Allyson Pooley - IR, Financial Profiles Alberto Paracchini - President and CEO Lindsay Corby - CFO.

Matthew Clark - Piper Jaffray Michael Perito - KBW Terry McEvoy - Stephens Andrew Liesch - Sandler O’Neill Brian Martin - FIG Partners.

Good morning. And welcome to the Byline Bancorp, Inc. Second Quarter 2018 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded.

I would now like to turn the conference over to Allyson Pooley, Financial Profiles. Please go ahead..

Thank you, Austin, and good morning, everyone. Thank you for joining us today for the Byline Bancorp’s Second Quarter 2018 Earnings Call. We will be using a slide presentation as part of our discussion this morning. Please visit the Events and Presentations page of Byline’s Investor Relations website for access to the presentation.

Before we begin, I’d like to remind you that this conference call contains forward-looking statements with respect to future performance and financial condition of Byline Bancorp that involves risks and uncertainties.

Various factors could cause actual results to be materially different from future results, expressed or implied by such forward-looking statements. These factors are discussed in the company’s SEC filings, which are available on the company’s website. The company disclaims any obligation to update any forward-looking statements made during the call.

Management may refer to non-GAAP measures, which are intended to supplement, but not substitute, for the most directly comparable GAAP measures. The press release available on the website contains the financial and other quantitative information to be discussed today as well as the reconciliation of the GAAP to non-GAAP measures.

And with that, I’d like to turn the call over to Alberto Paracchini, President and CEO..

Thank you, Allyson. Good morning, and welcome to our second quarter call. Joining me this morning is -- are Lindsay Corby, our CFO; and Tim Hadro, our Chief Credit Officer.

As is our practice, I’ll start by writing you with an overview or performance and key highlights for the quarter then pass the call over to Lindsay who will cover our results in more detail. After that, we will open the call for questions.

We’re pleased to report that we had a very solid quarter characterized by strong growth coming from our diversified lending businesses and improving profitability. We like our position in the market, and after closing the First Evanston transaction, feel that we’re well positioned to capitalize on market opportunities.

Turning over to Slide 3 of our deck. Net income came in at $2.8 million or $0.08 per share. There were several non-recurring items impacting results that I’ll get into in a minute. But adjusting for those, our earnings came in at $10.6 million or $0.32 per diluted share.

During the course of our integration planning, we had the opportunity to take a hard look at the core systems, both Byline and First Evanston and made the decision to migrate the combined bank to FIS’s IBS platform.

We feel this platform will enhance our product capabilities, particularly in commercial banking, give us better application integration and allow us to operate the bank more efficiently. We anticipate the system conversion will take place during the first quarter of 2019.

As a result of this decision, we recorded certain non-recurring expenses this quarter related to contract termination and other conversion-related expenses. Moving over to revenues. We had total revenue of $53.6 million, which was approximately 19% higher than last quarter.

The growth was largely the result of increased volumes, higher net interest income and strong fee income driven by higher gain on sale of government-guaranteed loans. Profitability continues to improve with adjusted ROA coming in at 110 basis points, up 36 basis points from last quarter, ROE above 8% and ROTCE coming in at 10.9%.

From a production standpoint, the quarter was strong. Originations came in at $195 million, and we saw nice growth in our originated portfolio of approximately $186 million or 11.5% in the second quarter. Excluding the impact of the acquisition, our portfolio grew by 22% on an annualized basis.

Our strong production was truly a team effort as we saw broad contributions from our diversified commercial lending businesses and lower-than-anticipated payoff activity. As you know, payoff activity is difficult to predict from quarter to quarter, so it’s certainly nice to see it moderate during this quarter.

Our government-guaranteed lending business performed very well with originations exceeding $170 million and strong gain on sale revenue.

This quarter, we saw good product diversification in originations and we’re also recognized by the SBA at the top 7(a) lender in the state of Illinois, which speaks to the quality of our bankers and team in that business. On the deposit fund, we ended the quarter with total deposits of $3.6 billion. Balances were impacted by the acquisition.

But if we exclude that impact, total deposits grew by 3.6% from the prior quarter. Non-interest-bearing DDAs grew by 5%, and deposit composition remained excellent with DDAs accounting for almost 33% of total deposits. Average deposits per branch continues to move in the right direction ending the quarter at $61.8 million.

This reflects both the lower legacy branch count, the impact of the acquisition and higher deposit balances. Moving over to expenses. We continue to gain operating leverage.

Revenue grew nicely outpacing expense growth which, if you exclude the impact of the transaction, increased by 1.9% and stemmed largely from branch consolidation expenses that we incurred this quarter. On an adjusted basis, our efficiency ratio came in at 63.4%, which improved by 3 percentage points on a year-over-year basis.

This ratio can have some volatility quarter-over-quarter, but there’s no question we’re making progress in getting to our targeted level of below 60% by the end of 2019. Lastly, asset quality improved with NPAs declining from 100 basis points in Q1 to 70 basis points this quarter.

Credit costs also declined, while our provision increase was largely driven by new loan growth. That’s all I had. So with that, let me pass the call over to Lindsay, who will give you more detail on our results..

Thanks, Alberto. Good morning, everyone. I will start on slide 4 with the review of our loan and lease portfolio. Of total loans and leases were $3.3 billion at June 30, an increase of $1.1 billion from the end of the prior quarter. First Evanston contributed approximately $944 million in total loans.

Our originated loan portfolio increased approximately $186 million net. During the quarter, we saw increases across all of our major lending areas with the strongest growth coming in our C&I and commercial real estate portfolios. Moving onto deposits. On slide 5, our total deposits increased to $3.6 billion at June 30.

Excluding the impact of the acquisition, we saw good growth in our deposit portfolio across all categories with total growth of $90.1 million. Our non-interest-bearing deposits represented 32.7% of total deposits at the end of the second quarter.

As we anticipated, our cost of deposits increased by 11 basis points to 52 basis points, which was primarily driven by promotional CDs and money market campaigns to bring in funding to support our loan growth we had in the quarter. Moving to Slide 6, I’ll discuss our net interest income and margins.

Our net interest income increased by $5.4 million, primarily due to the 1 month contribution of First Evanston. Our reported net interest margin decreased 2 basis points to 4.43% or 12 basis points when you exclude accretion income. Excluding the impact of the acquisition, our net interest margin declined 14 basis points to $4.32.

This was attributed to a 6 basis point decline in our average loan and yield leases combined with a 10 basis point increase in our total cost of deposits. Turning to Slide 7, and our noninterest income. Compared to the prior quarter, our noninterest income decreased by $3.1 million.

Excluding the acquisition, the most significant driver was the $2.2 million increase in our net gains on government-guaranteed loan sales. The volume of loans sold exceeded the prior quarter and our average premium on loan sales also trended higher this quarter due to a more favorable mix of loans sold.

We also had an increase of $668,000 in other noninterest income, mainly due to a $946,000 increase in our customer derivative fee income. During the second quarter, we added a new line item in noninterest income for our wealth management and trust business as a result of the acquisition.

For the month of June, this business generated $192,000 of noninterest income. As a result of our additional fee income and revenue from the acquisition, we expect that our net gain on sale of government-guaranteed loans will trend down as a percentage of our overall revenue mix over time. Moving to Slide 8. Let’s look at our noninterest expense.

Our second quarter not interest expense reflects the impact of the 1-month of First Evanston’s operations. It also includes $10 million of expenses related to the significant items from the core conversion and other merger-related expenses. Excluding the acquisition, our noninterest expense grew modestly, increasing by approximately 2%.

This is primarily attributed to an increase in expenses of $891,000 related to the branch consolidation during June. These charges had a $0.03 impact on our earnings performance share in the second quarter. As Alberto mentioned, we had planned our system conversion for the first quarter of 2019.

After the conversion, the cost savings from the combination with First Evanston will be more apparent in our reported results. We are on track to meet the cost savings expectations associated with the acquisition. Turning to Slide 9, we’ll take a look at asset quality.

Our nonperforming loans decreased 81 basis points of total loans at the end of the second quarter. On an absolute dollar amount, our NPLs increased $2.5 million, mainly due to inflow from our government-guaranteed lending business. At June 30, government-guaranteed loans accounted for approximately $7 million of our NPLs.

Our nonperforming assets declined by $1.5 million, driven by a $4.1 million reduction in our OREO. Our net charge-offs were $1.9 million or 29 basis points of average loans and leases for the quarter. Charge-offs were primarily related to the unguaranteed portion of SBA loans. Provision expense for the second quarter was $4 million.

The second quarter provision included allocations of $3.7 million for our originated loans and leases, which was offset by a $528,000 credit to the provision for acquired impaired loans. Our provision expense this quarter was primarily driven by growth in the portfolio.

Our allowance for loan and lease losses to total loans was 59 basis points at June 30, down from the end of the prior quarter due to the loans added from the acquisition.

In addition to the traditional allowance of the percentage of loan and lease metric, we also analyze the allowance in conjunction with the acquisition accounting adjustments impacting our acquired portfolio.

At June 30, the acquisition accounting adjustments plus the allowance for loan and lease losses represented 214 basis points of total loans and leases. With that I would like to pass the call back to Alberto, for closing remarks. .

Great, thank you Lindsay. In summary, we are focused on executing our strategy and have positive momentum going into the second half of the year. We expect to see more of the benefits as Lindsay mentioned, of the transaction in the coming quarters, as we realize projected synergies and continue to grow our business.

On the M&A front, we continue to evaluate opportunities in the market and remain interested in acquiring banks that fits well with our culture and can add value to our franchise. With that operator, we can open the call for questions..

[Operator Instructions] And our first question today comes from Nat Race with Piper Jaffray. Please go ahead. .

Hey good morning, It’s Matthew Clark pitching in for Nate..

Hey Matt, Good morning. .

Good morning.

Just on the SBA volume very, very strong this quarter, want to get a sense for the pipeline going to 3Q and whether or not you might think that, that level of activity might come down a little bit going forward or not?.

I think the -- just overall, the pipeline remains strong. I think one thing, Matt, this quarter that we saw a little bit more off was we had originations that were well diversified. And by that I mean, we had good, very good 7(a) production. We also had some USDA production.

So in general, the mix of loans that we had there was more than just the traditional 7(a) loan. We also had some 504s. Those are obviously, for us, our balance sheet products. So in general, we like what we saw. Obviously, the company had a -- or the unit had a very good performance as far as originations.

And as we said in the past, it’s a business that where we take a longer-term approach on a quarter-by-quarter basis not only in originations, but also with gain on sale revenue, you can see some volatility. But that said, pipeline remains strong..

Great.

And then just within the NPLs, any update on the credits you were working through last quarter?.

Still working through, particularly those credits. And I think if you go through the release, we’ve added more detail, so that you can see really the portions of loans that are in our NPL bucket that have a government guarantee.

So as you can see there in that schedule, we’re still working through, it’s about roughly about $7.4 million that are in our NPL line that are related to guaranteed portions of loans, but it takes time to work out some of these assets, but we continue to plough ahead and expect to ultimately see those reductions as they are -- as resolutions start to occur..

Okay, great. And then last one, just want to get your broader thoughts on the commercial real estate landscape, good growth there this quarter.

Just any commentary on where you’re seeing opportunities?.

I think we continue to see opportunities in the areas where we -- in our -- falling in our target markets, good competition. Pricing is always a consideration, but we’re seeing plenty of deal flow. We haven’t seen a slowdown.

It’s -- obviously, you’re not going to bat 1,000, we hope to bat somewhere in the kind of 250 to 300 range, and the key is being able to see transaction flow so that you can continue to be selected, but I don’t know that I would say that there’s anything unusual there.

It’s just continue to focus on getting enough at bats and doing a good job for clients..

Thanks..

Our next question take comes from Michael Perito of KBW. Please go ahead. .

Hey good morning guys. Thanks for taking the question. .

Good morning, Mike. .

I wanted to maybe start just on the expense run rate. So the conversions happening in 1Q ‘19, obviously, the branch closures happened in late Q2. So if you think about all -- everything kind of together here, I mean, the full quarter of First Evanston in 3Q.

Just the run rate kind of drift up forward like $37.5 million and worked its way down to the high-$36 million range by the early part of next year? Is that kind of generally range bound consistent with what you guys are thinking at this point?.

Mike, I understand your question. It’s difficult to really field it back this quarter just given that there’s only 1 month in there, and I think the easiest way to look at this is just do the backwards math.

And so the way that I think about it is if you look at our current expense rate of $45 million, you back out the $10 million of the onetime then you can see the $35 million, and if you add on First Evanston’s expenses, which on average run anywhere from $7 million to $9 million, call it, that will get you a pretty good pro forma from there.

And then I’d say going forward, we won’t start seeing the branch expenses start coming out until later this year. There is always a lag, because we close them here at the middle of June, call it.

So there’s a little bit of a lab but you’ll start seeing that come out towards the end, and then the expense savings in terms of First Evanston are very much back-ended with the conversion. And so you’ll start seeing a little bit of it here in the next third and fourth quarter coming up, but the bulk of it comes with conversion..

All right. That’s helpful. Thanks.

But maybe asking the question slightly differently, I guess, if you exclude any other legacy growth, we just kind of look on like a pro forma off the today’s number that $35 million, where does that number go with the full cost saves of both the branch and the First Evanston? Is it like $39 million, $40 million? Or I don’t know if that makes sense, but if we just kind of look ahead, but assume all else equal, do you have a sense of where that number moves to with all the cost saves and from the branch closures and the First Evanston targeted cost saves?.

Yeah. I think your $40 million number, it feels pretty good in terms of how I’m looking at it right now..

Okay. Thank you. And then on the margin, if I recall correctly, at First Evanston, they were -- pro forma is going to be little dilutive to your NIM. I’m assuming that was part of the quarter-over-quarter compression in the core NIM.

Just curious, if you can give any thought on where that trends next quarter with both the legacy Byline dynamics you’re seeing, but then also a full 3 months of First Evanston?.

Right. So if you recall, Mike, when we talked last quarter, I brought up a onetime item that contributed about 10 basis points to the NIM. So really we view the NIM on a quarter-over-quarter basis as pretty flat.

So there was a little bit of compression by a couple of basis points, call it, not much, but that was a result of the core deposit pricing and the pressures that we saw mainly in money market and CDs. So the remainder of the core deposit base, the betas were, remained pretty low and within our expectations. So on a go-forward basis….

There could be some pressure in the third quarter from the full 3 months of First Evanston, but all in, I mean the trends are fairly positive on the core NIM side?.

All right. I’d say they’re pretty flat here. Like we’ve said in the past, we are asset-sensitive, Mike, so you will see a slight expansion in terms of the yields on the loans, however, it will be offset by the deposit pressures. So we view it as slightly flat going into Q3 here and then possibly expanding slightly going forward from there.

We will see a little bit of the benefit in the rate increase that occurred in June in the third quarter so that will help and then if you get one in September that will come obviously, into the fourth quarter..

Okay. Helpful.

And then just lastly, Alberto, any updated thoughts, I mean, obviously, there’s been some volatility in the Fifth Third and BFI share prices, and I’m just curious if, has the uncertainty around that transaction changed anything on the ground level there? Or just generally speaking in terms of disruption in the market, I mean, are using a higher velocity of opportunities yet? Or still just mostly kind of people poking around and in early stages?.

Well, that’s a really good question, Mike. And I think you guys put out a piece and talking about a little bit of uncertainty. But all kidding aside, I think it’s too early. One thing I’ll tell you is, we have seen situations, where as a result of that merger, we have been able to pick up some business.

I don’t get the feeling that this is something that’s broad, but we have seen already the benefit of being able to see some transactions where we’ve been able to win the transaction as a result of clients having concerns over changes or clients feeling that they want to, maybe it’s a good time to look at potentially in a different banking relationship.

So that’s a positive. As far as opportunities potentially because with lenders as result of the transaction I think that’s still too early. And I think that’s not something that we will see probably until much closer, if not, till post transaction..

The next question comes from Terry McEvoy with Stephens..

Maybe I’ll ask the other side of that question. You’re number 1 in market share in deposits in Evanston, no doubt, competitors have kind of stepped up their game in that market. I think somebody announced they opened a branch and discussed it last week.

Have you seen any runoff? And what are you doing or do you have to play a little bit of defense here in what is that shift to maybe more offense? And how do you go about doing that?.

Yes, good question, Terry. Competition is a fact of life, and we compete -- with some of our competitors, we compete with them not only in Evanston, but in other markets as well. And I think we’re holding -- we’re more than holding our own.

We remain very comfortable with our position in that market and the type of banking that we do, and the relationships that have been built in Evanston by formerly First Evanston over a 25-year period. So we are relationship and client-focused there to the degree that we have to defend our position, we will do so.

But at this point, I think we are -- we feel pretty good with where we are in Evanston, and frankly, in the other markets where we compete. So hopefully, Terry, that gives you some color on the question..

It does. Thanks. And then maybe just Mike’s question, looked at a different way. And I normally don’t ask about monthly margins, but June had the full impact of the transaction.

Was there a noticeable change in the margin on a monthly basis that maybe would help us better understand the trend as we start Q3?.

No, it was pretty close, Terry. A couple of basis points different, nothing material..

Okay.

And then just lastly, -- Thank you -- was there customer-derivative free product that was mentioned in the release or I think in the call or earlier, is that a sustainable level? Was it just a large transaction? And how should we think about that revenue line in the back half of the year?.

That’s a great question, and we have -- had a really good performance here for the first half of the year in terms of that portion of our business. So we’ve been really happy. I’d say, Q2 was higher than normal, but I do feel that it’ll remain pretty strong here going forward..

Yes, I think, Terry.

One thing I would add on that is, I think during the first half of the year, what we saw is as clients started seeing rates backing up and interest rates, short-term rates going up and the talk of potential additional rate increases to the degree that they had the opportunity to lock in rates, I think some clients took advantage of that.

So I think one thing to keep in mind going forward is, I think, that will be -- it’s, to some degree, even though we’re not in a, -- we’re not a, call it a derivatives -- we do have a derivative business. This is more customer-related transactions. It has some correlation to movements in interest rates there.

And the perception by customer is that now maybe it’s a good time to lock in long-term financing. So to the degree that there’s some volatility there, I think that will drive swap income, which is really largely what we’re doing there..

Understood. Thanks and have a nice weekend..

Great. Thank you. Terry..

Your next question comes from Andrew Liesch with Sandler O’Neill..

Good morning..

Good morning, Andrew..

Good morning, Andrew..

Just a question on the loan growth here, especially, on the C&I, it was pretty strong.

I was just curious like, was it -- was any of it pulled forward from this quarter? And how does the pipeline look going into the third quarter?.

Well, pipeline was -- I think pipelines in general remain solid. And I think we had -- I think, as I mentioned in my comments, it was just broad contributions. Sometimes you have quarters where one group or one area tends to have a better quarter than another group.

Here I think what was interesting was, one, it was just broad contribution across the board from our different commercial lending businesses. And two, and this is an important point is, payoff activity which, as you all know, has at times on a quarter basis can add some volatility and can certainly have impact on net loan growth.

This quarter, it was very -- it was muted. I mean, it was lower certainly than last quarter and certainly lower than what we’ve seen in the first half of the year. So that contributed.

Obviously, any time, that payoff activity is lower than we anticipate and certainly much lower than what we had been seeing in prior quarters, it’s obviously, going to give you some -- it’s going to give you some wind at your back to push net loan growth higher..

And then just related to some of these C&I loans, some of these commercial businesses that you added, is there an opportunity for you guys to add some core deposits through them? Or maybe just reduce the reliance on some of the campaigns you’re running?.

I would say, yes. We are a relationship lender on the C&I side. So when we are looking to -- the C&I business that we do is not just -- it’s not about doing a loan transaction with a customer. I mean, we want to get the deposit relationship and we expect to get the deposit relationship as part of our transaction.

So I would -- the answer to that question is, yes. One thing there -- one thing Andrew to add, to give you additional color. One thing that’s important to us is, we want to remain core deposit funded.

So it’s important to us that, on the DDA side, on the relationship side, we continue to build relationships, add DDA accounts on the commercial side, on the small business side through our branches.

But it’s important to us that as we grow the portfolio, we want to -- medium to long-term, we want to make sure that we have the funding for that portfolio coming largely from our deposit base. Just a comment there on strategy..

Great. Thank you for answering those of my questions..

[Operator Instructions] Your next question comes from Brian Martin with FIG Partners. Please go ahead. .

Hey, good morning. .

Good morning Brian. .

Lindsay, just 1 question. The breakdown on -- I think last quarter you talked about -- like you said just a little bit ago, little -- -- maybe a 10 basis point benefit.

The accretion this quarter, I guess, can you just give us some color on the breakdown between what was First Evanston and what was kind of legacy? I guess, just so we can have an idea of how to think about it prospectively..

Sure. Sure. So last quarter, I did talk about the 10 basis points. So happy to answer any questions on that. But that showed up in the loan yield, and obviously, fell down through to the bottom line, but that was not part of accretion. So just to be clear on that piece.

And then in terms of the accretion breakout, the accretion last quarter was about 31 basis points. So when you strip out the First Evanston acquisition, it held in pretty close there. It fell slightly, just under -- you call it, under $100,000 of net accretion impact on the margin there. So just a couple of basis points there, Brian.

And then the rest obviously, was related to the First Evanston acquisition.

Was that helpful?.

Okay. Perfect. Yes, that’s helpful. Thank you.

And then the just -- can you just talk about the -- I mean, you’ve talked about obviously with the funding cost going up, just what trend you’re seeing on the pricing, on the loan side? I mean, are you getting better pricing? It sounds like, you are, if your expectation is to kind of maintain the margin but, just any color on just kind of what the rates are -- what the rates looks like on current production and how you’re thinking about that?.

I’ll give you a relative answer on that.

On a quarter-on-quarter basis, I mean, depending on the business, I think our SBA business, we haven’t -- we priced the business a certain way, we do a lot of work, I mean, those are -- I mean, there’s a lot of work involved in a SBA loan and we want to make sure that we get properly compensated on that business.

And so there, we’re obviously selective, but it’s a business that where we tend to be pretty firm in terms of pricing.

Some of our other businesses, it’s obviously, a competitive market, but on a quarter-over-quarter basis, I couldn’t tell you that we have seen a compression in our -- broadly speaking, in our -- in the rest of our commercial lending businesses. I think it’s -- I think, quarter-over-quarter, I would characterize this as more just neutral..

Okay. All right. That’s helpful. And just the last thing for me.

I think they asked a question about the loan pipeline, but just -- as far as First Evanston, kind of, coming into the fold, I guess, is there any expedition that there’s any runoff in that portfolio that, kind of, offset some of the pipeline growth you expect? Or just not to think about it that way?.

No, I mean, I think it’s natural to expect some. I mean, there’s some natural runoff in the portfolio. And I think we only have 1 month where we’re actually finally just seeing it for 1 month.

So I think as we move forward here this quarter, starting this month and certainly in the months and quarters ahead, I think we’ll start to get a much better perspective. But First Evanston, it was very much -- very similar to us. Relationship lender, building long-term relationship with clients.

So it’s the pipeline, but it’s not unreasonable, Brian, to expect some degree of just regular paydown activity. That said, it’s a granular portfolio and that’s primarily a C&I portfolio. So that’s not -- there’s not a lot of lumpiness in that portfolio.

So over time, I think we’ll see and -- how that plays out, but we feel pretty good about that aspect going forward..

Okay. And then the last one for me. Just -- Lindsay, you talked about the expenses a little bit.

Just so I’m clear, next year, I think when you go to the conversion, would you expect the first clean quarter with, kind of, all the cost savings realized, it could be the second quarter or more of a third quarter event based on timing?.

I would say more of the third quarter, to be honest. I think you’ll start seeing it after the first quarter conversion happens, you’ll start seeing things come down, but I really think it’ll be that latter half of 2019, where it’s very clean..

Okay. Alright. Thanks for taking the questions. .

Excellent. Thank you Brian..

And this will conclude our question-and-answer session. I would like to turn the conference back over to management for any closing remarks..

Great. Thank you. And I just want to say thank you for joining us this morning, and we look forward to speaking with you again next quarter. Thank you..