BankFinancial Corp (BFIN) 2006 Q2 法說會逐字稿

Good day, ladies and gentlemen. Welcome to the second quarter 2006 BankFinancial Corporation earnings conference call. (OPERATOR INSTRUCTIONS). I would now like to turn the presentation over to your host for today's conference, Mr. Morgan Gasior, Chairman and Chief Executive Officer.

Thank you, Candace. Good morning everyone. Before we get started I'll turn it over to Vice President Terry Wise for our forward-looking statement.

This conference call may contain forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995 concerning BankFinancial Corporation's future operations and financial results. Such statements are based on management's views and expectations as of today based on information presently available to management. These statements are subject to numerous risks and uncertainties as described in our annual report on Form 10-K for the year ended December 31st, 2005, and other filings with the Securities and Exchange Commission. And as a consequence, actual results may differ materially from those anticipated by the forward-looking statements. BankFinancial undertakes no duties to update these forward-looking statements.

Back to you.

Thank you, Terry. Good morning, everyone. As is our usual custom, we don't really prepare any advanced remarks, so I'll just dive right into questions. It looks like our first candidate is --?

Kevin Reevey, Ryan Beck.

First question relates to your insurance commission and annuity income line item, which was up pretty substantially from the first quarter. That 400,000 number, is that a number that we should use as a normal run rate going forward, or was there an anomaly during the quarter?

First, I'd be careful making any kind of projections on this. We don't really publish those kinds of forward-looking statements. I will say that we had an unusually strong sales quarter, as we noted in the publication. Typically when rates rise, investments like fixed annuities tend to be more attractive to customers. And for the first time in a while we saw annuity rates reach a level where customers thought that they were a good value and invested. But whether that will continue to be the case in the next couple quarters, I don't know. So I would be cautious in annualizing that number.

And your service charge line item was up nicely linked-quarter. Was that seasonality-driven, or were there any price changes that were instituted company-wide?

There were no price changes. I think, as we noted in the publication, that was something a return to historical norms. Also remember we had a contribution from the acquisition of University National.

My last question is -- how is the University National deal working out, in terms of has it met, exceeded or missed expectations with respect to employee retention and customer retention?

Good question. We're very pleased with the University transaction so far, and all evidence at this point indicates that our new customers are very pleased with the transaction. We're just very fortunate to have this institution. We have great employees down there and our retention has met or exceeded our expectations there. Absolutely don't want anyone listening to think we're taking anyone for granted, but I think both sides -- the customers, the employees and ourselves -- are all very pleased with what's happened.

The transaction in terms of the integration has gone on a little bit ahead of schedule. We're planning our data conversion for just about a month from now. And really what that will mean is within about a seven-month timeframe we'll have wrapped up all the related integration matters. So we have one more step to get through with that data conversion, but at this point in time, all systems go.

I've been out in the community, spending time at both branches as recently as last week, Friday, meeting local political leaders, the aldermen, who are also community leaders and are interested in what's going on. I always hate to say about exceeding expectations, but I think all sides are well satisfied at this juncture.

Brad Milsaps, Sandler O'Neill.

Just quickly, maybe you could give me a little more color on the expense side and just sort of what fell to the bottom line in terms of how the University National deal impacted the second quarter. It looks like on a net basis, you made less than you did in the first quarter, and well less than you did in the third quarter of last year. Can you offer me anymore color? Is it really just you had a lot of upfront expenses in the numbers and that's sort of what caused that, or am I going down the wrong path there?

Let me ask our CFO, Paul Cloutier, to answer that.

Let me break down quarter-over-quarter for you what went up, what went down. Basically, University added about 450,000 of expense for the quarter to the G&A expense. So, that was about 60% of the increase, roughly -- a little under 60%. Our Holding Company expenses were up due to the annual meeting; some franchise taxes that we had to pay. So that accounted for about 180 of the increase. And then the ESOP, because of the increase in our stock price, that was up about 71,000. So taking all that together, that's about 700,000 of the roughly 800,000-plus that expenses went up. And the only other big item, when you look at our activity from the first quarter carried forward to the second quarter, was some deposit marketing. We made a more concerted effort to market for deposits, so that expense was up quarter-over-quarter.

On the deposit marketing, we engage in a variety of marketing activities, and one of them tends to be periodic cross-media, billboards, things like that. Part of it is name recognition, just getting (technical difficulty) getting in front of people. That does not happen every quarter; it happens somewhat seasonally. We're in, we are out. We do it for a while. We pull them out, come up with a new campaign. So from time to time you'll see those expenses increase and then decrease somewhat and then increase again.

I will tell you, though, on deposit expenses, that is a line item to keep an eye on. We continue to accelerate our deposit marketing, especially for new customers and especially for small-business customers. So I would -- even if our cross-media campaigns ebb and below, there's going to be a certain core expenditure that's going to continue.

In terms of changing the dynamics of University National's balance sheet, was most of that done later in the quarter, so that may not have given you a full quarter's impact?

The restructuring of their balance sheet -- when we closed the deal April 5th, we basically liquidated most of their investment portfolio. So that impact was felt for most of the quarter. But we also had duplicate expenses that we carried for the quarter, which we'll continue to do so until we complete the IT conversion. So you had a little of both in the second-quarter numbers.

So a combination of money spent by the core BankFinancial franchise, coupled with doubling of back-office expenses, really kind of hurt the net income number this quarter?

Actually, University was accretive to earnings for the quarter. It was slightly accretive, say, approximately $0.01 a share.

We are still -- as we've said in the last couple of quarters, we are still experiencing a certain element of margin compression. So you're correct in perceiving that that's occurring.

Something else to keep an eye on -- I wouldn't want to -- I don't want to quote the number from September to you, but if my memory serves, the stock closed somewhere in the neighborhood of 13.50, maybe 14, in September. In the June '06 timeframe it was probably around high 16, 17. And that ESOP will have a material effect on it. If it comes out at $10, $11, you're talking a 900,000 expense. If it goes to 17, you're talking closer to 1.7 million, 1.6 million. So it does factor in there.

Also remember that -- and this is probably the first time we have had the opportunity -- our normal business plan cycle implements our cost of living adjustments, and budgets and healthcare and all of that, at the end of the first quarter. So the second quarter is the first time you'll see that increase to the run rate.

Final question and I'll step back. Morgan, can you talk a little bit about just the demand for loans in Chicago? Most of my banks I follow there have shown at least some increase over the prior quarter, saying demand is still pretty strong. For you guys is it just a sense of pulling back because of pricing, or are you just seeing less demand from your customers? Can you kind of talk through that a little bit?

The answer to all those questions is yes, but that's another good question. We had a pretty good run on loans all the way going back to the IPO, putting the capital to work, and then seeing the opportunity with University to convert that securities portfolio to loans. So in one sense, I think, second quarter was a breather.

But in all of our sectors -- let's go one by one. The real estate sectors, the income property, multifamily and commercial real estate, we are seeing customers being increasingly opportunistic. Just a couple of quick examples.

One of our senior vice presidents -- I was out to lunch with her and a customer, and she was telling me about a customer who came in to do a single-tenant deal of Starbucks. At a 55% loan to value ratio, the deal didn't qualify for debt service, just to give you a sense of how high valuations have gotten in certain markets and what the residual equity requirement is. And that just didn't make it economic for the customer. The customer passed on it.

Recently we had another customer that was looking to invest in a townhome project that somebody else built. We ran the numbers. It wasn't the strongest deal we ever saw. We showed them our numbers, he agreed and moved on. So, customers are being very opportunistic.

The multifamily sector, same type of thing. Historically, the last 12 months, what's been driving that has been the use of multifamily buildings as conduit conversion raw materials, thereby driving the price per unit of those buildings up. That is starting to moderate, but the valuation of those units is still fairly consistent the last couple of quarters. And again, it's making it hard to make money on those buildings. So we're probably seeing more customers selling buildings than buying them. Those that are buying them seem to be buying them based on personal income as opposed to qualifying the building as income property.

On construction, as we've noted before, we have been taking a hard look at that sector for well over a year now, and you saw our balances drop a little bit as a result. It's not that we're out of the market, but again, customers are taking a good, hard look. And I'd say probably the first time we've seen customers just saying -- you know, maybe I'm going to wait to see what happens with this market, get a better sense of absorption rates, and not jump in right away. So we might do a property acquisition for them, but they're not jumping right into the construction.

At the lunch I was with one of those customers, one of our builder customers, and another factor that has jumped into his mind is raw materials prices. All of his vendors are telling him whatever we put on the contractor's affidavit, put a cushion in, and when you're getting ready to install -- so let's assume its windows, three or four months away, call us back for an update. And that's again giving people pause because of the cost of the land. Then you start taking out a bigger contingency for raw materials prices. They start looking at their margins and then they look at the cost of carry with rising interest rates, and they're thinking hard about it.

So we're seeing opportunities and we follow up on them diligently. But if anything, the selectiveness that we've seen the last couple of quarters, now we're seeing the customers increasingly getting more selective. So almost everybody is on the same page.

That being said, they're all real estate investors and developers, and they're constantly looking for new opportunities, so it's not doom and gloom; I'm just thinking people are being a little more cautious and more selective across the board.

On the leasing side, we had a very good run there for a while, and just this quarter things were pretty quiet. Don't really have any other explanation for it other than people weren't buying a whole lot of equipment, putting it to work. But again, we had quite a run there for a while, so I have a feeling we might be in a position where our leasing customers are helping their clients install and position the equipment, and they'll be back in the cycle.

And we did have a little bit of an increase in the C&I stuff. We've been working on that, and we are seeing some progress on that. It's not going to be material to the big picture, but it is a focus for us and we continue to push forward on it. Was that helpful to you?

Yes, very much so. Thank you very much.

(OPERATOR INSTRUCTIONS). [Chris Bonafed], [Oz Capital].

Now that -- following the acquisition, you guys still have significant amounts of excess capital available. And I think the one-year regulatory restrictions on share repurchase has come and passed. Can you comment about what your capital plans are going forward and how it relates to buyback as well?

I anticipated that was going to be your question. You know, nothing has really changed from our last conversation. The Board continues to review it. You'll notice that we declared our second dividend at the annual meeting, so that aspect of the capital plan continues.

The most recent briefing the Board got was on SEC rule 10b-18, restrictions on buybacks, so that we understand compliance issues correctly. I don't really have any timetable as to when that might be announced, but it is a topic of continued Board interest, and they are getting into the specifics at this point.

As far as broader capital plans, we also continue to look at various merger and acquisition activity. Interesting enough, we have seen somewhat of a slight increase in opportunities this last three to four months. And I can think of a variety of reasons why that is happening. But obviously, when we get to the point where we're ready to announce an opportunity that has been consummated, we'll let everybody know right away.

I'm not completely familiar with the 10b-18 rule. Can you -- is there -- will that provide some other restrictions, or what would that have (multiple speakers) enable you to do?

I think the basic thing you need to know about 10b-18 is it governs how an issuer functions in the market vis-a-vis acquisition of its own shares. For example, there is -- you can't be the first bid in the first transaction of the day. You can't trade in the last 30 minutes of the day. There are limits on daily activity. And interestingly (multiple speakers)

(multiple speakers) that's not new.

No, but it's new to the Board.

The shares trade at a fairly low multiple of book value relative to a lot of peer companies. How does that come into play when you think about the buyback potential versus the acquisition for -- if you were to use stock in an acquisition?

I think we're looking at a couple different things, as we've said before. Obviously, one is what's the accretion dilution to net income. And obviously, when you do a buyback, you're taking funds out of interest-earning assets or potentially borrowing funds, and thereby increasing a cost, versus the improvement in earnings per share. So that's, let's say, a benchmark to keep an eye on.

Same basic rules apply in (technical difficulty) acquisitions; what's the accretion dilution on year one? What can you do in the first year? University is, as I said, meeting our expectations. And once we get the remaining of the cost saves out of it, we're feeling very good about that.

And then you look at tangible book value dilution; what's that doing? Can you earn out of it in a reasonable time? How does growth factor into that earnout calculation? Obviously, the bigger the institution, the harder it is to grow. So growth is a little more feasible in very small institutions like a University than it is in a bigger one.

But you compare one against the other. Obviously, buybacks are a form of financial engineering. Acquisitions help develop a franchise. So there's a little bit of an intangible that you have to pay attention to there. And as I said, the Board keeps all of that in mind. And another function of buybacks can be funding equity incentive plans. That was adopted by the shareholders in June. You have to possess the shares before anyone vests, so there's another component to that as well. There's another separate business purpose.

Ron Peterson, Sterne Agee.

A follow-up question on the loan growth outlook. Obviously, it looks like, excluding the acquisition, loan growth was kind of subdued; you [can't address] that. But going forward, it sounds like you're still maybe expecting maybe a little slower growth than you've seen since the IPO.

I would say that that's probably a fair statement, especially given the sizable growth we had since the IPO. It just -- we hit a seam where we could be very competitive in pricing for very good loans, we had customers that were looking to get things done, and everything was clicking. But at this point in time, almost a year later, the overall economy has changed a little bit, the outlooks have changed, so -- and our appetite for growth is a function of how profitable it can be. And credit spreads, if anything, have continued to tighten.

So we have passed on a few deals where the pricing just couldn't work for us. It was either the risk wasn't priced correctly, or when you looked at the marginal funding of it all, it just didn't make sense. And that -- that's probably -- those two themes there, tightening credit spreads and the risk equation, are probably going to be driving our decisions and even customers' decisions as time goes on.

As far as pricing, would you consider the pricing in your markets rational, or not?

Really good question. The difficulty in answering that -- I'm trying to give you as broad a view as I possibly can. The difficulty in answering it is because we see competition from so many different sources.

In some cases, for larger, very good commercial real estate deals, you're competing with commercial real estate conduits. And that's just an apples-to-oranges type of competition. They have no funding structure; it's just a net asset return to the investors. So if we are competing against them, it's very difficult for us to run a net interest margin on that property. Now, that's not our typical deal, but once in a while we'll lose an opportunity to a conduit.

Customers, on the other hand, sometimes back away from conduits because of the massive restrictions. If they want to be flexible in the portfolio, the yield maintenance stops them in their tracks, and other restrictions stop them in their tracks.

But overall, I would have to say, if we are competing against other banks in the market, particularly other community banks, occasionally we will see irrational pricing. Sometimes they desperately want to hang onto a customer, we've been successful penetrating a new relationship, and they'll just do whatever they've got to do to keep that customer, even if it's a breakeven or even a losing proposition. Truthfully, we will try -- we try very, very hard to keep our customers. But there is a point where we say, you know, you can't justify it, and we have to let the deal go.

So I would say we see occasional irrationality. I would say probably the thing we see more are pretty aggressive underwriting standards for somewhat rational pricing. In other words, the credit spread might be consistent to previous years, but the risks that people are taking are significant. And sometimes we pass it up even though the pricing looks okay. In a general sense, we can make money on it. The risk that we would be taking is just not worth it. So, if anything, risk premiums, when you are taking on more risk, have eroded, and we're seeing that probably more consistently.

(OPERATOR INSTRUCTIONS). Paul Woo, Friedman Billings Ramsey.

Morgan, just another follow-up question on the M&A environment. What amount of deals are you seeing today versus, say, six months ago? More or less?

Slightly more. I would say that, based on the work we do just to talk to different people in the market, people we know, there is a somewhat greater level of interest in doing something. And on institutions that are put on the block by investment bankers, books that we see, we've also seen a greater quantity. So both in, let's say, private opportunities as well as more public opportunities, we're seeing it.

And I think, if I can anticipate your next question, the reason for that is a couple of things. One, obviously, the profitability of marginal growth in this environment is difficult. It's just harder and harder to really make significant progress on profitability in this environment.

Two, I just have to say from my conversations with other bankers, and even just watching what's going on here, the amount of work on regulatory compliance, whether it's the Bank Secrecy Act, whether it's customer privacy, you just -- every time you turn around you're putting in another major piece of regulation that is an institution-wide thing that's a Board level attention and zero tolerance. And after a while, especially at the smaller bank level, both the costs and the time that are required to attend to these compliance matters tend to start consuming the entire franchise.

And then three, although I don't see it as often, I think just the notion of Sarbanes-Oxley for some institutions and the tighter environment there is also a factor. Also, prices are fairly high, and historical matters are fairly attractive. So I think some people are just saying -- with all these different challenges in front of me, maybe this is a good time.

It looks like the University Bank acquisition looked very positive for your company. How much bigger of an institution could you acquire?

I think it's a function of the deal. Our history has been that we really like to work with institutions where we put them together and we take the best of both and move forward. It's not been our case yet that we've done something for purely financial reasons, where you had to strip it out and really hit financial targets, particularly cost saves, to make the deal work.

So in a transaction where it's smaller, we could do a series of smaller deals and we have that capability. We could do a larger transaction, assuming that we're working together and it's a net win for everybody, and we know what we have to do in terms of costs saves, the usual suspects, data processing, audit, things of that sort. But we're not having to materially transform the institution to something else. In other words, it's complementary to what we're doing.

Could we handle a $500 million-plus deal? Sure. But it just depends on what it is and what its issues are, why are we doing it, and what does the result of the institution look like going forward and what do we want it to do. So some smaller deals, and the sequence of them are certainly within our capabilities. A larger deal is also within our capabilities. We would have to be pretty confident about a larger deal, though, because obviously it's going to take more time to do that, and it would take you out of the market for some potentially attractive smaller deals that would present less execution risk and potentially (indiscernible) franchise a little faster. Does that make sense to you?

It definitely does. You guys sold some securities after the quarter. It looks like that will benefit net interest margin. But that being said, how is your balance sheet position, given if the Fed didn't -- stopped raising rates or, in the other scenario, if they continue to raise rates?

I think we're in reasonably good shape. The Board's asset liability committee is pretty focused on maintaining as much of a neutral stance, not putting a bet on either rates going up or rates going down. We might be slightly more exposed to a downdraft in rates, but after that security sale, perhaps not so much. One of the uses of the proceeds simply could be to retire advances or other wholesale funding costs, and thereby mitigate future rate increases. So I think we're feeling very fairly comfortable about that. It's something we watch pretty carefully, and we don't really like to take bets on either side. So, that securities positioning was a win-win on a couple different fronts. We felt it was good timing and the results worked out well.

Most of those securities were sold from the University National Bank?

Not exclusively so. We still have some of the University securities, but we did sell some of those. We also sold some of ours. So it was kind of a mix.

It was two separate transactions. The one in April, when we closed on University, we sold securities out of their portfolio. The restructuring that was done in July was our existing portfolio that we restructured.

So the net result was a mix, but you had two separate sets of activities.

Ross Haberman, Haberman Fund.

Morgan, could you tell us how big is your condo exposure (indiscernible) or your condo conversion exposure, if that's of significance?

Sure. First of all, we have no Downtown Chicago or vertical condo exposure whatsoever. Secondly, I'm just going off the top of my head right off the bat, but I keep reasonable track of this. I would say probably of the 78 million we had in construction loans, probably about a third is some form of condos. And then you might add some townhomes that we have along the way.

We have one big condo project that's in Oak Park, but we've also participated that out. Whenever we have a bigger project like that. we usually like to find a participant and both share risks and reduce concentrations. So I think a third is a reasonable estimate; it might be a little higher if you toss in some attached housing. But that's pretty good.

What are you seeing in that category specifically, either in-town or out-of-town, in terms of pricing?

At the moment, if you're asking are prices going up or down, I haven't seen any massive markdowns of inventory at this point. We do see some borrowers throwing in some options, or paying a couple months' worth of condo assessments as part of the deal. They almost have to anyway to fund the condo association.

So there are some borrowers wanting to move some inventory and stay on their schedule, principally because the cost to carry continues to increase. But I haven't seen anything that would indicate a collapse or a material downward trend.

Part of our thinking when we originate these loans is to look at where our inventory is vis-a-vis the rest of the market, and make sure that if -- understand what the per square foot cost is to us and what we need to get out at, and how does that compare to the rest of the market. And that was one of the things that was causing us concern back in March, April, May of last year, is we didn't really like where our inventory was vis-a-vis the rest of the market. And so we've tried to avoid being the last institution in the -- the last building on the block. Because at that point you're at the highest cost compared to all your other competition.

There are some out there that could be out at the higher cost, but they also might have a better location -- closer to the train, closer to the lake, something like that. But at the moment, no material downward trends. But stay tuned; downtown might feel it more than our neighborhoods will, but it is possible that somebody somewhere could start a trend. Haven't seen one emerge yet on a broad material basis, though.

Ladies and gentlemen, this concludes the question-and-answer portion of today's conference. I will turn it back to Mr. Gasior for any closing remarks.

I hope we've answered everyone's questions to their satisfaction. Any last opportunities for questions at this point? I don't see anybody wanting to come back, so I'll thank everyone for their participation and attention, and their interest in BankFinancial. We look forward to talking to you or seeing you soon. Take care.

Thank you for your participation, ladies and gentlemen. Have a wonderful day.