BankFinancial Corp
NASDAQ:BFIN
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BankFinancial Corp
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Good day and thank you for standing by. Welcome to the BankFinancial Corporation First Quarter 2023 Earnings Conference Call. [Operator Instructions] 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.
All right. 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.
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 provision. 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 effect of our plans and strategies is inherently uncertain and actual results may differ from these -- from those predicted. For further details on the risks and uncertainties that could impact our financial conditions 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.
And now I'll turn the call over to Chairman and CEO, Mr. F. Morgan Gasior.
Thank you. At this time, all filings are complete and we would be pleased to take questions.
[Operator Instructions] Our first question comes from the line of Manuel Navas with D.A. Davidson & Company.
I noticed loan growth was a little flatter than expected this quarter, probably some seasonality and lot of growth last quarter. Maybe there's some pull forward then. How do your 5% to 10% expectations look for 2023 given current trends and current like demand conditions? Just kind of trying to get a feel for what you're thinking going forward.
Well, I would say, given what's happened with the yield curve and 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. So that's not going to be as active as it might have been at the beginning of the year. And -- but 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 -- we had good growth in it for first quarter. Our health care borrowers are still somewhat volatile. We see line utilization for a short period of time and then they get remittances in and pay it back down. So I have to say the health care side seems a little less certain than it did at the beginning of the year because their cash balances are holding up and their remittances are shorter than we would have otherwise expected.
So all in all, if we look at -- and then 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 as muted as it was as we thought at the beginning of the year. So all in all, I'd say if we got to a 3% growth from where we're at, 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 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.
So as I said, in the Equipment Finance space, especially with the inverted yield curve at its current levels, some of those transactions just don't meet our yield objectives at this point, so we'll see less growth.
Okay. And the -- so I guess that's all encompassed in some of the origination trends slowdown but payoffs also slowed down. Those two trends kind of continue to kind of hit that 3%, a little bit less payoffs but also probably muted originations?
Yes. 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 relatively muted activity but you're not going to see a significant amount of refinance activity in terms of payoffs. So the real estate portfolio will continue to pay down pretty much along the lines of what we 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 2 to 3 to 4 to 5 quarters. That's always part of our liquidity strategy. And 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.
Health care 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. So that's where I think we'll see some volatility in loan balances is in the commercial finance sector. And again, we're going to 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.
Could I shift over to the -- to deposit outflows a bit? Just kind of what are you seeing there? What's driving them? 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?
Well, in our first quarter -- and we try to put more detail in the MD&A in the 10-Q. But 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. So 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 sold their business. They are selling 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 -- the business is closed and they're in retirement mode, so they're investing in other assets. And we'll see -- we'll continue to see some of that and that will introduce some volatility 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 7 figures and in some cases, low-8 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. So as we said in the 10-Q, our tracking showed us about $12 million to $13 million of competition losses. And they haven't slowed down a bit but it's still there. And as a result, we could still see some declines in deposits due to competition. But I'll also say that 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. And we pivoted right into making sure that customers are comfortable with deposit insurance. And 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. So that is actually something that has helped us bring in new deposits from existing customers. In their first week, the week of the 13th, we saw a handful of customers, including a couple of commercial customers, look around and try to diversify a bit. But we've seen some of those customers come back again now that they understand that there are many deposit insurance options available to them.
So, I would say going forward, we'll still see some loss of gross loss, if you will, on competition. There's competitors out there that are in the low 5s 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 5 that is pretty well tied to the short-term indexes and should be competitive. But 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 going to come out. But 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 and we saw some recovery in the last week of April even after we did the tax disbursements.
So 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 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 and we'll see how we do from there. But if we can keep deposits stable, maybe even growing a little bit by the end of the year, that same 2% to 3% and keep our loan-to-deposit ratio in the 90%, 91%, 92% range, that would be a good result by the end of the year for us.
That's actually really helpful and kind of leads into a NIM question and NIM outlook discussion. Like is there still some -- previously 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?
Well, as we said last quarter, the wildcard was deposit interest expense and it remains the wildcard. The -- that is going to be the key to what happens next. And actually, we've been saying it for about a year now. As the deposit competition is 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. So I'd say, number one, higher deposit interest expense is the greatest challenge in terms of maintaining and expanding net interest margin. After that, the next issue is going to be maintaining appropriate yields on originations. So 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 the Fed increase potentially today affecting our prime rate loans, that will give us a better chance at stabilization and even expansion. But I'd say the key to expansion is going to be the growth of the commercial finance portfolio. Those are the higher-yielding Wall Street general prime-plus assets. So the key to that is increasing the commitments and increasing the utilization. If we get that, that is our number 1 best chance towards margin expansion. If it stays stable, that probably gets us closer to margin maintenance.
And we're going to do our best to avoid diluting the margin with lower-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. But 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 margin stabilization and expansion. And the wildcard will be deposit interest expense.
That's really helpful. My last question is there's a little uptick in NPLs. Can you offer any color on that as in commercial?
Yes. 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 is concerned and if necessary, potential avenues of recovery with the private contractor and the vendor. But this process is going to take a while and 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're dealing with -- we've been doing this. But at the moment, we were comfortable with 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.
[Operator Instructions] Our next question comes from the line of Brian Martin with Janney.
Morgan, can you -- your comment about the loan growth may be slowing a bit with those Equipment Finance originations, I mean what could change on the yields? I guess, I don't know what type of spreads are you getting today that aren't acceptable versus kind of what they were a quarter ago? And I guess, is there some possibility that changes and you get -- potentially get some benefit or from getting some originations throughout the year? Or just kind of what has to change there to kind of swing that back in the positive direction?
Generally speaking, at the moment, we put minimum yields on that portfolio. And the problem we're running into is the inverted yield curve. So if somebody wants to do an investment-grade 5-year transaction, Equipment Finance transaction, you are talking about yields that could be as low as 4% to 4.25%. And we lost some 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. And so that's going to take us out of the government space, that's going to take us out of the investment-grade space for most credits. Now from time to time, because the lessor has fair market value leases, we might get -- we might see something in the very high 5s that we might do, especially if it's shorter duration, 3 years. But we're just not going to 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.
So, 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 7s and that's where they need to be for this to work in terms of projections on margin maintenance and margin expansion.
Got you. Okay. No, that's helpful. And just 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. So just kind of trying to understand, you funded from here, what's the -- is it going to come from deposit growth? Is there still -- do you utilize that cash? Just how you're thinking about funding the loan growth you plan this year?
Generally, it will come from repositioning the balance sheet. And some of the securities that are maturing, we might keep in liquidity for the time being and we'll have a 5.25% yield in the cash account. So that's kind of a baseline. Another reason why the investment grade and the government equipment don't necessarily make sense to us. We're better off in cash. But going forward at that point, we can still fund from the cash flows from Equipment Finance. We can fund commercial finance growth. We've got some cash flows from real estate that can fund commercial finance growth. And we can reposition the cash flows from investment grade and government equipment finance in the corporate other, middle market and small ticket.
So generally speaking, 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. But our growth -- our goal is to go 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're going to 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 severely inverted yield curve.
Got you. And just as far as what -- maybe I missed what you said on just kind of the margin percentage outlook. I mean, if you -- given what's repricing over the next 12 months, if we get a rate increase today, I guess, how are you thinking about the kind of that margin percentage at this point over the next couple of quarters?
Yes. 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 second -- in the first half. So it's possible we could see a bit of margin compression in the second quarter, something because we have a little bit less repricing in the second quarter. But then the third and fourth quarter, we have a greater quantity of cash flows coming back and a greater opportunity to reprice. But 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. Average yields in the commercial finance portfolio and originations in April were 9%, probably likely go higher. But what is the utilization percentage?
And that's why specific numbers are just a little bit difficult right now. We're going to have to see how competition is on deposits. We'll have to look at utilization. And 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. And then as things are stable, 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 upward.
Got you. Okay. And how about just the deposit beta? Just I guess, your sense is that -- does it -- your funding cost -- maybe the funding cost peak -- I mean, do you have a sense on what your outlook is that when funding costs peak for you guys, I guess, given the Fed does pause after today's potential hike?
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. And in terms of calling a deposit expense peak, I think it comes down to what is the level of Fed funds in the 3-month, 6-month T-bills. You're competing against short-term money market funds that are funding in that short duration. And until that changes, I think it would be difficult to call a peak. So we don't particularly believe there's a Fed pivot in the short term here. We're thinking and planning as if there is not. So I think that is going to be probably the key fact. If all of a sudden, there's a material change in short-term 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.
Got you. Okay. And then how about just a couple of last ones. Just on the expense side, just kind of your expenses look pretty well maintained this quarter. Just kind of any change in how you're thinking about approaching expenses over the balance of the year?
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. So where there is 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. So there's aspects of that. But 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. And we have to maintain our critical controls.
So right now, we -- if there were some ambitious -- some mildly ambitious things that we might want to do in the second half, we'll probably back off of that a little bit. And 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, our facility is closed in April. So we've got the cost saves 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. And if that closes after the grant's received, hopefully in third quarter, then we'll get another material expense save on the occupancy side. So that will be helpful to us. Again, that provides some opportunity to protect profitability even if we have higher deposit interest expense.
And so 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.
Got you. Okay. And then the buyback, I guess you bought a few shares back this quarter. I guess, is that given where valuations are on capital and loan growth outlook, is that maybe more of a priority or more of a focus given current conditions, just kind of moving a bit -- moving around a bit?
I would say that the activity is going to be no higher than it was in the first quarter and likely less, at least for now. Obviously, given the recent events in the market, stability is a good thing and liquidity above all. So as attractive as it is at these levels, 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. We did a lot last year and obviously, again, it's attractive right now. But just maintaining stable liquidity at all levels, the bank, the holding company everywhere is the key. So right now, I would expect less activity in the second quarter than there was in the first quarter. And then we'll take things a quarter at a time.
Okay. And just given your comments, Morgan, about the loan growth being a little bit less and kind of the other items in there, it sounds as though the profitability forecast is probably a bit lower given some of what's occurred here. So I guess, how are you thinking about kind of the ROA or just where you kind of trend to given kind of the change in pivoting conditions here in the market?
I guess I would -- again, we tend to focus on earnings per share. So a good goal for us is, as we said, to maintain the mid-20s, maybe high 20s, in the second and third quarter. Again, we may see a little bit of deposit -- a little margin compression in the second quarter just based on relative cash flows. If we can stabilize that and improve it a little bit in the third and fourth quarter, we would -- 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. 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. So we'll be pretty happy if we can keep it in the mid to high 20s for the next couple of quarters. And if we see a pivot later, sooner than we're thinking, the market thinks in the second half, we do not, then that will help. But it will turn on what our 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.
Got you. Okay. That's helpful. And maybe just a last one. On the credit, outside of the one credit you spoke about earlier and mentioned in the Q, I guess, trends are continuing to be pretty strong. I guess, it looks -- from what you can see from the filings and just the numbers themselves but anything you're seeing from a credit standpoint out if that -- other than that one-off, how trends are performing?
The real estate portfolio is doing extremely well. And as you know, our portfolio is very focused on the multifamily loan portfolio which continues to perform very, very well. And 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 of years but the vast majority of the loans have been around a long time. We have very little exposure to office. It's something about $16 million. And of that, one of them is a loan on one of our own branch offices that's held by an investor. So we really don't have any CRE office exposure to be concerned with. And generally speaking, we're comfortable with what we're seeing. We have -- you can see it in the substandards. There's a couple of individual borrowers, one in the equipment side, one on the C&I side of Chicago customer.
They've been substandard for a while now that we're working with to the best of our ability and will resolve as best we can. But fundamentally, 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.
[Operator Instructions] Our next question comes from the line of Henry Welbeck [ph] with HFW Capital.
Morgan, I like your outlook for the mid-20s 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.
Yes. That's the one credit we spoke of earlier in the government finance portfolio. I think I covered it 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. But 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. But it's something that happened. Because of the claims process, we put it on that accrual. We'll go forward from there. But that was the issue in the first quarter.
Is that a local NPA? Or is that like in some foreign state?
I'm sorry. That's a United States government credit.
Okay. Is that like a local Illinois credits?
No, United States government.
And 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.
Thanks to 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 and please enjoy your day.
This concludes today's conference call. Thank you for participating. You may now disconnect.