Good day, ladies and gentlemen, and welcome to the BankFinancial Corp., Q4 and Year-to-Date 2018 Review Conference Call. Currently at this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time.

[Operator Instructions] Also as a reminder, this conference call is being recorded. At this time, I’d like to turn the call over to your host F. Morgan Gasior, Chairman and CEO. Please go ahead..

Good morning and welcome to the fourth quarter 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, and as all filings are complete, we are ready to take questions..

Thank you. [Operator Instructions] Our first question comes from Kevin Reevey from D.A. Davidson. Please go ahead..

Hi, everyone.

How are you?.

Good morning and happy New Year..

Happy New Year. This is actually [Chris Keith] on for Kevin..

I was going to say it didn’t sound like Kevin..

It’s a recognizable voice so. All right. So I have a couple of questions. First on loan growth throughout 2019.

How can we look at that specifically related to the categories? Where do we expect to see the bulk of the growth?.

I would say if you looked at the directions in 2018, they'll be fairly similar to 2019. We've said consistently that we're looking to grow the C&I portfolio in the double-digits and I think we have an opportunity in 2019 to do the same thing in C&I, possibly pick up on it a little bit when compared to 2018, but similar trends.

Leases, I think we'd like to see a little more growth out of leases. Managing the cash flows and the asset allocation within the portfolio will be a focus, but we had very strong growth in the middle market leases for 2018. We expect that to continue, possibly accelerate.

The only real question is do we put any money into investment grade leases based on credit spreads, yields and the absolute level of yields. So I'd say, again, the middle market leasing portfolio did well in 2018. It will be the continued focus in the 2019. Multifamily, we'll probably do in the mid-single digits.

It is one of those things where it'll be a kind of a function of how well we do in capturing external refinances. Purchase activity will probably slow down a little bit given the markets mature, so refinance activity.

But we also have a growing presence among professional investors who have more flexible credit facilities and we continue to see interest in that. So I would say, generally, multifamily in mid-single digits, it might touch 8%, but more likely 5% to 6%, all told.

So the focus will be on C&I and leases in terms of continued commercial growth followed by multi. We'd expect commercial real estate to probably hold flat. We'll see some opportunities in commercial real estate, but we'll also see some portfolio reductions based on our credit quality.

We're not big fans of retail right now, and so unless the retail property is performing very well, it may not stay around very long..

Awesome. Great. Thank you.

And to trail on that multifamily comment, what geographic areas are representing that increase?.

Well, I think if you looked at the 2018 shareholder presentation, we're going to be filing an updated one for 2019 here shortly. So you'll be able to take a look at that and compare them year-over-year. In fourth quarter, we had good growth in all the markets.

But I would expect in 2019 the markets outside Chicago will continue to demonstrate better price performance and better growth characteristics than in Chicago. Consistently the yield performance in Chicago is materially worse than in other markets.

And the underwriting is going to get tougher, with the change in administrations in Illinois and in the City of Chicago and at the county level in Chicago. Taxation is going to be an even bigger challenge in Illinois than it was prior. So you're going to see real estate taxes increasing throughout the market.

And particularly in markets that have not had as much of a tax impact, the northern suburbs and the north side of Chicago could see double-digit rate increases in their tax bills. And rents are going to be flat. Utility expenses will probably go up a little bit. So we don't necessarily see a lot of strong NOI performance coming out of Chicago.

So in terms of risk, you have basically flat employment. In fact, [even if it means] net out migration from the Northern Illinois and Northeastern Illinois area, pockets of downtown are growing and then pockets of other places are not.

Whereas outside of Chicago, the Colorado, Texas, Florida, South Carolina markets all are continuing to see influxes of people, demand for multifamily, and especially the more affordable multifamily that we lend in. So for all those reasons, we think that the strengths of the market are going to be more outside Chicago than inside.

Having said that, we have new products for community development lending for Chicago. We saw some good growth in some of those products in the second half of 2018. We'll continue working on them in 2019, but you're talking $10 million, $20 million in that portfolio total. It will not be as material as the rest of the portfolios growth..

Okay. Great. Thanks for that color. And if I can just squeeze one more in. Shifting over to the fee income, the trust and insurance commissions were up quite a bit in the fourth quarter. Can you provide some color on where that growth came from and how we should look at that on a….

The insurance stuff is seasonal. We go through a cycle of insurance renewals and it typically concentrates in the fourth quarter every year. Trust is starting to perform better. We're starting to grow the trust assets. And again, we released some new products and trust that are having some traction.

So we hope to see some modest growth in trust, maybe 10% fee income growth and trust in 2019. Insurance should remain about the same.

However, we are working on a new relationship with property and casualty insurance that it might reduce the rate that we get paid on a premium – net premium commission, but we should have better product solutions and therefore the volumes might increase. So, maybe insurance goes up 5% to 10% next year. We hope trust goes up about 10%.

But the insurance stuff will continue to be concentrated in the fourth quarter at least for 2019..

Awesome. All right. Thanks. I’ll get out and jump back in the queue..

Thank you. [Operator Instructions] Our next question comes from Brian Martin from FIG Partners. Please go ahead..

Hey. Good morning, Morgan..

Good morning. Happy New Year..

Same to you. Just one last question on loans, Morgan.

You kind of gave the breakdown there, but if you've kind of just look at the net growth for the year, you kind of talked about it, I guess is that – is your expectations similar on the net growth for the year in 2019 versus 2018 pretty similar? Or I guess just kind of when you boil it all down, I mean where are you kind of – if you could tend to kind of talk about a range and just, I guess as you think about it, I mean there's been a lot of angst in the market and concerns about the economy slowing, and I guess are you sensing any of that? Or, I guess, are you kind of building anything of that into your forecast? Or just how you're thinking about what we're hearing in the market and then your growth for 2019?.

Okay, well, first of all just let me go down to the balance sheet a little bit because either it will be helpful to you and others to frame it.

So starting on the loan side, figure – again, overall mid-single digits growth for the overall loan portfolio, so for example, if we got to a net loan portfolio of about a $1.4 billion, we would consider that a pretty good achievement for the year given what we're seeing in the market right now.

Challenges going forward, the healthcare side, we continue to see good growth opportunities. It is however getting a little more competitive. So we have a number of opportunities now, one that are pending. I'm hopeful that we win them, but they're not 100% certain. Another issue related to healthcare is going to be timing.

A good quantity of our healthcare loans are focused on financing accounts receivable and inventory and equipment, not financing real estate. The real estate is ultimately financed by HUD. HUD is shut down.

So deals that would close and say, early first quarter are probably not going to close until at the very soonest, late first quarter, and so forth and so on. I don't know, HUD’s going to wind up being 30 or 60 or 90 days behind what we thought they'd be, but they will be behind. But we still see healthcare as an important growth aspect.

Note that those cash flows are going to be pretty stable given the payor sources. And this year we'll be doing a little bit more diversity in terms of lending on practices, which will a) help stabilize balances, will probably get a little bit better average balance and average commitment utilization through that.

And we'll also wind up getting a little more volume growth because we will be talking to different sets of people. So we feel pretty good about the C&I growth, especially on the healthcare side.

On the lessor credit side, notice that the leasing volume is shifted to non-investment grade leases because one, that's where there's more of a demand to lease equipment. Investment grade in 2018 saw a credit spread compression and lower volumes for a variety of reasons.

Some of it is lease accounting, some of it is repatriation of funds, the ability just to pay cash for equipment. But the smaller companies definitely continue to use leasing as an aspect of their capital investment plan and we're seeing some pretty good growth in that.

That will also turn into a greater utilization of bridge and warehouse lending, especially by those lessors that are focused on that area. One thing that was kind of quiet in 2018 that I think is still a question mark for 2019 is to what extent lessors will continue to invest in residual – equipment residuals.

We're seeing a little bit less of that in part because of the nature of the equipment that's being financed and the type of financing agreements that are being struck. So that was kind of flat for 2018. If we saw a return to 5% to 10% growth, then that's probably 3% to 5% growth from the C&I portfolio.

But again, we feel good about the C&I, healthcare will be the bigger driver of it, but lessor credit had good performance in 2018. We have some opportunities in front of us, but probably not the same growth rate that we saw in healthcare.

And as I said, multifamily to the earlier question, again mid-single digits, probably stronger outside Chicago than inside both due to pricing and a little bit of underwriting. But again, the community development will probably be the stronger part of the portfolio growth in Chicago. Let me just talk about deposits a little bit.

We think that the rate of deposit expense increase will slow in 2019 compared to 2018. I think we can start to bend that curve down a little bit. So we'll be focused on reducing the borrowings and the wholesale deposits to the extent practical. We have some ideas on commercial deposits because we've seen some good growth in commercial deposits.

We have some new ideas to try again in 2019. But we think we can ameliorate the increase in the deposit beta by focusing on knocking down the wholesale where we can. It's useful to have if we have a sudden burst of loan growth. It's a good thing to have and we'll take advantage of it.

But the longer-term deposit strategy would be to reduce the average balances over time through one device or another. And I think that'll hopefully put a lid on deposit expense. And for that reason, for example, we could see the loan portfolio yield growing by 50, 60 basis points, but the deposit beta might grow by less than that.

And so again, we'll see an opportunity for margin expansion in 2019. And if we're successful on the deposit side, the rate of margin expansion could accelerate in the second half of the year, more so than 2018. So that's kind of why if we get the right loan mix and we can work a little bit on the deposit mix, we have a fairly good outlook for 2019.

And on the broader thing about the economy, I think we'll start – we'll know more after we get into the first quarter on where people are thinking. There sounds like there might be a resolution to China, presumably the government opens up by the end of the first quarter.

I think there's so much uncertainty in the market that taken the temperature of a customer would mostly find a high reading on the uncertainty scale. But most of our healthcare customers are going to continue to borrow. Some of the industry consolidation is certainly benefiting us. We expect that trend to continue.

The smaller lessors and the smaller lessees are going to continue to invest in their businesses even if it's replacement equipment. So we think that will be intact, how competitive it will be, it will be a more a thing to determine. And multifamily will continue to attract investor interest.

The real question will be the absolute level of rates and the amount of refinance volume that's out there. People might just sit on their billings for a while because they don't see a lot of trading opportunities..

Okay. That’s really helpful, Morgan. Just going back to the deposits, so I was going to go there for a minute. Just the borrowings look like they are at a pretty low level as we stand, and I guess, so the part you'd be looking to improve on the funding is more just kind of the wholesale CD's.

Is that what you'd look to replace with just kind of more core funding? Is that kind of the game plan?.

Yes. Use of mix of a very low yielding cash flows coming off the asset side and replacing it with commercial core – some form of commercial core deposits to pay down the wholesale. But those would be the two principal sources of cash to reduce those wholesale deposits..

Okay. All right. That’s helpful.

And then just, I guess to the extent that the Fed is on pause, Morgan, I guess, does that change? I mean if you kind of talk about the margin and the contexts of not seeing – I mean, I guess when you just kind of gave your color there on the margin? I guess, is that kind of built with the assumption that there's no rate increases, and I guess how are you guys thinking about that? I guess I assumed that was what your kind of commentary was, but if it's different maybe you can just talk about what it was with no rate increases after Fed's unpaused here?.

Well, we kind of think though, they might do something during the course of the year. So if you just took a midpoint assumption that they'll wait a little while, see how the first quarter, first half shapes up.

But it appears that they're going to be patient, but not necessarily have they drawn the line and saying, we're done or the next thing we're going to do is a cut. So you have to assume maybe one increase or one chain somewhere during the course of the year.

Having said that, in the fourth quarter for example, the originations on leases, the yield on lease originations was 130 basis points higher than the portfolio yield at the end of 9/30.

So if we continue to reposition and optimize the portfolios as we have been, then we're going to get some natural improvements in interest income even in the current curve. So we're really not expecting a whole lot of help from the curve either way.

If we get a little lucky, the three to five-year-part trends up in terms of absolute yields, and if we get a little unlucky, it continues to trend down. C&I increased by 66 basis points, some of that of course was an increase in December. And even multifamily increased 53 basis points based on the portfolio yield at 9/30.

So with all those things in mind, we do think we continue to have opportunities to reposition cash flows at higher yields. And if the deposit expense increases, trend down a little bit, mellow out a little bit, that's where we can see margin expansion even without a whole lot of changes in interest rates..

Okay. That's actually helpful Morgan.

And the breakdown, just – I don't think you guys given in the release, but the breakdown between the money market and the investment grade leases, what's the split there on those leases? I guess, do you have a number?.

It's in the five quarter supplement..

Okay. All right. I'll get it. I may have missed it. I apologize..

It’s on Page 5 and it gives you the trends. So what you'll see is a consistent reduction of investment grade and a consistent increase in the other category..

Brian Martin:.

– :.

Yes. Well, let's do 2019. We'd hope to get expenses around $38 million for 2019. Now having said that, if we see opportunities to invest in good commercial bankers or some other opportunities, say in trust for example, then we'll absolutely take advantage of those and that may create a little extra expense.

But some of the activity in fourth quarter was designed to create a lower run rate in 2019 and we think we'll achieve that, may feather in through the first four months of the year as we get things organized. But we're looking to do around $38 million for expenses for 2019.

In fourth quarter, a couple of things, one is you just had enough loan growth and the timing of the loan growth was such that we had to put away the loan loss reserves to match new loan growth.

I think you mentioned this earlier in 2018, notice that the reserve ratio there was around 70 points or so, 71 points, which is about what we thought it would be, right, because you're putting on a little bit higher risk assets, a little more volatility to them. So we put away more money for them.

And of course, we did the full-year in the interest income to pay for that in the fourth quarter, but we will in the first quarter. Two, on the expense side, so we had some accruals related to incentive comp, both for business plan, performance and especially for loan originations in the fourth quarter.

So we had to do a catch up, it all kind of happened in November, December. So that was a total incentive accruals for the quarter alone. We're about 500,000. We had a little bit higher occupancy expenses as we reposition our occupancy in the main building and bridge that should settle down during the course of the year.

The only question, we're concerned about an occupancy right now is utility expenses a little bit, but especially real estate taxes. As I said, it's going to affect all commercial properties in the Chicago area. We already have pretty high tax rates in our markets and we don't see them going down anytime soon, even after we appeal them.

So again, the expense side, $38 million, the compensation side, probably somewhere between $20 million and $21 million, and everything else should – we're going to keep it as flat as we can given the things that we have to do..

Okay.

And no higher – I guess, the first quarter being the highest for the year based on kind of increases and what not, is that fair to think about it?.

Yes, I'd say so, especially because of accruals for payroll taxes. They start to reach caps in the second quarter, but the first quarter is wide open. So we always have a little bit higher expenses in the first quarter, plus, we still have to plow all the lots and it keeps snowing..

Okay. All right. Last two for me, Morgan.

Just kind of the – maybe if you or Paul could give an update on the buyback and just kind of where the authorization and how you’re thinking about things today?.

Well, as we said last quarter, especially giving current trading activity, we remain very interested in the share repurchase. Right now, I think we have about 500,000 shares remaining and I fully expect that the Board is going to consider that carefully very soon and I would expect them to expand it.

So standby, I expect we'll have some news on that front soon. But it does appear like a pretty good opportunity right now to retire some shares.

And if you think about it, if we could improve the net interest margin by about 5 percentage points in terms of dollars, get the expenses around $38 million and then somewhere do between 5% and 8% buybacks during the year. We'd have another pretty good pop to operating, earnings per share for 2019.

And in this environment, we think that's a pretty good results for shareholders..

Okay. I agree with that.

And I guess if you kind of execute as you think Morgan, I guess, where do you see the – I guess, I'm sure you'll provide some guidance in your shareholder note, as far as just kind of how you're thinking about ROA? I mean, I guess we talk about this just, maybe just think about later in the year as you kind of get through some of the plans you've got here.

If you look at a fourth quarter type of run rate in ROA as far as where you think it's achievable?.

We’d certainly hope that we're north of 100 points. I'd say probably the best case scenario for us, it'd be touching 110. But if we're somewhere between 100 and 110, maybe 105, that's probably a pretty good place.

Obviously the key here is there's a lot of moving parts on credit mix, moving parts on yields and credit spreads, timing of closings, how much we have to put away in reserves in any given moment in time.

So all things considered though without taking – keeping the direction that we're going and noting the fact that we have really no construction exposure and certainly no residential mortgage banking revenues, so taking volatility in both credit and non-interest income out of the equation, if we get to 105, 110, we think we're doing a pretty good job on this franchise in this environment..

Okay. And then just remind me, maybe you said this Morgan, but the rates you're getting on the new – just run back that pickup in yield that you're getting.

So the parts of the portfolio you're going to grow in 2019, you said the C&I multifamily and…?.

Yes, leases continue to enjoy the greatest advantage because of the relatively low yields coming off of the portfolio. Now obviously that gap will close over time as the portfolio repositions.

But just to review the numbers briefly, for the fourth quarter, the rate on the lease originations for fourth quarter was approximately 130 basis points over the portfolio yield at 9/30 and that just reflects the change in mix. You get the next biggest pop out of C&I and admittedly that had a benefit from a Fed rate increase in December.

And then the next one after that is multifamily. Of the two, right, we would expect leases to continue showing the most benefit as we reposition the portfolio. We think C&I will continue to perform well, maybe not quite as good as 2018 because you're not going to have quite as many Fed increases.

And I think multifamily will still have 50 basis point advantage that will depend on where the loans are located and the mix within the portfolio.

Is it more lines of credit? Or is it more your basic first liens? What are the borrowers doing? And where are we doing it?.

Okay.

And the C&I was about 60 basis points? It’s so great, roughly multifamily and C&I are about 50 to 60 basis points better in the pickup?.

C&I was 66 basis points, multifamily was 53 basis points..

Okay. All right. That's very helpful. Okay. Well, you've answered everything, Morgan. I appreciate it and I'll look forward to talking to you next quarter..

Thanks. And if we get lucky, [indiscernible]..

Thank you. [Operator Instructions] This concludes the Q&A session. At this time, I'd like to turn the call to Mr. F. Morgan Gasior for closing remarks. Please go ahead..

Well, we thank everyone for their interest in BankFinancial. We look forward to talking to you later in 2019 and we wish everybody a good spring..

Thank you, ladies and gentlemen for attending today's conference. This concludes the program. You may all disconnect. Good day..