F. Morgan Gasior – Chairman and Chief Executive Officer Paul A. Cloutier – Chief Financial Officer.

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

Good day, ladies and gentlemen, and welcome to the Bank Financial Corporation Second Quarter 2017 Earnings Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to turn the conference over to F. Morgan Gasior, Chairman and CEO. Please go ahead..

Good morning. Welcome to the second quarter of 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 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 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 not complete. Last night, after the close of business, the Board of Directors decided to expand the share repurchase program, increasing the total share repurchase program by 250,000 shares and a filing to that effect will be made later today. With that information, we’re now ready for questions..

[Operator Instructions] And our first question comes from Kevin Reevey with D. A. Davidson. Your line is now open..

Good morning Morgan.

How are you?.

I am well.

How are you?.

Doing well thanks. So my first question is related to the NIM. I know you guys took on some additional borrowings earlier in the year. And I know when we last chatted, you had mentioned that you expect the NIM to rebound later in the year.

Is that the case? And if you can kind of give us some thoughts as to where you think the NIM will fall out by year-end?.

Okay. Well, there’s always the uncertainties of timing, right. Timing for us is usually dependent on 2 things. First of all, the timing of our loan originations, we get a considerable amount of cash flow from the portfolio on a pretty ratable basis throughout a period.

And we always have to make sure that the loan originations are timed to match those cash flows. And if there’s a mismatch, then we’ll have some time where there’s excess cash sitting around that needs to be put back to work. Secondly, if we need funding, we might take funding out ahead of time – ahead of scheduled originations.

That happened in second quarter. We wanted to get funding organized before any movements in the Federal Reserve rate environment. So those were 2 factors that happened second quarter.

Having said that, the loan origination yields continue to improve across the board, both in C&I, leasing and real estate, and rather materially, especially if you look at it from where we started at 12/31/16. So that’s going to help drive revenues forward during the remainder of the year.

We should see some amelioration of the rate of increase in cost of funds. So from a margin expansion perspective, we’re looking to see if we can get somewhere between 3.3% and 3.4% by the end of the year. I think 3.4% would have to be in an environment where pretty much everything worked out perfectly for us.

So probably a conservative estimate would be closer to 3.3%, but that’s the rate we’re trying to hit for year-end..

That’s great color. And then on the loan growth, you had some very strong growth in your commercial loan. Was that driven mostly in your health care business, or was it spread out among other verticals? And then by geography, if we could get some color there, that would be great..

Well, the growth – everybody contributed to the C&I growth, health care was a strong contributor—that’s obviously a national platform. Direct – commercial leasing, direct lessor credit also contributed. That’s also a national platform, and then behind that, was Chicago commercial banking.

So the 2 national platforms provided the most growth, given the geographic scope of what we’re able to do. Chicago was in third place..

[Operator Instruction] Our next question comes from Brian Martin with FIG Partners. Your line is now open.

Hey, guys say, maybe just a follow-up to Kevin’s question on kind of the margin, Morgan, or Paul, just as you kind of think about the rate environment and kind of looking into ‘18, I guess, if – and talk a little bit about funding pressure, I mean, if you kind of ramp-up the growth or just talk – look about the grow you’re targeting and kind of funding pressure, I guess what – how do you anticipate the margin performing with kind of a flat environment here and maybe no more rate increases and kind of talk a little bit about the funding pressure you’d expect or if you’re seeing any and how that dynamic plays into ‘18?.

First, we continue to have the opportunities to improve yields on the portfolio. As cash flows roll-off portfolios, especially in the context of a leasing portfolio, we have the opportunity to redeploy those cash flows into higher-yielding lease assets. And with a broader credit distribution of those assets, we have even more opportunities.

So I would say, even in the rate environment we’re in, the portfolio is positioned for better yields, both in the leasing portfolio and actually in the real estate portfolio because the cash flows that come off the real estate portfolio, including some of the prepayments, are at lower yields.

So if even all we do is replace those volumes as opposed to grow them, we’re going to see some improvement in the interest income side.

On the interest expense – and that’s without really material growth, if we add 10% to 15% C&I growth, if we add 5% to 7% leasing growth for 2018 on top of that, then you’re going to see an even bigger expansion of the interest income. And, obviously, we have plenty of capital to support that.

On the interest expense side, one of the more interesting things is the portfolio asset sensitivity continues to improve. We’re, therefore, not necessarily required to go out and hedge the funding side and extend the durations on the funding side. We’re able to bring the average duration of the funding in to a shorter duration than we had previously.

That means even with a flattish curve, we’ll have an opportunity to fund a little bit better matched at the shorter end of the curve and probably have a little bit better price performance on the interest expense side. And we have some marketing ideas on some new ways to draw deposits in, both on the retail side and the commercial side.

And to the extent those are successful to help marginal funding growth, then we could see some pretty well-sustained margin expansion, given the yields on the C&I portfolio, the higher yields in real estate and leasing versus some more, say, reasonable and moderated marginal funding cost..

Okay. And just the opportunity, Morgan, on the improved pricing.

I mean, can you just give us kind of an update on whether in the real estate or the leasing side, I mean, how much opportunity – I guess, can you talk about what you’re seeing currently or just kind of how some of it’s played out? How much of a pickup you’re seeing? And maybe, if that type of level just continues and kind of the size of the piece that could continue to – or has opportunity to pick up some benefit?.

Well, I would say, let’s start with the real estate portfolio. If it throws off $15 million to $20 million a quarter, we can probably pick up somewhere between the 50 and 75 points on that, depending on the average that rolls off, let’s say, 50 for conservative purposes.

The leasing portfolio, you’re able to pick up as much as 75, and in some cases, 125, depending on what the cash flows are. And the lease portfolio, will throw off somewhere in the neighborhood of $90 million to $100 million in a conservative mode next year alone.

So that’s why we say, there’s a pretty good opportunity for interest income expansion in 2018. The C&I portfolios, the floater rates, obviously, to your premise, if we’re not going to see much in the way of Fed increases, that will ameliorate a little bit.

And that’s why we’re really looking at that portfolio growth will be the main contributor to an increase in interest income there..

Okay.

And just to your point about loan growth, Morgan, just kind of the – any change in expectations as far as kind of the amount of growth and just kind of where the growth comes from? Maybe any update on that you could provide?.

Well, I would say, if you look at second quarter, the growth that we had in the C&I portfolio still seems to have momentum. I think we did something like $26 million in the quarter, plus or minus $25 million. And that we have the potential to do that for the foreseeable several quarters ahead. Pipelines and opportunities continue to come in.

Timing, as I said, of those, when those close, is variable. We don’t control the closings, the lessors do or the borrowers do.

Sometimes they’re refinances, sometimes they’re purchase opportunities where somebody is acquiring a business, and sometimes, we think it’s going to happen in one period and it happens in another or happens late in the period where we thought it would be earlier. But so far, the health care expansion continues.

Proposals continue to go out the door at, or in excess of, the rate we had in the second quarter. We continue to see growth in the direct lessor opportunities. So we’re feeling pretty confident about both those sides. Chicago commercial banking, is going to do its mid-single digits, probably not do much better than that, given the environment.

And then real estate, we said that we’d be in the high single digits, that’s a function of both market conditions and just looking for the right opportunities in terms of risk and yield. And we’re still pretty comfortable with that.

It might trend a little bit higher from time to time as we get into new geographic markets and develop some new opportunities, but it’s also a function of the underwriting is going to meet our standards and sometimes it will, and sometimes it won’t..

That’s helpful.

I guess, just from a standpoint on provisioning and kind of margin or provisioning and reserving goes, if you look at putting on the growth in the respective buckets, kind of you’re talking about, I mean, what’s the appropriate way to think about how you’re reserving for new loan growth going forward? I mean, is there – I understand the mix, but maybe just kind of outlining kind of how much is for each bucket or how you’re thinking about that would be helpful..

Yes. I think there’s no question that you’re going to see higher provisioning from the growth. Our asset quality is to the point where reserve release – what little bit could happen either because of recoveries or because the loss ratios continue to improve, but they’re in pretty good shape already.

So in terms of new growth, mix, as you said, is important, but I would say that on the low side, if we had – if everything else was stable, there was no activity in recoveries, no activity in quantitative or qualitative ratios, we’re just provisioning on the growth, then somewhere in the 60 basis point on the low side to 85, 90 basis points on the high side would be about the right reserve ratio.

The reserve ratios are, obviously, indexed to risk. So obviously, if it’s an investment-grade lease that is being replaced by a BB+ lease, the reserve ratio is going to be higher than the relatively low reserve you need for an investment-grade lease.

So again, as the credit mix shifts, the credit spectrum shifts, and the mix shifts, you will see probably a trend to a higher net reserve ratio over time. And I would say, low side, 60, high side, 90, take the midpoint, 75 – you probably won’t be too far off..

Okay, that’s really helpful. And just one thing circling back on the loans, Morgan.

I mean, now that you’ve kind of – I guess, the bank charter’s been – the charter’s been changed, and the opportunity now on to go after some of the commercial growth, I mean, does that, I guess, give you more optimism that the historic type of loan growth may see a little bit of an uptick from what you’ve historically done, just given, you’ve got a little bit more ability to go after some of this? I guess, what I’m asking is, could the growth rate in loans be higher in 2018, that change and kind of your outlook today? Or is it still about the same where it’s maybe mid- to high single digit type of growth? And I’m not putting words in your mouth, I just don’t know if – I’m just trying to understand if there’s a little bit more optimism on loan growth as you go into 2018? It kind of sounds that way..

Yes. There’s no question we’re optimistic about it I think to restate what I think I said before, if you look at the C&I portfolio, quarter-over-quarter, we grew about $25 million. That seems to be a pretty rate, given the current level of opportunities we’re seeing.

If the opportunities – if we get pricing pressure, if we get underwriting pressure on some of this stuff, that rate could diminish. But we kind of like the level of opportunities we’re seeing. A key to that, though, is keeping the money working.

Line utilization can be very volatile in that, to Kevin’s earlier point, tends to affect the margin on a quarter – intra quarter basis so to speak. So no, we like where we’re at right now. The direct lessor opportunities continue to expand. We see some new lessors coming into the mix that we haven’t seen before.

We’re seeing some opportunities with existing lessors to expand the relationship. We’re adding new health care customers. So in both those segments, we’re seeing some good opportunities and we’re pretty optimistic about what were – what are our prospects are. On the leasing portfolio, the challenge, the challenge there for us is the cash flows.

We throw off a lot of cash into that – off that portfolio. But having said that, we got to the end of – end of the year. We said that we’d try to keep the leasing portfolio at about the $360 million level through the end – through 2017, so that we could reposition the credit mix of that portfolio. We’re being successful with that.

If you look year-over-year, that makes a shift by about 25%. We’ll probably do another 25% just in the second half of the year. And then for next year, we’re going to try and get the leasing portfolio up about 10%. So you’ll see 10% growth in that portfolio in 2018 that you didn’t see it in 2016.

And as I said on the real estate side, we would expect high single digits right now. We’re not trying to conquer these markets, we’re trying to make the right balance of price and risk. So far, we’ve been successful with that, we’ll continue to be successful, we think, especially with the product mix that we have in the market.

So if I give you the summation, you should still – can see low to mid – 10% to 15%, if not higher, growth in the C&I portfolio; low – mid-single to high single digits in the real estate; the leasing portfolio will be the bigger wild card, but next year, we’d like to see about 10% growth from the end of 2016 to 2017.

This year, we’ll probably only – we’ll keep it flat to go up another 2% to 3% for the remainder of the year..

Okay, that’s really helpful, Morgan. I mean, it sounds like it’s still an upper single-digit type of number when you kind of blend it altogether. But the color on the individual buckets is helpful, so I appreciate that. So maybe, just the last few things for me.

Just from a concentration standpoint, any change on how you’re thinking about managing the CRE concentration levels, or just maybe just an update on that?.

Capital ratios remain strong. The portfolio performance remains exceptionally strong. You note the 50% risk-weighted assets in the multifamily portfolio increased by about 25%, 26% year-over-year. But the overall CRE portfolio only went up about 5%. So once again, the quality of the portfolio continues to drive the opportunities.

So I think we’re in good shape on CRE concentrations, we’re not expecting to expand the portfolio at particularly aggressive rates. Continue to focus on the right mix of price and risk. So I think, right now, steady as she goes..

Okay, so the current level is not something you want to move that lower, you’re fine where – at least where it’s at for the time being?.

I think that’s a fair statement for now..

Yes, okay. And then lastly, just on the expenses. I mean, you guys have made a lot of progress and, I mean, the numbers look great.

So, I guess, just kind of thinking about any – now that you’ve kind of reset the numbers, with the heavy lifting done here, a lot of it done, I mean, I guess, how do we think about expenses, or is there any change in kind of what you’ve talked about in the past with the expenses and how to think about that over the next 4 to 6 quarters? Any initiatives that would kind of take it higher or highers or just plans you guys have looked at that are opportunities?.

I think a couple things and I can have Paul fill in some details, but first and foremost, even though we have a very nominal level of REO and NPA – the location in Chicago, the high-cost market that it is, real estate taxes, insurance and things like that, we’re going to be very focused on knocking down those REO expenses.

I mean, I don’t want to say it’s low hanging fruit, but it’s clearly not contributing to the success of the organization. It’s overhead that we need to get rid of as soon as possible.

So we’re probably going to be a little bit more aggressive on pushing things through the pipeline, even more than we already have been, and getting those expenses down and out. If you looked at second quarter for example, the total expense related to that category was $271,000 or almost $1 million annualized.

Just cutting that in half, if not more, would be a really good goal to achieve. So that’s going to be an increasing focus in the second half of the year to get a better run rate on that. And taking that cash and investing it in either new opportunities, new marketing opportunities, especially on the deposit side, would be a very good trade-off.

Second of all, we are seeing some additional opportunities to look at high efficiency ratio operations and trim them back. So there’ll be some more progress on that.

So Paul, from a run rate perspective, why don’t you fill in the blanks?.

Compensation, there’s still some reduction there that’s possible. On the IT side, we just re-negotiated some IT contracts. You see the dip quarter-over-quarter, first to the second quarter, a drop of about $80,000. There will be a further drop in the third quarter as that gets fully phased in, those reductions.

And then looking out into 2018, if you look at the amortization of intangibles, currently running at $122,000 a quarter. Starting in second quarter next year, that will drop to $20,000 a quarter. So all told, looking out into the future, right now, we’re run rating, as I say, 38 to 4.

We can see that getting down over the course of the next few quarters in the $37 million to $37 million range – annualized..

Right. Okay. All right. That’s really helpful.

And then just the capital levels, you talked about the buyback, Morgan, I guess, any sense as far as the – how aggressive or not aggressive you plan to be with the buyback? I guess, is it a priority, is it not a priority at this point? Is this, kind of, basically going to be on the – depend on the pricing?.

Well, I think the fact that the board just increased the allocation by 250,000 would indicate it’s a priority. Let’s – if you look, we’ve been doing about 200,000 a quarter, sometimes a little bit more, sometimes a little bit less, and even at these pricing levels. So I think that’s a pretty good baseline to where we’re at.

And given that they’re paying attention to that, it wouldn’t surprise me that they look to be a little bit more aggressive on that after a while. I think they’re really focused on watching the EPS and to the extent that a buyback helps that, that’s good..

The total – so it was increased 250,000.

What’s the total shares you can repurchase today?.

That takes it up to a current capacity of about 450,000 shares right now. Or about 2.5% of the outstanding..

Outstanding, okay. All right, I appreciate the color guys nice quarter and [indiscernible] 90 days..

And just to wrap up on your – just to total your numbers, Brian, you would probably look for us to do annualized 5% and annualized 10% growth rate for the remainder of the year. Next year, you could probably see us touch just a little bit above 10% because the leasing portfolio will start to move north.

So right around annualized, 10% to 11% for the remainder of the year, and maybe 10% to 13% for next year, if the leasing portfolio picks up a little bit..

Okay. Thanks again..

[Operator Instructions].

Going once, going twice, going three times? Thank you, everybody, for their questions and their participation. Enjoy the remainder of your summer, and you will see you next quarter..

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