BankFinancial - Q1 2023
May 3, 2023
Transcript
Operator (participant)
Good day, and thank you for standing by. Welcome to the BankFinancial Corporation First Quarter 2023 earnings conference call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. To ask a question during this session, you will need to press star one one on your telephone. You will then hear an automated message advising you your hand is raised. To withdraw your question, please press star one one again. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Chairman and CEO, Mr. F. Morgan Gasior. Please go ahead.
F. Morgan Gasior (Chairman and CEO)
Good morning and welcome to the BankFinancial Corporation First Quarter 2023 Investor Conference Call. At this time, I'd like to have our forward-looking statement read.
Speaker 5
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 purpose of invoking the 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 their use of the words believe, expect, intend, anticipate, estimate, project, plan, or similar expressions. Our ability to predict results or the actual effects of our plans and strategies is inherently uncertain, and actual results may differ from these for those predicted.
For further details on the risks and uncertainties that could impact our financial condition and results of operations, please consult the forward-looking statements declaration and the risk factors we have included in our reports to the SEC. These risks and uncertainties should be considered in evaluating forward-looking statements. We do not undertake any obligation to update any forward-looking statement in the future. Now I'll turn the call over to Chairman and CEO, Mr. F. Morgan Gasior.
F. Morgan Gasior (Chairman and CEO)
Thank you. At this time, all filings are complete, and we would be pleased to take questions.
Operator (participant)
Thank you. If you have a question at this time, please press star one one. One moment while we compile our Q&A roster. Our first question comes from the line of Manuel Navas with D.A. Davidson & Company. Your line is open. Please go ahead.
Manuel Navas (VP and Research Analyst)
Hey, good morning. I noticed loan growth was a little flatter than expected this quarter, probably some seasonality and a lot of growth last quarter. Maybe there's some pull forward then. How do you, how do your 5%-10% expectations look for 2023, given current trends and current, like, demand conditions? Just to kind of get a feel for what you're thinking going forward.
F. Morgan Gasior (Chairman and CEO)
Well, I would say, given what's happened with the yield curve, and, you know, what happened in focusing on liquidity, we're not going to see as much growth in the equipment finance side. The government and the investment grade side just don't meet our current yield requirements. It's not going to be as active as it might have been, you know, at the beginning of the year. Still, we'll have some growth in certain sectors of equipment finance, just not as much as we thought. The focus remains on the commercial finance sector. We had somewhat, you know, we had good growth in it for first quarter. Our healthcare borrowers are still somewhat volatile. We see useful line utilization for a short period of time, and then they get remittances in and pay it back down.
I'd have to say the healthcare side seems a little less certain than it did at the beginning of the, of the year because their cash balances are holding up, and their remittances are shorter than we would have otherwise expected. All in all, you know, if we look at. In real estate, with the current market conditions, both in terms of the pricing of the credits, and flat rents, we don't see as much purchase activity. We are seeing some refinance activity, but we expect that to be, you know, as muted as it was, you know, as we thought at the beginning of the year.
All in all, you know, I'd say if we got to a 3% growth from where we're at 12/30 or here from at 3/31 to 12/31, with again the primary focus being the commercial finance portfolio, a little bit of growth in corporate other, middle market, small ticket, that's probably a reasonable range for us right now. It could also, you know, compress a bit. The focus is going to continue to be on maintaining appropriate levels of liquidity and maintaining yield discipline for profitability and margin maintenance. As I said, in the equipment finance space, especially with the inverted yield curve at its current levels, you know, some of those transactions just don't meet our yield objectives at this point, so we'll see less growth.
Manuel Navas (VP and Research Analyst)
Okay. I guess that's all encompassed in some of the origination trends slow down, but payoffs also slowed down. Those two trends kind of continue to hit that 3%, a little bit less payoffs that also probably muted originations?
F. Morgan Gasior (Chairman and CEO)
Yeah. You know, if you take it sector by sector on payoffs, real estate payoffs declined significantly, as you saw. Assuming the yield curve stays about where it's at, we'll continue to see some payoffs just from people selling buildings and, you know, relatively muted activity. You're not gonna see a significant amount of refinance activity in terms of payoffs. The real estate portfolio will continue to pay down pretty much along the lines of what you saw in the first quarter, absent a big change in rates. The equipment finance portfolio is very liquid. It will pay down rather significantly over the next, you know, two to three to four to five quarters. That's always part of our liquidity strategy. Commercial finance is all about line utilization.
Like I said, we had good line utilization in the equipment finance sector in the first quarter. That continues actually into the second quarter. Healthcare has been a little more volatile. We probably saw less growth in utilization in the first quarter and now even in the second quarter than we expected. That's where I think we'll see some volatility in loan balances, is in our commercial finance sector. Again, we're gonna be selective in equipment finance, so it's possible that the equipment finance portfolio payoffs will continue, and we just won't do as much in originations.
Manuel Navas (VP and Research Analyst)
Can I shift over to deposit outflows a bit? Just kind of what are you seeing there? What's driving them? You know, rates are going up for everybody. Just kind of your thoughts on in light of the liquidity discussion and just kind of your thoughts on where deposits can stabilize a bit?
F. Morgan Gasior (Chairman and CEO)
Well, in our first quarter, we, you know, try to put more detail in the MD&A and the 10-Q. Our first quarter was somewhat typical for us. We had outflows of our collateralized public funds. That's fairly typical. It was a little bit higher this year than last year because the taxes were a little bit higher this year than last year. On the flip side, we're already seeing some of that money flow back in here in April and May. That seasonal activity appears to be seasonal. We had somewhat higher distributions in the estate and trust area than we usually do. We have a couple of customers that are in liquidation mode. They've sold their business.
They are and sold related assets, and they're busy distributing to beneficiaries, but they're also reinvesting. We saw some good growth in the trust department in first quarter from funds that were deposited initially into the bank through their asset accumulation and liquidation process, and now they're putting it into other markets. They're, you know, the business is closed and they're in retirement mode, so they're investing in other assets. We'll continue to see some of that, and that will introduce some volatility, you know, throughout the year. It's just the stage that some of these customers are in, and they've done very well. We are talking about seven figures and in some cases low eight figures asset accumulation by these customers, which obviously results in some volatility in deposits.
During the first quarter, we saw more competition for deposits, particularly as we got into the middle part of the quarter and then accelerating into March and again into April. As we said in the 10-Q, you know, our tracking showed us about $12 million-$13 million of competition losses. That has slowed down a bit, but it's still there. As a result, you know, we could still see some declines in deposits due to competition. I'll also say that, you know, when the issues started with Silicon Valley Bank and Signature, we've had a very robust and well-established training program for deposit insurance. We've had the deposit insurance networks established for years. We pivoted right into making sure that customers were comfortable with deposit insurance.
That process has actually resulted in increased deposits and increased share of wallets from customers who understand that there are many options to get better deposit insurance coverage, and they're taking advantage of it. That is actually something that has helped us, bring in new deposits from existing customers. In that first week, you know, the week of the 13th, we saw a handful of customers, including a couple commercial customers, look around and try to diversify a bit. We've seen some of those customers come back again now that they understand that there are many deposit insurance options available to them. I would say going forward, we'll still see some loss of growth, if you will, on competition. There's competitors out there that are in the low fives for rates.
We don't necessarily feel we have to go that high to maintain adequate liquidity. We have a variable CD account that's right at five that is pretty well tied to the short-term indexes and should be competitive. At the same time, our focus continues on developing the commercial deposit base and continuing to strengthen share of wallet with the existing deposits. Hard to say where that's gonna come out. So far the combination has resulted in pretty good stabilization. For example, in April, which is our tax month, we actually were pretty stable in April. We saw some recovery in the last week of April even after we did the tax disbursements. At the end of the day, we're mindful of what's going on with deposits.
There's still quite a bit of competition. Don't really want to make, you know, hard and fast projections about deposits right now other than the work we're doing on deposit insurance has provided some stabilization and some growth. We're going to continue to work the commercial side to see if we can get some additional growth to offset any runoff we might have due to retail competition. We'll see how we do from there. If we can keep deposits stable, maybe even grow a little bit by the end of the year, you know, that same, you know, 2%-3% and keep our loan deposit ratio in the, you know, 90, 91, 92 range, that would be a good result by the end of the year for us.
Manuel Navas (VP and Research Analyst)
That's actually really helpful and kind of leads into, kind of a NIM question and NIM outlook discussion like is there still some previously, we had discussed about, some potential upside in the back half of the year with a little bit less loan growth probably in the higher yield equipment finance. Is that a little bit less robust? Just kind of an update on where you see the NIM trajectory going.
F. Morgan Gasior (Chairman and CEO)
Well, as we said last quarter, the wild card was deposit interest expense, and it remains the wild card. That is going to be the key to what happens next. Actually we've been saying it for about a year now. As the deposit competition has intensified, it obviously means that we're going to have potentially a higher interest expense, even if we are successful bringing in new deposits in the commercial side. I'd say number one, higher deposit interest expense is the greatest challenge in terms of maintaining and expanding that interest margin. After that, the next issue is going to be maintaining appropriate yields on originations. In the first quarter, we did pretty well. The average originations in the first quarter yield was 8.67.
If we can maintain that, maybe even strengthen it a bit, with a Fed increase potentially today, affecting our prime rate loans, that will give us a better chance at stabilization and even expansion. I'd say the key to expansion is going to be the growth of the commercial finance portfolio. Those are the higher yielding, prime, you know, Wall Street Journal prime plus assets. The key to that is increasing the commitments and increasing the utilization. If we get that is our number one best chance towards margin expansion. If it stays stable, that probably gets us closer to margin maintenance. We're going to do our best to avoid diluting the margin with low yielding assets, but we will do some originations for customers in real estate for refinances.
We will do some originations in investment grade for customers on equipment finance. We have to maintain these relationships. We're going to do our best to maintain our origination yields first, then we're going to do our best to originate the commitments and the balances that support margins, stabilization and expansion. The wild card will be deposit interest expense.
Manuel Navas (VP and Research Analyst)
That's very helpful. My last question is, there's a little uptick in NPLs. Can you offer any color on that as in commercial?
F. Morgan Gasior (Chairman and CEO)
Yeah, that's in the government equipment space. We wrote about it in the 10-Q, and we probably can't talk much about it. It's going to go through a government claims process. There is an issue between the government and the vendor, where we've reviewed it with outside counsel. We're comfortable with the collection position, both as far as the government's concerned, and if necessary, potential avenues of recovery with the prime contractor and the vendor. This process is going to take a while and, you know, usually a minimum of 120 days is what we're being told. This is the first time we've actually had to go through it in the many years we've been doing this. At the moment, you know, we were comfortable where it is.
We put it on nonaccrual given the claims process duration, and then wrote about everything we could write about in the 10-Q.
Manuel Navas (VP and Research Analyst)
Thank you. Thank you. Appreciate it. I'll jump back into the queue.
Operator (participant)
Thank you. As a reminder, if you have a question at this time, please press star one one on your telephone. One moment for our next question. Our next question comes from the line of Brian Martin with Janney. Your line is open. Please go ahead.
Brian Martin (Managing Director and Equity Research Analyst)
Hey, good morning, guys.
F. Morgan Gasior (Chairman and CEO)
Good morning.
Brian Martin (Managing Director and Equity Research Analyst)
Hey, Morgan, can you your comment about the, you know, the loan growth maybe slowing a bit with those equipment finance originations. I mean, what could change on the yields? I guess, I don't know, you know, what type of spreads are you getting today that aren't acceptable versus kind of what they were a quarter ago? I guess, is there some possibility that changes and you get a, you know, potentially get some benefit or some, you know, getting some originations throughout the year? Just kind of what has to change there to kind of, you know, swing that back in a positive direction?
F. Morgan Gasior (Chairman and CEO)
Generally speaking, at the moment, we put minimum yields on that portfolio. The problem we're running into is the inverted yield curve. If somebody wants to do an investment grade five-year transaction, equipment finance transaction, you are talking about yields that could be as low as 4%-four and a quarter percent. You know, we've lost some, you know, yield curve, from the latter part of the fourth quarter, and that's just not an acceptable yield. Generally speaking, we're trying to keep yields, average yields at 6% or higher. That's going to take us out of the government space. It's going to take us out of the investment grade space for most credits.
From time to time, because the lessor has fair market value leases, we might get, we might see something in the very high fives. That we might do, especially if it's shorter duration, three years. You know, we're just not gonna do as much in those lower-yielding spaces due to what our cost of funds is now and is likely to be on the margin. Therefore, the corporate other category, BB+, B+, the middle market and a smaller quantity of small ticket, those average yields in the first quarter were in the sevens, and that's where they need to be for this to, for this to work in terms of projections on margin maintenance and margin expansion.
Brian Martin (Managing Director and Equity Research Analyst)
Gotcha. Okay. No, that's helpful. Just the funding, the loan growth that you expect this year, I guess, given kind of what you're talking about, the deposit flows, what's your sense on, you maintain liquidity on the balance sheet currently. Just kind of trying to understand if you fund it from here, you know, what's the, is it gonna come from deposit growth? Is there still, you know, do you utilize that cash? Just how are you thinking about funding the loan growth you plan this year?
F. Morgan Gasior (Chairman and CEO)
You know, generally, it'll come from repositioning the balance sheet. Some of the securities that are maturing, we might keep in liquidity for the time being. You know, we'll have a five and a quarter yield in the cash account, that's kind of the baseline. Another reason why the investment grade and the government equipment don't necessarily make sense to us, we're better off in cash. Going forward at that point, we can still fund from the cash flows from equipment finance. We can fund commercial finance growth. We'll get some cash flows from real estate that can fund commercial finance growth. We can reposition the cash flows from investment grade and government equipment finance into corporate other middle market and small ticket.
Generally speaking, and if we even take some of the securities portfolio and put it into loans, if we're comfortable with liquidity, then we can pretty much self-fund internally. Our goal is to grow a little bit in deposits and establish a pricing baseline for deposits. That's the conversation we had last quarter in terms of commercial. If we can continue to establish a stronger commercial funding base and a stable commercial funding base at a reasonable price, then we can fund loan growth in all categories in a little more normal pricing environment than a, you know, severely inverted yield curve.
Brian Martin (Managing Director and Equity Research Analyst)
Gotcha. Just as far as what maybe your comment was, and maybe I missed what you said on, you know, just kind of the margin percentage outlook. I mean, given what's repricing, you know, over the next, you know, 12 months, I mean, I guess if we get a rate increase today, I guess, how are you thinking about the, you know, kind of that margin percentage at this point, you know, over the next couple quarters?
F. Morgan Gasior (Chairman and CEO)
Yeah. I just think there's too many variables right now to be talking about specific numbers. As we said in the last call, and it remains stable, we'll get more cash flows out of the portfolio in the second half of the year than we will in the first half. It's possible we could see a bit of margin compression in the second quarter simply because we have a little bit less repricing in the second quarter. The third and fourth quarter, we have a greater quantity of cash flows coming back and a greater opportunity to reprice. Again, it comes down to deposit interest expense, and that is what makes it a difficult thing to predict.
The other thing that makes it difficult to predict is the mix on the commercial finance side and the utilization. You know, average yields in the commercial finance portfolio and originations in April were 9%, probably likely to go higher, but what is the utilization percentage? That's why specific numbers are just a little bit difficult right now. We're gonna have to see how competition is on deposits. We'll have to look at utilization. At least in the second quarter, we'll probably carry a little bit higher liquidity in the portfolio. It's not really hurting us at current yields. If things are stable and continue to be stable as we get into the third quarter, we'll have more cash to work with and a greater opportunity to reprice upwards.
Brian Martin (Managing Director and Equity Research Analyst)
Gotcha. Okay. How about just the deposit beta? Just I guess in your sense, is it, you know, does it, you know, funding costs, maybe did funding costs peak? I mean, do you have a sense on what your outlook is on when funding costs peak for you guys, I guess, given the Fed does pause after today's potential hike?
F. Morgan Gasior (Chairman and CEO)
I don't. I think it's too early to make a statement like that. I think part of this is, you've got a severely inverted yield curve, in terms of calling a deposit expense peak, I think it comes down to what is the level of Fed funds in the three-month, six-month, T-bills. you know, you're competing against short-term money market funds that are funding in that, short duration. Until that changes, I think it would be difficult to call a peak.
Brian Martin (Managing Director and Equity Research Analyst)
Okay.
F. Morgan Gasior (Chairman and CEO)
You know, we don't particularly believe there's a Fed pivot, you know, in the short term here. We're thinking and planning as if there is not. I think that is gonna be probably the key fact. If all of a sudden there's a material change in short-term money, monetary policy, if the market's right that there's a Fed pivot in the second half of the year, then I think it might be appropriate to start looking at a deposit interest expense peak, but probably not before then.
Brian Martin (Managing Director and Equity Research Analyst)
Gotcha. Okay. Then how about just a couple last ones? Just on the expense side, you know, just kind of your expenses was pretty well maintained this quarter. Just, you know, kind of any change in how you're thinking about approaching expenses over the balance of the year?
F. Morgan Gasior (Chairman and CEO)
You know, fundamentally, no. As you know, we've been pretty stable, and it's maintained pretty well on a consistent basis for a long time. We are being careful with variable expenses. Where there's, you know, a possibility to maybe do a little less traveling for conferences and marketing, we still have our major events that we meet customers at, but maybe we don't go to as many minor events, and maybe not everybody goes on the trip. There's aspects of that. Fundamentally, things that we have to do, we have to continue marketing for deposits. We have to continue marketing for commercial finance. We have to make sure we have the appropriate level of personnel for commercial finance originations. We have to maintain our critical controls.
Right now, you know, if there were some ambitious, you know, some mildly ambitious things that we might want to do in the second half, we'll probably back off of that a little bit. Therefore, we think expenses will be reasonably stable. We will get the benefit of some savings in occupancy expense. One of the as we noted in the 10-Q, one of the branch offices, facilities closed in April, so we've got the cost savings on that. A second facility is getting ready to go under a contingent contract. It's a regional, governmental authority who's getting a state grant to operate an emergency services area, operation, which we think is a great thing for the community.
If that closes, after the grant's received, hopefully in third quarter, then we'll get another material expense save on the occupancy side. That will be helpful to us. Again, that provides some opportunity to protect profitability even if we have higher deposit interest expense. That's kind of where we're focused is keeping resources available for deposit interest expense to maintain profitability and then secondarily to execute our key strategic matters for deposits, commercial deposits and commercial finance.
Brian Martin (Managing Director and Equity Research Analyst)
Gotcha. Okay. Then the buyback, I, you know, I guess you bought a few shares back this quarter. I guess is that, given where valuations are in capital and, you know, loan growth outlook, is that maybe more of a priority, you know, or more of a focus if, given current conditions, just kind of move it a bit, move it around a bit?
F. Morgan Gasior (Chairman and CEO)
I would say that the activity is going to be no higher than it was in first quarter and likely less, at least for now. Obviously, you know, given the recent events in the market, stability is a good thing and liquidity above all. As attractive as it is at these levels, you know, at this point in time, I'd expect a relatively muted share repurchase program, at least for the second quarter. We'll see how events unfold during second and third quarter in the market. You know, we did a lot last year and obviously, you know, it's attractive right now. Just maintaining stable liquidity at all levels, the bank, the holding company everywhere is the key. Right now, I would expect less activity in the second quarter than there was in the first quarter.
We'll take things a quarter at a time.
Brian Martin (Managing Director and Equity Research Analyst)
Okay. just given your comments, Morgan, about, you know, the loan growth being a little bit less and, you know, kind of the other items in there, it sounds as though the, you know, the profitability forecast is probably a bit lower, you know, given some of, you know, what's occurred here. I guess how are you thinking about, you know, kind of the ROA or just, you know, where are you kind of trending to given kind of the change in pivoting, you know, conditions here in the market?
F. Morgan Gasior (Chairman and CEO)
You know, I guess I would. Again, we tend to focus on earnings per share. You know, a good goal for us is, as we've said, to maintain the mid-20s, maybe high 20s in the second and third quarter. Again, we may see a little bit of deposit of a little margin compression in the second quarter, just based on load of cash flows. If we can, you know, stabilize that and improve a little bit in third and fourth quarter, we would re- because of deposit interest expense risk, I'd say getting into the low 30s is harder today than we thought it would be at the last call.
You know, we would really have to see some strong growth in commercial deposit originations and some strong growth in commercial finance to overcome what we're expecting to see on deposit interest expense on the retail side. We'll be pretty happy if we can keep it in the mid to high 20s for the next couple quarters. If we see, you know, a pivot later, you know, sooner than we're thinking, you know, the market thinks in the second half, we do not, then that'll help. It will turn on, you know, what are deposit interest expense is going to be and then how the mix of loans goes in the remainder of the year, but particularly in the second half.
Brian Martin (Managing Director and Equity Research Analyst)
Gotcha. Okay. That's helpful. Maybe just the last one. On the credit, outside of the one credit you spoke about earlier and mentioned in the Q, you know, I guess trends are continuing to be pretty strong. I guess it looks as, you know, from what you can see from the filings and just the numbers themselves. Anything you're seeing from a credit standpoint out, you know, other than that one-off, you know, how trends are performing?
F. Morgan Gasior (Chairman and CEO)
The real estate portfolio is doing extremely well. You know, as you know, our portfolio is very focused on the multifamily loan portfolio, which continues to perform very, very well. Our commercial real estate portfolio is a very seasoned portfolio. We've grown it a bit with relatively low-risk assets here in the last couple years. The vast majority of those loans have been around a long time. We have very little exposure to office. It's, you know, something, you know, like $16 million of that. One of them is a loan out of one of our own branch offices that's held by an investor. We really don't have any serious office exposure to be concerned with. Generally speaking, we're comfortable with what we're seeing.
We have, you know, you can see it in substandard. There's, there's a couple of individual borrowers, one in the equipment side, one in the C&I side, a Chicago customer, they've been substandard for a while now, that we're working with to the best of our ability, and we'll resolve as best we can. Fundamentally, you know, other than a couple of isolated issues, things remain stable. We haven't really seen any trends to think otherwise. Obviously, if the economy weakens, that could change, but so far so good.
Brian Martin (Managing Director and Equity Research Analyst)
Gotcha. Okay. I will step back. Thank you for taking the questions.
F. Morgan Gasior (Chairman and CEO)
Thank you.
Operator (participant)
Thank you. Again, to ask a question at this time, please press star one one on your touch-tone telephone. One moment for our next question. Our next question comes from the line of Henry Welbeck with HFW Capital. Your line is open. Please go ahead.
Henry Welbeck (Analyst)
Hi, Morgan. I like your outlook for the mid-twenties for next quarter. Can you give me some color, more color on your NPAs? I mean, they went up to $8.8 million versus $1.3 million.
F. Morgan Gasior (Chairman and CEO)
Yeah, that's the one credit we spoke of earlier in the government finance portfolio. I think I covered as best as I could. There's an issue between the government and the vendor. We need to go through the claims process and understand what's going on. We have recourse with the government. We have potential avenues of recovery with the prime contractor and the vendor at this juncture, so we'll have to let that process play out. It's something that happened. Because of the claims process, we put it on nonaccrual. We'll go forward from there, but that was the issue in the first quarter.
Henry Welbeck (Analyst)
Is that a local NPA or is that like in some foreign state?
F. Morgan Gasior (Chairman and CEO)
I'm sorry. That's a United States government credit.
Henry Welbeck (Analyst)
Okay. Is that like a local Illinois credit?
F. Morgan Gasior (Chairman and CEO)
No, United States government.
Henry Welbeck (Analyst)
Okay. Thank you for that call. Thank you, and keep up the good work.
F. Morgan Gasior (Chairman and CEO)
Thank you.
Operator (participant)
Thank you. I am showing no further questions at this time, and I would like to hand the conference back over to Mr. Gasior for any further remarks.
F. Morgan Gasior (Chairman and CEO)
Thanks, everyone for the questions and their interest in BankFinancial. Obviously unusual and difficult times we're all working through. We look forward to talking to you at the end of the spring. Please enjoy your day.
Operator (participant)
This concludes today's conference call. Thank you for participating. You may now disconnect.