Good day, and welcome to the BankFinancial Corp. 2021 Year-end Earnings Conference Call. [Operator Instructions] As a reminder, this call is being recorded. .

I would now like to turn the call over to Mr. F. Morgan Gasior, Chairman and CEO. You may begin. .

Good morning. Welcome to the 2021 fourth quarter 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 the statement for the 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 the 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 from those predicted. .

For further details on risks and uncertainties that could impact our financial condition and results of operation, please consult the forward-looking statements declarations and 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 statements in the future. .

And now I'll turn over the call to Mr. F. Morgan Gasior, Chairman and CEO. .

Thank you. Let me just start with a brief statement. One, we have filed our 5-quarter supplement and press release. We'll file our 10-K on schedule later during the quarter. Two, we had a mixed bag of results in the fourth quarter of '21, but some strong progress in certain areas.

Certainly, our originations in commercial credit strengthened pretty much across the board, especially so in equipment finance and C&I, and that was reflected in the growth in the balances as well, notwithstanding some extraordinary payoff activity that we had throughout the year and again in fourth quarter. And we expect that to continue for 2022. .

The capabilities we've built are obviously showing progress and delivering results on strong originations growth. We can get a little help on reductions and payoffs that will certainly help net growth. But nonetheless, we're going to keep pushing on growing the commercial side of the franchise. .

Noninterest income picked up a little bit. That's consistent with the efforts in trust and commercial deposits, and we're seeing a little bit of help in recovery of fee income, principally from deposit card usage on the retail side. So we hope that continues as well with the recovery in consumer spending and the economy. .

And expenses were up a bit. We've invested in our commercial credit capabilities. And again, you're seeing the results in the originations. We'll obviously continue to refine that capability and expand it as we can, especially on the C&I side and the equipment side. We would have loved to see greater net loan growth, especially in the fourth quarter.

But the franchise is on the right path to generate stronger commercial credit, have a more diverse portfolio and continue to diversify the deposit portfolio, which over time will be important. .

So with that said, I'll open it up to questions and go from there. .

[Operator Instructions] Our first question comes from Manuel Navas from D.A. Davidson. .

You touched on the paydowns you're seeing. Is there any sight line or how that can progress going forward? And obviously, the origination activity was really pretty strong.

So my second part of the question is, how does that kind of come together into your loan outlook for next year? Does that change much from the $40 million per quarter level you've been targeting in the past?.

Let's look at paydowns first. As you saw in the fourth quarter, we had some -- somewhat exceptional paydown activity when you compare it to the third quarter. And we, in some ways, think that they are maybe nearing an end for a couple of different reasons, but I don't think we're completely out of the woods, so to speak. .

So for example, in commercial, in the multifamily portfolio, payoffs increased by about $15 million, and that was actually only a handful of transactions, but there were a couple of some of our more seasoned larger customers who got great deals on their buildings, sold them for an enormous amount of money.

So the bad news is we lost the balances, but also we lost the prepayment exposure at that point. Those were larger, low LTV, strong debt service deals that are not going to be replaced with that size of a deal. We're going to replace it with smaller transactions, but not quite that size. .

So I think we should hopefully see a little bit lesser payoff levels in real estate as time goes on. Also certainly increases in interest rates will play a factor in that a little bit. Also, it is getting somewhat harder for our customers to find replacement properties.

So some customers continue to have excess cash after they sell something and pay it down. But we also think customers might just hang on to what they have. The 1031 issue of whether it's going to be continued or not seems to be settled. So less tax-driven, selling might be an issue here. so we'll see. But hopefully, a little bit less on the prepayment.

If you said instead of being 25% or 30%, it's more like 15% to 20%, that would be helpful but that still is hard to predict. .

The one thing we know is some of the very seasoned properties in the portfolio that had significant unrealized gains have been harvested. The more recent reduction doesn't have quite that pop in valuations. They're more value-add, long-term plays. So that would speak to a little bit lower payoff rate going forward.

And if interest rates help a little bit on that, then obviously, that prepayment rate can come down. .

But again, our point there is we can have -- continue to have to strengthen the origination. So last year, we did about $120 million in multifamily originations. This year, we're looking to do more like $135 million to $140 million. We also would like to do more along the lines of $20 million in commercial real estate. We did $15 million last year.

So again, originations are going to be the answer to whatever the payoff rate is but a little bit stronger originations, a little bit lower payoff. We should see some growth in real estate. .

Equipment finance. Again, debt in portfolio is showing a rather substantial growth in pretty much all categories of the portfolio. Middle market contributed about $45 million in originations for the year. Small ticket contributed another $12 million. And we think both of those are going up.

But we did see some unusual payoff activity even in middle market. A company was sold, and they paid down their leases. So that will continue to happen as the portfolio grows. We also saw some borrowers just selling portfolios because they had the opportunity to make a lot of money. .

But again, I think as the supply chain unfolds a little bit, we'll see stronger originations in that -- hopefully, a little bit less of the rate-driven or opportunistic selling in the equipment portfolio. .

And C&I, obviously, the portfolio is now getting weighted towards lines of credit, and that has a certain amount of volatility. We saw $20 million of paydowns on lines in the last week of the year. They will draw during the course of the year, and we grew our commitments rather substantially during the year.

So we're going to be focused going forward on commercial line utilization rates. .

Lessor finance was at almost an all-time low. And even in commercial finance, there just wasn't that much demand in the latter part of the fourth quarter for funds. But our originations continue to increase.

And with that, even if average utilization stayed around 50%, if we grow our commitments and we only get about 50% usage, we're going to pick up volume in C&I, and it's going to stick. The more we grow commitments, the better off that result is.

If we get a little less liquidity in the economy where money is just not sloshed around a little bit, then we'll see even better utilization and better growth. .

Health care is a good example. Historically, that portfolio is at utilization rates pre-pandemic in the 70% range. And at the end of the year, it was barely in the 22% range. So there's a lot of runway for growth that people just use the lines they have, and that's even without us increasing the commitments. .

So net-net, we still believe in our number. I know it's hard to look at the quarter-by-quarter results and say you're going to get there with the paydowns, but the thing to keep your eye on is the originations volume and the growth in commitments. And there, we're delivering solid results. .

I appreciate that color. Is -- I noticed that the yield for the new originations ticked down a little bit, but still above that 4% level.

Anything to call out on the origination yield?.

Yes. That was -- that's a good point. That was the mix of the quarter. Fourth quarter was strong in multifamily, as you saw. And it was strong in equipment finance, particularly on the government side, and both of those are lower risk and lower yield originations.

When we have stronger -- we have stronger line utilization, especially in the commercial finance side, then that yield ticks up quite a bit as it did in the third quarter. .

So again, we feel pretty good about the yield position overall. I would say, if we could see 4 in a quarter or better on the origination yields for the '22, that would reflect probably a better mix, but any quarter could be -- any quarter could be affected.

For example, one of our customers on the government equipment finance side, their year-end is 3.31. That typically is 1 of their stronger quarters. They're trying to get things done like everybody else. So I could see third -- first quarter having a little bit of a skew.

We'll do the volume, but we could see yields under 4 in that portfolio because you're talking about very strong [ product ]. .

Even so, we're seeing a little bit of an ability to get some pricing increases. We recently quoted a transaction and picked up 25 basis points. So on that transaction, which could close here in the first quarter, it will be closer to 3.75. So again, we'll see a little support even closer to the 4% from the low-risk portfolio. .

So I think as line utilization picks up and the commercial finance side picks up a little bit, health care picks up a little bit, it naturally supports that yield, but any quarter could have a little different mix as fourth quarter did. .

And as that kind of feeds into your NIM, can you talk a little bit about the possible benefits from a single rate hike? And kind of what are the key metrics for me to consider right with this hike? Is it a possible March hike? Like is -- what are the things that would move first?.

Well, the commercial lines will all move. So right off the bat just notionally, if you have $100 million of lines outstanding at any one moment in time, you're going to pick up 25 basis points right off the bat. What's less clear -- and that will happen every single time there's a rate increase.

And obviously, if utilization improves on that, then you get even more help..

Obviously, we're sitting on such a strong part of liquidity and excess liquidity with deposits. We don't expect to need to get very aggressive on cost of funds. So we would expect that the net benefit on net interest margin from a rate hike would be positive.

And then, of course, just on the cash that we're carrying, we'll pick up some benefit just on the overnight funds. So even if you say $200 million in cash, you'll again pick up at least 15 to 25 basis points, if there's a point-by-point increase in the overnight rate. .

So again, we're obviously very asset sensitive and liquid. It will continue to have benefits. What we hope happens is the benefits compound. One, we'll get the benefit from alliance. Two, we'll get the benefit from hopefully slightly reinvestment rates as cash comes off the portfolio, and it's reinvested at higher rates.

And three, if we get commitment utilization, if liquidity in the market fades a little bit, people need more cash, then we'll get better utilization at a higher rate. .

And just to add a few points. Noninterest income strengthened during the year, and we hope that should continue. We continue to see good activity in the trust pipeline.

We continue to see some movement forward in commercial deposit fees, and that will be an increasing focus on noninterest income growth with respect to our treasury services department and strengthening deposits relationships with small businesses. .

With respect to small businesses, we're looking forward to seeing some greater growth in loan activity. Obviously, they've had the support from PPP 1 and PPP 2 over the last 2 years.

But eventually, they will start needing additional credit, and we're preparing to use our existing commercial finance capabilities to strengthen the products in that area. .

And finally, expenses. We would expect expenses to remain relatively flat. I know in an earlier call, there was some interest in branches. And right now, the plan is to downsize some branch facilities and reduce the square footage, which reduces the occupancy costs.

So the net count for '22 is not likely to change, but the gross square footage that we're using will change potentially significantly. .

And we're looking at 2 things there. We're looking at how customers are using the facility and can we deliver the same level of customer service at a much smaller facility. And we think we have at least 2 opportunities now to do just that. The net impact on expenses on a run rate won't be terribly significant, might be $250,000, maybe $300,000.

The brand staffing will change a little bit. What we're really after are the occupancy expenses, particularly real estate taxes and then maintenance, reducing the depreciation run rate a bit and just making it a smaller but still more effective footprint. .

[Operator Instructions] Our next question comes from Manuel Navas with D.A. Davidson. .

I was going to ask about the branches. I appreciate that. Does that keep you still in the similar kind of run rate -- quarterly run rate that you've kind of given in the past? It was a little bit higher this quarter. .

Yes. It was a bit higher this quarter. And first quarter is always a little bit higher because of one, snow removal. We are sitting at about 8 to 10 inches of snow today. So I'm not looking forward to that bill arriving in about 2 weeks. And then employee benefits are always higher in the first quarter.

But I would say a run rate of about $40 million, plus or minus $1 million, is probably what we're going to see. .

We said before that the branch themselves were not a huge source of cost savings. We manage the staffing carefully to customer demand. And so the improvement in expenses on the brand side is mainly making the facilities more cost effective on an occupancy basis.

We have made our conversion to our new data communications network, and we're aggressively moving into our new infrastructure. We're already seeing the benefits of the savings in the data communication side, and that will continue. .

And in all other respects, we're going to try and keep the line on expenses as best we can. Obviously, with inflation and the economy, we're going to see cost pass through to us. So that growth in expenses might be a bit voluntary, but we're going to do everything we can to hold the line.

So as our usual approach is increasing compensation for commercial credit, commercial deposit production, increasing the focus on marketing so that we can get the originations we need to get the loan growth going and the deposit growth, we'll be the top focus. Everything else has a close microscope on what we're going to spend. .

Got it.

So the plan includes like wage inflation in there with your new hires?.

Yes, because we've been pretty much at market all along, and we've made the adjustments that we've made to make in the organization, but we've also found ways to offset those expenses.

So we'll still need to be competitive in the market, and there's no question that overall consumer inflation is going to have an impact, but we will continue to find ways to mitigate those impacts as best we can.

And sometimes, that's just finding more efficiencies in different ways of doing things than and being creative about it, and that's what this environment demands. .

What drove a little bit slower buybacks this quarter? And kind of what is your thought process on their use as -- component of use of capital?.

One, we have reached our limit in terms of our [ authority ] from the Federal Reserve. We purchased slightly over 10% of the issue during the course of the year. And there are limits on what we're allowed to do. Obviously, we used the proceeds of the subordinated debt to take advantage of market conditions and trade accretion for shareholders. .

But I would expect it to be a far more nominal rate during 2022. One, we're trading closer to book, not quite there, but closer. So the accretion benefit is less. And two, the volume of cash that we'll have available is going to be somewhat less. So right now, we're slightly -- we're right around 13,200,000 shares.

We have an authority of just under 300,000 shares, and I think we'll probably remain within that authority for '22 absent some development we're not currently anticipating. .

That's helpful. You added a good amount to the securities portfolio.

Roughly what yields did you add because it would seem that it was back half of the quarter loaded? And is there an appetite to kind of see that keep growing? Or you really just want -- I know the priority is just to use cash for loan growth, but just wondering if you could see that tick up any higher. .

one, where is the yield curve going. It seems to have stalled out a little bit the last few weeks, and that will be a factor in just how much we put into securities.

We're not really interested in putting a lot of long duration securities out there in either, a, watching the curve, then shipped higher yet and, therefore, create potentially an unrealized loss and nor are we interested in locking up a lot of liquidity long term. .

So I would expect that a reasonable range for the securities portfolio might be up to $150 million on the low end, about maybe $125 million on the low end as much as $200 million on the high end. And if it averages around 1 point to 1.25 points, that seems like a reasonable range based on what the yield curve might do. .

But one thing we're also watching is changes in deposits. Obviously, with the change in interest rates, all of a sudden, the market for funds keeps up during the course of the year. You could see some excess liquidity run out of accounts.

As our borrowers use their excess liquidity and then draw down their deposits, we'll have less deposit -- excess deposit liquidity. We will also have greater line utilization. Our health care portfolio is a pretty good example of that. And that trend has already started. .

So we are actually looking at the possibility that the footings could compress a little bit if we saw, say, $50 million to $100 million of deposit declines that we were basically carrying at very little profit, just a little bit of excess cash. That would affect our view of how much we should put the securities. .

So I would like to be -- I'd hope to be more precise than that. But right now, there's a lot of moving parts in interest rates and what happens with liquidity in the economy with how borrowers consume excess liquidity. They too might see greater expenses, and therefore, a higher demand for cash from inflation.

So the securities portfolio is designed to help net interest margin but also keep our options open as far as funding over the next couple of years, and we don't want to overcommit to it. .

So would you term that $50 million to $100 million in deposits you're kind of watching as excess or surge deposits.

Those are the ones you kind of are most worried about with a rate rise?.

I think it's fair to consider that. I mean these are deposits that have been around -- that were not there pre-pandemic. They were a result of the fiscal and monetary stimulus that occurred during the pandemic. We also see some depositors just sitting with some unusually high balances on the commercial side, which we expect to dissipate over time. .

So with the combination of some depositors sitting on excess proceeds either from sales of residuals or getting other funding sources, but also burning off the stimulus.

That's why we think there is between $50 million and $100 million of potential decreases in deposits both on the retail side, but especially on the commercial side as the year goes on. And in some cases, that's going to translate to loan growth, which is very much something we'd like to see.

In other cases, it's just going to be a one-off of deposits, but we don't want to rely on them as a funding source for something like securities. .

[Operator Instructions].

Well, with no more questions, we thank everybody for their interest in BankFinancial. As we said, we're going to push on in '22 with the continued expansion of our commercial credit originations and deposit originations capabilities.

We certainly hope for a good, stable economic environment and one that's a little more favorable to loan growth with a little less liquidity and a little higher interest rates, but we thank everyone for their attention and their patience, and we look forward to '22 being a good year for everyone. .

This concludes the program. You may now disconnect. Everyone, have a great day..