F. Morgan Gasior - Chairman and CEO.

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

Good day ladies and gentlemen and welcome to the BankFinancial Corp’s First Quarter 2018 Earnings Conference Call. [Operator Instructions]. As a reminder, today’s program is being recorded. And now I’d like to introduce your host for today’s program, F. Morgan Gasior, Chairman and CEO. Please go ahead..

Good morning, and welcome to the first quarter of 2018 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. As all filings relative to the first quarter of 2018 are complete, we’re happy to take questions at this time..

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

Your question please?.

First question is related to your, your margin came in much higher than we had expected in the first quarter.

Was that driven by less in the way of pay-downs and pay-offs in the quarter, and were there any other unusual items in the quarter that positively impacted the NIM?.

You’re seeing the impacts of the loan mix take effect in in our very (inaudible) process towards managing the loan portfolio. So the originations and draws for the quarter trended to higher yielding of C&I loans, and we actually did reasonably well in originating non-investment grade leases.

So all those had a positive impact, and at the same time to the extent we got repayments, they were in lower-yielding investment-grade leases and lower-yielding multi-family loans. So the combination of those factors is as we had hoped setting up a higher yielding loan portfolio and creating a better efficiency versus the funding..

And then Morgan as look out into the second quarter and in the third quarter, is that a trend that you expect to continue, which should positively continue to impact your margin throughout the year?.

We would hope so. We try to put a range in the 10-Q about what we thought would happen, and as we said in the last call, it’s going to be a function of how the asset generation unfolds versus especially in this environment the funding costs.

So we’ve had a very good start to April, particularly on the leasing side, and therefore we’ve made up quite a bit of ground in terms of asset generation compared to the end of the year and the 3-31 balance. We have good pipelines going pretty much across the board. The timing, of course, of closing these loans and the leases is always the challenge.

But we’re feeling pretty good about loan generation and the right mix for 2018. So if you were to go forward, we would still think that we’re going to see high-single digits net loan growth from this point forward, probably a little stronger in the second quarter based on pipelines.

Third quarter tends to be a little bit slower, and then we tend to have a little bit stronger fourth quarter. So if you said, maybe 3% growth in the linked-quarter growth in the third - in the second quarter, maybe tail off a little bit in the third quarter, and then pick back up in the fourth quarter.

With the mix again we’ll expect C&I to continue to grow pretty consistently with the trends we’ve had for the last several quarters. We expect multi-family to continue to do mid-single digits as we thought we would for the year. We’re not really interested in taking on low yielding multi-family.

Some of the costs of pay-offs will be - we’re just seeing some pretty aggressive pricing on some of those assets for longer durations, and it’s not necessarily helpful to what we’re doing, and that’s especially true in the commercial real estate market.

So we are perfectly happy trading off low-yielding, fixed term CRE loans for floating rate C&I loans in this environment, and that will be the continued focus.

So yes, I think the careful managing of the loan portfolio for yield, for risk and for interest rate risk will continue, and I think the data that we presented in the 2018 shareholder information and the themes that we talked about the last time are still intact..

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

It’s just one thing, just back on the question on the loan side; you gave a pretty good summary there.

Just the growth this quarter was, at least on a net basis a little bit less to start the year, just given for the pay-offs you’ve kind of talked about, but it sounds as though that the outlook for the year kind of that upper-single digit type of loan growth that’s still consistent with your expectations, even if it’s a little bit slower start to the year or do you think that’s a little bit lower now? Could you maybe you kind of said it was mid-single digits from here.

Just trying to understand kind of full year, how you’re thinking about things and does it change with the start here?.

If you just took a 2.5% linked-quarter growth, first quarter to second quarter, second quarter to third quarter, and third quarter to fourth quarter, so about upper-single digits, that’s where we’d like to be at the end of the year. As I said, we’ve had a good start to April.

The mix of the assets continues to be moving in the direction we wanted to move, and really, that’s on all fronts. So the real estate pipelines are good. The yields in the pipeline are good, if they’re not, we don’t put them in the pipeline.

Leasing had one of their better quarters so far in second quarter, in terms of the mix of originated leases, and especially, when we’re looking at the area, the risk categories that we’re focused on in the double [D] space, for example, so all of that is moving in the right direction.

To us, the timing is always going to be, does the pipeline close, and when does it close? That continues to always be the wild card here. But we like the thought of growing at somewhere between 2.5% to 3% linked quarter in the second quarter, 2% to 2.5% in the third quarter, and then 2.5% to 3% in the fourth quarter.

That seems achievable to us based on what we know now..

Just on the margin, I know it was a little bit stronger this quarter, and you’ve kind of alluded to some of that.

When you kind of look at it, I guess, could your expectation be that if you continue to optimize the loan portfolio, as kind of you’re talking about, that the direction on the margin ought to be upward or if you can talk about the (inaudible) where maybe the margin could decline from the current levels, and then maybe expand back up or just kind of what are the puts and takes on the margin that could take it higher or lower as you kind of look over the balance of the year?.

Well I think in terms of yields, we continue to see and will continue to see improvement in yield. And I think, again, the mix that we’re talking about will continue to strengthen there. Obviously some of the C&I growth has variable rate components and that’s helpful if the fed decides to move.

On the funding side, what we’re also trying to do is manage interest rate risk.

So we will continue to balance liability durations, and if our mix tends to be more fixed term, either leases and/or multi-family that growth on the margin will compress the margin a little bit, obviously because you’re having to balance off the asset and the liability duration.

On the other hand if the mix skews towards the more variable rate, that gives us a little more flexibility on funding, and the margin will skew a little bit higher. So we had said that the range we’d expect is 340 to 360 range.

Right now we’re feeling pretty good about the higher end of that range, but if we start funding more on margin and we have higher growth than we’re currently expecting, then that margin will compress a little bit, because we’re funding more with marginal funds..

And just on the funding side, you’ve kind of run off the wholesale function circus. What’s the outlook on just kind of the funding side? I mean, your loan-to-deposit ratio is around 100.

You guys kind of had a target and what are the current funding costs on the deposit side, and kind of how you’re thinking about deposit this year as you look forward?.

Obviously too it’s going to be a function of again what happens with the federal reserve and how does that change market expectations. Wholesale for us is opportunistic, if we see a good growth opportunity we’re going to grab it and close the loans and fund it short-term or medium-term wholesale.

But then we will work to replace that wholesale with local deposits as we have in the first quarter, and we’ll continue to do so. So generally speaking, we like to keep wholesale at or under 10% as a general rule, we prefer it to be lower. But if we need it to help balance off interest rate risk or to facilitate loan volumes, we will.

Pricing is a mixed bag. You are continuing to see more pressure on the market. As we said in the last quarter’s call, there are some premium money markets out there, and of course, CDs are moving up along with the treasury curve. We tend to be more focused on the CD side.

And again, it helps us balance out interest rate risk than the money markets too because they’re still obviously subject to repricing. But it’s really a function of who is doing what out in the market.

We’ve been recently successful on funding, so far, we are cautiously optimistic that we can continue to do so, but if somebody jumps in the market with a big special or a different plan, then we’ll have to adjust to that..

And just last one on the loan-to-deposit ratio, where it’s at, do you want to see it lower, or are you comfortable where it’s at today?.

We’re comfortable where it’s at. If it goes up a little bit, we’re fine with that. But we’re comfortable where it’s at. Remember we have a considerable amount of liquidity coming off of this portfolio, as you’ve seen in the quarter-over-quarter results, so, liquidity for us is not really a concern.

The entire portfolio generates a lot of cash to redeploy. So that’s why we’re not particularly concerned about the loan-to-deposit ratio at these levels. We also have a considerable amount of standby liquidity should we need it.

So for us it’s keeping the deposits working with the right mix of assets at the right yields and the right risk profile, and that will produce the optimum results given the funding base..

And how about just on the expense side, maybe a touch higher than, kind of we were thinking this quarter some of it may have been incentive or just normal seasonality first quarter, but just kind of big picture how you’re thinking about the expenses over the balance of the year, and just kind of the current run rate, how do you characterize that?.

Well, first thing is in the second quarter, we’re going to have a special 401(k) contribution, and right now I think, that’s about a $300,000 expense item. So that will be an event in the second quarter. In future years, it will probably be spread out throughout the year.

But the way the plan (inaudible) had to work this year, it’s going to be a onetime event for 2018. We did sell our office building here in Chicago, and we’ll be moving later this year. So there’s going to be a little bit of overlap on occupancy expenses to facilitate that, probably a couple of hundred thousand dollars.

So we’ll have a little bit of bumpiness in second quarter expense and third quarter expense, but I would generally think that the run rate on a normalized basis should be somewhere between 9 million to 9.5 million, just maybe 150,000 either side of that to 200,000 either side of that. Again, the other wild card would be incentives.

If the loan growth and/or the commercial mortgage banking growth continue to proceed as we’d like them to, then we’ll be reporting some higher growth every quarter that pay those incentives. But obviously, you’ll see the results in the non-interest income side and the interest income side..

Okay, so the 9.5 is more of the baseline and then these items that you called out, the 401(k) and kind of the building expense or the occupancy expense that would be kind of in addition to that kind of baseline you’re thinking about..

I think for second quarter, certainly, we have some other things that roll off in the third quarter. So yes, second quarter or third quarter, I’d say that’s accurate. But once we get into fourth quarter, unless it’s incentive-driven, we’ll start to trend at or below that 9.5 number..

And then can you talk a little bit about just the commercial mortgage team that you’ve hired? I guess it looks like they’re beginning to contribute to the fee income side.

Just kind of how you expect momentum there to pick up or just kind of little bit kind of what these folks are doing, and just kind of your expectations as far as or how we think about it prospectively?.

Well it’s very early days with this, and the practice here is, we have a very broad base of market participants in the multi-family and commercial real estate space, and more so now than probably ever before, there is an equally broad base of (inaudible), whether it’s insurance companies, Freddie Mac, commercial loan funds, obviously, CMBS is still out there, but the CLOs are a greater factor than they ever were before, and some of those providers can provide some very attractive financing if you are a real estate investor.

Most recently, we saw a transaction in the Chicago market that was a normal neighborhood, mixed-use property that went to a CMBS structure with only a $1.3 million loan balance. Non-recourse, the number couldn’t probably support the loan amount from our underwriting, but it did for theirs.

So these individuals, plus our normal team of bankers, because everybody is both trained and actively seeking out these transactions. We want to serve the customer regardless of their needs, and if it fits the portfolio, terrific.

We have a variety of portfolio of products to meet their needs, typically shorter duration, more flexible financing, aimed at the [render] by necessity and the value-add market. But if you’re looking for long term, fixed rate, non-recourse financing, we have those solutions available for you, too, through real estate capital markets.

We charge you a placement fee to take care of you on that regard, and sometimes we’re able to put both products together in the same deal. So they might get a certain amount of fixed-term financing, but they also might have a line of credit or some flexible financing that goes with it. So it gives us a lot of presence in the market.

We went from a situation where if the phone rang, we could take care of people two or three times out of 10 depending on their needs to a situation where we can take care of them eight or nine times out of 10.

So it gives us a lot of flexibility to take care of the customer, and therefore the revenue opportunities from the marketing that we do are much, much greater..

And as far as the momentum, this is like you said, very early on.

So this revenue, do you expect this to be somewhat lumpy or is this going to be a pretty consistent type of revenue stream as you look forward?.

Too early to tell, but I think lumpy is probably the word for ’18, because we’re into originating with new market participants that we’re getting to know, they have their own process that we do not control, and we facilitate the transactions on both sides, getting the lender what they need and helping the borrower get their deal organized and in the right slots, but anything can happen.

So it’s really a function of - we have a very strong pipeline of transactions, when they close and how they close is still kind of an unknown for us. But we have a good serve.

Everybody got on the board in the first quarter, the bankers who have been with us now have learned the products, and we have a handful of bankers that now have capital market deals in the pipeline, in addition to their portfolio loans in the pipeline.

So the more familiarity everybody gets with this and the more predictable the process becomes to all sides, the smoother the process will go. But I think lumpy is probably the right word for the remainder of ‘18, as everybody gets familiar with it.

Having said that, we would hope that commercial mortgage banking can add 3% to 5% to our non-interest income by the time we get to third and fourth quarter of ‘18. That’s not a lot of money, but its steady progress and it’s a platform to build on for ‘19.

And it will be especially useful in a flat yield curve environment; it will be especially useful if market sentiments change; it will be especially useful if, all of the sudden, risk parameters change because market participants might pull out, others might come in, and we’ll be able to take advantage of that movement..

Understood, thanks for the color there, and just the last couple of things.

Capital deployment, Morgan, I guess, how are you thinking about that as far as priorities?.

We were pleased to increase the dividend for the quarter. Dividends continue to be a priority for the board, and so raising it up a penny seemed very consistent with where we’re headed. And no promises, but the Board will continue to look at that each and every quarter, and an improved dividend is certainly part of the capital management plan.

You saw that we expanded and extended the share repurchase plan, earlier in the year by a little over 600,000 shares.

Some of that will, of course, accommodate the (inaudible) termination, which will take place here on the second quarter; some of it has already started, and furthermore we added additional capital to the holding company just in the last few days to the tune of 9.5 million.

So in addition to the dividends going from the bank to the holding company on an ongoing basis, the holding company has a bigger war chest for share repurchases if market conditions are favorable.

So I think both the dividends and the share repurchase program are intact, and because of the (inaudible) especially, they’ll be a little more active than we thought last quarter, but there’s plenty of cash to support it..

And just as far as looking at something from an M&A perspective is that still on the table, is it more just kind of organic growth, and kind of what you outlined with the buyback and the dividend?.

Yes. We’re in the same place we were in last quarter’s call. We’re really not interested in taking on legacy credit risk and legacy issues.

So what we’d be looking for, especially if our organic loan growth continues and is at the higher end of the range for thinking, would be to add something that had a lower loan-to-deposit ratio that would be complementary to the funding needs. I don’t think we’re alone in that desire, but that would probably make the most sense.

Alternatively, something that was complementary to our asset generation would also be something we’re interested in. But what we’re not really interested in doing is adding, is taking on somebody’s legacy credit risk or taking on asset classes that we’re not particularly comfortable with.

So if somebody is making a lot of money on construction lending or high yield commercial real estate or things like that, that’s not really what we do, and we wouldn’t regard that as particularly helpful; more of something to be unwound than wound. If it’s done in small proportions of course that makes sense, and maybe a little bit of diversity.

But for us it’s a pretty narrow window of things we’d be interested in on the M&A front and we think our time is better spent on organic. And that’s to say smaller is the focus, if something else comes along, we’ll certainly look at it, but as I said, that’s consistent with what we thought last quarter, and I think that theme remains intact..

And just your expectations on hiring, if you go more of the organic route is there an intent to hire folks this year from that side to -..

We were always looking and we probably will think about expanding. Right now, I think people are pretty focused on executing their business plans. If anything, we’re going to add a little capacity in the back office and C&I for portfolio management purposes and risk management purposes, given the growth rate in C&I.

We’re also adding some analytical capacity to accommodate deal volume. But certainly, I would say both in the health care space, leasing space, we will look to add some people, regional commercial banking, so we’re always open for talents if anybody is listening.

But I wouldn’t expect it to make a material impact to ‘18, either on the revenue or expenses at this point in time..

And lastly just going back to expenses for a minute, I think the credit expenses were a little bit larger this quarter. There’s a little bit of (inaudible), some cleanup litigation, I think you talked about it in the Q.

With credit quality worth that, is the expectation that those numbers come from the expense side would decline from the current levels, so I guess that seems fair?.

Yes, I absolutely agree with that. We had the one big collection case that we concluded. There’s still one more out there that will probably require less funding from this point forward. So yes, I would absolutely think that would go down actually rather materially. Again to your point, the asset quality is in a pretty good shape.

We still think we can improve it to some degree throughout the year, (inaudible) but I would expect those NPA costs to go down to kind of where we thought they would originally. We spent some money getting the stuff cleaned up and moved out, and now having realized the benefit of that, those expenses have trailed down..

And just the pay-offs this quarter, Morgan, it sounds like they were a bit higher.

How do you think about pay-offs, I guess do you expect them to be a bit high, or are you expecting them to drop a fair amount from what they were this quarter?.

Hard to say; I think the real estate side is probably going to be more volatile, because you have a variety of expectations in the market. Some people want to, as I said, lock in long term financing, 10 or 15 year financing on the real estate assets, and they may want to do a large cash out at these cap levels.

That’s more of a capital markets transaction; that could precipitate a pay-off. We’ll capture some revenue on the other side of that, but that could precipitate a pay-off. So that’s an example of probably something we’ll see on a continuing basis throughout the year.

At the same time, some of those investors want to reposition the cash-out proceeds into another asset. Those tend to be more flexible loans, more value-add deals, so that tends to support the origination side.

So it really will be a function of some investors just sell, they think markets are close to peeking for a real estate, and they just want to get their cash and move on to something else. Others hold the asset long term, but if it’s a long duration, non-recourse loan, it’s not going to fit our portfolio; you will see a pay-off.

Others are going to want to continue in the market, probably look within a range of cap rates and properties they want to position themselves for, and so we’ll some redeployment of pay-offs into new originations. So I’d say, real estate, in particular, multi and commercial estate, we’ll see a fair amount of volatility on pay-offs.

C&I is a function of draws and repayments. It’s not unusual in the health care space to see a state payer go out 60, 75, 90, 120 days and then all of the sudden get a slug of money in from taxes or a bond or something and then send a whole bunch of money back to the providers.

So in one month in one day we saw $14 million come in from a state Medicaid plan. But then, it’s redrawn almost immediately for operating needs, but it does create volatility in the C&I portfolio. Same in commercial leasing; we’ll have draws for bridge lines, which are a great thing because this kind of lease are coming at you in future periods.

But then, all of the sudden, as we’ve said before, it will pay down usually close to the end of the quarter. So again, you’ll see volatility. So when you looked at the first quarter data, you saw terrific volumes and originations in C&I, but you also saw some repayments on the lines. And so it’s hard to give you a number to quantify.

I would say first quarter was probably a little bit higher than normal, but it’s hard to give you a run rate on that. It’s just going to be not very predictable throughout the year other than that it’s going to happen. I would hope that it mellows out.

April has been quieter than March and February, but that’s not to say that it could pick back up in May or June based on external events..

I think you’ve answered all my questions. I appreciate it. Thanks for taking the time, Morgan..

Always a pleasure, thanks for your interest. .

[Operator Instructions] And this does conclude the question-and-answer session of today’s program. I’d like to hand the program back to F. Morgan Gasior, Chairman and CEO, for any further remarks..

Thanks everyone for their interest in BankFinancial. Please enjoy the summer, and we’ll speak to you soon..