BankFinancial - Q3 2023
November 1, 2023
Transcript
Operator (participant)
Good day, and thank you for standing by. Welcome to the BankFinancial Corporation 2023 Q3 Earnings Conference Call. At this time, all participants are in the listen-only mode. After the speaker's presentation, there will be a question-and-answer session. To ask a question during the session, you will need to press star one one on your telephone, and you will then hear an automated message advising 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, F. Morgan Gasior, Chief Executive Officer. Please go ahead.
F. Morgan Gasior (CEO)
Good morning. Welcome to our Third Quarter 2023 Investor Conference Call. At this time, all filings are complete, and I'd like our forward-looking statement to be read.
Katie Multon (Marketing Communications Manager)
The remarks made at this conference may include forward-looking statements within the meanings 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 these statements 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 the 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 those predicted.
For further details on the risks and uncertainties that could impact our financial position and results of operations, please consult the forward-looking statements, declarations, and the risk factors we have included in our report 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 (CEO)
You know, I'll apologize in advance for my voice. I'm fighting a bit of a respiratory bug, but let's proceed with questions.
Operator (participant)
As a reminder, to ask a question, please press star one one on your telephone and wait for your name to be announced. To withdraw your question, please press star one one again. Please stand by while we compile the Q&A roster.
F. Morgan Gasior (CEO)
Now I'll yield back to the analysts.
Operator (participant)
For your first question, it comes from the line of Henry Walczak. If your line is open, please ask your question.
Speaker 5
Good morning, Morgan. Hank Walczak calling here. I just got one quick question, and I'll pull back to the analysts and the people who are smarter in the queue than I am. So Morgan, like, Wells Fargo is to spend $175 million on a Chicago retail build-out. They're planning 30 branches versus the 7 they currently have. So Morgan, just I just wanna ask this question: Isn't it getting harder and harder and harder to stay a small, independent bank? Thank you.
F. Morgan Gasior (CEO)
Well, I guess I'll say this. I don't necessarily think it's harder to be a smaller independent bank, if you're focused on the right priorities. So as far as deposit priorities, I think our results have shown we've got a pretty consistently strong deposit portfolio. We built it over many years, both organically and through acquisitions and strategically, as well. It's also a case that we're continuing to build the deposit franchise, increasingly on commercial deposits, which has been an increasing focus now for a while and will accelerate in 2024. Wells Fargo is building branches because, at their current size level, they're not permitted to acquire banks. They're just too big, and so the only way they can build a presence is to expand by branches.
They had acquired World Savings, the former Golden West, a while ago, which is how they got the branches that they have here in Chicago.
Speaker 5
Thank you.
Operator (participant)
One moment for your next question. And for your next question, it comes from the line of Kevin Roth from Black Label Capital. Kevin, your line is open. Please ask your question. Once again, I'm Kevin Roth from Black Label Capital. Your line is open. Please ask your question. All right, we'll move on to the next question. One moment, please.
F. Morgan Gasior (CEO)
Let's just go to Brian.
Operator (participant)
All right, apologies about that. For the next question, it actually comes from the line of Peter Winter from D.A. Davidson. Your line is open.
Peter Winter (Managing Director and Senior Research Analyst)
Thanks. It's Winter. Good morning. I was wondering, could you give an update from a credit perspective just with the U.S. government equipment finance business? Also, I noticed that there was a pretty big jump in loans, 30-89 days past due.
F. Morgan Gasior (CEO)
Sure. Well, let's talk about the 90, past due 90 and still accruing. Those were- and we wrote about it in the 10-Q. But the, the first one, larger one, was a RE transaction. And, it- they had mis-billed the invoices for the first 3 payments, and by the time they get all cleaned up, on processing, it had crossed 90 days. We, we received the money in mid-October, and it's current, so no issues there. The smaller one is a commercial deal, and again, as we wrote about, the situation seemed as recently as this week, Monday, seems to be working its way through a resolution, wherein we'll not only get the payment due in what was due earlier in 2023, but potentially the 2024 payment as well, and just be out of the transaction completely.
That's not guaranteed, but that does appear to be the way it's headed at the moment. And so in the next, you know, certainly by year-end, we'd be out of the deal. So at that point, those issues are completely resolved. On the two U.S. government deals, the claims are finished. They're in. There's two counsels involved, one for us and one for the servicer, and actually a third one for the prime contractor. They are all getting ready to do their reviews and then submit the claims, which we would hope to have here in November.
Then, there's, as we've said, between a 60- and 120-day period for the agencies involved to do their review. We are aware of one case recently, where on very similar facts, another military department received the claim, never responded to it, but as soon as the claim appeal was filed, the DOJ, Department of Justice, reached out and started settlement negotiations. So can't say that's gonna happen to us. But again, the claims process is an administrative function. We have prepared these claims to be ready for appeal, if that's necessary, and so that's where we are in the process. But, the passage of time has been beneficial, both on the legal research as well as some factual matters that have come out, and we're ready to file them as soon as we get through the last joint review by all parties.
Peter Winter (Managing Director and Senior Research Analyst)
The increase in the 30-89 days past due?
F. Morgan Gasior (CEO)
There wasn't that much, there wasn't that much. I wouldn't say there's anything particularly concerning there.
Peter Winter (Managing Director and Senior Research Analyst)
If I'm not mistaken, I think that's—
F. Morgan Gasior (CEO)
Oh, the—
Peter Winter (Managing Director and Senior Research Analyst)
Yeah, and there's a multifamily loan.
F. Morgan Gasior (CEO)
Oh, what I can say about anything with government is it got paid. Everything is renewed so far, that was supposed to be renewed, and it got paid on schedule. So we're not worried about that at all. The ones we highlighted that we're watching carefully are the ones we put in the 10-Q.
Peter Winter (Managing Director and Senior Research Analyst)
Okay. And just multifamily, you know, there's been some talk about multifamily and some overbuilding, and then some pressure when the rates reset. And so I did see that there was a 30-89 on multifamily. I'm just wondering if you could talk about multifamily from a credit perspective, what you're seeing?
F. Morgan Gasior (CEO)
Multifamily has been stable. As far as overbuilding is concerned, I can very much see the concerns in that. But overbuilding is a function of what I would call Class A buildings. You know, large downtown or suburban projects. Ours are all neighborhood projects, you know, the BC buildings, where, if anything, the supply is contracted. So you know, probably a bigger concern would be if there is a recession where, you know, consumers are having to make choices, then you worry a little bit about you know, vacancies just like you would in any normal economic context. But right at the moment, multifamily is stable. There's nothing of particular concern in the portfolio.
I think we have a couple of cases, smaller cases, where there was a fire in the building, and so we're going through the insurance process, but we have business interruption insurance on the buildings. That is not atypical in multifamily, where, you know, somebody's smoking and falls asleep, and there's a fire in the building.
Peter Winter (Managing Director and Senior Research Analyst)
Got it. And if, if I could just ask one more question, just the outlook for, loan demand and, and loan growth. I think part of loans have been declining. Part of it is, running down the, the equipment finance business. I was just wondering if you could talk about loan demand, loan growth outlook.
F. Morgan Gasior (CEO)
Yep. Well, you're absolutely right that the decline in the government finance and getting everything paid was a significant contributor to liquidity. It was also a reasonably helpful contributor to earnings because we were picking up, you know, probably about 200 points on the replenishment of that cash into just overnight checking. So as we look at 2024, we think that, you know, continuing to work on the commercial finance side and the business finance side, working capital lines of credit and related matters, both on the commercial side, businesses 5-20 million, and on the smaller business side, 1-5 million, are one of our key initiatives. Equipment finance, commercial and corporate, particularly corporate, will still play a role. Credit spreads are very tight still.
We were looking to put a little more investment grade on, and, you know, we've consistently seen credits, credit spreads tight, you know, as low as the low 6%s, which isn't necessarily for a 3-to-5-year deal, which isn't that compelling for us, given where, you know, overnight funds are. But our priorities, first and foremost, are commercial finance, business finance, equipment finance on the commercial corporate side. And then we'll do some real estate with some demand for refinances. There's still a little bit of purchase activity out there, as well, but obviously, as the rates continue to rise, as they did in the third quarter, that just makes it harder and harder for these buildings to trade.
Yields right now, what we'd like to target in equipment finance is low to mid-7%s. You know, probably low 7s in the real estate side. The commercial finance side would probably go between 9.5 and 10. It's also the case that the commercial finance customers maintain deposits and maintain treasury services and sweep activity with us. So all of those are contributors that we'd like to continue to focus on. With that said, it's a little early for us to think too much about growth in the portfolio, but I would say that we'll probably be, you know, potentially even on the portfolio. But you know, given the cash flow spread we've seen in the fourth quarter, down a bit more once we get the rest of the cash in.
So from that baseline next year, you know, we'd love to see the fastest growth in commercial finance. It's just the hardest thing to predict right now. But all told, you know, 5% growth, maybe 6%, net growth. We still will have quite a bit of cash coming off the equipment portfolio next year that we should put to work somewhere. And if we can allocate it along lines we're talking about, we're going to have margin expansion. It's just a question of how much.
Peter Winter (Managing Director and Senior Research Analyst)
Got it. That's really helpful. Thanks for taking the question.
Operator (participant)
Thank you. One moment for your next question. For your next question, comes from the line of Brian Martin from Janney. Brian, your line is open. Please ask your question.
Brian Martin (Director and Senior Equity Research Analyst)
Hey, good morning, guys.
F. Morgan Gasior (CEO)
Good morning.
Brian Martin (Director and Senior Equity Research Analyst)
Hey, just wanted to touch base on, Morgan, you talked about the cash flows coming off the portfolio over the next, you know, 12-15 months. Can you just give us an idea, remind us what, what's coming off there, both in loans and securities that you're going to replace, and just kind of where that, you know, kind of that current yield is, just in, you know, kind of where new yields are today, just so we can kind of think about that dynamic here?
F. Morgan Gasior (CEO)
Brian, the cash flows coming off from the securities portfolio between the end of the third quarter to the end of 2024, there's about $100 million coming off at sub 2% yields. And then in the loan portfolio, the scheduled principal is about $220 million from the end of third quarter to the end of 2024, and that's coming off at yields just over 4%. So weighted average of that $320 million, it's high threes.
Brian Martin (Director and Senior Equity Research Analyst)
Okay. And then as far as the, you know, the replacement, you know, I guess, yields on loans, if you are targeting more, I guess, it sounds like more the commercial finance variety or just how do we think about it if you kind of put that back to work outside of, if you don't put it, you know, just leave it in cash, at the Fed, you know, kind of how, what you think you are achieving there, just kind of what the current rates are?
F. Morgan Gasior (CEO)
You know, I'd say if you wanted to go with a relatively conservative benchmark, it's again, it depends on the mix. And if we do do some investment grade, again, credit spreads are tight, but part of the advantage of doing some investment grade in the equipment finance portfolio is some protection on the downside. If suddenly, even though everybody's expecting higher for longer, we are exposed to a sudden decline in rates, at -200 and further, and our equipment portfolio, the investment grade, would help protect that. We have to put a decent amount out there, though, to have a material impact on that number. But let's assume we do some of that investment grade during the course of next year for precisely that purpose.
Then I could see that averaging the yields down, so it would be closer to 8.5, eight and a quarter, 8.5. If we don't do that much investment grade, then I could see that averaging closer to 8, 8.75-9—again, the, the prime-plus stuff is going to go off pretty much at prime-plus one, on average. Some might be less, some might be more. We are expecting one more Fed increase. We'll see what happens today, but it seems like, you know, a, a prime rate of 8.75 to start the year seems at least feasible. Next quarter we talk, we'll know what that number is, and that'll be our baseline. So that's why we're saying, you know, prime-plus 75 is 9.50, prime-plus one is 9.75.
Even if you weighted average the investment grade and some equipment finance and even some real estate into that, you probably still get into the low 8s, we should think.
Brian Martin (Director and Senior Equity Research Analyst)
Got you. Okay, and it sounds like loan growth is pretty, at least for next year, you're thinking low to single digits, and then maybe fourth quarter is still pretty modest. You know, I guess, I don't know how near-term trends look in fourth quarter?
F. Morgan Gasior (CEO)
Fourth quarter is probably going to be pretty modest. We had decent pipelines coming into the quarter. It slowed down in October quite a bit. And so we'll close what we have, but we're also not pushing a lot. We noticed that rates, you know, basically kept going up during the summer. We were mostly having discussions about customers trying to lock in, and we're like, "Wait, you didn't send us everything we needed to," so forth and so on. But I would say just with the amount of cash that's still going to come at us in the fourth quarter, I would expect the loan portfolio to pay down a bit more. And then we'll start to get the pump running here.
Our first quarter market here is going to actually start here in November and December, just reaching out to people and happy holidays, and then follow up in December. And then that'll continue at a pretty steady clip all through next year. So I—that's why I said if we could see a little bit of a sprint to the end, this is about the time you start getting calls about, do you still have room and capacity? And we do, to get something done. It's also the case, though, that right at the end of the year is also when we get pay downs on the lines of credit, especially in the Lessor Finance side, then that could mean a $10 million drop in a week.
So that's why I say, one, between the cash flows that are scheduled for the quarter, two, kind of an intermittent demand. It's not steady. It comes and it goes. And then three, just the normal year-end activity. Probably a little bit more of a decline, yeah, expected decline in the loans in the first - in the fourth quarter, with starting to pick up as we get into next year.
Brian Martin (Director and Senior Equity Research Analyst)
Gotcha. And that government portfolio, Morgan, I think you said last quarter, you kind of ceased operations and really aren't originating more. Is that continuing? You know, I guess, or is that something you're evaluating?
F. Morgan Gasior (CEO)
Let's break the government into three components: federal, state, and municipal.
Brian Martin (Director and Senior Equity Research Analyst)
Yeah.
F. Morgan Gasior (CEO)
We have ceased federal until we get a handle on what is actually going on with these two credits. At the moment, it's only these two credits. Everything else is renewed and paid. But yes, that is on the federal side, we are done for now. Until you can understand what happened here, you cannot predict another similar case. We have appropriate contractual protections, and the government did what they did anyways. So there would be no way to predict this at the moment. We do do some state and municipal, so I would expect that to continue. But again, in a more limited sense, the budgets for all of these governments, state and local governments, are declining.
They do not have the same amount of stimulus support that they did 2019, 2020, 2021, you know, 2021, 2022. As a result, the flow of capital to those entities should decline, and therefore, I would expect our originations to decline. The final part of these, these are annual payments. Not all of them. Some of them, like the one in Nebraska, this last quarter, was monthly. But generally speaking, the government portfolio will be down principally because the federal is terminated in terms of new originations, and secondly, because we expect state and local to just originate at a much lower level of activity, given that they're going to have fewer resources to work with in the future.
Brian Martin (Director and Senior Equity Research Analyst)
Gotcha. Okay. So, then, I guess, just flipping last couple of questions, just on the funding side, are you seeing the pressure on funding costs begin to abate? I guess, and then you talked about a little bit about dynamics there last quarter, but have you seen that slow?
F. Morgan Gasior (CEO)
Yep, I would say we have. There are still, there is still some activity, but in two dimensions, we've seen a little bit of pressure come off. One, somewhat fewer customers and requests coming in for, you know, new products and changes. And two, we've noticed that some of the competitors have backed off their premium rates, even in the last several weeks. So that obviously is helpful in both regards. We're not having to stretch and meet rate where somebody's running a special. There are fewer specials out there. And generally, customers seem to be happy with what we've done so far. But I wanna, I wanna caution everyone that, that's a situation we'll take week by week.
You know, if there is greater pressure on the economy and the Fed from a rate perspective, that may not, you know, stay that way. Higher for longer has certain risk to it. But at the moment, things have been a little quieter, both in terms of customer requests and in terms of competition from competitors.
Brian Martin (Director and Senior Equity Research Analyst)
Gotcha. Okay, and the last two for me, just I think, reading what was in the queue, I think I understand that, but just on the expense side, I know there's still some costs related to, you know, the claim filing. So I guess, should we think about the expense run rate going forward, just kind of normalizing post, you know, kind of the, you know, the costs involved with, you know, the, the two credits you kind of talked about in prepping that paperwork?
F. Morgan Gasior (CEO)
Yep. You—we very much should see it normalize. Once the claims are filed and we're reaching, like I said, the end of that process right now, they'll—we'll be quiet for a while, but we have prepared these to be ready for an appeal. We've done the legal research into it, so there'll be some work if we have to get to that point, which we're expecting, but nowhere near the level of investment that we've had to up to this point. We did it upfront. So in terms of gross expenses, again, we're going to be working on prioritization around here as we finish up the year-end. Prioritization in the marketing budgets, and aligning them with the business, you know, hyper align with the business plan, to focus on commercial financing, business finance, and commercial deposits.
Right now, we're doing product training and advanced credit training for bankers so that they can get out and sell the products that we developed in the last 18 months or so. Some of them have worked with asset-based lending and factoring before, many have not. So they understand basic commercial credit, everybody does, but they haven't had a chance to work through specific cases on how an ABL and a factoring work, especially when they're in one product. So that's another focus we'll have. That is an internal expense. We're reallocating resources from one department to another. It won't really change the bottom line on us.
So net-net for next year, we do our best to keep expenses right around $40 million, maybe $500,000 up, $500,000 down, especially on a going concern run rate, once we, you know, once we get rid of the expenses on the, on the federal claims. Obviously, we'll do everything we can to make the place more efficient, but we still will see some increase in compensation, just on baseline. The benefits plans are coming in well, so we don't really see a lot of pressure on the benefits side. We will see some expense increases just across the board. Technology seems to be an area that everyone's looking for their, you know, extra increase of one thing or another.
Even real estate taxes seem to continue to increase, especially, in our northern suburban locations and our western suburban locations. One note on that, we are working towards a contract on our one remaining branch that's for sale. Process continues to take longer than we would like, but it appears that all the parties are getting their approvals together. They recently asked us for some help in financing, which, you know, depending on how their revenue sources work, this is a special purpose unit that is being constructed by several of the local municipalities to provide a state-of-the-art 911 center. It'll be a great thing for the community. We're pleased to be part of it. So we've reached an agreement on the price for the asset.
We're waiting to find out exactly how they're going to hold title to the building and where the revenues come from. And under Illinois law, they're permitted to borrow money to finance the building. And once we have all the answers to that, we'll see if we can get this thing closed.
Brian Martin (Director and Senior Equity Research Analyst)
Gotcha. Okay. Yep, just the last—I guess my last one was just on, like, Morgan, you talked about kind of your outlook in terms of whether it be ROA or pre-tax, pre-provision earnings, kind of the near term or just kind of into 2024. Can you give any, any sense of if any of that, your previous kind of commentary has changed? Or I guess, kind of where you're at today as far as kind of outlook goes.
F. Morgan Gasior (CEO)
You know, first of all, on EPS, you know, we see ourselves getting closer to being able to sustain $1 a share into 2024. Again, we concern ourselves a bit with what could happen in terms of deposit interest expense. But the range of outcomes for next year will in part depend on how well we do with loan originations. The fact that we're repricing so much from the low- to mid-3s, you know, mid- to high 3s in some cases, into 5.75 in a checking account, puts a natural floor underneath the yields and the earnings. But the real optimization of the franchise would be if we can get a reasonable growth rate in commercial financing business. At that point, you're looking at 95 points return on the average assets or so.
In terms of ROE, we look at ROE in, in the context of, you know, the required capital to run the place. Right now, 9%, we're observing the community bank ratio. So if you use 9% capital, then we should get, you know, very close to a 9.5%-10% return on the 9% bank community bank ratio. We're holding considerably more than that in capital, but potentially going into a recession, not to mention having that one or two shooting wars going on, and still, you know, trends in the economy that don't look like we've got inflation beat. We like that higher capital ratio, but in terms of a targeted ROE, if we dividend out the excess capital, you'd have to have 9%.
Our target is 9.5%-10% on the Community Bank Leverage Ratio.
Brian Martin (Director and Senior Equity Research Analyst)
Gotcha. Okay. I appreciate you taking the questions. Thank you.
F. Morgan Gasior (CEO)
Thanks for your time.
Operator (participant)
As a reminder, to ask a question, please press star one one on your telephone keypad. There are no further questions at this time. I would like to turn the conference back to F. Morgan Gasior for closing remarks.
F. Morgan Gasior (CEO)
Well, we thank everyone for their interest and their questions. We wish everyone a happy and healthy holiday season, and we will talk to you in 2024.
Operator (participant)
Thank you, and this concludes today's conference call. Thanks, everyone, for participating. You may now disconnect.