BankFinancial Corporation

Good day, and thank you for standing by, and welcome to Bank Financial Corporation 2023 Q2 Earnings Conference Call. At this time, our participants are in a listen-only mode. After the speaker's presentation, there'll be a question and answer session. To ask a question during the session, you'll need to press star 11 on your telephone. You will then hear an automated message advising your hand is raised. To withdraw your question, please press star 11 again. Please be advised that today's conference is being recorded. I'd now like to introduce your host for today's call, Chairman and CEO F. Morgan Geyser. Please go ahead.

Good morning, and welcome to the second quarter 2023 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 a 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 this statement for purposes of invoking these safe harbor provisions. Forward-looking statements involve significant risks and uncertainties and are based on assumptions that may or may not occur. They are often identifiable by the use of the words believe, expect, intend, anticipate, estimate, project, plan, or similar expressions. Our ability to predict these results or the actual effects of our plans and strategies is inherently uncertain and actual results may differ from those predicted. For further details on the risks and uncertainties that could impact our financial conditions and results of operation, please consult the forward-looking statements declaration and the risk factors we have included in our reports to the SEC. These risks and uncertainties should be considered in evaluating forward-looking statements. We do not undertake any obligation to update any forward-looking statement in the future. And now I'll turn the call over to Chairman and CEO, Mr. F. Morgan Geyser.

Thank you. At this time, all filings are complete and we are prepared for questions.

As a reminder, to ask a question, please press star 11 on your telephone and wait for your name to be announced. To withdraw your question, please press star 11 again. Please stand by while we compile the Q&A roster. And again, oh, there's one moment for our first question. And our first question comes from Kevin Roth from Black Maple Capital. Your line is now open.

Hi, Morgan. We're a shareholder in the company and wanted to get some more information on the disclosure related to the government equipment finance default. So it's my understanding that this is the second default that you've had on this platform. And I guess the question is, I mean, how many as a percentage of, I don't know how much exposure you have to this government equipment finance platform. But if you could let me know what that number is, you know, these defaults as a percentage of total exposure. But also, are you rethinking the, you know, this platform, any additional considerations as to whether to continue to do this going forward? That would be helpful. Thanks.

Sure. The exposure detail is in the 10-K. It's in the section on the granular section on the loan portfolio. And so that will give you a sense of the total exposures. Also, in the government space, the portfolio is broken down between federal, state, and municipal. So in big picture terms, we've done about, in history, something over $300 million of this type of activity. At the moment, the portfolio totals approximately $165 million, and that is broken down a little bit over $100 million is federal, and then there's state and municipal, and they're roughly the same proportions that you saw in the 10K. Okay. In terms of future activity, obviously these two federal cases are highly unusual. It's our understanding from speaking to market sources, it's never happened to us before to start with. It's our understanding from market sources that, and, you know, this was part of our original due diligence years ago, that these type of activities are very rare, something like two or three in a 20-year period. But somehow, very recently, starting in late 22 and 23, there has been a spike in activity, something like 15 of them, and we have two of them. So the issue next is working through what we have. In these particular cases, we've tried to put as much disclosure as we can, given that the claims process under the Contract Dispute Act is still ongoing. non-public, if it gets to the next step, then we'll publish more on these specific cases. So at this point in time, obviously there is an issue in this federal space. We understand that in the original case, the first quarter case, the government department, military department, another source, but they are still using the software. They publicly said they're still using the software. So we don't understand if their contract was limited by non-appropriations risk and they have money to spend on the software, what has happened. And in the second case, this is another large government agency, they are still using the system. that they intended the software to be used on. So once again, we're working on the investigation side to understand what their decision has been. So for the time being, and I would say until these cases are resolved, the federal portfolio has no more originations, and it really wouldn't anyways given yields. We said that last quarter to begin with, but obviously under the circumstances, until we understand what is going on with these two specific cases, and potentially in this space as a whole, given the spike in activity, that that portfolio is topped off and will simply wind down. As far as the state and municipal goes, we still do, we still have two or three sources for that. We're doing a modest amount of that in the state and municipal area school districts and things like that. But it's obviously a much smaller scale, much smaller deals, something we've been doing for 20 plus years. And as there have been in these two federal cases. Having said that, too, though, we're mindful of the fact that at all levels, you know, government of government, but including state municipal, the stimulus money that was provided to these various government entities is no longer. So we would expect, I should say, that the exposure to government overall will wind down over time as the resources wind down.

Okay. One follow-up, just in reading the language here, it says that after the 120-day period to respond to the filings, the claims can be filed with a federal court of claims. So, Morgan, what exactly does that mean? I mean, so you file it with the federal court of claims, and then it gets further adjudicated in that particular court, and then they issue a judgment, or what's the next step?

That's exactly correct.

Okay. Okay. Okay. And are you able to collect on professional fees as part of the judgment?

Yes. When you look at the different approaches to the claims, There are formulas under federal acquisition regulations. If one theory is a breach of contract, you're able to collect interest on the claim plus professional fees, and the same goes in a termination for convenience or a constructive termination for convenience. So that's, you know, the first step here is to get the claims filed. That starts the interest clock rolling, and then the costs related to the claims can follow with that. But we also have to make sure that we get all the facts we can possibly gather into the claim and then be prepared for the steps that need to take place.

Okay. And just on switching gears here on the commercial equipment finance chapter 11 note on page 32 of the 10Q, I saw that you took a charge off on that of $627,000 on that equipment. I would Could you just comment on how, you know, once you get the equipment back, which I presume you have a lien on, a UCC filing, et cetera, how quickly can that equipment be remarketed? And is it kind of, you know, regular way type of equipment that's used in this industry, or is there a risk that the equipment may be a white elephant, so to say, where it may be difficult to release out?

I would say, you know, first of all, the process is subject to court order. We are working to get the property listed for sale. It is special use. The nature of this, it's excavation, tunnel boring equipment that's used for large civil infrastructure projects. It is not like a forklift or something else. You know, it's essentially uses you can get for a company that does this for their business, but it is large. Both pieces are larger pieces of equipment, hence the size of the exposures. And we are concerned that depending on demand at this time, especially if we try to push a liquidation, that there could be a further reduction in value. We won't know until we get out and expose it to the market. and then we'll have to decide just how hard we want to push it to liquidate and get the cash back working.

Okay. All right. Well, that's helpful. Thank you.

And thank you. And one moment for our next question. And our next question comes from Brian Martin from Janie. Your line is now open. And Brian Martin, your line is now open.

Sorry about that. Good morning, everyone. Thanks. Just one follow-up for me, Morgan, on the last question was just in terms of the other 15 or 10 to 15 circumstances that are similar to this that have happened. Do you have any comments on kind of the outcome of those so far, or how has that played out? Is there any data you can share on that?

You know, everything we have is anecdotal. We've heard one is going to the court of claims, and one got resolved through negotiation, but we don't know a lot of specifics about it. You know, there's several players in the industry, and we've obviously been focused on our cases and not really active in the industry right now, but at At that juncture, we expect that it's going to go through the full claims process and potentially likely have to go to a court of claims. We're not necessarily expecting a settlement. Obviously, we're open to that discussion once we can understand what exactly is going on with these two cases and why they've taken the action that they have.

Gotcha. Okay. And then can you just give some comments on – I know the – The payoffs were up a little bit this quarter. The originations were down. Just kind of how you're thinking about, you know, kind of loan growth here in the back half of the year, you know, as you, given the payoffs this quarter.

Yep. We, right off the bat, in second quarter, as we said, we decided to just back off of accredited originations generally. Wanted to understand how liquidity and Market conditions would unfold And you know, we kept the loan to deposit ratio. We're only constant and that was one of the things we said we were going to do deposit trends strengthened a bit in in the second quarter and So based on that we feel that especially with the liquidity that we'll have in the second half we can reposition some cash into higher yields in the second half of the year. So for us, we'll see some increase in originations in the corporate equipment finance, a little bit in middle market, a little bit in small ticket as we have. Middle market and small ticket were well had a good quarter in terms of utilization. You know, we had stronger utilization throughout the quarter. And then as we said in the filing right at the end of the quarter, between the health care borrowers getting their cash in from state receivables and the equipment finance borrowers getting their deals closed at the end of the quarter, we saw payoffs in that last quarter of the week. Sorry, last week of the quarter, excuse me. And that, but again, we had a reasonably good quarter for utilization. Healthcare is growing less quickly than we thought. Their cash balances remain strong. Their receivables collection remains strong. And we did have one borrower pay off in full. off. Pipelines and commercial finance going into the third quarter are good. We actually just closed a $4 million new exposure last week. Healthcare continues to grow. We probably have about $15 million in the pipeline that is working its way through various HUD approvals, some of which we'll see close in the third quarter, and some of it will close in the fourth quarter. utilization on those exposures. You're looking at another $8, $9, $10 million of growth out of that portfolio, and that's just what we have in the pipeline starting now. probably not that much. Equipment finance, again, the corporate side will continue to grow. Middle market will grow a little bit. So what that would do for us is continue to improve interest income. It would still leave us around somewhere between 90% and 92% loan to deposit ratio, assuming the deposit portfolio stabilizes at current levels. And we're seeing some slight improvement in deposit marketing. Gotcha.

Okay, so most of the growth would be health care and commercial finance. Those are kind of the two engines, if you will?

Yep. Yeah, that's been the consistent plan throughout is let cash run off of either equipment finance or real estate and continue to strengthen commercial finance at all levels, the community, small business platform, and the health care platform as well. Gotcha.

Okay. And how about just from that government portfolio, the runoff, how much, I guess, is there a – can you kind of put a fence around how much runs off over the next 12 months on that portfolio, just kind of normal runoff?

I'd probably take you all the way to the end of next year, and I would say probably 60% of it.

Okay, and that portfolio you said was about $165 million or so today? Okay, so $60 of the $165 comes down. Okay. Okay. How about just switching gears just to the expenses for a moment? Just the, you know, outside of the, you know, kind of the items you guys called out in the 10Q on kind of the costs related to the non-performings, you know, is the outlook for expenses to be relatively stable, you know, absent that item? Is that how you're looking at things today?

Yeah, we would think so. On the Compensation side, we are going to add a little bit of depth in the commercial finance side and a little bit more depth on the credit controls for the commercial finance side. We still see some volatility in comp on the branches based on staffing levels. We're a little more stable than we were, but we still see turnover, and so there's some volatility there, including some recruiting fees. And then You know, originations, if originations are stronger, then there are some deferred expenses related to originations. That was obviously a greater impact last year than it will be this year, but that increases some volatility to come. Most of the benefits costs are behind us now for the, you know, for the rest of the year. As far as the rusty expenses, you saw, you know, IT tick up a little bit. in the 10Q filing. But once the claims are filed, then those expenses will start to ameliorate a bit until it's time for the next stage. However, the work we're putting in now is preparing for all stages of this. So we'll have some expenses going forward, but, you know, probably one more quarter of some heavier expenses and then it will come down. So all told, we would see the expenses, you know, start to level off probably somewhere in the neighborhood you can get a closer look at the run rate.

Okay, perfect. And then how about just from the margin standpoint, I think NII, I guess, is your expectation that, you know, it looked like this quarter a lot of the reversal of the accrued interest was what really took the, you know, the NII, you know, downlink quarter, I guess. Is your outlook... it seems to be that the dollars of NII should be able to grow in the second half of the year, I guess sequentially from 2Q to 3Q and then 3Q to 4Q. Is that kind of how you're thinking about with the margin and the growth you're expecting from the higher yielding units you talked about?

Yep, that's accurate. We'll work to put a little more cash to work at higher yields, and obviously the assets that are rolling off the portfolio at our considerably lower yields We are still mindful, though, of deposit interest expense. And, you know, with the Fed activity and customer awareness, a rate that is a play that's still out there. And we'll see how that comes out. So if things move in the direction we're expecting, where we do a little bit more originations volume during the second half of the year, and the trends that we kind of looked at expense remain, then we think we have a reasonable chance of stabilizing net interest margin and possibly even adding to it a little bit by the fourth quarter. But that will depend on how our originations go and also, you know, what happens with deposit interest expense, which I'm sure everybody is working through right now.

Yeah, and your deposit costs were, you know, deposit betas were very much below peer-better I guess even the DDA trends were pretty positive, you know, link quarter basis, I guess. Do you feel like there's a lot more remix to occur, or is that things kind of stabilizing on the deposit side for you today?

You know, it's a great question, and I think the best answer we have is that the longer that the attention continues on the Fed in an up If somehow, and we don't really anticipate this, if somehow the Fed has a change of heart and starts to reduce rates, you could see some migration while people try to lock in. And if the Fed announces they're done, Most of the activity has been in the specialty products, and there's not been a broad move in the market on the core pricing. And obviously, too, the work we've done on the non-interest-bearing commercial and the Treasury service size has certainly helped. But the longer this environment goes on, the We've been playing what we would consider to be reasonably good defense. It's important for us to know, it's important for customers to know that we respect their business. We have customers with us for the long haul, and they know that

Gotcha. And just remind me, in a down rate environment, if we do see cuts next year, how would you anticipate the margin performing in that environment?

Let me turn you over to Paul on that, because he's done some analysis on that.

Yeah, Brian, initially for the first 100 basis points were well matched off, but if it were an abrupt cut of over 100 basis points, then it would start to cut into net interest margin a little bit. Gotcha. Okay, perfect.

And then just maybe the last one or two for me, and I'll step back, is on the buyback or just capital, how are you thinking about that today, given maybe a little bit less growth or just, I guess, some of the credit issues as you kind of work through here? How should we think about that?

Well, you know, we were actually somewhat over budget in terms of the second quarter. We're kind of ahead of plan on that. And so we But we would expect that the activity we had in the second quarter wouldn't continue. And in third quarter, it'll probably be considerably lower. As you say, we work through things. And then we'll take a look at it when we get to fourth quarter. But right now, we were kind of over budget by almost two to one. So we'll probably balance that out for third quarter.

Gotcha. Okay, and then really, my last question was really on the earnings, but just going back to the government credits, I mean, given the remainder of that portfolio, I guess, do you think there's a risk that we see more of this activity? You know, I guess it's hypothetical at this point, but you've had two credits that kind of fall in this camp. You've seen elsewhere in the industry, you know, a pickup here. You know, I guess, are you concerned that there's more of these that could, you know, come up here in the short run, or are these... I want to say they're more isolated in the cases that have already come up, but just in general, how do you feel about that, the risk of that occurring?

It's certainly a risk. We are monitoring everything we can possibly monitor. we understand more of what's happened with these agencies or in the governmental all the activity we can and we'll be as transparent as we can if something does happen.

Yeah, that's helpful. And just to remind me, the other – the credits that have, you know, turned that last quarter and this quarter, you know, the $8 million, $10 million, is that – I guess are those some of the larger credits in that portfolio? I guess if we were to see others come up, I mean, kind of the average size of that portfolio, you know, the credit in that portfolio, are those pretty typical for what the portfolio consists of, or are those more the larger size that have gone –

You know have migrated negative migration here Well, they're on the larger and they're on the larger scale of things given the size of this particular government department It's one of the largest departments in the entire federal government one of the largest purchasers in the world So their credits tend to be larger But if you go back and looked at the 10k We have a we have a larger portfolio in terms of the quantity of credits. There are still some credits that are about this size out there. They've got one or two years left to go. But in terms of the overall exposure, we have a significant range of smaller exposures that continue to pay down. Some of them are on annual appropriations than they pay annually. But this portfolio was designed to be short-term. You don't want, you know, very long-term exposure to non-appropriations risk. And so it was designed to be short-term to begin with. So these were two of the larger ones. There are

Gotcha. Okay, and last one for me, Morgan, and I'll step back, was just on the outlook, kind of your outlook for ROA earnings. You know, I think you talked about maybe trying to get to the mid-to-high 20s over the next couple quarters. I mean, asking kind of the items you, you know, we called out this quarter as far as the accrued, reversal of accrued interest and expenses, it looked like you were pretty close to that type of level, right? I mean, I guess just how are you thinking about the back half of the year or maybe into 2024 at this point on that?

Well, we would say, first off, that because we can proceed forward and work to stabilize the margin, and apart from some blips and some inconsistencies, $4.5 million to $4.75 million, $4.75 million range. And if we can hold that number on a core basis, then that, you know, looks to have Gotcha.

Okay. And your comment on the loan growth, man, would you expect more loan growth third quarter or fourth quarter? There's typically been some seasonality, but as you kind of think about the back half of the year, the growth that you do get, can you get some of this cash to work sooner in the third quarter?

Well, right off the bat, we won't get a lot of the cash to work. And two, you know, seasonally, third quarter is usually pretty slow. You know, the commercial finance side might draw a little bit more, as you saw in the second quarter, especially in healthcare. It's not necessarily seasonal in some cases, but, you know, in the seasonality and the generation of marketing will all probably produce more results in the fourth quarter if all goes well for us.

Gotcha. Okay. Perfect. I appreciate you taking all the questions. I'll step back.

Thank you. And thank you. And one moment for our next question. And for our next question, we have Henry Balzac, private investor. Your line is now open.

Hello, Morgan. It's been great on credit. But when I saw the MPAs go up from Q4 of 2022 from 0.13 to Q2 of 2023, Of 1.64, I was kind of shocked and confused. But I guess you explained most of that. So just on a timeframe, how long is it expected to resolve this issue of these two government credits?

Yeah, we have to take it one step at a time. 20 days. And then after that, then we have to file with the court of claims. Uh, that could be at least six months and maybe longer. So, uh, you know, the, the key to us is getting the claims properly presented and then prepare for the next step, uh, you're probably talking about six months to 12 months on the inside before we'll see meaningful results. Wow. So we're looking like at 2023 at the earliest? I would say maybe certainly 20. Yeah, I would say at least 2023. It's not. force. Okay. Thank you.

And just to circle back to your share buyback, I think you bought 93,515 shares in Q2, and you stated you're going to dial back on your purchases in Q3. Is that correct?

We said we were going to try to do about 50,000 shares a We didn't do any blocks during the quarter, and we wound up just doing a little bit every day, not even close to the daily max.

And just to come back to the dividend, is that dividend still safe with all the uptick in the NTAs?

Well, you know, the board declared a 10 cent dividend. Our earnings for the quarter are 18 cents. So we had But we make no promises. Okay. Thank you, Mark.

And I guess you answered all my questions. And if you can, give me a call. I'll dial back. Thank you. Sure. Happy to.

And thank you. And one moment for our next question. And our next question comes from Eric Grubelich for a private investor. Your line is now open.

Yeah, hi, good morning. I just wanted to circle back on a couple of things. One related to the questions Kevin Roth asked you about some of the problem loans of the non-performers. That tunnel slash boring equipment loan, that commercial finance loan, is that equipment stuck in the ground or is it up out in the open, mothballed in a lot, whatever, where you can access it and easily deal with it if it needs to be repossessed and sold?

We It's a good question. Let me just say it's getting a little granular, but at the moment the equipment's accessible and it is available for sale.

Okay, great. Obviously, you folks are the expert on these government-sponsored or government loans, like the software one that went bad. I know you're going through this court process, and there's some procedure that you have to do to do that. I get it. But at the end of the day, is your risk on these with the government or that entity that you lent the money to?

The payor is the United States government. So that's the payor. That's the payor.

Okay.

No, no, that's fine. That's fine. It's obviously not Your standard can of corn type alone, it's a little bit more complicated, but thanks. And then just one last thing, just sort of generally. You know, you talked about the margin, you know, before with regard to, you know, the loan activity that may occur in the second half. I was just curious, on the deposit side, is I think Brian in his marathon of Q&A asked you about the, You know, you mentioned the deposit paid was pretty low. Your savings accounts, and I forget which is the other kind of, I mean, it's the now accounts. What do you attribute to the relatively low rate on those? Is it the granularity of the account that is allowing you to not be or not need to aggressively raise rates there, or what is it? And then related to that, Where do you think the biggest risk is on the deposit side? Is it more migration into higher cost CDs or money market? What do you think that may come from or go into?

Well, let's take the two questions. We've worked for 30 plus years to build a very strong deposit franchise. And with a significant quantity of customers throughout the metropolitan area, but also, especially in the savings accounts and the money market accounts. But it's also the case that many competitors, in terms of core deposits, are priced, we're usually at or near the top of core deposit pricing in the market anyways. So on a relative basis within a core product, we're always pretty strong. But at the end of the day, the difference between the current market prices for retail money market accounts and the core savings, the core money markets, it's pretty widespread, one of the widest in recent memory. Many of our customers are using their savings accounts for day-to-day risk-bearing checking, the money markets, or the savings. And the longer that delta continues, the greater that risk is. So our strategy is to work with those customers. We have a variety of different programs in place to work with them. And so far, it's been successful. But I would say the environment continues to persist, and that risk continues to persist. On the commercial side, we've been effective, with the view towards we want to keep the cash working with us and for us at all times. Again, within reason. And then finally, our focus is always to make sure that customers know that they can always talk to us if they have funds in other places, and we were able to do something for them on migrating funds that are already at the bank. We never lose accounts. And once they understand we can do something for them with their deposits here, we're now starting to see some migration of inflows in from banks that are not maybe paying quite as much of attention to their customers. And we've seen that both on the commercial side and we've seen it on the But I have to say, you know, we would not conclude that

Okay, great. Thanks for that qualitative detail. That was thorough and helpful. Thanks. Have a good rest of the day.

Thank you for your call. By the way, let me just say that we always welcome Brian's questions, however detailed they are. So, you know, marathon away, Brian. We're ready, willing, and able.

And thank you. And if you would like to ask a question, that is star 11. Again, if you would like to ask a question, that is star 11. And one moment for our next follow-up question. And our next follow-up question comes from Kevin Roth from Black Maple Capital. Your line is now open.

Hi. My question was answered. Thank you. Thank you.

There's one moment. And we have another follow-up question. One moment, please. And our follow-up question is from Eric Grublich, a private investor. Your line is now open.

Yeah, hi. I just want to make a comment. I used to be a publishing sell-side analyst myself. I used to do the same thing, and that was a compliment to Brian, not any kind of

Well, we appreciate your views on that, and we appreciate all the questions from all sources. We appreciate your interest in the company as well, and we'll do our best to answer every question we get as thoroughly as we can.

Thanks. Bye-bye.

And thank you. And I am showing no further questions. I would now like to turn the call back over to Chairman and CEO F. Morgan Gager for closing remarks.

Well, we thank everyone for their interest and questions. We will work our way through these issues that have come up with us and resolve them as quickly and as effectively as we can. And in the meantime, we thank you for your interest in the This concludes today's conference call. Thank you for participating.

You may now disconnect.