BankFinancial Corporation

a date, and thank you for standing by. Welcome to the Bank Financial Corp Q3 2021 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. Instructions will be given at that time. Please be advised that today's conference is being recorded. If you require any further assistance, please press star zero. I would now like to hand the conference over to your speaker today, F. Morgan Gasher. Please go ahead.

Good morning and welcome to the third quarter 2021 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 the 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 belief, 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, 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 statements in the future. And now I'll turn the call over to the chairman and CEO, Mr. S. Morgan Geyser.

Thank you. As all filings are complete, we are ready for questions. Please proceed.

At this time, if you would like to ask a question, press star 1 on your telephone keypad. Again, that is star and the number 1. Your first question is from the line of Manuel Navas with DA Davidson.

Good morning. Good morning. Good morning. I have two similar questions, I guess, to last quarter. One, expenses were a bit higher than we expected, and maybe your quarterly expected run rate, and it looks like you have some new hires. Can you talk about expenses going forward, and what are some of those new hires coming on, and if they're producers, what lines are you investing in?

Okay. Well, one, Expenses will probably be in a range somewhere between 9.8 on the low side and 10.2 on the high side, depending on seasonality. Compensation will be a little bit volatile. We'll make some improvements in certain types of compensation, but we'll spend money in other types of compensation, specifically commercial asset generation and commercial deposit generation. and commercial and trust fee income. So I think that's a range, but again, that's a range that could go either way a little bit further. For example, winter with occupancy and snow plowing and things of that sort could spike it a little bit. And seasonally, we could see some drops in compensation if, for example, we're not putting quite as much in incentive compensation in the early part of the year or something like that. As far as investing, In people, I would say the focus continues to be on the C&I originations. Specifically, in the last nine months, we've added the government finance, asset-based lending, and factoring capabilities, commercial finance, asset-based lending, and factoring facilities. The commercial finance people got on the scoreboard in the third quarter with their first factored accounts receivable transaction, which we're glad to see. And we'll continue to look at equipment finance and a little bit in multifamily as well. But the focus right now is on the CNI side, followed by equipment finance, followed by real estate. And that follows the basic business plan. It also shows you the results that we're seeing where we had stronger CNI originations, stronger balance utilization. especially in the healthcare and the lessor finance areas in the third quarter.

That's great. That's helpful. Shifting over to loan growth, originations were up a good amount. So were payoffs. Can you talk about trends that drove both those increases?

Yep. First, on originations, we were pleased to see growth across the board, at least in certain segments. So for example, multifamily had their fifth consecutive growth, quarterly growth in originations. And we like to see that. Obviously, it helps fight the payoffs. And it's important to note that we actually grew multifamily loans in the quarter. Not by a lot, but we grew multifamily loans And even though it's not a huge focus, we did grow the commercial real estate category very slightly, again, based on stronger originations. Lessor Finance was strong. We continue to book new commitments, and we get draws on the new commitments. Healthcare, we thought healthcare would start some utilization. It actually was somewhat stronger than we thought it would be for third quarter. And we're also seeing some new customers coming in with some new transactions now here in the late third quarter, fourth quarter. But I still think healthcare is volatile, and it will contribute to payoffs. So they have money, they need it, and then they might get a slug of cash in and pay it down. The same is true for lessor finance. They'll get good draw activity during the quarter, but then we'll get transactions ready to discount, and that'll happen right at the end of the quarter. And Some of that activity is changing. For example, in third quarter, one of our lessor finance customers did about a $4 million pay down. That pay down usually happens in December. But he got his portfolio organized and he got the deal done in third quarter instead of fourth quarter. So there are some timing issues out there as well. I would say going forward, we don't really see a lot of change in the market as far as payoffs and multifamily. In fact, we just had a borrower sell a building for approximately twice what he paid for it about 24 months ago and pay us off. And as long as this rate environment remains, and especially those people who may be motivated by changes in capital gains rates, and again, just seeing the prices they're being offered for buildings that they never truly expected to see. We would expect payoffs to continue more or less at these levels. Could change, but for now, we wouldn't necessarily predict a big downshift in payoffs on multifamily. In equipment finance, a little more unusual activity. One of our independent lessors was sold to a bank. and because the bank has considerable excess liquidity, the bank elected to pay off all the discounted leases and make a prepayment. That doesn't happen every day, but again, it shows you kind of some of the unusual things that are going on in the market right now. So I do think that we'll see some continued payoff activity, at least for the fourth quarter. We'll probably see about $25 million more than we would have otherwise, and we'll also see some amortization activity. So, for example, in the government equipment finance portfolio, the calendar year end for the federal government is typically third quarter, September 30th. A lot of activity historically has gotten booked in third quarter and some in fourth quarter, so naturally you see the payments coming in in those periods as well. So, for example, in government equipment finance, scheduled payments were approximately 18 million more than they were in the second quarter. So that's why, for us, the originations volumes are so critical, and that's why we're putting the money into people so that, one, we've got the flow coming in to grow the portfolio and overcome the payoffs, and as time goes on, as rates moderate and the payoff environment slows down a little bit, then we'll really see some stronger growth than the average bear.

That's great detail. If we kind of wrap it up, is there any changes to your growth outlook as you go towards the end of the year or into 2022?

I'm going to rest on the numbers we've worked with consistently. Our goal every quarter is to do close to $40 million of growth at an average yield of 4%. So in the third quarter, we had less growth primarily because of scheduled payments and some pay downs that we weren't expecting. But we did do a yield of 433 all in on originations and line draws. So the mix of originations in the third quarter was favorable. The overall Level of originations in the third quarter was favorable. The payoffs were the unfavorable factor. And we just can't control payoffs. So our goal is to continue to grow originations, continue to diversify the mix. If or but the yield could change. For example, the weak spot in the third quarter was corporate equipment finance. Part of that might be supply chain. The equipment's not getting delivered. And part of it might be excess liquidity and corporate portfolios, especially in investment grade. And part of it was yields under 2%, and it's below our floor for corporate equipment finance. But with the moves in rates during the third quarter, we think there might be an opportunity to get back into corporate. We're going to try to put another focus, but those yields are probably in the mid twos. So there you could see a change in the mix where it's better quality. lower yield, and therefore you might see $45 million, for example, but the yield would be under 4%. But our focus is on originations. It's the thing we can control the most, continue to diversify the CNI portfolio and the equipment finance portfolio. So, for example, we were pleased in third quarter that middle market and small ticket equipment finance were 30% of total originations. They both have good pipelines going into fourth quarter. those average yields are quite strong and they help achieve our goals for originations and they help achieve our goals for yields. And especially if in 22 you see a rising rain environment but also some potential flattening, the moves we're making on CNI and diversity of credit risk are going to be helpful.

That's great. Thank you. I can step back and have a other questions be asked. Thank you.

Again, if you'd like to ask a question, press star 1 on your telephone keypad. Again, that is star and the number 1. Your next question is from the line of Brian Martin with Janie Montgomery.

Hey, good morning.

Good morning, sir.

Hey, I wanted to find out, Morgan, maybe just going back to the hires for a minute. You talked last quarter about kind of what would round out your expectations. I guess are you I guess, have you made progress on that, or are you largely complete with what your hiring expectations are? I know you'll always be opportunistic, but as far as what your capabilities are, are you kind of full today, or is there other places you're still adding?

I'd say we're pretty close to full. We're making some moves to reposition resources right now for better results, but if I go around the horn, equipment finance is in pretty good shape. Again, potentially some movement of resources, but the dollars involved are pretty close to where we want to be. Government finance and commercial finance are both where they should be, both in terms of the originations and in terms of the controls for underwriting. Healthcare is stable for now. And real estate, again, we're moving some resources around. We probably could benefit from one or two producers in selected markets, but it won't be a tremendous amount of money. So if you add it all up, I'd say we're somewhere between 90% to 95% complete on the build-out. The focus is shifting to outreach and marketing, and of course, making sure the resources we've invested in are producing. Gotcha.

Okay. That's helpful. And then just on the, you know, I guess on the growth front, your bogey, your target as far as kind of what you're looking at, I mean, can you just briefly or just, you know, kind of give some color on, you know, what components, you know, what's driving the, you know, the $40 million? As you think about a high level, you know, by segment, you know, where is the growth coming from? Where do you expect the greatest growth from?

Yeah, we'll see it in the CNI portfolio first. the lessor finance side, and then commercial finance government, and healthcare. Then equipment finance, some of the equipment finance portfolio obviously has scheduled prepayments, and that's some of the volatility you see in payoffs. So as that portfolio gets bigger, it also gets a little harder to grow. But lessor finance, along with the rest of the CNI portfolio is the area you should see the most. Again, payoffs will be part of the story. Equipment finance next, and then multifamily after that. You're just not seeing the same volume of transactions in multifamily. We still see purchases, but the market is pretty rich right now, and the market is also starting to get priced to the point where it's harder to make the deals work from an underwriting perspective. We think perhaps the next six months or so, there's still an open window for refinances. Perhaps rates going up have convinced investors that maybe the time is now to lock in a refinance rate and if they're not planning on selling and move forward. But historically, the message on refinances have been, well, I think I'll wait because rates could go lower. So perhaps that window is closing for them, and we still have another six to nine months for us. But C&I, equipment finance, healthcare, I'm sorry, C&I, equipment finance, and multifamily in that order. Gotcha.

Okay. And then you talked a lot about the origination side. I mean, the originations were great this quarter. I guess when you look at, you know, what level, given you can't control the payoffs, I mean, what's a you know, kind of a what are you targeting as far as, you know, originations go or kind of what's sustainable in your mind, you know, given kind of current conditions and the people you've added and staff or at least expectations on, you know, kind of how we monitor that line?

You know, I think it's a little too early for me to put that out there. I think that'll be a good question for our next call. Right now, let's talk about fourth quarter. We have good lessor finance pipelines going into fourth quarter. Probably among the strongest we've seen in some time, and given the growth in that portfolio, that's quite positive. We have very good multifamily originations going into the fourth quarter, and we had a good October for originations as well. We're seeing actually a few commercial real estate opportunities in the Chicago market that seem to be workable, so I think that pipeline is also favorable. Equipment finance. The government portfolio will do about what we expected it to do. It's hard to look ahead much more than four months on that as you get through the bidding process, but we've also been out talking to some additional lessors. Probably too early to put a run rate on that right now, but we would certainly hope to grow it from where we're at. So I think we like fourth quarter origination so far. Corporate, I'm still concerned about the corporate equipment finance. Middle market, I think, will be fine. Small ticket will continue to improve. Government will be good. Maybe not outstanding, but good. If we get one more transaction booked for the quarter, then I'd probably put it in the really good category. But right now, I'd say probably better to get a handle after we get our marketing out the door on government finance and commercial finance. for next year to ask that next year. So bottom line, fourth quarter originations look good. I'd like to reserve judgment on 22 until we actually push more of the marketing out the door and see what the response rates look like.

Gotcha. No, that's helpful. Understood. And in the, just the net growth, I mean, I guess when we look, it sounded like payoffs could be a little bit, a touch higher. I mean, there was just one category and I didn't hear you clearly, but in fourth quarter, but you know, net growth in fourth quarter and then just kind of big picture, you know, how you're thinking about that number next year. I guess, have you come, I guess, are you able to give some color on, you know, next year on the, on the net growth and maybe, or maybe just more fourth quarter today?

Oh, I guess I'm going to go with for fourth quarter. We have, as I said earlier, the pay downs and the equipment finance portfolio and then the larger multifamily pay down. So we're already plus 25 in pay downs for the, for the fourth quarter. But I do believe our originations for the fourth quarter could overcome that, which means our originations are 25 million stronger than they were in third quarter. I don't really want to make predictions about payoffs next year. We're getting calls on, again, we're getting calls from borrowers who are apologetic and saying, look, I never thought I'd get these prices. I'm selling the building. I'll pay you your prepayment penalty, but I have to take this deal. So I'm going to stick with what we said before. The goal is to grow 40 million net per quarter at 4%. Payoffs will be the wild card. And to the earlier question, originations probably have to strengthen further from what they are to achieve that. That's why we put the resources in place to do it. What that number looks like, I'd prefer to reserve for next year. The $25 million in additional payoffs certainly didn't help in the fourth quarter. I think we can overcome it. If we actually grew $40 to $50 million in the fourth quarter, that would be, for us, I think a very, very good result. But that also assumes we're not going to see any more big paydowns this quarter. And I can't tell you that's a valid assumption right now.

Yeah, gotcha. Okay. All helpful. And how about just as far as the net interest margin or net interest dollars, I guess how you're thinking about that? The margin was relatively stable this quarter, and certainly the mix is, I guess you're a lot driven by the mix, but just how are you thinking about the margin percentage or the margin dollars here in the next quarter or two?

Well, I think for starters, We were glad to see interest income continue to rise and net interest income before provision did well. And as you point out, we picked up, you know, we were stable in the margin, picked up a point on the spread. The originations yields picked up quite a bit and the payoff yields fell a little bit. So, I'm hopeful that that has stabilized. and actually we can pick up some margin going forward if the mix picks up. And even for us, given how much cash we're sitting out there, even some of the lower yielding assets in the 2% range obviously increase the interest income and they actually contribute to margin a little bit. So I think we're feeling pretty good as long as the originations continue and increasing the absolute level of originations, interest income goes up, We're not really expecting a lot of changes in interest expense right now. Therefore, margins should go up a little bit over time.

Gotcha. And is there any expectation, you know, given where the yield curve is at, to deploy any of the liquidity into securities at this point or still kind of maintain it where it's going to go into loans as you see the originations continue to trend higher?

Yeah, that conversation has started. It's a good question. I think you could see us putting a little bit more into securities in the shorter duration world. Obviously there's a lot of moving parts right now with the Federal Reserve both in terms of quote unquote taper and potentially bringing Fed funds increases into focus earlier than people were thinking. So in the securities area we would still stay relatively short duration, but I do think there's some possibility of picking up some yield. and just holding it for a relatively short-term maturity and leaving it at that. Nothing fancy, nothing complicated, but there might be some opportunity to pick up a few bucks and put some cash to work, and then have those maturities arrive just about when we've worked off all the other cash, and then we can reposition it even higher. So standard protocol in a rising rate environment, and I think the yield curve might have gotten to the point where a baseline investment might make sense.

Gotcha.

Okay.

That makes sense. And just last one or two for me. Just on the reserve levels in this quarter, I guess you reserved for the growth, but still had some recapture on other areas. Just how should we think about the reserve in general, given growth expectations, particularly for the more commercial-oriented businesses here?

Well, we were glad to put reserves away for growth in CNI, because that's what happened. And we would like to do more of that. The recovery was due to getting cash from loans that had either been charged off or reserved, and we collected it, so we're glad about that, too. I would say, going forward about reserves, there is still some remaining excess provision related to COVID. So far, the asset quality, as you've seen, remains very strong. The reserve coverage ratio is very strong. So I expect that there will be potentially some recapture of the provisional reserves soon, probably fourth quarter and possibly in the next year, we'll see. But again, we're hoping to consume as much of that release in loan growth as we possibly can. Whether we would have a net recovery in a given period, fourth quarter, I would say that we'd have to have quite a bit of loan growth to overcome the reserve from the provisional reserves. But then after that, that reserve recovery should mellow out and we should just be provisioning after that based on growth.

Okay. Gotcha. So the provision line should be positive next year once you burn through a little bit of what you've got here the next couple quarters.

That would be our objective, yep.

Okay. And then just lastly, on the capital front, just, you know, obviously the share purchases were strong this quarter. Just kind of how are you thinking about capital at this point and either, you know, the best deployment of it? Like you said, there's still buyback potential or the dividend or just M&A. Just how should we think about that?

I would say capital is going to remain relatively stable. We're nearing limits, regulatory limits, on buyback from a timing perspective, so the volumes will not be as strong as they were before. We've kind of used most of our excess buyback capability from a regulatory perspective, and that'll continue through first quarter of next year. We're not really looking at M&A right now. Our focus remains on organic growth, I would say if we do do M&A, it's going to be in the asset origination-focused area. For example, the payoff we got somewhat unexpectedly, a $10 million payoff in equipment finance, corporate equipment finance, was due to a bank buying an independent equipment lessor. They are paying off the discounted lease exposure, and they want the asset origination. So there's an example of something we could do. And we have another lessor we know of that may be exploring a sale. So that activity is out there. But right now in the relatively short term, I would not expect any material M&A activity on our side. We prefer to focus the resources we have now on organic growth. We really obviously don't need any additional deposits. We'd like to focus resources on organic business deposit growth, and we're seeing some early signs that that's working in our treasury services area. And we'd like to focus resources on growing our trust income, which is also starting to make some progress. So I would expect capital to remain stable over the next couple of quarters. I would not expect any big changes that we know of right now.

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

Appreciate your time. Thank you.

Again, if you would like to ask a question, press star 1 on your telephone keypad. Again, that is star and the number 1. There are no further questions at this time. I will now turn the call back over to Morgan Gashier.

Thank you. You know, one question that wasn't asked is about what's going on with branch facilities. And a couple things about branch facilities. One, we are seeing continued customer interest in the branches, but it's been asked before what we're thinking about in terms of branches. We are nearing the end of that review, and I would expect in the next couple quarters we'll have some announcements about where we're going to head with branch offices. We're especially focused on on looking at how business customers are changing how they use branch facilities, how to look at technology in working with those customers. And we're also looking at the fact that we are increasingly growing business deposits within the CNI portfolio, and those customers are not dependent on branch services. So the diversity of the deposit base continues, and that points us more towards electronic services, telecommunication services, and less bricks and mortar. So all of those trends and factors continue to be evaluated, but I would imagine over the next three to six months we'll have some announcements about how we're going to work in this brave new world of both customers working from home and a broader diversification of the geographic base of our deposits. With no further questions, we thank you for your interest in Bank Financial. We wish everyone a happy holiday season upcoming, and we will talk to you in 2022.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.