BankFinancial Corporation
Q4 2007 Earnings Call Transcript

Published: 8 Apr 2008

[Operator:]

Good day ladies and gentlemen and welcome to the fourth quarter 2007 BankFinancial Corp earnings conference call. My name is Lauren and I will be your operator for today. At this time all participants are in listen only mode. We will conduct a question and answer session towards the end of this conference. (Operator Instructions) As a reminder, this conference is being recorded for replay purposes. I’d now like to turn the presentation over to your host for today Mr. Morgan Gasior, President and Chairman and CEO.

[F. Morgan Gasior:]

Good morning. Welcome to our fourth quarter 2007 conference call, our first call of 2008. At this point in time we’d like to read our forward-looking statement.

[Female:]

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 10K for the year ended December 31, 2006 and other filings with the Securities & 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 forward-looking statements.

[F. Morgan Gasior:]

First, all filings are complete. We were a little bit ahead of schedule this time around so we decided to get the information out as soon as it was ready so we do apologize for the shorter notice on the conference call. But having said that, everything is out and we’re available for questions.

[Operator:]

(Operator Instructions) Your first question comes from the line of Ross Haberman with the Haberman Fund.

[Ross Haberman:]

Could you talk about your interest rate exposure and as rates are coming down how do you see that affecting the spread and the margin? And one specific thing, how much of your loans are adjustable rate as of yearend?

[F. Morgan Gasior:]

I guess the specifics on that Ross are going to come out in the 10K here shortly. So, I don’t want to preview the 10K without having the exact numbers available but let me just recap where we were at the end of third quarter and give you some basic views on the topic. We were slightly liability sensitive at the end of third quarter and as we had said at the time we felt that we wanted to improve that liability sensitive and become a little bit more neutral as time went on and we were able to do that. Going forward that slightly liability sensitivity will still be out there, it will be somewhat less than it was at the end of third quarter. Adjustable rate loans obviously, there’s going to be various categories of adjustable rate loans you’ll have adjustable rate mortgages that will reset during the year, you’ll have commercial lines of credit that adjust sometimes monthly, sometimes quarterly. Sometimes you’ll have lines of credit that are fixed for a year that will then mature during the year. So there’s a variety of moving parts in that and I think it’s kind of hard to generalize. But, the board of directors and the board and asset liability management committee has been very focused on maintaining a fairly careful balance on ALM and looking at gaps and spreads along those lines. What I would tell you is that the current interest rate environment notionally should be more favorable for net interest [inaudible] and net interest spread and as we said in the filing the principal risks of that view are going to be the intensity of deposit competition and to the extent that we see shorter term higher rate loans such as construction loans and certain components of the healthcare commercial line of credit portfolio paid down. To the extent that those loans are replaced by commercial lines of credit you won’t see very much impact and we should get the benefit of a more favorable interest rate environment. Through the extent that they’re not replaced or they’re replaced by more fixed rate assets then you won’t quite get the benefit.

[Operator:]

(Operator Instructions) Your next question comes from the line of Ron Peterson with Stearn AG.

[Ron Peterson:]

Just going through my model and the press release looking at the expense for the quarter if you pull out the stock-based compensation expense compared to last year’s fourth quarter obviously the expense were down but if you look compared to the third quarter there was like a 4.5% jump or so. Obviously, there was some expenses related to the settlement with the servicer during the quarter but were there any other maybe additional items or non-recurring items in there that pushed that number higher? Or, is that a good run rate to use going forward?

[F. Morgan Gasior:]

Let me address part of that and then I’ll ask our CFO Paul Cloutier to address part of that. During the fourth quarter we had some transitional expense on the headcount and the comp side. We brought on some new people in retail commercial banking, we also had some new recruits in the branch operations particularly in the branch management area and we still had the original folks on staff. We kind of saw some transitions coming in and decided when we saw some good people to bring them aboard. So that’s one, headcount went up to some degree and there were some associated expenses. We also kept a couple of people around extra to work on some special projects in fourth quarter and those are wrapped up or just about wrapped up and so again you’ll see a couple of people leaving on that basis. We were up a little bit in headcount and you saw some transitional compensation expenses there. We also had a couple of projects ramp up and we accrued some incentive expenses in fourth quarter due to the successful completion of those projects. Apart from the comp side there were some things that were going on that I think would be best if Paul gave you a more accurate run down.

[Paul A. Cloutier:]

If you look at the fourth quarter expenses and Ron you pointed you had the Visa settlement, that’s an unusual item. So, if you back that out and the settlement on the third party loan servicer which was about $150,000 of additional expense, expenses were up a little over $500,000 quarter-over-quarter and Morgan already touched upon the compensation side of it which was a little over a couple of hundred thousand of that $500,000. But then, we had a few seasonal items such as printing postage and supplies. As we get near the end of the year and then we see it also in the first quarter that goes up as you’re sending out notifications for year end and then the year end statements in the first quarter. So, if you look at the five quarter trend you’ll see that fourth quarter and first quarter are usually higher than second and third quarter so that added about $75 to $80,000 of expense in the fourth quarter. Then, there was snow removal, this was a bad year of here in Chicago for snow and it started in December so we had to incur a fair amount of snow removal costs, that was about $60,000. Then we had some repairs within occupancy expense related to the buildings and the furniture and equipment and that was about $80,000. So, there were some items that I wouldn’t say will continue but they were necessary in the fourth quarter. Hopefully, that addresses it for you Ron.

[Ron Peterson:]

Yeah it does. That’s very helpful. Thanks.

[F. Morgan Gasior:]

I don’t know if you can model this Ron but it costs more for snow than it does to mow.

[Ron Peterson:]

On the mowing side it’s a little more easier to estimate just giving it’s probably on a regular basis.

[F. Morgan Gasior:]

That’s every couple of weeks. Snow removal you’re at the mercy of mother nature.

[Ron Peterson:]

It can be almost every day. Can you give us some insights on what you’re seeing on the asset quality front?

[F. Morgan Gasior:]

As we’ve said it’s been fairly stable. We have the one customer that decided to do what they did and now they’re correcting that behavior and we expect that to return to status quo ante. Generally speaking, the portfolios remain stable, we’re always watching a couple of customers doing different things. The thing that we continue to watch very carefully is the absorption rate on the construction loans. It was quieter in fourth quarter than it was in third quarter and I think that was pretty much true of real estate particularly residential real estate certainly in Chicago and it appears nationwide. But, we’re now almost two thirds of the way through the first quarter and we’ve started to see activity pick up on absorptions. Even in the last two or three weeks we’ve seen some pay downs on some sales and some customers booked some sales that will be either paying down later this quarter or very early in the second quarter. It appears that the absorption rates might be picking up a little bit. That will ameliorate our concerns about investor’s ability to continue to service debt. On the flip side of course what that really means is that replacing those assets as they pay down will present the newer challenges especially since not very many customers even when they liquidate inventory are ready to jump back in the market. There may be some people who buy a lot or two and just hold on to it for a while but we’re certainly not seeing people start new projects in anticipation of sales that are about to happen or just starting to happen.

[Ron Peterson:]

So it looks like loan growth could be a little slow over the next couple of quarters? If you exclude the impact of the securitization in the quarter it looks like loan balances were relatively flat with the third quarter.

[F. Morgan Gasior:]

I think that’s an accurate thing. I think if you look at – I would almost break the year off in to two halves, the first half and the second half. I would say that multifamily and commercial real estate could show mid single digit growth this year. I think the real constraint in commercial real estate particularly the retail side is going to be watching valuations of properties and being careful with your estimates of vacancies. If the economy is in fact weakening and the consumer is weakening then you’re going to see some of the neighborhood retail shopping areas see problems with either retaining tenants or retaining tenants at current rental rates. Then, just to look back at your income flow from the property and it will also affect your valuation of the property in terms of the capitalization rates. At the same time the fundamentals of real estate in terms of credit spreads and the steepness of the yield curve are very much working in our favor more so than I’ve seen in several years. So, I think that is very much cause for optimism and we are certain to see some customers get ready for some buying opportunities. In the last four to six weeks there have been some requests to set up some lines of credit and otherwise make resources available to participate in the market. We weren’t really seeing much of that in the second half of 07 at all. So again I think there are some reasons for optimism on growth on in the real estate sector. The main concerns we’re going to have it the valuation of the collateral and being careful with assumptions on debt service. Replacing the construction loans is just going to be a challenge. We are seeing some opportunities on the commercial line of credit side being kind of selective as to what sectors. You won’t see it very much in sectors like auto manufacturing for obvious reasons but there are other sectors of the economy that are still doing pretty well and we could see some growth to offset the construction loans there. The healthcare side as we’ve said consistently one of the drops in our commercial lines of credit year-over-year were the resolution successfully of several healthcare credits. These are the credits where the operators are either weaker in their management of the facilities and thus the results of the facilities don’t support the credit or they’re in weaker markets that just don’t support the facility itself, it’s not enough business for that facility. We are seeing some opportunities to replace the weaker credits that they pay off with other customers with stronger credits but the rate of exchange if you will is just really opportunistic. We’re focused on resolving the ones that we’d like to resolve and if there’s a gap between that and the replacement volume, so be it. The lease side remains steady. Interestingly enough we’re seeing pretty good volumes in that however, the thing about that is the assets amortize so quickly that material growth in that is really going to take a stronger burst of economic growth than we’re seeing right now in the overall US economy. So, I would say if overall including replacement work if our loan portfolio grew as much as 5% overall in the non-residential sectors, everything but one to four residential loans we’d consider that a successful year for 08.

[Ron Peterson:]

Okay. Then one final question, it looks like the securities portfolio at least looking at [inaudible] balances were up during the quarter given that the slope of the yield curve, return of the slope of the yield curve to you see maybe additional chances to grow the portfolio to increase average earnings assets and growth of net income?

[F. Morgan Gasior:]

Even more so – we said at the last call that we were kind of cautiously interested in that and I would say that overtime as the yield curve has emerged we are increasingly interested in that. Again, the thing we’d look for is to make sure that we don’t present ourselves with surprises down the road if the shape of the yield curve were to change or if inflation turned out to be an issue and all of a sudden interest rates, the entire base line of the curve were to shift suddenly upwards. You’ve got to look at commodity prices and the slope of the curve and ask yourself if the overall level of rates will stay at these levels over a three year time frame. But, we are more interested in that. I think the key to it is finding the right asset to leverage that you’re comfortable with and we might have more to say about that in the second quarter’s call once we finish some of the due diligence and run some of the models with the current yield curve and do some stress testing and see where it comes out. Compared to our views last quarter we’re more interested in it then we were and I think we’ll probably be in a better position to discuss more specifics in the next two calls.

[Operator:]

(Operator Instructions) Your next question is a follow up from the line of Ross Haberman with The Haberman Fund.

[Ross Haberman:]

Did you guys put out any sort of information regarding new branches for 08? Any plans? Any relocations at all?

[F. Morgan Gasior:]

No. We’ve announced no new branching plans for full service facilities. The economics of that continue to be in our view disadvantageous and increasingly so as time goes on. That’s not to say that we’ll never ever open another branch. But again, when you look at the entry costs of the facilities, then the staffing costs, then the costs required to market and obtain deposits, then the average costs of those deposits the breakeven, the profitability of that facility in any kind of reasonable time frame is just suspect in our minds. I think we’re seeing some competitors who are wishing perhaps they hadn’t been quite so aggressive in their branching opportunities because now they’re stuck with the expense and I think that’s also what’s contributing to the stickiness in overall deposit competition. There’s just people who have built facilities and they’re going to put deposits in them and hang the costs and obviously that’s going to affect everyone. So, we don’t have any material plans to do bricks and sticks full service branch expansion. We might see an opportunity during the course of the year next year. If we do, we’ll make sure that everyone knows it. And, it would be a fair question at that time why we thought that was a good idea given our generally pessimistic views on the profitability and prospects of de novo branching.

[Ross Haberman:]

Any existing branches really losers at the branch level and any plans to sort of weed them out or relocate them?

[F. Morgan Gasior:]

No. None, whatsoever. We’re comfortable with our locations. There’s obviously markets within Chicago that due to the fundamentals of the demographics they’re stronger growers or steady growers or even some are contracting but we’ve served all of these communities for a long time, we’re very tied into the community and we’re interested in getting as much growth and as much penetration in the communities we have as we can.

[Ross Haberman:]

Just a housekeeping question, the number of shares which are outstanding as of the end of the quarter was what?

[Paul A. Cloutier:]

Total outstanding shares were 22,244,000.

[Operator:]

(Operator Instructions) You’re next question comes from the line of Barry White with River Capital.

[Barry White:]

With your answer to the last question in mind, what is your strategy to build this business? It doesn’t look like there’s obviously no new branches coming on, or no branches being taken off line, long growth is zero, deposit growth doesn’t look like it’s great. What’s the strategy here over the next couple of years to just increase returns and just make this a better more efficient bank?

[F. Morgan Gasior:]

That’s a long question but let me give you a couple of points. There principal reason for going public was to raise capital for acquisitions. We were able to do the University National acquisition and that was a very good acquisition both in terms of the deposit franchise, the geographic franchise and profitability. At the same time, we passed on numerous acquisition opportunities because they didn’t grow the deposit franchise in an effective way with core deposits, they wouldn’t add to profitability or at least not any time soon. Or, even worse, they would materially dilute tangible book value. There may be opportunities this year in fact, probably this year more than others to do some acquisitions at what we would call attractive prices that would add to the franchise and that’s always, always, always going to be the principal developer of the franchise. Chicago is a market that does not see a great deal of organic growth. If we do single digit organic growth in loans and deposits and do so effectively for asset quality and core deposit pricing purposes we’re having a good year. So acquisitions will drive the franchise when they happen. In terms of efficiency we published the non-GAAP core measures and that’s what we manage to. As the equity incentive plan matures and gradually dissipates you’ll see that the return on average assets is producing what we would call reasonable results. You have to exclude fourth quarter a little bit with the Visa and some of the other noise that was in the fourth quarter non-interest expense. But, generally speaking right now we’re looking at the return on average assets is one of the key features and when we look a peer commercial banks in the area especially looking at the relative risk and the loan portfolio we’re thinking that for now managing the franchise cautiously forward and awaiting acquisition opportunities is probably the best strategy. It’s probably pretty clear to people by now that massive asset growth particularly in higher risk categories like construction was probably not the right strategy and we’re really looking forward to building step-by-step the core community bank franchise and growing it through acquisitions. I think the industry is starting to navigate its way through some tricky waters and tricky times and it’s not at all clear that the times are now behind us and things could be better going forward. So again, caution seems to be appropriate here. But, if we see good asset acquisition opportunities that make sense for shareholders we’re going to jump on them, we’ve said so before. In the meantime, we’re going to keep growing the core franchise forward consistent with the opportunities we’re presented. And as far as efficiency one other point to mention, we went through a fairly careful operational review during the course of 07 and materially reduced headcounts and overall compensation expenses and really optimized the franchise. So, in a variety of ways we think that the core company is well positioned for the future and we’ll await the opportunities that present themselves over the next couple of years.

[Operator:]

(Operator Instructions) There are no further questions in the queue. I’ll now turn the call back over to Mr. Gasior for closing remarks.

[F. Morgan Gasior:]

Well, we very much appreciate your participation today especially on short notice. We’ll try to return to our normal five to seven day advance schedule for the next quarter. We will be getting the 10K out here in the next couple of weeks as it goes through the normal review process and we will keep you posted of any and all developments as required and as appropriate. We wish everyone a good end of winter and a happy spring and we look forward to talking to you soon. Thanks for your interest in BankFinancial.

[Operator:]

Thank you for your participation in today’s conference. This concludes the presentation and you may now disconnect.