Good day, ladies and gentlemen, and thank you for standing by. Welcome to the BankFinancial Corporation First Quarter 2019 Earnings Conference Call. [Operator Instructions] Now it's my pleasure to turn the call to F. Morgan Gasior, Chairman and CEO. You may begin..

Good morning. And welcome to the BankFinancial conference call for quarter 2019 earnings and performance. One filing is complete, we will have our 10-Q and call reports filed later on schedule. But 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 like believe, expects, 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 to 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 we noted, we have our five quarter supplements and press release for the first quarter of 2019 release and on file. At this time, we are ready to take any questions..

Thank you. [Operator Instructions] And our first question is from Kevin Reevey with D.A. Davidson..

Good morning, Morgan. .

Good morning, Kevin..

So first question is related to the NIM, looks like you had some really nice linked quarter NIM expansion.

Were there anything – was there anything like the usual going on in the first quarter, like prepayment fees or anything like recoveries that would have resulted in that? And how should we think about the NIM going forward for the remainder of the year?.

Well, there wasn't anything unusual in the results for first quarter. If anything, the mix skewed a little bit towards multifamily loans for the quarter. So we have more of a fixed rate and lower-yielding quarter.

Going forward, as we noted in first quarter, we had certain closings that we were hoping to get closed in the first quarter but were delayed by the shut down. Those now appeared to be ready for second quarter close. So we're starting to see C&I be more of a factor for originations in the second quarter or early third quarter.

And therefore, we would hope that the mix will skew a little bit more toward C&I growth in the second quarter.

We also hope to see a little bit more in line utilization from existing customers in the second quarter, maybe not fully recover the paydowns that we saw in the first quarter, but we're starting to see some indications of additional business going through those lines as activity picks up for those customers.

So being with our usual cautious optimism, we would hope for, at least, second quarter, our mix will skew a little bit more to C&I and provide a little bit more possibility for a NIM expansion on the loan yields side. On the funding side, we continue to manage the funding base carefully. That's always part of the equation.

So I think, again, depending on how deposits flows work in the second quarter, we'll recover a little bit of funding on the commercial side. And we're getting just past tax season now, which was usually the drain on funding for customers. But as those balances start to recover, we should also see potentially a little help from the funding side.

So we're pretty cautiously optimistic about the asset side for second quarter. It could change if the current closings don't close on schedule. Funding should be stable, we might see a slight benefit from that as well. .

And then loan growth, I know when we talked last quarter, I think, your outlook for loan growth was roughly about 5% year-over-year with C&I being kind of leading the pack here.

I assume that's still the case given kind of the slower start to the first quarter?.

Yes, I think so. If you look at kind of where the markets are, we're seeing that tremendous activity in the leasing side. We had a good quarter for leasing, especially if you look at year-over-year. But we are now talking to customers and some of our lessors are somewhat active and some of them are less active.

So I'm concerned about leasing going forward. That's going to be a focus for the remainder of the year. As we noted, C As we noted, C&I had some growth potential, and I would expect to continue that process going forward. Right now, the issues are going through the risk profiles that are presented by the opportunities carefully.

And say, which ones makes the most sense for us. Multifamily, as we've said before, we again see opportunities in that. The opportunities are getting a little thinner because the market is so mature.

We were working with the borrower just the other day on a transaction here in Chicago, and the borrower decided not to proceed with the purchase because the profitability was just too thin. It didn't help that Chicago release real estate tax assessments earlier in the month.

And he ran the numbers on what that purchase would cost him in real estate taxes and decided the purchase were just a little too rich for him.

So the maturity of the market and the fact that some of the expenses are catching up to little probably at best flat rents are going to put a little bit of a damper on the multifamily opportunities even though rates might look to improve the funding cost for those borrowers a little bit, the overall market conditions are somewhat of an inhibitor.

So it's pretty consistent with what we thought. I think 5% seems like a good growth goal. But I will caution you that a lot depends on line utilization by our C&I customers. The upside for us as we get more lease growth and we're currently looking at it right now, the downside is we don't see much in line utilization on the C&I side..

Okay, thanks Morgan..

Thank you. [Operator Instructions] Our next question is from Brian Martin with FIG Partners. Your line is open..

Hey Morgan, how are you doing?.

Doing well, how are you Brian?.

Not too bad. I appreciate you taking the questions. And one, just on that last point. Morgan, you mentioned the part about the line utilization and kind of that being a question mark.

Can just tell us, I mean, what was the line utilization this quarter versus kind of what it's been previously? I mean, was it significantly different? Or just kind of give us some background on kind of where it is relative to whether it be normal the last quarter? How do you can frame it?.

Well, we had a strong fourth quarter. For us, line utilization can work in two dimensions. For our commercial lessor credits, those are project related. So if customers draw on the lines to complete projects, some of those projects maybe relatively short draws, they pay vendors and then convert the lease to a discounted lease and pay off the line.

Some of them maybe longer period projects. We are starting to talk to people about longer duration projects. So I would tell you that in the fourth quarter or first quarter, the line draws were shorter duration projects.

I think going forward, we're going to start to see line utilization on longer duration projects, which means the line utilization goes up. That's why we're cautiously optimistic about better line utilization going forward, but it is volatile. You could see borrowers draw on the lines and have it out there for 30, 60, 90 days.

And usually when you get to quarter end, part of their profitability model is to convert that executory lease to a fully executed lease and discount it to the market, get their gain on sale treatment as appropriate. And so they're motivated to pay down those balances right at quarter end.

So as I've said before, we'll get the benefit of the line utilization during the period and have a little bit higher average utilization during a given quarter. But when you look quarter-over-quarter at period-end balances, you can see some volatility. .

Okay. That’s helpful. And how about just on the C&I side, I mean, you guys have kind of – you sounds as if you're optimistic you're still the lead grower this year, but there are some cautious optimism here.

I guess when you look at kind of your long-term target, I mean, you also talked about was it the leases maybe not being as optimistic on the leases going forward? I think your longer-term targets seem like it was 50% for kind of the combination of C&I and leases.

I mean given the outlook on leases, I guess, can you talk about the opportunity to kind of work toward that goal of 50% over time? I realize it's a multiyear strategy, but I guess does the outlook for leases kind of inhibit that a little bit more in the short term?.

It could, mostly because of the rapid amortization of the portfolio. Leasing opportunities to put equipment on the books for 84 months, but when you looked at the underlying lessee, they're in the retail business. And obviously, that might not be as good of a bet on the credit side for an 84-month duration.

So we're always striking the balance for what's the appropriate credit exposure and maintaining the assets working in the portfolio. But I will say that, as time goes on, we'll probably see a somewhat extended duration in the lease portfolio. The lessors are shifting more and more to financing harder equipment.

We'll still see some balance in say 36-month paper, people doing shorter ITS. But that is shifting away from owning the asset to leasing software, Software as a Service which technically is more commercial finance than leasing anyways. So I think leasing presents a challenge principally because of the rapid amortization.

And in some cases, you're still seeing quite a bit of yield and credit spread compression, where some of these credits probably are underpriced and we have to keep that in mind. But the goal remains the same. We're still going to – we don't expect multifamily to go all that rapidly. Commercial real estate is going to stay even at best.

So we're still going to be pushing the C&I portfolio forward. I would say probably the line utilization in the health care side will, in the short term, will be faster growing. But our medium term over the next 12 to 15 months to 18 months on the very outside is to continue to strengthen lease originations and get that portfolio growing again..

Okay. And then the actions – I guess the reduction in the investment-grade lease portfolio this quarter.

I guess is that largely done now? Or is there more to come on what you were doing there as far as reducing some of the impact?.

That's a function of several things. One is pricing in the market. There are occasions where you'll still get investment-grade credits, but they're more in the governmental side. And those can have a somewhat more favorable yields. You're taking in some inherent risk to governmental credits, like non-appropriation risks.

And there is a bit of a premium for that. But if we are looking at straight corporates, I would say, we're probably letting more of that portfolio run off than attempt to retain portfolio run off than attempt to retain it. And we're going to be focused on the BB, B+ space.

We're obviously going to take a little bit of a look at tax exempts as part of the mix going forward because as our federal tax position warrants will be able to potentially reduce our effective tax rates modestly going forward. So those are all potentials in the lease portfolio.

But corporate investment grade will probably not be much of an originations factor for us. The yields are still too thin. And with the move down in the yield curve it made that situation even a little bit worse. But noncorporate investment grade could still be an opportunity for us. .

Okay.

So I mean, you would expect the lease portfolio to grow in 2019, even though it's off to a little bit of a decline in the first quarter?.

I think that it could grow. I would say probably it won't grow much more than 10% to 15% at the absolute max from where we are today because of the amortizations involved..

Okay..

One of the factors in that is we will see annual payments on the governmental leases as opposed to quarterly. So usually, you can see in third and fourth quarter, you'll see a balance drought simply because it's time for the annual payments on the governmental leases and it's tied to their appropriation in fiscal cycles.

So again, that's why I'd say the cash flow – the good news about this is the portfolio is, it provides an excellent re-pricing opportunity. The bad news is, it's sometimes hard to grow..

Okay..

So 10% to 15% growth from this point on the leasing portfolio for 2019 is, I'd say, on the high side of it unless we see a pool or something else that's more of a unique opportunity. And I would say probably, 10% – 5% to 10% would be more of a realistic range if we can get all the ducks to walk in a row. .

Okay.

So really, the dominant line of growth in the loan side will continue to be the C&I book? I mean, that's really where the opportunity is?.

I’d say from a growth perspective, C&I first. Multifamily will continue to grow probably a little bit more reliably because of the longer duration cash flows. And leasing will be, from a growth perspective, leasing will probably have the greatest variability of growth rate..

Okay, perfect. That’s helpful. And just the new yields, I mean, with the yield curve, where it's at, Morgan, I appreciate the color this quarter on the yield you're getting on new business and versus what the payoffs are. I mean, if it was skewed toward – at least not toward the C&I this quarter.

I mean could that pick up that you're getting on basically the new originations yields even be greater next quarter if you skew more towards the C&I part of the book? Does that seem fair that I used that gap?.

That’s right..

Okay. So that's the opportunity for the margin expansion is, if you're able to hold that, I guess if you're able to expand that yield that you're getting there with maybe a stable funding base, that's kind of the opportunity for the outside of the margin..

Yes, I would say there'd be a couple of sources. One is the C&I book, especially the line utilization and adding business to that is the number one opportunity. I think, secondly the repositioning of leases from corporate investment grade to corporate non-investment grade is your second biggest opportunity.

And your third opportunity is you will see some repricing upward of the multifamily loan portfolio as, loans come out, as loans either kind of reset or they're out of prepay and the borrowers want to lock-in funding and what they think are relatively attractive levels. It's just not as optimum for us as it was 90 days ago.

So you'll still see some upside. But I just saw along the other day that went from three in quarter to four and a half, but ideally 90 days ago that would have been closer to five..

Okay.

So the pickup, you're getting an average these pieces I guess, can you kind of quantify what type, if it's not the – is it the 125 basis points you've just talked about? Is that kind of more than normal versus what it was earlier or is that kind of fair? How to think about it?.

Yes, it’s really - there are so many moving pieces Brian, I know you're trying to put pieces on a slot. I would tell you that the multifamily side probably would see more of a 50[ph] to 75 point repricing at this point compared to what might've been a 100 to 125, 90 days ago.

Now you have loans from the mid-to-high three’s that'll refinance into the mid-fours probably I'd say at this point. Then the C&I thing you'll have loans going on somewhere around five plus one and a half on average, so that's a pretty healthy yield.

And leases, if we're in the mid-fives, lower mid-fives the leases in a 36 month duration we're doing pretty good and we are consistently been able to do that, the volume is the big wild card, but we're only going to put the asset on the board if it meets our risk and pricing parameters and not underprice risk for duration..

Okay. That's helpful.

And just on the funding side, Morgan, I guess you talked about in the release or just a little bit of commentary on the shift in just the funding strategy as far as CDs going, kind of some of the moving parts are, can you just talk about what your – I guess going forward, I guess, do you have more changes to make on the funding side or is there a strategy you guys are undertaking and just kind of the outlook on deposit price increases? If the Fed is on pause, are you starting to see some signs of abatement and the increase in funding costs and maybe just as it relates to your strategy and I know that's a factor as well..

Yes, I think let's talk about market conditions. We've seen some moderation, I would not say it's a great deal of moderation, but we have seen some moderation in at least the rate of increase with competitors, so let's call it a flattening of trends.

That not won't necessarily translate to a decline in cost of funds I think the Fed would actually have to move to precipitate that. But we do see the rate of change stabilizing and obviously we're going to do everything we can to enhance that, consistent with taking care of customers and dealing with competition.

To the extent that we can reduce the wholesale funding there, as you saw in the data we provided still provides a certain amount of additional data and we like to reduce that whenever possible. We'll use it, if we have a bunch of closings and draws to fund it's there for a reason, but then our goal would be to replace it.

CDs and money markets are priced almost on top of one another right now. So if you're going to have the choice to make any interest expense, why not get some duration protection? Maybe that's less important, now the Fed is on hold, but we're not entirely sure what the Fed's going to do, that's probably not entirely sure what they're going to do.

And I would just probably observe that through this rate cycle, strategy has produced some – I would say reasonably effective results on maintaining a neutral interest rate risk posture and allowing us to benefit from higher rates while protecting our downside from higher rates and we need to keep that neutrality firmly in position..

Okay.

And it seems like your talk on – just kind of as it relates to the margin, it seems like the bias would be upward, which it kind of seems like we're near the high-end of kind of what you guys were looking for, kind of getting to over time I guess, does that seem fairly, that the bias is upward based on – I know there's a lot of moving parts, but the bias generally seems like it would be upward and maybe it's a little bit above the range.

You guys had talked about previously on how we think about the margin prospectively, if you're able to execute on growing the C&I book and with the Fed now being on pause..

Yes. I think the one thing about the Fed being on pause is it does give us a little bit more breathing room if you will on the funding costs. And as we've said last quarter the improvement in asset yields wasn't necessarily index to the Fed moving. So I would agree with your statement that the bias could be to the upside, if the pieces fall into place.

We should be able to generate better asset yields and we should have at least a little bit more chance to have a stable funding base and that would be where the upside bias to net interest margin can come from.

If we get the mix, completely where we want, then it's theoretically possible to exceed the kind of ranges we were talking about last year and earlier this year. But that mix would have to happen and then would have to sustain itself. So that's the probably the trickiest part of all..

Okay. That's fair. How about you just on expenses? I know there was an unusual – at least that seems like an unusual items little bit last quarter, there's a little bit this quarter.

Just kind of as you start to think about the normal first quarter seasonality dissipating and just kind of the initiatives you've taken in the last couple quarters and putting some efforts in place to reduce expenses going forward, is there a lot of change to your annual outlook on expenses or just how should we be thinking about that?.

Well, I'll throw this over to Paul in just a second, but just broadly, you correctly noted that we've been positioning the last couple of quarters for reduced comp levels and again given the shape of the yield curve and the bias down in market yields that focus needs to continue.

It's the one thing we can control the most, but let me ask Paul address it on a more specific level..

For 2019, our expenses will still be in line with guidance we gave previously. It was just kind of front loaded with some of the cap expenses but the expenses should normalize in second quarter to somewhere around 9.5 million for the quarter and then trend down from there in the second half of the year as some of the compensation expense falls off.

So when you look at first quarter, I mean we had a couple of unusual items, the 215 cap, we had snow removal expense of $327,000, which hopefully won't be repeated in second or third quarter.

So when you take those two out, you're looking at a $9.5 million base for second quarter and then we'll start to trim that as some of these compensation costs work their way out.

So if you look over the course of the year, we'll still be in that 38, 38.5 total for the year, but when you get to third, fourth quarter, you'll see it moderating down below $9.5 million a quarter..

Okay, perfect. That's helpful Paul, I appreciate it. And yes I hope we don't have the snow removal costs in second quarter, although we did have a snow day. I know you guys know that, so maybe just the last few things, just on fee income.

I mean, there was a couple – I guess a little bit of a downtick this quarter relative to kind of previous run rates, I know it's not a major component of the earnings in general, but just any unusual items on the fee income side as maybe a little bit lower rate here absent the securities gains, a better way to think about the outlook perspectively?.

Yeas, I’d say the security gains in fourth quarter and first quarter were two events that we do not expect to recur.

The positive side, I would expect those long-term trends to remain just as life changes, we do see some of the products that we have on the deposit side generating some additional fee income, I'm not sure that will be enough to completely offset the broader trends in retail deposit fee income. The trust side, we'll see a little bit more volatility.

It's a balance between adding new trust business, depending on the fee structure and the asset management structure that the customer selects versus any distributions. In an aging population, you'll see trust to start to disperse sometimes larger ones and those could be anywhere on the spectrum.

It just so happened in first quarter we had a distribution of our long-term customer that was a full trust management relationship and therefore at the highest fee level.

On the other hand, we replaced those assets and as we started to grow the trust assets but the average rate on that growth was lower than the one lost, so you'll just see, just like in any fee income business you will see a little bit of volatility on that.

But we hope that the trust income has a little bit of an upward bias over time just from the growth to get out of it. And then managing the expenses in the trust department are important too and we've taken steps on that to improve the overall profitability from the trust department and we're pretty comfortable and confident with that direction.

On the loan side we're starting to see a little bit more fee income from line usages and draws from loan originations. So that will be a modest positive going forward and we are seeing capital markets transactions come in, that market is incredibly competitive.

We've seen people doing deals at zero fees and then they get a kickback from the DUS lender. So it's kind of interesting how the market is pricing their services right now. So that one we're less confident in candidly because we haven't gotten a handle on the secret sauce for success in that formula.

But since we really have no dedicated expense base to that, anything we do get out of that is almost gravy and therefore pure profit to us..

Okay. Certainly, it doesn't sound like there's anything that unusual in this lower number this quarter. Maybe there's some of it's more on the deposit side, so maybe we just think about that being a little bit above where we're at today, but not a whole lot.

So it's still down from where it was previously but up a little bit from first quarter it's fair to think about so….

Yes. I would agree with that assessment..

Okay. And the last one was just on share repurchases or just kind of capital utilization at this point, where the priorities are. And you guys have taken a lot of steps on this front on the buy back, but just kind of where you're on the buy back and just maybe in terms of M&A or other uses of capital..

Well, before we leave the balance sheet and income statement, one thing to note is obviously the asset quality has continued to improve and the asset selection continues to remain focused and one of the benefits of that is the loss ratios on the portfolio continue to improve.

So we are very much hoping that we get the C&I grow up in the second quarter that we're looking forward to, but at the moment we think that we could see a ALLL recovery somewhere between 200,000 and 300,000 for second quarter because of changes in the loss ratio.

If you recall, we sold a loan in 2016 on the commercial real estate side and booked a loss. That loss is rolling off on the three year look back and it will significantly improve the reserve ratios for CRE. Now we're again hoping to absorb as much as possible in loan growth for the second quarter.

So if the world really works in our favor, you won't see any income statement at all in the ALLL and we'll have a terrific the interest income for the second quarter and the going into third quarter. Turning to the share repurchases, again that is working.

We've been able to repurchase the shares and create an effective impact on EPS and at the same time we're still growing the tangible book value per share.

With that in mind, especially where we've been trading in the first quarter than we would look to continue that, I would say that if we could get ourselves at/or under 15 million shares more or less ratably over the next 12 months, that would be a good goal to have.

Obviously, if the share price improves significantly, if it recovers to where we were in second quarter last year, that gets a little more challenging because it's a little more expensive to divide the shares.

So we may not get to that goal if the equity price recovers substantially to where we were in second quarter last year that would be good news for everyone. But that would still be the goal if we're in the environment we are today. And on the M&A front, we are looking at a couple of smaller opportunities.

They initially fit our parameters in terms of a low credit risk exposure overall and there are smaller community bank opportunities, but we're still working through this precise composition of the deposit base.

Looking through what latent credit risks there might be in the portfolio, but the portfolios look pretty clean now from a point in time perspective, but it's too early to say whether we'll get something done or not, but we are seeing some opportunities out there and those would help on two fronts.

We would certainly get the benefit of just a greater earning asset base. We'd get better efficiency ratio out of that, certainly deploy capital even more effectively and that could provide another strong boost to earnings per share if we are careful about it..

Okay.

And just remind me, Morgan with the activity you've done on a buyback side, increasing the authorization and doing the repurchase you did in the quarter, where is the, I guess how much is left on the authorization as we stand today at quarter-end after the repurchases?.

Not much, under a 100,000 shares. So I'm expecting the board to take a look at that very, very soon. And I expect they'll continue to extend and expand the authorization more or less consistent with what we've said before. No guarantee that we'll use it all, but I know that they want it out there.

So it's available if we see the opportunities to execute on it..

Okay. So only 100,000 left on the current authorization as of first quarter and that this is the decision to …..

Stay tuned. .

Yes, stay tuned. Okay. Alright, look I think that's all the questions I had guys. I appreciate you taking the time. Morgan, thanks so much..

Thank you. [Operator Instructions]..

Well, at the moment it appears there are no further questions. We thank everyone for their insightful questions and participations in the conference and we look forward to talking to you after the end of second quarter. Have a good spring and summer. .

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