Good day, and thank you for standing by. Welcome to the BankFinancial Corporation 2023 Q3 Earnings Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded. .

I would now like to hand the conference over to your speaker today, F. Morgan Gasior, Chief Executive Officer. Please go ahead. .

Good morning. Welcome to our Third Quarter '23 investor conference call. At this time, all filings are complete, and I would like our forward-looking statement to be 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 attend 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 these statements for purposes of invoking the safe harbor provision. .

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 operations, 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, Mr. F. Morgan Gasior. .

I'll apologize in advance for my voice. I'm fighting a bit of a respiratory bug, but let's proceed with questions. .

[Operator Instructions] Your first question comes from the line of Henry [ Walzak ]. .

[ Hank Walzak ] calling here. I just got one quick question, and I'll pull back to the analysts and the people who are smarter in the queue than I am. So Morgan like Wells Fargo is to spend $175 million on a Chicago retail build-outs. They're planning 30 branches versus the 7 they currently have.

So Morgan, just -- I just want to ask this question, isn't it getting harder and harder and harder to stay a small independent bank?.

Well I guess I'll say this. I don't necessarily think it's harder to be a smaller independent bank if you're focused on the right priorities. So as far as deposit priorities, I think our results have shown we've got a pretty consistently strong deposit portfolio.

We built it over many years, both organically and through acquisitions and strategically as well. .

It's also a case that we're continuing to build the deposit franchise increasingly on commercial deposits, which is and an increasing focus now for a while and will accelerate in 2024. Wells Fargo is building branches because at their current size level, they're not permitted to acquire banks. They're just too big.

And so the only way they can build a presence is to expand by branches. .

They had acquired World Savings the former Golden West a while ago, which is how they got the branches that they have here in Chicago. .

[Operator Instructions] And for your next question, it comes from the line of Kevin Roth from Black Maple Capital. .

All right. We'll move on to the next question. For the next question it actually comes from the line of Peter Winter from D.A. Davidson. .

It's Winter. I was wondering, could you give an update on the -- from a credit perspective, just with the U.S. government equipment finance business. Also, I noticed that there was a pretty big jump in loans 30 to 89 days past year. .

Sure. Well, let's talk about the 90 -- past due 90 and still accruing. Those were -- and we wrote about it in the 10-Q. But the first one larger one was a new transaction. And they had misbilled the invoices for the first 3 payments. And by the time they get all cleaned up on processing it across 90 days.

We received the money in mid-October and it's current. So no issues there. .

The smaller one is a commercial deal. And again, as we wrote about the situations seen as recently as this week Monday, seems to be working its way through a resolution, wherein we'll not only get the payment due in what was due earlier in '23, but potentially the '24 payment as well and just be out of the transaction completely.

That's not guaranteed, but that does appear to be the way it's headed at the moment. .

And so in the next -- certainly, by year-end, we'd be out of the deal. So at that point, those issues are completely resolved. On the two U.S. government deals, the claims are finished. They're in -- there's two consults involved, one for us and one for the servicer and actually a third one for the prime contractor. .

They are all getting ready to do their reviews and then submit the claims, which we would hope to have here in November. Then There's, as you said, between a 60- and 120-day period for the agencies involved to do their [ review ]. We are aware of one case recently.

We're on very similar facts and other military department received the claim, never responded to it. .

But as soon as the claim appeal was filed the DoJ, Department of Justice reached out and started settlement negotiations. So can't say that's going to happen to us. But again, the claims process is an administrative function. We have prepared these claims to be ready for appeal if that's necessary. And so that's where we are in the process.

But the passage of time has been beneficial both on the legal research as well as some factual matters that have come out and we're ready to file them as soon as we get through the list joint review by all parties. .

And the increase in the 30 to 89 days past due?.

There wasn't that much -- there wasn't that much. I wouldn't say there's anything particularly concerning there. .

If I'm not mistaken, I think that's -- it's like $10 million? Yes. And there is a multi-family loan. .

What I can say about anything the government is it got paid. Everything is renewed so far that was supposed to be renewed and it got paid on schedule. So we're not worried about that at all. The ones we highlighted that we're watching carefully are the ones we put in the 10-Q. .

Okay. just multifamily. There's been some talk about multifamily and some overbuilding and then some pressure then the rates reset inside there was a 30 to 89 in multifamily. I'm just wondering if you could talk about multifamily from a credit perspective, what you're seeing. .

Multifamily has been stable. As far as overbuilding is concerned, I can very much see the concerns on that. But overbuilding is a function of what I would call Class A buildings, large downtown or suburban projects. Ours are all neighborhood projects, the B.C. buildings where, if anything, the supply is contracted. .

So the -- probably a bigger concern would be if there is a recession where consumers are having to make choices, then you worry a little bit about vacancies just like you would in any normal economic context. But right at the moment, multifamily is stable. There's nothing like particular concern in the portfolio.

I think we have a couple of cases smaller cases where there was a fire in the building, and so we're going through the insurance process, but we have business interruption insurance on the buildings. .

And that is not atypical and multifamily where somebody smoking and falls asleep and there's a fire in the building. .

Got it. And if I could just ask one more question. Just the outlook for loan demand and loan growth. I think part of loans have been declining. Part of it is running down the equipment finance business. I was just wondering if you could talk about loan demand loan growth outlook. .

Well, you're absolutely right that the decline in the government finance and getting everything paid was a significant contributor to liquidity. It is also a reasonably helpful contributor to earnings because we were picking up probably about 200 points on the replenishment of that cash into just overnight checking. .

So as we look at '24, we think that continuing to work on the commercial finance side and the business finance side, working capital lines of credit and related matters, both on the commercial side businesses $5 million to $20 million. And on the smaller business side, $1 million to $5 million are one of our key initiatives. .

Equipment Finance, Commercial and Corporate, particularly Corporate will still play a role. Credit spreads are very tight still.

We were looking to put a little more investment grade on and we've consistently seen credit spreads tight as low as the low 6s, which is necessary for a 3- to 5-year deal, which isn't that compelling for us given where overnight funds are. .

But our priorities, first and foremost, our Commercial Finance, Business Finance, Equipment Finance on the Commercial corporate side and then we'll do some real estate with some demand for refinances. There's still a little bit of purchase activity out there as well.

But obviously, as the rates continue to rise as they did in the third quarter, that just makes it harder and harder for these buildings to trade. .

Yields right now, that we'd like to target in Equipment Finance is the low to mid-7s, probably low 7s in the Real Estate side. The Commercial Finance side would probably go between 9.5% and 10%. It's also the case that the Commercial Finance customers maintain deposits and maintain treasury services and sweep activity with us.

So all those are contributors that we'd like to continue to focus on. .

With that said, it's a little early for us to think too much about growth in the portfolio. But I would say that we'll probably be potentially even on the portfolio.

But given the cash flows we're going to see in the fourth quarter down a bit more once we have the rest of the cash -- so from that baseline next year, we'd love to see the fastest growth in commercial finance. .

It's just the hardest thing to predict right now. But all told, 5% growth, maybe 6% net growth. We still have quite a bit of cash coming off the equipment portfolio next year that we should put to work somewhere. And if we can allocate it at alliance we're talking about, we're going to have margin expansion. It's just a question of how much. .

For your next question comes from the line of Brian Martin from Janney. .

Just wanted to touch base on -- Morgan, you talked about the cash flow was coming off the portfolio over the next 12 to 15 months.

Can you just give us an idea of -- remind us what's coming off there, both in loans and securities that you're going to replace? And just kind of where that kind of current yield is kind of where new yields are today, just so we can kind of think about that dynamic here. .

Brian, the cash flow is coming off from the securities portfolio between the end of the third quarter to the end of 2024, there's about a $100 million coming up at sub-2% yields.

And then in the loan portfolio, the scheduled principal is about $220 million from the end of third quarter to the end of 2024, and that's coming off that yields just over 4%. So weighted average of that $320 million, it's high 3s. .

Okay.

And then as far as the replacement, I guess, yield on loans, if you are targeting more, I guess, it sounds like more of the commercial finance variety? Or just how do we think about it if you kind of put that back to work outside of -- if you don't put it just in cash at the Fed kind of what you think you are achieving there just kind of what the current rates are?.

I'd say if you wanted to go with a relatively conservative benchmark, it's -- again, it depends on the mix. And if we do some investment grade.

Again, credit spreads are tight, but part of the advantage of doing some investment grade in the equipment finance portfolio is some protection on the downside is suddenly, even though everybody is expecting higher for longer. We are exposed to a sudden decline in rates at minus 200 in total.

And the equipment portfolio, the investment grade would help protect that. We have to put a decent amount out there, though, to have a material impact on that number. But let's assume we do some of that investment grade during the course of next year for precisely that purpose. .

Then I can see the average in the yields down, so it would be closer to 8.5% in the quarter, 8.5%. If we don't do that much investment grade, then I could see that averaging closer to 8.75% to 9%. Again, the prime plus stuff is going to go off pretty much at prime plus 1 on the average, some might be less, some might be more.

We are expecting one more Fed increase. We'll see what happens today, but it seems like a prime rate of 8.75% to start the year seems at least feasible. .

Next quarter, we talk, we'll know what that number is, and that will be our baseline. So that's what we're saying, Prime plus [ 75 ] is 9.50%. Prime plus 1 is 9.75%. Even if you weigh the average the investment grade and some equipment financing even some real estate into that, you probably still get into the low 8s we should take. .

Okay.

And it sounds like loan growth is pretty -- at least for next year, you're thinking low to single digits and then maybe fourth quarter is still pretty modest, I guess, I don't know how near-term trends look in the fourth quarter?.

Fourth quarter is probably going to be pretty modest. We had decent pipelines coming into the quarter. It slowed down in October quite a bit. And so we'll close what we have, but we're also not pushing a lot. We noticed that rates basically kept going up during the summer.

We're mostly having discussions about customers trying to lock in and we like, wait, you didn't send us everything we need it to so forth and so on. .

But I would say just with the amount of cash that's still going to come at us in the fourth quarter, I would expect the loan portfolio to pay down a bit more. And then we'll start to get the pump running here.

Our first quarter market is going to actually start here in November and December, just reaching out to people and happy holidays and then follow up in December. .

And that will continue at a pretty steady clip all through next year. So I -- that's why I said we could see a little bit of a sprint to the end. This is about the time we start getting calls about you still have [ roving ] capacity, and we do to get something done.

It's also the case, though, that right at the end of the year is also when we get pay downs on the lines of credit, especially in the lesser finance side, and that could be the a $10 million drop in a week. .

So that's why I'm saying, one, between the cash flows that are scheduled for the quarter, two, kind of an intermittent demand, it's not steady, it comes and it goes.

And then three, just the normal year-end activity, probably a little bit more of a decline -- expected decline in the loans in the first -- in the fourth quarter with starting to pick up as we get into next year. .

Got you. And that government portfolio more, I think you said last quarter, you kind of ceased operations and really are originating anymore.

Is that continuing? I guess is that something you're evaluating?.

So let's break the government into 3 components of Federal, State and Municipal. We have ceased Federal until we get a handle on what has actually gone on with these two credits. At the moment, it's only these two credits. Everything else is renewed and paid. But yes, that is -- on the Federal side, we are done for now.

Until you could understand what happened here, you could not predict another similar case. .

We have appropriate contractual protections and the government did what they did anyways. So there would be no way to predict this at the moment. We do to some states and municipal. So I would expect that to continue. But again, in a more limited sense, the budgets for all of these government, state and local governments are declining. .

They do not have the same amount of stimulus support that they did '19, '20, 2021, '22. As a result, the flow of capital to those entities should decline. And therefore, I would expect our originations to decline. The final part of these are annual payments. Not all of them, some of them like the one in Nebraska, this last quarter was monthly.

But generally speaking, the government portfolio will be down principally because the Federal is terminated in terms of the originations. .

And secondly, because we expect state, local to just originate at a much lower level of activity given that they're going to have fewer resources to work with in the future. .

Got you. Okay.

So the -- and then just flipping last couple of questions, just on the funding side, are you seeing the pressure on funding costs begin to abate? I guess, I know you talked about -- a little bit about dynamics there last quarter, but have you seen that slow?.

Yes. I would say we have. There are still -- there is still some activity. But in 2 dimensions, we've seen a little bit of pressure come off. One, somewhat fewer customers and requests coming in for new products and changes. And two, we noticed that some of the competitors have backed off their premium rates, even in the last several weeks.

So that obviously is helpful in both regards. We're not having to stretch and the rate where somebody is running a special. .

There are fewer specials out there. And generally, customers seem to be happy with what we've done so far. But I want to caution everyone that that's a situation we take week by week. If there is greater pressure on the economy and the Fed from a weight perspective that may not stay that way higher for longer, has a certain risk to it.

But at the moment, things have been a little quieter both in terms of customer requests and in terms of competition from competitors. .

Got you. Okay. And the last two for me. Just I think reading what was in the Q, I think I understand that. But just on the expense side, I know there's still some costs related to the claim filing.

So I guess, should we think about the expense run rate going forward, just kind of normalizing post, kind of the costs involved with the two credits you've kind of talked about in [ prepping ] that paperwork. .

Yes. We very much sure to see it normalize once the claims are filed, and we're reaching, like I said, at the end of that process right now. Will be quiet for a while, but we have prepared these to be ready for an appeal. We probably got research into it.

So there'll be some work if we have to get to that point, which we're expecting, but nowhere near the level of investment that we've had to up to this point. We did it upfront. .

So in terms of gross expenses, again, we're going to be working on prioritization around here as we finish up the year end. Prioritization in the marketing budgets and aligning them with the -- hyper aligned with the business plan to focus on commercial financing business, finance and commercial deposits.

Right now, we're doing product training and advanced credit training for bankers so that they can get out and sell the products that we developed in the last 18 months or so. .

Some of them have worked with asset-based lending and factoring before. Many have not. So they understand basic commercial credit, everybody does, but they haven't had a chance to work through specific cases on how an ABL and a factory work, especially when they're in one product. So that's another focus we'll have. That is the internal expense.

We're reallocating resources from one department to another. It won't really change the bottom line at us. .

So net-net, for next year, we do our best to keep expenses right around $40 million, maybe $0.5 million up, $0.5 million down especially on a growing concern run rate once we get rid of the expenses on the Federal claims. And obviously, we'll do everything we can to make the place more efficient. .

But we still will see some increase in compensation just at baseline. The benefits plans are coming in well. So we don't really see our pressure on the benefit side. We will see some expense decreases just across the board. Technology seems to be an area that everyone is looking for their extra increase of one thing or another. .

Even real estate taxes seem to continue to increase, especially in our northern suburban locations and our Western Suburb locations. One note on that, we are working towards a contract on our one remaining branch that's for sale. Process continues to take longer than we would like.

But it appears that all the parties are getting their approvals together. They recently asked us for some health and financing, which depending on how their revenue sources work, this is a special-purpose unit that is being instructed by several of the local municipalities to provide a state-of-the-art 911 center. .

It will be a great thing for the community. We're pleased to be part of it. So we've reached an agreement on the price for the asset. We're waiting to find out exactly how they're going to hold title to the building and where the revenues come from and on the Illinois line and permitted [ because of ] money to finance the building.

And once we get all the answers to that, we'll see if we get this closed. .

Got you. Okay. Just the -- I guess my last one was just on Morgan, you talked about kind of your outlook in terms of whether it be ROA or pretax pre-provision earnings kind of the near term or just kind of into 2024. Can you give any sense of your previous commentary changed? Or I guess, kind of where you're at today as far as kind of outlook goes. . .

First of all on EPS we see ourselves getting closer to being able to sustain $1 a share into '24. Again, we concern ourselves a bit with what could happen in terms of deposit interest expense. But the range of outcomes for next year will, in part, depend on how well we do with loan originations. .

The fact that we're repricing so much from the low to mid- to high 3s in some cases, into [ 575 ] in a checking account puts a natural floor underneath the yields and the earnings. But the real optimization of the franchise would be if we can get a reasonable growth rate in commercial financing business. .

At that point, you're looking at 95 points return on the average assets or so. In terms of ROE, we look at ROE in the context of the required capital to run the place. Right now, 9%, we're observing the community bank ratio. So if you use 9% capital, then we should get very close to a 9.5% to 10% return on the 9% bank -- community bank ratio. .

We're holding considerably more than that in capital, but potentially going into a recession not to mention having that 1 to 2 shooting wars going on and still trends in the economy that don't look like we've got inflation beat.

We like that higher capital ratio, but in terms of a targeted ROE, if we dividend out the excess capital, you'd have to have 9%. So our target is 9.5% to 10% on the community bank ratio requirement. .

[Operator Instructions] There are no further questions at this time. I would like to turn the conference back to F. Morgan Gasior for closing remarks. .

Well, we thank everyone for their interest and their questions. We wish everyone a happy and healthy holiday season, and we will talk to you in 2024. .

Thank you. And this concludes today's conference call. Thanks, everyone, for participating. You may now disconnect..