BankFinancial Corporation
Q1 2013 Earnings Call Transcript

Published: 11 May 2013

[Operator:]

Good day ladies and gentlemen and welcome to the Q1 2013 BankFinancial Corp. Earnings Conference Call. My name is Clinton, and I will be your operator for today. At this time, all participants are in a listen-only mode. We will conduct a question-and-answer session towards the end of this conference. (Operator Instructions) As a reminder this call is being recorded for replay purposes. I’d now like to turn the call over to Mr. F. Morgan Gasior, Chairman and CEO. Please proceed, sir.

[F. Morgan Gasior:]

Good morning and welcome to our first quarter 2013 investor conference call. At this time I would like to read our forward-looking statements.

[Unidentified Company Representative:]

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 the purpose 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. These are often identifiable by the 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 statements in the future. And now, I’ll turn the call over to Chairman and CEO, F. Morgan Gasior.

[F. Morgan Gasior:]

Thanks, David. A couple of notes, first as you maybe able to tell from my voice, some of us are battling the spring cold. So I apologize in advance for coughing or sneezing or anything, like that. Glad everyone else is on the other side of the call. And then two, the only other thing I’d like to point out is, this quarter in our five quarter supplement, we added some additional data that I think underlines some of the things we’ve been saying for the last quarter or two. We added some information on loan origination, loan payoff and loan payoff activity that involves a higher risk rated loans. For example, watch list loans rated five, Special Mention rated six or sub standards rated seven. and we did that just to kind of start to break out the loan origination trends that’s obviously one of the critical metrics that we’re all managing too, if critical to put the cash to work and rebuild the net interest margin and the best way for investors to see the grossed up of data rather than net data. So just for that – for those purposes, we’ve included that data. We’ll maintain them for the foreseeable future. But just wanted to call your attention to that data that’s out there that’s new for this period of time. And with that, our order filings are complete and we’re happy to answer questions.

[Operator:]

Thank you. (Operator Instructions)

[Unidentified Company Representative:]

It’s a quite day on the question line, I’m happy to provide a little more of an overview of the quarter and trends if that would be useful.

[Operator:]

We do have an audio question it comes from the line of Brian Martin of FIG Partners. Please proceed.

[Brian Martin:]

Hi, Morgan.

[F. Morgan Gasior:]

Good morning.

[Brian Martin:]

Morgan, can you talk just a little bit about the data you put in this quarter about the originations in the paydowns and maybe when you expect to see some let up in the paydowns and payoffs, just given, it looks like the originations have been reasonable here especially, maybe you can even talk a little bit about that as far as the originations when you look at the commercial piece, which seems to have interacting pretty nicely, just being a bit overshadowed, if you will, by some of the credit clean up, I guess, in just the payoffs and what not?

[F. Morgan Gasior:]

Yeah, there is actually – and thanks for the question Brian. There is a couple of factors moving in there that I’d like to draw some attention to. Let’s start it top to bottom now. As you can see and as we’ve been discussing in the last couple of quarters, the loan origination activity is picking up and if I were to tell you kind of segment by segment, as we went through the business mining process beginning middle of last year and reconfigured products and pricing and everything else to deal with the environment we’re in. National Commercial Leasing really came out of the gate early and has had a couple of very good quarters. Usually, first quarter is one of our weakest quarters, everybody gets the right key budgets consumed in the third and fourth quarter and then they kind of take a breather and it picks up again later in the year. But the programs we rolled out to the market had a good stimulative effect. We’ve also added some good new lessees and strengthened the relationships with lessors. So I would say it will still be somewhat (inaudible) you’ll not see every quarter in the $30 million range. But we continue to maintain a reasonable pipeline going forward. And a corollary to the leasing volume is, particularly in the bridge line activity as you saw in the overview. When a lessor is installing equipment for a lessee, the credit exposure will initially show up on a bridge line if we are going to wind up with the lease at the end of the installation period. So in that what happens then is when the lease is finally funded and converts to the discounted lease then the bridge line is repaid and the lease takes its effect. So to some degree of that period is a zero–sum game, but the good news for us is, we’re putting the money to work earlier in the process, which is always an advantage to us. Leasing still has some different products to rollout and both on the lessor and on the lease side, so I would say that while our volumes in that category will not necessarily be consistent quarter-over-quarter, we’re still going to trace $120 million, $140 million for the year totaled would be a very good target range for us in leasing. So you may have a weaker second quarter, but I already consult from pipelines that we’re going to have a pretty good third quarter coming up. The equipment installation periods sometimes are shorter 60 days, sometimes as long as 150 or 180 days. On the multi-family front, we actually thought we do a little bit better than first quarter given the pipelines. We had a couple of deals that we lost due to purchases where the borrower and the seller couldn’t come to an agreement on one of the terms or another, one of those deals resurrected itself and it looks like it’s going to close in second quarter, one of the deals they walked away from. But again those pipelines are strengthening. And with some of the moves we’ve made to the market, we’re trying to shorten up the origination process by getting due diligence done earlier in the process. So I would say that the first quarter for multi-family was a fairly light quarter for us for 2013. Those numbers should be moving up fairly aggressively in second, third and fourth quarter. Commercial real estate was a good quarter. That’s a little more opportunistic. So if it was what it was in first quarter, it might be 20% less, it could be 20% more in any given quarter. But again, we’re seeing a fairly steady stream of that. And one broader thing about multi and commercial real estate which we’re now starting to see the payoff activity and really for the first time in a long time is we’re seeing more deal opportunities for purchases. And that’s actually was a bit of a surprise to us in first quarter. We did not expect the pay down activity we saw in either commercial real estate or multi to that extent. We knew a couple of borrowers had buildings up for sale and that had been under contract and we expect those to close. But I would say probably a good 35% of our multi-payoffs were building sales and some of those were in at the risk rating 5 and risk rating 6 category. And the reason for that is the prices have stabilized to the point where the borrowers have been able to get out, pay us often slow and then start managing that building. And that has two components. The good news is you’re getting rid of those marginal credits. The bad news is you’re getting the cash back and the ultimate bad news is those are usually higher coupon loans because you risk-priced them according to the risk rating. So you take a little bit more of a hit to the net interest income as a result. But it’s still probably the right place to be. Our challenge in that environment is to get in front of that purchase and we started taking steps as we saw that activity coming the quarter; we went back out to the market with a couple of programs that are designed to us in front of the purchase, sooner rather than later. It’s somewhat easier said than done because often the purchaser has their own financing in mind or in place. So you’ve come into the part kind of late, but if you’re working with the real estate broker or the transaction originator upfront, you might have a better chance of at least competing head-to-head on that transaction. And the same thing on a sale, one of the things we’re going to do is, get back out to the borrowers and say, look whether you are high risk-weighted loan or not, if you’re thinking about selling a building into strengthening market after so many years of watching valuations either be stagnant or decline. Why don’t you send your – why don’t you send your purchaser to us, we constructed a relatively efficient cost and processing mechanism sort of like refi plus if you would think of it that way. So that right off the bat you’re going to take the hit on the coupon, if it hasn’t already reset. But at least you’ll keep the credit you get an opportunity with the new borrower. So in that if there’s going to be a purchase, let us provide the market with the most efficient purchase financing possible and maybe you get a chance to keep that credit as opposed to just watching the pitch combined getting the payoff letter. So those are some the initiatives we’ve taken. And I’d say in a perfect world for us, Brian, what would happen is the middle column where you see payoffs declined, because we’re capturing either the sale activity or getting in front of that refinance competitor more and more effectively, but the five in hirers, we want those to continue to payoff especially in the sixes and the sevens, so we can get under our 30% classifieds to capital ratio that we’re targeting for the end of the year.

[Brian Martin:]

Okay. I guess right now the payoffs you’ve seen in the last couple of quarters, I mean, I guess, is that – you would expect that number to be materially lower or just modestly lower, I guess, over the next couple of quarters?

[F. Morgan Gasior:]

I’m going to go, until I get a better handle on how we’re going to be able to get in front of these transactions, let’s go with modestly with the optimal goal of being materially.

[Brian Martin:]

Okay.

[F. Morgan Gasior:]

It’s just not a good time to be losing the good loans to good loan opportunities regardless of why it’s happening. So that’s why we turn around and took another look at how we can get in front of those transactions to protect that portfolio and it takes some rather unusual steps. We’ll get in front of that customer and get that due diligence organized very, very early in the process to the point where our purchase could close in as little as 14 to 30 days as opposed to 60 to 75 days is what is typical on the market. And that usually works for both sides and especially works for our transaction facilitator like a real estate broker.

[Brian Martin:]

Okay. So I mean I guess the end goal, I guess, is as you look maybe over the whole year as opposed to just a given quarter, was your thought be you can demonstrate in that loan growth in…

[F. Morgan Gasior:]

Yeah, absolutely. We absolutely have to.

[Brian Martin:]

Okay. And as far as…

[F. Morgan Gasior:]

We have…

[Brian Martin:]

And as far as kind of putting that excess liquidity to work, what are your thoughts, if it takes a bit of time to get the loan pipeline kind of generating bottom line growth, I mean I guess do you just leave this in cash for the moment, do you put it in the bond portfolio or how are you thinking about that, I guess, more near-term?

[F. Morgan Gasior:]

Yeah, it’s an interesting question. One, we’ve been taking a look at various options in the securities portfolio and obviously with the behavior of interest rates in the first quarter, it gave one a little bit of pause. You saw a rising rate environment for the first eight weeks of the first quarter, but by the end of the quarter, rates were smacked up back into where they were at the beginning of the year. And really, you haven’t seen much movement since the end of the quarter on that, rates seemed to be bumping along the bottom. And in some cases, yields and mortgage loans touched fresh lows in the second quarter. So what you likely see during the course of the year is we’ve designated a certain amount of cash roughly about $75 million. But the number changes that could be as high as the 100 depending on the composition of the deposit days for a liquidity portfolio. It’s there to be a source of strength for customer deposits and corporate needs especially if you have a extremely unusual rising rate environment or something else would have happened where you want that on balance sheet liquidity. OCC is focused on balance sheet liquidity. Our board is focused on balance sheet liquidity. Right now, you’re not running interest rate risk or mark-to-market risk with the money sitting in cash. You probably could pick up a 100 points, maybe a little bit more, maybe a little bit less by putting some assets in some short duration high grade securities. So maybe a 75 points you’d pick up. You might see us move towards that especially if there’s kind of a movement in a little bit of a higher interest rate, not much about 2, 5, 10 basis points. It’s just a little bit uncomfortable to be investing at or near the bottom of the market in terms of yield, knowing that five seconds later, even a 20 basis point move is going to put that security under water. Now they are very short durations, six month, one year, 18 months and the durations are laddered out, we’re not going to be particularly concerned about that. But right now, cash especially when you saw yields go as low as they were and not really move, cash seemed like the safest place to be. We will start to build that liquidity portfolio up over the course of the year. To go further, say 18 month duration, 12 to 18 month duration, that’s a little bit more of a challenge for us. We’re actually (inaudible) going to look at growing the residential portfolio using a couple of different new hybrid arms, you’re going to get better yield performance, you’re going to get customers with it, you’re going to get a servicing asset with it, and you’re going to get a better risk based capital then say a corporate bond security or something like that. So I think two things is, we’re going to start to move in liquidity portfolio, we’re probably not going to really push the duration window in the securities portfolio to any great extent. But we will start looking at booking some residential loans with new hybrid arms and see if that can bridge the cash gap.

[Brian Martin:]

Okay. And maybe just last two questions, just on the expense side, I think you’ve talked about those and maybe give – maybe some color on just how you’re looking at those, I mean, maybe relative to two kind of buckets, maybe just a credit related cost that flow through that and then kind of the other cost just kind of the more core expense then I guess I would say.

[F. Morgan Gasior:]

Let’s do the core expenses first actually. We have a little bit of bump in our core expenses in the first quarter to the seasonality and also some of the new tax law changes had a little bit of bigger bite on things like Medicare taxes, payroll taxes than they did before. So if you looked at the trend line, we were up almost $500,000 quarter-over-quarter and that core quantum benefits expense will trend back down, now that we’re passed that first initial window, but some of the loan, because they’ve uncapped some of these payroll taxes. The larger point on core expenses is we did some benchmarking late last year, looking at some Chicago peers of different sizes, because Chicago being the cost environment, we have to deal with real estate taxes and things like that. And what we decided to do was, after we looked at transaction activities, the continued migration to electronic channels, electronic usage. we decided to make some fairly significant structural changes in the branch operations and in call center operations and then we did our normal business reviews of strengths and weaknesses in commercial loan origination. So as I’ve referenced in the overview, we’re probably going to have a rather significant headcount reduction that’s processing through the second quarter and we’ll settle in somewhere in low 300s in terms of personnel, but even with that we added four new commercial bankers from some very strong competitors in the last two quarters. And we haven’t even seen some of their new loan production yet hit the pipeline. So, you are just getting acclimated and back out to the their market sources. So for the first quarter we had, probably I would say $400,000 or $500,000 worth of sort of seasonal expense. You are going to see that start to drop on the comp and benefit side starting in the third quarter, after we get down with severance payments and so forth. In the second quarter you will see a nominal impact, but you really start to hit it in the second half of the year. You will also see some improvement in IT and FF&E expenses. We tend to run very short depreciation cycles. We’re re-programing one facility that we are doing as a sort of a 20% rate customary service center in the University Chicago high product market. We really just didn’t get the usage that we are hoping out of that market, the mobile check deposits and Smartphone growth is over shadowing a need they even come into a limited service facility that’s technologically advanced. So, we are going to be closing that facility and repurposing it through a sublease. So, you will start to see the depreciation and IT and [FF&E] expense start to decline in the second half and we’ve already seen this in the early part of 2014 as the finally depreciation schedules roll off. So I think a $3 million, $3.5 million maybe as much as $4 million improvement in base core expenses is already in the works and it will manifest itself gradually through the year, but have full force and effect at the first quarter of 2014. On the credit expenses we about couple hundred thousand dollars worth of some trailing expenses related to the bulk sales that hit in the first quarter. But one of the reasons we moved the $7 million of loans in the non-accrual was to go out and (inaudible) from the borrower. Recall that when we did the bulk sales; this is the best way to get rid of the assets that have the least demand and the lowest hold period. So we’ve already eliminated the litigation expenses pretty much in this point forward on those assets. As I said, we had some trailing costs in first quarter. The next question was for some of the smaller assets that there is equity positions or ordinary course of business dispositions, what is the best way to move those assets off expeditiously? And the answer was to not renew the loans and just push the borrowers for resolution today. Some will cooperate and give us a deed in lieu, others will not. They’ll force us to go through some process. But even then, they really understand that once the receivership takes over and the cash flows are chopped off, there’s really no upside for them. So I expect that we’ll see better results over the next two quarters as they realize the inevitable is upon them. And as you can walk away from the deal, the deed in lieu reliefs somebody – anyone on a deed in lieu relive somebody of personal liability. If you’re going to walk away from the deal and give us the keys, avoid personal bankruptcy, avoid getting your credit rating dragged through the course for the next two years, people might see the ultimate wisdom and benefit to themselves. So again the credit costs will start to decline starting second in second quarter. We’ll see a little bit of volatility as some of a couple of the larger cases that we put on non-accrual go through the early litigation process. But even then, that will start to mitigate itself. The real estate tax expense will start coming down as we resolve more of the REOs. We did a pretty good resultant first quarter and we’re looking to have an equally good result in the second quarter for REOs. And again, the more of this stuff we can push off the books all those numbers go down rather precipitously. So on both fronts, the expense issue on the core has been fairly aggressively addressed there is always a little more opportunity here and there, where we took some fairly significant moves already and there are some smaller moves to come. Without necessarily sacrificing marketing for the key loan types that we need to do, In fact if anything we strengthened up and the credit cost will start to come down during the course of the year as we move the assets off, especially if we have a reasonable success in doing the deed in little reps. It will just be a lot faster, we’ll save money on those, we’ll save money on receivers, we’ll save money on real estate tax accruals post place insurance all those things are to our benefit and to do it as quickly as possible.

[Brian Martin:]

Perfect that’s helpful and then just maybe last thing just from a bigger picture standpoint with the moves you are making with the liquidity and giving the loans generation started up again. My I guess, is your thought that the margins should be cut bottoming out and trending higher I guess as the loan growth materializes maybe it’s not second quarter, but just perspectively.

[Unidentified Company Representative:]

Yeah I would agree with that. We still have a couple of quarters of standard decent size quantities of maturing loans. But one of my least favorite sources of income is prepayment income, loan prepayment income and I still have requests on my desk for waver our prepayment penalties from customers who just think everything should be for free, but we still have a couple more quarters where rate variances are still somewhat of an issue for us, once we get passed those and towards the end of 2013 then it’s really I think our opportunities for margin expansion will be in front of us. Now it’s also possible that you could see further compression of spreads in the origination market. We get out there early with some fairly aggressive programs. There were some competitors who aren’t there, but obviously they might get there. So, we’re always looking above our shoulder to see who is chasing us, but I would say that we do have some good opportunities for margin stabilization and especially margin expansion in the latter part of the year and started to get into 2014. I don’t want to ever say we’ve turned the quarter and here we go. But we do start seeing the light at the end of the tunnel here.

[Brian Martin:]

Okay. And you said, if I heard you right and maybe in your earlier remarks, you talked about the class 5 ratio, your expectation is that gets down to 30% sometime by the end of this year?

[Unidentified Company Representative:]

That’s our target. We want to get at or under if we can. It doesn’t mean big bulk sales and taking huge hits to capital.

[Brian Martin:]

Right.

[Unidentified Company Representative:]

But it’s part of why we looked at and said okay, how fast can we move these assets off the books and get to that number as opposed to just sitting here and letting the courts take their time and get to the same place six months or 12 months later.

[Brian Martin:]

Okay, perfect. Thanks for your time.

[Unidentified Company Representative:]

Thank you. Good questions.

[Operator:]

Thank you. (Operator Instructions)

[Unidentified Company Representative:]

Okay. Well, I would normally solicit more and more questions, but my voice is about to give out anyways. So I’ll go, going once, going twice, going three times. Thank you for your participation, your interest in BankFinancial. We’ll be having our Annual Meeting coming up in June, and then obviously our regularly scheduled investor conference call after the second quarter results. So spring has finally sprung in Chicago. So we hope you enjoy the new weather wherever you happen to be. Thanks, again.

[Operator:]

Thank you, ladies and gentlemen. That concludes your conference call for today. You many now disconnect. Good day.