converted into leases over the next 3 to 6 months. So we're a little bit encouraged by the line usage on the bridge side. And I would say to the extent that it continues, we'll do even better than low double-digit growth in C&I.

But again, it may peter out just as fast as it's occurring. On the real estate side, we've said consistently we thought low single -- low to mid-single digits, maybe high single digits if we get into a groove. In net growth, that would be very much tempered by payoff activity.

We're seeing owners that are getting -- what they think are extremely attractive offers on buildings that they've owned for 1 year, owned for 1.5 years, they're perfectly willing to pay the prepayment on it given the spread. And then sometimes, they will find a replacement property and sometimes they will not.

And sometimes the prices that are being paid for these properties don't fit within our underwriting envelope the same way that the previous acquisition or refinance did.

So on the real estate side, we think that high single-digit growth, so if we were at say $550 million in multifamily at the end of the third quarter, touching $600 million at the end of the year would probably be a good goal for us, net-net.

We'd expect commercial real estate to stay flat, maybe go up low single digits, but that's really going to be opportunistic. So low double-digits we hope for C&I, high single digits for real estate, multifamily and commercial real estate.

And on leases, as I said last quarter, if it grows by $3 million to $5 million, $10 million in the remainder of the year, that would be great. If we see another little portfolio acquisition to take a competitor out, we will certainly take advantage of it. But just on the organic side, we're far more focused on moving that -- moving those yields up.

And flipping the -- and shifting the profile of the portfolio. So if we kept it flat for the year, we’d be perfectly fine with that. .

Okay, I got you. That's helpful. And then maybe just, I don't know, for you or for Paul, maybe just give a little commentary, I guess, on the margin and just kind of listening to what you're talking about the yield side, it seems like you're optimistic that some of this can continue, certainly some caveats in there.

But just a little bit of bounce back in the margin, but I know you picked up the leases late in the quarter so they weren't really in the numbers.

So just any thoughts on how the margin plays out based on kind of what trends you're seeing today, maybe over the next quarter or so?.

Yes, Brian. If you go back to fourth quarter, we had the dilution in the margin, due to the purchase -- the initial purchase of the commercial lease portfolio. So we dropped down to 3.11% from our normal run rate around 3.30%.

You can see we picked some of that back up in the first quarter as Morgan mentioned as the cash flows came off and we were able to reinvest in higher-yielding leases, that helped boost that margin. Also with the real estate that we put on, the real estate loans at higher coupons, that helped increase the margin.

So we're looking at the margin growing back to its historical level through the remainder of the year. .

Okay. The rate impact, Paul, I guess, what have you seen -- how much of a benefit or can you quantify, if you at least look at the December rate hike now that you've had 1 full quarter, how that impacted the numbers based on the fact that you don't see much pressure on funding side, that probably is embedded in the margin increase as well.

Is that how we should think about it?.

Yes, you saw that our cost of funds on the retail side, interest-bearing deposits went up about 3 basis points for the quarter. So we have a modest repricing, some of that was CDs that matured that then got renewed at higher rates.

So you're going to see a slight drift up, but nothing material on the funding side, at least at this point we haven't seen it from a competitive standpoint. On the asset side, as I said, we're looking at the growth in the yield. So those 2 taken together, we see a positive trend forming over the next few quarters. .

Okay. And maybe getting back -- I guess getting back to that normalized level by the third quarter is -- I guess if you think that's realistic.

It sounds like given everything you're seeing today, getting at least back to that the prepurchase here -- purchase of a leasing should be realistic with 2 rate increases and the yield pickup you're getting?.

That's the goal. But as Morgan mentioned, the big caveat there is payoffs, depending on payoff activity that could have an impact on hitting that by third quarter or maybe not having it happen until fourth quarter. .

Maybe just lastly, Morgan, with the move with the ESOP, the impact on the -- I guess you kind of talked in the past about what your expectations are for profitability? And how much of an impact I guess, what impact does the, to your kind of targets if you will, where your ambitious are on the ROA front? If ESOP was here, would that change -- has the profitability target moved up now?.

The profitability targets are the same for the size of the company. The changes in the expense structure just made it easier to achieve. .

Okay. So no -- so this is kind of -- at least in the back of your mind, some of this was kind of in the works and will help you get to the target that you already had set. .

Yes, I would say so. It just makes the company more efficient, both in terms of comp and benefit expense, but equally so we made improvements in IT expense. We had a nice push to get some new marketing programs out in the first quarter. So the marketing expense was almost double what it usually is.

But that will start -- that will trend back down to its more normal run rate. So again, as we look at it, we're going to be looking at $0.14 to $0.15 a share in the second quarter, we think that'll be sustainable and buildable, depending on what happens with the loan yields and the loan origination mix net of payoffs.

Core funding ought to be relatively stable and we'll see if we can make a little bit more progress on the non-interest income side. But when we talk about the ROA, you're also talking about an allocation of risk. And even though we are shifting the risk profile and the leasing portfolio gradually, it's still a relatively conservative organization.

We're not going to be investing in construction loans, we really don't have any exposure to residential mortgage banking, which would tend to be drag if rates continue to drift up. So we feel pretty good about getting to those original targets, both in terms of greater loan yields and improving the mix. And in terms of improved efficiency.

And we have some more ideas about efficiency that will also help contribute over the remainder of the year. .

I appreciate all the commentary. And now let me step back.

Maybe just the last thing, Morgan, if you -- I guess any thoughts on -- any potential hires that are out there, you guys had any more people you brought aboard, any color on that, if you're done anything on that front, or status quo?.

We did -- we're in some conversation as we speak on the C&I side, on the leasing side, and nothing happened in the first quarter. We're in some conversations now. We'll have to see how those go. Again, our priorities are leasing healthcare and C&I. And again, bringing things to the table that we don't already have.

Whether it's a geographic expansion of relationships, relationships in different segments of those industries that we don't have and we've got some opportunities and we'll actually probably accelerate that path a little bit.

Our first quarter is always a little slow because people are getting their year-end reviews and year-end incentive compensation so you don't see a lot of movement. Second quarter is typically when you start seeing people assess what their prospects are and if it's time for a move.

That's why we put ourselves in front of people early and kind of wait for them to be ready. .

[Operator Instructions] And our next question comes from the line of Kevin Reevey with D.A. Davidson. .

So Brian has asked most of my questions. I will focus more on the non-interest income line items.

Specifically looks like just deposit service charges were down, was that seasonal and should that pick up in the second quarter?.

You know, it's getting a little bit harder to predict that. I would normally have told you that it was seasonal. But you are continuing to see a drift down in revenues related to ATM and debit cards as mobile takes greater hold. So I think some of it was seasonal, just especially compared to fourth quarter and holiday activity.

But we're a little concerned that some of it is not. It's just changing a little bit, in terms of how people use technology. The -- so that's, I would say, probably one of the bigger influences. To offset that, we are starting to rollout some newer programs in capital markets for apartment and real estate -- commercial real estate loans.

Starting to set up some relationships so if it's a loan that doesn't meet our underwriting parameters, there are people out there who would like the paper, sometimes it's nonrecourse, sometimes it's a different advance rate or a structure. Even a location that doesn't quite fit our box. But there are investors out there who like that kind of paper.

So we've started to work towards building those relationships and hopefully start recording some revenue on the commercial mortgage brokerage side as opposed to the residential side. It just fits what we do better.

There's also some opportunities, we've done a little bit of added leasing, and even working on the residual equity side to generate some non-interest income there. It's too early to make hard predictions of what those are.

But given the trends on the deposit side, even though we've, part of the marketing expense for the first quarter, was a push for newer customers and some more monthly -- monthly maintenance accounts, more focused on transaction activity than they are balances. And we added a couple of hundred new customers in the first quarter.

So that push is starting in first quarter with some modest results, and we hope to build on that. So bottom line, I would say, if we're lucky, we can keep deposit fees at about the same level in the first quarter, maybe build on it a little bit. But again, the trends on the ATM, debit card have us a little concerned.

And we're also seeing customers adopt more electronic technology and obviously, then surcharges for things like paper statements and manual services tend to fade if they adopt that technology. We get a little bit of non-interest expense efficiency out of that. But you'll lose the offsetting revenue too.

So I think going forward, stabilizing the deposit side, maybe building on it from the March levels, 1% to 5%, is probably a reasonable goal for us. We're going to work a little bit harder on the asset side of loan yields and loan fees because, given the volumes we're doing and the markets we're serving, we see more upside there. .

And then on the trust fee side, that was down from the fourth quarter.

Do you expect to see that to pick up throughout the year?.

I would say, it won't be material. It will be modest. Trust is a business where you'll have distributions and transfers and some of them could be material, all at once. We have one larger one in the first quarter. Replacing those assets is very much more of a process than an event.

So if you have the assets under management drop down a little bit, you may -- it may take 1 quarter to 2 quarters, maybe even 3 quarters if you have a sizable trust to distribute. So trust is something that, again, if it stays stable to grow 5% to 10%, that's a good result for us.

But I would caution that distribution activity and life activity can make that volatile. .

And then lastly on the operating expense line, if we pull out the $1.1 million that you discussed earlier related to the ESOP, so is roughly about $10 million, is that a good number, maybe $10.3 million would be a good number to use as a run rate on the operating expense line item going forward?.

We've said before, Kevin, that $10 million was a reasonable run rate, but we're starting to see with the efficiency measures that Morgan mentioned on IT and some other things, that should start to trend down from $10 million more towards mid $9 million number. So you should see that continue down after the big bump up in the first quarter. .

Okay.

So you'll get to the mid $9 million sometime in the fourth quarter, is that kind of the game plan?.

Over the course of the year. .

And the sooner the better. .

[Operator Instructions] And I'm not showing any further questions in the queue. Sir, I would like to turn the call back to Mr. F. Morgan Gasior for any final remarks. .

Well, just a couple of things that were covered in questions. We felt very good about the company's capital position at the end of the quarter. Tier 1 capital just under 11% at the bank and risk-based capital at 15%. We felt very good about asset quality, commercial, non-accruals at 1 basis point.

We pulled forward some classified loans and put them into REOs so that we could liquidate them. So we're feeling good about asset quality. We were active in the share repurchase market and of course the ESOP had an impact too. So the share count declined from 19.3 million to 18.4 million during the quarter.

So we're getting some efficiency on that as well and a little help on earnings per share as a result of that. The board saw fit to raise the dividend up to $0.07. So we're happy to providing more return to shareholders through both dividends and share repurchase activity.

So we are, net-net, feeling of pretty good about the end of the first quarter and the start of the second quarter.

We're looking forward to continued progress in the loan portfolio, particularly on C&I growth and shifting the leasing portfolio to higher-yielding assets, continuing to shift the real estate portfolio into higher-yielding loans and continuing to make progress on operating efficiencies, a little bit of help on some of the new activities and non-interest income.

So with that said, we look forward to talking to everybody after the second quarter. Enjoy your spring. .

Ladies and gentlemen, thank you for participating in today's conference. This concludes the program, and you may all disconnect. Have a wonderful day..