BankFinancial Corp (BFIN) 2017 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the BankFinancial Corporation Fourth Quarter and Year-To-Date 2017 Review. (Operator Instructions) As a reminder, today's program is being recorded. And now I'd like to introduce your host for today's program, F. Morgan Gasior, Chairman and CEO. Please go ahead.

Good morning. Welcome to the full year 2017 fourth quarter 2017 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 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 use of the words believe, expect, intend, anticipate, estimate, project, plan or similar expressions. Our ability to predict results or the actual effect of our plans and strategies is inherently uncertain, and actual results may differ 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 statement in the future.

And now I'll turn the call over to Chairman and CEO, F. Morgan Gasior.

Thank you. As all filings are complete, we're ready for any investor questions.

(Operator Instructions) Our first question comes from the line of Brian Martin from FIG Partners.

To start, I guess, can you -- I guess, a couple moving parts in there, but can you maybe just talk a little bit about -- I guess, one of the highlights was the margin and just kind of what the drivers of the margin and just kind of how you're thinking about that going forward as it pertains to the loan mix and kind of the improvements you made on the funding side as well this quarter? Just kind of a recap of the quarter and then just how you're thinking about it since it looks like you obviously exceeded kind of where you're hoping to get to a little bit sooner? So that would be helpful.

Okay. Well, let's start with loan mix and the margin. So the loan mix continues to move in the right direction. The C&I growth was strong in 2017 and we would expect that to continue in '18. Pretty close to the same rate that we did in '17. We have a pretty good pipeline of C&I in all 3 segments of C&I going into '18. And so I think that will provide continued strength to yield and it'll provide continued strength to margin because the vast majority of those assets are floating rate assets at good spreads. The lease portfolio had quite a bit of activity in fourth quarter. As you saw, the investment grade leases paid down rather considerably. But we had probably about $25 million, almost $30 million of extra paydown in the fourth quarter that we weren't quite expecting. It was just a lot of cash came in on accounts receivables lines, cash came in on lease rewrites; a lot of cash came in. So we are starting the year slightly behind where we thought we would start the year in terms of interest income. So I could see the margin dipping a little under 3.40% early. But I think the same thing that held true in '17 will hold true in '18, which is that the loan mix will continue to drive the yields forward and create a margin expansion. So our goal would be sit in the mid -- low end of the range especially with a couple less days of activity in first quarter, might be in the mid-3.30s, but we could see it getting to the 3.50% range by the end of the year if the trends continue as they did in '17. On the funding side, we had hoped our best case scenario in '17 was to replace all the cash flow coming off the investment-grade portfolio with other types of leases. And we just didn't have enough volume in there yet to accomplish that. So the easy solution was to pay down the wholesale and since that's the most rate-sensitive asset we have, that was a pretty easy decision and helps with the margin. And I think that trend will probably go -- continue in '18. So we'll still see -- we have to be consistent with what our customers expect on the retail funding side. We'll continue to focus on growing retail funding. But in terms of the loan portfolio, you'll see quite a bit of cash coming off of the investment grade portfolio again in '18. You'll see quite a bit of cash coming from the residential portfolio. And those 2 things will provide more than enough cash to help drive the margin expansion during the course of the year if the origination trends continue.

Okay, that's helpful. And just -- as far as -- just kind of going to the originations for a minute. I mean, commercial was a little bit less this quarter than it kind of had been in the last couple quarters. Can you -- but you kind of mentioned in your previous comments about -- can you just talk about the -- your outlook? Has anything changed? I mean, you kind of gave us a pretty good update last quarter on how you're thinking about '18, but just by segment, kind of commercial within the commercial components in the real estate side, how are you thinking about it?

Sure. Let's start with C&I side. We had good growth in C&I on the health care side, but we had a couple of larger closings that just didn't get done by year-end, got into year-end timing and some of them related to HUD loans on the real estate side where we're partnering and just got to be too late in the year to get it done. So those loans actually just closed. That was a $12 million commitment, immediate draw of about $5 million or $6 million, which was closed last week. So we're back on track on the health care side. We like the diversity in the pipeline of different kinds of health care, and we're feeling pretty good about that. The Chicago commercial lending, C&I regional commercial banking also had a good year in '17 and they started '18 with a stronger pipeline than they've seen in a couple of years now. So they will not grow as fast as the health care C&I side, but it is starting to see double-digit growth in their portfolio. Their marketing is getting into a groove. We are always in the market to add 1 or 2 more C&I lenders. So if that happens, that would be even more helpful. But that's turning out the year on a positive note. National commercial leasing lessor credit, we have some -- another -- we have also some good opportunities in the pipeline. We added a couple of new lessors late last year, third quarter of last year. We have 2 or 3 new ones in the pipeline for this year and that too could see low- to mid-double digits growth in that portfolio. So if you take all those together, that's why we think in the C&I portfolio, growth in the 25% range on the low side and equal or even exceeding the 2017 growth rate of 54% is feasible. But I caution you that these deals take a while to take hold. The draw activity can be volatile, as you saw that in fourth quarter, we got a lot of accounts receivables lines paid down right at the end of the year. So the good news is it helps the average earning assets and the average yield, but the period-end balances could be volatile. On the real estate side, we would expect that multifamily will do about mid-single digits next year -- or in '18. You will see higher rates affecting the market a bit, both in terms of debt service coverage capacity on new deals, and also you might even see the cap rates nudging up a little bit, which will have an effect on valuations and investor interest in buildings. Already the deal vine is a little thin. People are looking around saying, "I really, really like the value on my building, and I'd love to monetize it, " but they are having an increasingly difficult time finding a replacement property. That said, we're seeing more interest in our other products, real estate lines of credit, things like that so people can be active in the value-add market. And we would expect to see more of that in '18. So that's kind of why we think, even though the market volume might slow a little bit, especially in the second half of the year, as higher rates -- if we get 2 and 3 rate hikes, those higher rates will start slowing down those opportunities. The way we're positioned in the market in the rent-by-necessity smaller market, we still should see a reasonable amount of value-add opportunities and repositioning opportunities as the year goes on. And then, in leasing, you saw that we were able to grow the other part of the portfolio outside of investment grade fairly well, not quite as well as we would've liked. That continues to be the focus in '18. And gradually, as we get out with the lessors and talk to different people, we're seeing more of those opportunities. But we would think that leasing -- the lease portfolio might grow 5% off of that 2017 baseline. We'll still get a lot of cash from that portfolio. And outside of investment grade, it's pure credit. You really have to look at these lessees, understand the structure, understand the essential use of the leased assets and really know what you're doing. And I'll also say that the credit spreads in there are as compressed as we've ever seen. So you also have to make sure you're getting paid for risk. So with all that being said, we would see the commercial-related portfolio, which is multifamily commercial real estate, commercial leases and C&I grow about 10% to 12% in '18 and the offsets of that will be residential portfolio paying off, and the risk to that would be we get more paydowns on the investment grade portfolio and we're not able to replace them as much as we would've like with the other leases. One thing we will add to leases this year, we expect to earn out of the federal DTA towards the end of the year. As a result, we can open up a new channel for tax-exempt leases both on the federal side and to offset state taxes in certain markets where we're generating state taxable income. We have not been in that market. So we may see a little bit of help from volumes by looking at that market. We're not sure if the yields will still justify it. We'll have to get talking to people about that and see what it looks like. But if we see some modest volume out of tax-exempts, it'll both help the lease volumes and reduce our overall tax rate for '18, and those are 2 good things.

Perfect. That's really great color, Morgan. So kind of putting it all together, maybe a little bit less than a 10% rate, if some of those -- if the 10%, 12% in the commercial and then a little bit backup elsewhere kind of a net number maybe somewhere a little bit less than 10% or around 10% is kind of how to think about all-in...

Yes, I'd say mid- to high single digits on the overall loan portfolio. We'd really have to get cranking on leases to make that number bigger than that.

Okay. And just going back to the margin for one minute. I guess, the -- where you guys ended the fourth quarter, just kind of given some of the timing issues of paying down those wholesale and getting the payments in -- or the cash in at kind of end of the year. I mean, I guess, as you enter the first quarter, I guess, it would -- maybe you said it was going to back up a little bit. Can you just, I guess, run through why it may dip a little bit in that first quarter. Maybe I just missed, was it just timing issues?

Yes, it's really kind of a timing issue. We got a lot of cash in right towards the end of the year. So if you just look at quarter-over-quarter payoffs, the prepayment rate was like almost $30 million between third quarter and fourth quarter, and we were not planning on all that cash coming back. So if you were to just take, say, a 4% yield on $30 million on average, we have to put that money back to work and then that will drive -- that will continue to drive the margin higher, but we took a step back. Also remember in first quarter, you have a couple of days less for interest-earning assets. So that hits it a little bit. So those 2 things combined will probably cause a dip in the margin for first quarter. And paying down the wholesale is a good thing. But the wholesale that was rolling off was below 1%. The replacement rate would, obviously, be much higher now. So we did give up a little margin when that happened.

Right. Got you. Okay. All right, how about maybe just -- maybe 1 or 2 more and then I'll let someone else jump in, but just the -- on the expense side, things looked pretty good. I guess, maybe you can give an update or Paul wants to give an update. I'm just curious if anything's changed from kind of how you were thinking about things last quarter kind of getting down to I think it was maybe around a $37 million run rate as you get into late next year and just kind of the -- getting the NPA and OREO expense kind of down to pretty de minimis levels, I guess. Any thoughts on that?

Well, let me add a couple of points and then I'll turn it over to Paul. The -- we're thinking somewhere between $37 million and $38 million seems a good run rate for us. There are a couple of initiatives that might trim expenses down a little bit. But we added a couple people for commercial banking at the end of the fourth quarter and that will take a little time to -- for them to get moving on generating revenues. And so as a result, I'd say that $37.5 million, $38 million seems a good range. The NPA, as you point out, is under control. We actually have a few deals in the pipeline to get rid of some of the other assets we have now. And so far, that side looks pretty good on the expense side. IT will tick up a little bit this year. We put some more money into cybersecurity. We've upgraded applications for BSA compliance and things of that sort during the course of last year. So that will tick up just a little bit, but not by huge amount, maybe $50,000 to $100,000, if that. So the comp side will be the variable this year depending on how our incentive goes. But generally speaking, that $37 million to $38 million number seems reasonable to us. I don't think we'll beat it by very much, but we also probably won't exceed it by very much. Paul, do you want to add anything to that?

No, that's a pretty good summary. Brian, we're -- the change from third quarter, as Morgan pointed out, we hired a few new people, but with those people should come additional revenues, either on the net interest margin side or on the noninterest income side. So even though expenses are ticking up, we expect there to be an increase in revenue to offset that increase in expense.

Okay. So the -- so I guess, just to be clear, Paul, the -- while we're talking just in general kind of big picture, the run rate in the fourth quarter is kind of it -- the $37 million, $38 million you were just thinking for full year '18 were kind of in the $37 million, $38 million type of range.

For full year, we should be $37 million to $38 million. If these people perform, it's going to tick up closer to the $38 million when you add in the incentive comp associated with the activity that they will bring to the table. But if you start in first quarter, because of the seasonal expenses, the annualized run rate is going to be a little higher because you got the additional payroll taxes in first quarter that you have to cover and seasonal occupancy expense. So first quarter will have a little higher annualized run rate, but then it should normalize down into the mid-$37 million to $38 million annualized run rate through the year.

Yes. I think one thing for us in '18 is, we had flat noninterest income in '17. The people we've added in late '17, primarily will generate noninterest income either through trust or through some other activities. So we think that it's a reasonable estimate to think that our noninterest income will go up between 3% and 5% for the year. If we get to that higher end of the incentive comp, it will grow by more than 5%. And we should start seeing some of those revenues flow through early -- a little bit in the first quarter and then more robustly in second quarter. So from an efficiency ratio perspective, we'll either hold our own or we'll improve it by the time we start getting into the second quarter and for the remainder of the year.

Yes. Our efficiency ratio should start somewhere in the mid-60s, and by year-end, hopefully trend down to the low 60s.

Okay. And do you show the efficiency ratio this quarter, Paul, being around 60%? Does that seem accurate? Or is that my...

Yes. It was low 60s for the fourth quarter.

The fourth quarter, okay. And then, maybe one more, and I'll jump -- and I can join back if need be, but the -- Morgan, if you talk about just kind of big picture '18, kind of where you're most focused. I mean, it feels like the expenses are in pretty good order. It feels like the credit is in very good shape. The margins -- I guess, is it really about driving loan growth this year and improving the operating efficiency through that channel? I guess, is that the focus? Or is there other priorities that the board and you have that are -- I guess, maybe you can talk about?

Well, I would say, optimizing the loan portfolio is -- will be the #1 goal and it continues the trends in '17 and even -- I mean, in the '17. And so far that's been working. But we can see margin expansion and yield growth as we continue to execute that. And that is the top focus. You may or may not see, as we said earlier, double digit net portfolio growth overall, but you could see it in the targeted aspects of the portfolio we're focused on. And that can produce some pretty good results on the yield side with steady credit. The deposit side, we just want to keep optimizing the franchise there, if each one of our branches can grow their customer base and help fund the loan growth that we get on a net basis, work on the noninterest income side of it through different new products, that will all be positive to our bottom line without a great deal of additional expense. They're teed up for it. On the capital management side, we historically like to see a dividend payout about 50% of earnings. So I would expect that once we get past the first -- the fourth quarter here with the DTA adjustment and we get into first quarter, we'll probably be looking at the dividend rate -- the dividend payout again. And to the extent that earnings continue to improve, the dividend will continue to be in play. Share repurchases, we did pretty well with share repurchases in '17. Maybe we won't be quite as aggressive. It really depends on market conditions and availability and all that. But if you thought we might do low to mid-single digits on share repurchases, I'd say the 3% range sounds pretty reasonable to me, might be better if we see a lot more cash availability for the holding company or if there's some kind of correction that we can take advantage of market conditions. But at the end of the day, if the franchise gets to be a pretty strong earner with very good asset diversity, very good deposit composition, very good credit, very good capitalization, good shareholder performance in terms of dividends, EPS growth, that would be the focus. If other things come our way in terms of an acquisition, we remain interested in that. We would want it to be a lower risk deal or something that we think we can integrate smoothly and that fits the overall franchise, but it's not something that we're -- is our highest priority to execute. We think we got a good thing going here and let's perfect it.

Brian, let me just add one more thing, because I know it will help you in terms of your forward forecast and others. You can assume an effective tax rate going forward of about 27% for 2018.

(Operator Instructions) And this does conclude -- we've got a follow-up from Brian Martin from FIG Partners.

Well, I didn't know if anyone else wanted to jump in, but maybe just 1 or 2 others for me, and that was just on the -- Morgan, just kind of the -- with the tax rate and the tax reform, it seems like that's going to give an extra kick to kind of the profitability outlook. You've kind of outlined most of that, but just -- can you talk about, maybe, if you've changed your outlook on kind of looking at profitability maybe from on ROA standpoint or just how we should be thinking about it now that -- I mean, if you get rid of most of the -- and we used to talk about the pre-pre-ROA now that the provisioning is -- and the credit costs are much lower, just kind of from an ROA standpoint, how you're thinking about the franchise in '18 and beyond and where you think you can -- what levels you can get to?

Well, I think as far as '18 is concerned, we certainly get a benefit from the lower tax rate. And also -- but given the change in the improvements and just the fundamentals, we should start pushing north of at or above 100 basis points in the second half of the year and we should be able to maintain that. We had a pretty high effective tax rate even within the financial services area because we really didn't have any tax avoidance or tax protection like municipal securities or tax-exempt leases in the portfolio. So we probably got a little better pop than others. That said, we're still in Illinois and we have still what seems to me a relatively high tax rate compared to other people. But we should -- with the benefit from the taxes, but also the benefit from the changes in the organization, we should start in the second half of the year start pushing at or above 100 basis points. This is kind of prorated all if we can get to somewhere between 100 and 120 on a consistent run rate and continue to do what we're doing, I think that's reasonable. That might get ameliorated if we start getting into growth mode on marginal funding versus marginal loan growth. On the other hand, the efficiency ratio will improve. So that's -- we think that rising tide has reset the baseline. It just kind of helps the -- helps us move along towards that goal. We were in the mid-80s or so at year-end and we'll continue to build on that going into '18. And as far as '19 is concerned, we really have to see how '18 progresses. Will we get the stronger economic growth that we hope to get from tax reform and greater regulatory flexibility? We all hope so, let's see if it happens. What will be the impact of higher rates on market conditions, whether it's in the real estate side or even on the leasing side? What will be the impact of the tax reform on leasing? There's a lot of different speculation out there of the impacts of immediate deductibility of investment on leasing, then there's the conversations about all this cash coming in and repatriation and what that does to demand. Will people just pay cash for equipment? So we really need to see how '18 plays out. But we do think that the bar has been set higher given the benefit of tax reform and we're in a pretty good position to get there.

Right. Okay. And then, maybe just on the funding side, when you talked about the outlook for the loan growth. I mean, I guess my assumption is you will fund the loan growth with primarily with deposit growth and with -- like you're saying, you're resetting the wholesale piece there where you give up a little bit of yield. Can you just talk about that funding cost pressure in the market? It sounds like the last couple quarters it's been pretty de minimis for you guys on that front. But as you start to get into more loan growth and as you remix the portfolio, are you feeling anymore pressure today? Do you expect more? Or is it...

I would say, especially as -- if this 2 or 3 rate hike scenario plays out, you get another uncertainty, that you will see -- and we've modeled for higher deposit rates in the portfolio. It's -- there's still plenty of competition, plenty of banks in the Chicago area and customers are eager for higher yields. So we've been -- I think it's worked for us so far because we've been treating our customers appropriately in terms of deposit rates and keeping up with things. I think probably the bigger challenge over time when you get to the latter part of the year would be funding on the margin. We'll probably look more at CDs because of matching off against term debt here in the market. There is some pressure in Chicago on what I'll call premium money market accounts by a couple competitors, but they tend to set expectations and drive the market. On the core side, those betas and those yields -- those cost of funds will remain, I think, favorable, but you can't take people for granted, as we've said before. So I would say that we have a pretty good chance of meeting our funding needs just through the franchise we have now. If all of the sudden, we're growing loans rather strongly and we need to do something about deposits, that's when a small acquisition might make sense for us.

Okay. And on that front, Morgan, I guess, is there anything -- when you kind of look at the M&A pipeline, if you will or just kind of discussions, I mean, can you just comment, is there anything that -- have discussions picked up at all? Or are they still pretty low on the activity list? Or just how would you characterize activity or discussions? Can you give any color on that?

For our end, it's been fairly quiet. We continue to get to know people and look around a little bit, but our parameters are that we're looking for a relatively low-risk opportunities where the deposit franchise is strong and we can manage it appropriately and integrate it into our organization smoothly. We're also not really interested in taking on legacy credit risk, and sometimes that creates a pricing gap because we might have a different view of the assets they're trying to work through than they do and how to deal with those. So to us, we're really not interested in taking on other problems. And if the consequence of doing so, if we can't come to a price agreement because we'd have to swallow assets we'd rather not have or at a level we'd rather not -- we can't really justify, then we'd rather pass on the deal. And then, I think tax reform might change pricing expectations a little bit for some people and ironically make it even a little harder in some cases if their fundamentals don't change. They'll get a little bit benefit of taxes, but if the profitability is thin, expenses in Chicago continue to rise, whether it's real estate tax expenses, state tax expenses, utilities expenses, it's still a pricey market to operate in, and so we'll see. We're open to the dialogue. We will, I'm sure, have conversations with people here and there, but it would have to be the right fit in pretty much all fronts and we'll just have to see what happens.

Got you. Okay. And then, maybe last one for me, it was just more of the reserve kind of provisioning front. I mean, I guess, it sounds like, I guess, maybe any change to your thoughts that you guys kind of gave last quarter? I think you've talked about kind of maybe a 60 to 75 basis point range on the reserve or the provision going forward, Morgan. I guess anything -- I mean, I know it's dependent on the mix and how you guys are growing, but given that you expect to grow -- given your outlook for growth more on the commercial side, has anything changed there? Or is that still pretty consistent with how you see the reserve going forward?

I think it's consistent with what we're seeing. And again, depending on the mix if it's a little bit more C&I, I would probably be towards the higher end of that range. So certain [C&I] assets would be booked at the traditional 1%, maybe even a little higher. The lower risk assets would be in the 60s or 70s. So if you think of it this way, if we really skewed towards other leases, not investment-grade type stuff, if we skewed towards the stronger growth and the C&I portfolio, I would say that the reserve ratio would be at the higher end of the range rather than lower end of the range. Now the net provision might not be quite so much because we'll release reserves coming off of some of the portfolios and runoff. But for those assets that were bookended, it would be at the higher end of that range.

Okay. And still no concerns -- I mean, I guess, we've talked about this in the past on the concentration side just given how you guys are looking at that today?

No. I mean, we've had extensive -- internally, if you look at our concentration of credit, it remained relatively constant to capital. The 50% risk-based capital component of multifamily is at its higher level ever, probably has some more room to grow as credits season. So the risk profile there is very strong. The geographic diversification certainly helps because we're in markets in high demand from an economic perspective, whether it's employment demand or GDP growth. So that seems to be all working. That said, with a mid-single digits growth rate, we're not likely to change that profile very much so -- and again, look at the capital ratios. The capital ratios are and remain strong. So when you run virtually every stress test tool that's available to you, they all come out well. So we have the room to grow if we want to. I think our bigger constraint on it is, simply the market itself is pretty mature and we're going to have to work pretty hard with and for borrowers to get good deals done. Just because the valuations there are pretty rich right now, they kind of run ahead of the overall economy for the last couple of years. I'd say that's the bigger challenge to grow than concentrations.

And this does conclude the question-and-answer session of today's program. I'd like to hand the program back to F. Morgan Gasior, Chairman and CEO, for any further remarks.

Well, we thank everyone for their interest in BankFinancial, and we wish you a good early 2018. We'll be back in touch in the second quarter.

Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.