Ladies and gentlemen, thank you for standing by and welcome to the BankFinancial Corp Third Quarter 2019 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [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, sir..

Good morning, and welcome to our third quarter 2019 investor conference call. At this time, I’d like to ask 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 declaration 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. At this time, we filed our press release and our five-quarter supplement, and 10-Q document will be filed on or before the deadline. So, we are at this time ready to take questions..

Certainly. [Operator Instructions] Our first question comes in the line of Kevin Reevey from D.A. Davidson. Your question, please..

Good morning, Morgan..

Good morning, Kevin..

So, first question is related to your margin, which came in a lot better than we expected. It looked like it was – the cost was roughly to the significant jumping loan yield.

Could you give us color as to what cost of the significant linked quarter jump in loan yields? Was it mix, were there any prepayment fees and then your thoughts kind of on the margin going forward and what the key drivers are going to be?.

Well, the answer to your question is yes. It was both a little bit of mix and that we grew the commercial loan portfolio and some prepayment income. So, and I would expect both those to continue, at least in the very short-term, fourth quarter and potentially, in the first quarter.

The pay-offs obviously will generate a certain amount of prepayment income depending on the seasoning of the transaction and some of those investors received terrific offers on their property, where writing the check for the prepayment was just a cost of doing business. So, I would expect that relative a combination to continue.

I would say the prepayment will skew a little bit higher as it did in third quarter and fourth quarter. It’s probably too early to tell what’s going to happen in first quarter and second quarter on prepayment income. As far as the margin goes, a couple of things. First, let’s talk about the deposit side a little bit.

We have started to see some modest movement on the retail pricing side and we’ve been doing our best to nudge that along, where feasible. So, we will see some help on the deposit interest expense side, and we’ll especially see it on the wholesale side.

We don’t have that much of wholesale to begin with, but 90% of the wholesale is going to re-price in the next 12 months. So, we’ll see some help on the deposit side going forward. And on the loan side, I would say right now, obviously, we’re sitting on some excess cash. So, that’ll skew the margin to the lower side.

We had said before 3.40%-ish, if the mix was not optimized and with sitting on excess cash, the mix is certainly not optimized. But we spent time during the third quarter assessing, where we thought the rate environment would be and where markets were.

So, one, we reconfigured products and pricing on the real estate side to capture the lower risk, 50% risk-weighted transactions and be at or nearer market leader in that segment and we got the marketing pushed out in the third quarter. You saw the expenses flow through. We’re starting to see some stirrings of interest on that.

And the one you could think about the drop in yields is it brought more refinance volume to the table than it would – otherwise would have in the original rate environment. There are more investors out there, who could profitably refinance at these levels than they could 100 points higher.

So, what I would say, if you look at 2020, and that’s kind of our focus right now is looking at the full-year 2020. Given the cash position right now, we’re probably looking more in the 3.40%-ish range for net interest margin maybe 3.50% for the – between 3.40%, 3.50% in the first half of the year.

But if we get the mix right and in the commercial side, we saw some progress we’re going to see some more progress in the fourth quarter for new – some new customers and expanded relationships with existing customers in the fourth quarter.

Obviously, we’ll have to see what happens with line usage if it goes down, and that’ll have a certain amount of offset.

But if the trends continue in the commercial, the commercial area, then we could see something, a little bit of expansion in the second half, maybe 3.50%, 3.60%, because one the mix will improve a little bit and we’ll start to get the benefit of some of the re-pricing on the deposit side.

But it is going to be largely driven by mix including deploying excess cash with a certain amount of prepayment income that will provide some temporary support along the way..

Great. Thanks, Morgan..

Thank you. [Operator Instructions] Our next question comes from the line of Brian Martin, Director of Equity [FIG Partners LLC]. Your question, please..

Hey, Morgan. Good morning..

Good morning, Brian..

Hey, Morgan.

Can you just elaborate your last comment on the margin, just as it pertains to kind of how you were thinking, in the context of that outlook, what you’re thinking on rate cuts and kind of what’s factored into that outlook? So, how many cuts that that’s going to do and kind of timing?.

I would say that we’re kind of expecting right now that the Fed might cut one or two more times, but if we knew that for sure, we’d probably be buying derivatives and options and puts, but the deposit yields are not necessarily rate sensitive.

They seem to be more driven by local competitive factors and asset liability factors of the competitors than they are anything else maybe, even some strategic planning. On the yield side, yields have stabilized now for about the last month or so.

In fact, you saw a slight retracement, the low and the five-year, let’s say 132, 135, and now, we’re at 155, 160. So right now, the current yield environment is kind of our baseline on the asset side.

So, what I would expect is, all things considered, if you think that we’re going to skew a little bit more towards a 50% lower risk multifamily, we’re going to have some amount of investment grade leases or commercial finance assets. For example, a commercial finance asset is a bundle deal, where there’s equipment, but also quite a bit of software.

So, we have a large one we’re working with now, that’s an investment grade transportation company. If the bid hasn’t been awarded yet, but it’s about a $7 million transaction and it trades about 25 points higher than an investment grade lease would.

So, you get a little bit of yield benefit, but you get a considerable amount of credit quality that comes with that. So, all things considered, we would say that our overall asset yield to be somewhere around 4.25% for 2020, blended with everything in it, it would skew higher.

If we do a little bit more C&I, it will skew lower, if we do more 50% risk-weighted multifamily and investment grade leases, just going to be a function of what happens.

And we’d prefer to do the investment grade leases alternatively, to sitting in cash, but there’s a lot of people chasing those assets right now and there’s fewer than there used to be. So, it’s hard to say exactly how that portfolio – that end of the portfolio is going to grow..

Okay, I appreciate it.

And just maybe, your kind of high-level comments on kind of loan growth and kind of what and you had talked about some targets last quarter for kind of year end, what you thought you might like to get to or and what might be reasonable, but just kind of what areas are you expecting to see some growth in and then just kind of your targets as far as where you can get to on the loan portfolio?.

Yes. And I think let’s talk about full-year 2020. As we noted earlier, we will see some headwinds from prepayments and they’re kind of hard to predict. Sometimes we’re working with borrowers, who give us a heads-up. And that is helpful. Sometimes we just get a request for a payoff statement, and it just depends.

So, if we go, let’s look at the end of 2020 from where we are now. We, our goals kind of remain the same. We might face some headwinds, but the goals remain the same. On the loan side, if the loan portfolio was at $1.3 billion, the sooner we can get back to our original goal for our fourth quarter the better.

And if that means, we skew a little bit towards investment grade leases to get there, that cash rolls off pretty quickly. It’s a good place to be from a credit quality perspective, it’s a good place to be from an asset liability mix perspective provides some incremental yield. It continues the engagement with the lessor base.

So that will be our backup plan going forward. So, lease portfolio overall, if we got it to 3.25% by the end of 2020, especially with a better mix in the equipment side and the commercial finance side, we’d be pretty happy. But that portfolio runs quickly that kind of volume will be a bit of a challenge, but it should be achievable.

We’re also going to look to add a few people during the course of next year and give ourselves more chances to win with a broader base of lessors. The C&I side, that as I said, we have some large – we have some new business with existing customers in the pipeline. We also have some new business with new customers in the pipeline.

The goal there would be a portfolio somewhere between $200 million on the low side at the end of 2020 to $225 million on the high side.

These will probably be smaller transactions on the newer customer side, but there are people, who come to us with a group of facilities or a larger opportunity that some equipment, some line of credit, some capital improvements and so maybe, those transactions are a little bit larger; therefore, we get to our goal a little bit faster.

But $200 million to 225 million on the commercial loan portfolio seems about right. On the multifamily portfolio, that is the one that has the greatest amount of challenge in terms of productivity. Just because of the risk of prepayments, they’re uncertain. But we topped out at about $640 million earlier in 2019.

I’d say at the very, very high end, that’s where we go. There’s just not that many buildings trading and an underwriting level, we’d be comfortable with.

At the very end of that scale, we’re more likely to take the customer to capital markets, because that’s where they can get the most amount of proceeds with the best environment on rate and non-recourse, our portfolio underwriting more support that level of risk.

If we, on the other hand, hit a seam [ph] of replacing the payoffs with lower risk refinances, then I’d say, a result around $625 million at the end of the year seems feasible.

So, for 2020, low end of multi is $600 million; high end of multi is $625 million to go beyond that would assume things that are really of evident to us and I would hesitate to put that in a model somewhere. In commercials, they will stay about the same. It might go up by $10 million. it might go down by $5 million.

We’re really not looking at too much in the retail space right now. We do see some opportunities and some smaller office and industrial here in Chicago, which we follow up on.

We’re not saying no to retail ever, but it would have to be pretty low leverage with pretty stable tenants to get us interested, because the risk of vacancy on that remains high and the risk of NOI compression given real estate taxes and utilities in Chicago remains even higher.

So, it’s, we – it’s just been hard for people to keep these occupancies stabilized and we also see competitors out there doing a lot of non-recourse stuff, which is not stuff we’re going to do..

Okay. And your comments on the last quarter, when you talked about, hope, that the expectation you may be able to get to the $1.3 billion or $1.325 billion by year-end, I guess is that….

You’re on 2020..

Yes..

Yes. When we have $50 million of multifamily paid off..

Right..

That was just not going to happen anymore. So that came off the board as we saw a couple of those larger payoffs come through. And right now, we’re not really focused on replacing the larger customers.

The one largest payoff was a function of the customer wanting a maximum proceeds cash out on a portfolio basis and we were not going be able to provide it to him and therefore we got the payoff to replace that he wanted essentially to double his exposure almost or maybe, not quite double, maybe about a 50% to 60% more.

We just weren’t able to get there with him. So, I would have loved to be closer to the $1.3 billion, but we’re just not going to get there for fourth quarter 2019..

Right. And I guess that I was asking was the – did you kind of move that number to the end of 2020 is it $1.3 billion or a little bit north of that is kind of the outlook for where you’ll end up factoring in all of your comments as you get to late in 2020..

no. I would say I’d be – if things work the way we want to, we get to somewhere around $1.3 billion by the end of second quarter 2020. and then again, if we get things the way we want them to work, we’d get to close to a $1.350 billion, $1.375 billion by the end of 2020.

the $1.375 billion number is everything clicking for us plus we did not get another $50 million quarter tsunami of payoffs every single quarter throughout 2020..

Got you. Okay, that’s helpful. Thanks, Morgan. And just the comments about the prepayments and kind of how that factors in, do you guys have prepayment penalties on most of the loans – most of the larger loans out there. So, I guess we can expect that income to kind of be recurring – if your payment has continued to happen..

The answer is yes. We have almost every loan that’s originated in the real estate side has prepayment penalties. Some of the line of credit products don’t, but they’re also short maturities anyways, but also, it depends on the transaction. Some of the transactions are timed, if they sell or they refinance to be outside of the prepayment window.

Some of these transactions were very seasoned. So, it just depends. I would say it breaks into two categories. There are buy and hold investors, who get the offer, they just can’t refuse. And I would say probably 40% of the payoffs we saw last quarter reflected that type of activity.

And even in then, if they financed with us two or three years ago, they still have a trailing prepayment penalty, they wrote the check and paid it. The professional investors also have prepayment penalties. those transactions tend to move faster. They buy it. They do what they’re going to do to the property. they improve the performance.

the cap rate comes down and then they sell it. Those transactions might be on the books for one year and a half, two years, two and a half years, and then they go.

So, almost all loans are originated with prepayments, but it’s extremely difficult to predict what you’re going to get in prepayment income, because you don’t know which building and how seasoned the loan is when it pays off..

Got you. Okay. And just to be clear the – I guess where you’re most optimistic on the loan growth would be, it sounds like it would be if the C&I book and is that kind of how, when we think about 2020, where the most optimism lies as far as growth of, you’re talking about getting into a $200 million level or a little bit above that from 160-ish today.

It’s looking at maybe, 20% growth as we think about it from here..

Yes. I think so because we’re starting to add, as you saw in the third quarter, we’re starting to add new borrowers and new customers. So, you’ll see some additional use from the new customers. We’re doing more with existing customers. so, you’ll see some expanded use there. And we’re seeing on both sides of the ball.

we’re seeing in the healthcare space and we’re seeing in the leasing space. So, for those reasons, I think that’s why we’re optimistic, cautiously so, but optimistic. It’s also the growth focus for us. If we’re going to add talent in the market and expand our talent base, that’s where we’re going to add it.

So, for all those reasons, that’s why I think it’s what we want to have happen and we’re going to do our best to make it happen. But the signs that we have today give us the most comfort that we have a better chance of that.

The flip side on the leasing portfolio is the capital investment volumes are not as strong this time of year as they usually are. The phones are a little quieter. But the new products we released on the bundle to give us some chances at deals that we weren’t doing before and it also fits where the market’s going.

More deals are a combination of equipment and cloud services, and we reconfigured our products and are leaned our structures to be able to accommodate that. And that’s that one large transaction we bid on as our first one in that segment.

So, because we’ve expanded the profile, there’s some opportunity for growth, but you’re still facing the headwinds that there’s less equipment being leased than there used to be. A real estate is the big wild card.

We said that at last quarter and we continue to feel that there aren’t expanded base of refinances out there, but on the other hand, there are more people selling and not reinvesting.

We have any number of customers, who have sold the properties, but they are just sitting on cash and they’re going to write the check for the taxes on the capital gains and then they’re going to wait and see what happens next.

So, the uncertainties out there on the direction of the economy and the fact that the properties are fairly and fully valued in a lot of cases, we don’t see the level of reinvestment in our customer base that we see.

So, for example, some of the payoffs we’ve been seeing are more institutional investors buying from smaller partnerships or private investors. The private investors are sitting on the sideline. The institutional investors are the one driving the market..

Got you. Okay. And I guess just the new, the new yields you’re getting, I guess new originations on that commercial book.

And I know it kind of varies, but what are the new rates that you’re getting on the originations today, relative to what the portfolio yield is?.

For multifamily, it’s going to average right around 4% seems to be the consensus. Sometimes a little lower if the borrower is just one of these lower risk refinances, but 4% seems like a good number might skew down to 3.75%. It’s a lowers’ transaction, but somewhere in that neighborhood. Our commercial estates about 0.25 higher of 4.25%.

C&I, right around prime to prime plus a quarter. Again, some of those transactions we will price to get the best quality. So, it’ll be slightly below prime. Other transactions are prime plus one, prime plus two even. So, it balances out, but I would say prime plus a quarter. So, it’s probably a good place to be there overall.

And then the leasing portfolio, I would say right now, 3.75% seems like a reasonable balance. Obviously, though that could skew down if you do more investment grade, because investment grade’s trading at 100 over slops.

So that’s under three, but the balance we have 3.75% seems like a reasonable number, but again, it can skew a little bit lower if the investment grade leases dominate the originations..

Got you. Okay, that’s helpful.

And then maybe, just going, turning to capital for a minute, just if you can talk a little bit about, I think last quarter, you had talked about maybe, a little pickup and conversations on M&A, and just secondly, if you can just kind of talk about your appetite for the buyback today and how that plays and given you organic growth outlook.

You’ve got kind of what’s left on the buyback and how you’re thinking about that in the next couple of quarters..

Well again, with the price at these levels, we’d certainly be interested in the share repurchase program and we expect that to continue in the 2020. I think the board sees that as a helpful element to increase earnings per share at a relatively low risk basis.

So, we’d expect to be back in the market with various levels of participation depending on how we’re trading. We think that as funds are available it’s a relatively safe place for us to go and obviously, if there’s dips in the market, let’s try to take advantage of them.

So, we may even create a reserve, so that we just have money available in case, there is a sudden dip in the market for one reason or another that we can take advantage of. Secondly, on the M&A front, it’s been, we – it’s been quiet on our side and kind of deliberately so.

some of the conversations we’ve had, the people are deliberating and we haven’t heard much activity on their side. A couple of other conversations we had their price expectations moved around a bit. It really wanted to get paid for future earnings and in an environment where that was kind of tough to get visibility on.

So, at their current profile, they would be more of a branch purchase type transaction and therefore, for us mostly expense with our liquidity position right now that wasn’t necessarily in our interest to do. So, I think that one was a wait-and-see story on both sides.

If their earnings improved going forward per their plan, then it contributes more earnings to us and a price that they’re talking about might be feasible.

But if they don’t, then the price they were talking about would not be feasible and indeed the transaction wouldn’t make much sense for us, because it wouldn’t be very accretive in the short run other than cost saves.

So, right now, I think we’ll probably be, something could change tomorrow afternoon, but right now, I’d say we’re going to be pretty quiet on that front for at least the next six months, absent something different than what I know today..

Okay.

And just a reminder if Paul has it, just the amount of – on the repurchase plan, what’s still available out there and on the plan that you’ve not – the current plan?.

Brian, we have over 600,000 shares, so it’s 638,463 shares left on the plan that matures March 31 of 2020..

2020. Okay. thanks, Paul.

And then maybe, just the last one or two from me, just on the expenses, just any change to kind of the outlook that we’ve talked about the last couple of quarters as far as kind of how you’re thinking about managing the expenses and as you go into 2020, any new initiatives or any rationalization or new plans to – for spending?.

Well, I’d say, our run rate – we had set around nine, five, and actually at a core level, we’re kind of trending below that right now. We’re putting some extra money into marketing for the loan growth reasons we talked about. We’re putting some money into technology. We have a new website up and running.

We’re going to be developing a customer portal and we’re doing a refresh on some of the cyber security assets at the moment. So, but that will taper off over time. I don’t think it will be a material impact going forward, at least not very much. We’ll have a core banking contract to negotiate in 2020, but that will be latter part of the year.

So I think, those baseline expenses should be relatively stable. If they grow, our objective is to grow them by adding more commercial bankers, lease bankers to the mix.

And there might be a lag time on return on investment there, but if you told me we executed the plan with the people we’d like to get and we’re already out talking to people now and we added another $1 million or more of comp expense to get to our goals.

We’re absolutely happy with that, might not have an immediate pop to earnings, but we want to get those people out there with the products we have now also enables us to add even more depth to the products over time. So that would be the biggest variable as we add more staff..

Got you. Okay.

And lastly, I guess, can you just give any thought, if there’s any – I guess when you think about credit today, just how things are on the credit front and maybe, just talk about it with the plan you’ve laid out, Morgan, as far as kind of the margin outlook and the growth outlook, just kind of how you see the profitability level shaping up in 2020.

I mean, whether you can kind of put a range around, if you get to this growth level, but just how we can quantify your outlook on ROA or profitability in the outlook..

There’s just too many variables to give you a target. So, let’s talk about a range. Given the short-term environment, where we’re sitting on more cash than we expected, and asset yields decline faster than deposit rates.

We’re thinking, we would like to get somewhere in the $0.22 to $0.25 range on earnings per share over the first half of the year, but let’s see if we can get closer to $0.25 a share and hold that in the second half of the year.

So, what does that translate out to if we can do somewhere between a 100 points and 110 on ROA that would be good, but it may not get there to live middle of next year or the second half. We’re going to need a little help from the deposit expense side and to help out and that’s going to take some time. And then again, it depends on the mix.

One of the things that we’re going to continue to be focused on though is managing the absolute level of net interest income to the $52 million to 53 million range, it only got harder with the drop in yields and it got even harder after that with excess cash, but that’s still the goal.

And that would produce around 100 basis points or so on average assets and it would produce around $1 per share annualized. And that remains the goals, a little more challenging than it was, but that’s still what we’re going to shoot for..

Okay. All right.

And just on credit, just kind of your big picture, anything change, anything concerning to you today?.

The portfolio is stable and the annual loan reviews have been coming in well. so – and as we originate going forward, we’re going to skew more towards the 50% risk-weighted multifamily. We’re obviously talking more about investment grade leases than we have.

And that is a function of looking at where the economy is and saying, gee, there appear to be some decline in economic activity where, you do see some spreads widening out in the middle part of the credit curve and lower. So, putting big bets on the credit right now does not seem a prudent thing to do.

So, we’re going to try and offset that marginal credit benefit with a higher volume of lower risk assets. But right now, we’re comfortable with the asset quality. I think the origination path going forward gives us a relatively stable credit environment.

There’s always a chance that one thing or another could happen on one individual credit or another, but in the big picture, so far, so good..

Okay, perfect. I will step back. Thanks for taking the questions, Morgan..

Thanks for your time..

[Operator Instructions] And I’m not showing any further questions in the queue at this time. I’d like to hand the program back to F. Morgan Gasior, chairman and CEO for any further remarks..

Thanks to everyone for their participation and interest, and enjoy the remainder of 2019..

Thank you, ladies and gentlemen for your participation in today’s conference. this does conclude the program. You may now disconnect. Good day..