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BFIN > SEC Filings for BFIN > Form 10-Q on 8-Nov-2012All Recent SEC Filings

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Form 10-Q for BANKFINANCIAL CORP


8-Nov-2012

Quarterly Report


Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Cautionary Statement Regarding Forward-Looking Information Forward Looking Statements
This Quarterly Report on Form 10-Q contains, and other periodic and current reports, press releases and other public stockholder communications of BankFinancial Corporation may contain, forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, that involve significant risks and uncertainties. Forward-looking statements may include statements relating to our future plans, strategies and expectations, as well as our future revenues, earnings, losses, financial performance, financial condition, asset quality metrics and future prospects. Forward looking statements are generally identifiable by use of the words "believe," "may," "will," "should," "could," "expect," "estimate," "intend," "anticipate," "project," "plan," or similar expressions. Forward looking statements speak only as of the date made. They are frequently based on assumptions that may or may not materialize, and are subject to numerous uncertainties that could cause actual results to differ materially from those anticipated in the forward looking statements. We intend all forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995, and are including this statement for the purpose of invoking these safe harbor provisions. Factors that could cause actual results to differ materially from the results anticipated or projected and which could materially and adversely affect our operating results, financial condition or future prospects include, but are not limited to: (i) the failure of the real estate market to recover or further declines in real estate values that adversely impact the value of our loan collateral and OREO, asset dispositions and borrower equity in their investments; (ii) the persistence or worsening of adverse economic conditions in general and in the Chicago metropolitan area in particular, including high or increasing unemployment levels, that could result in increased delinquencies in our loan portfolio or a decline in the value of our investment securities and the collateral for our loans; (iii) results of supervisory monitoring or examinations by regulatory authorities, including the possibility that a regulatory authority could, among other things, require us to increase our allowance for loan losses or adversely change our loan classifications, write-down assets, reduce credit concentrations or maintain specific capital levels; (iv) interest rate movements and their impact on customer behavior and our net interest margin; (v) less than anticipated loan growth due to a lack of demand for specific loan products, competitive pressures or a dearth of borrowers who meet our underwriting standards; (vi) changes, disruptions or illiquidity in national or global financial markets; (vii) the credit risks of lending activities, including risks that could cause changes in the level and direction of loan delinquencies and charge-offs or changes in estimates relating to the computation of our allowance for loan losses; (viii) monetary and fiscal policies of the U.S. Government, including policies of the U.S. Treasury and Federal Reserve Board; (ix) factors affecting our ability to access deposits or cost-effective funding, and the impact of competitors' pricing initiatives on our deposit products; (x) the impact of new legislation or regulatory changes, including the Dodd-Frank Act, on our products, services, operations and operating expenses; (xi) higher federal deposit insurance premiums; (xii) higher than expected overhead, infrastructure and compliance costs; (xiii) changes in accounting principles, policies or guidelines; and (xiv) and our failure to achieve expected synergies and cost savings from acquisitions.
These risks and uncertainties, as well as the Risk Factors set forth in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2011, should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. We do not undertake any obligation to update any forward-looking statement in the future, or to reflect circumstances and events that occur after the date on which the forward-looking statement was made.

Critical Accounting Policies
Critical accounting policies are defined as those that are reflective of significant judgments and uncertainties, and could potentially result in materially different results under different assumptions and conditions. We believe that the most critical accounting policies upon which our financial condition and results of operation depend, and which involve the most complex subjective decisions or assessments, are included in the discussion entitled "Critical Accounting Policies" in Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2011, and all amendments thereto, as filed with the Securities and Exchange Commission.


Table of Contents

Overview
During the third quarter of 2012, national economic activity decelerated and local economic conditions in our primary Chicago metropolitan market area reflected at best minimal growth. The principal challenges in the local economy continue to be persistent unemployment and uneven economic growth, both of which continue to impact real estate values. Competitive factors also had an increasing impact during the quarter, as pricing and underwriting competition for multi-family and commercial real estate loans and commercial leases remained intense.
Loan portfolio balances declined in all categories except consumer loans; however, loan pipelines for multifamily, commercial real estate, commercial health care and commercial leasing are at their highest levels in the past four quarters. Residential loan balances declined due to scheduled loan amortizations and prepayments of our fixed-rate loan portfolio. Multi-family loan balances declined due to intensified pricing and underwriting competition, including the entry of new competitors into the sector. In approximately 50% of the cases in which we received a payoff on a multi-family loan, we elected not to match the competitor's offer based on the particular merits of the credit exposure, which involved unmonitored cash-out refinance transactions. Commercial real estate loan balances declined due to slightly lower loan origination volumes and certain targeted portfolio reductions. We expect to see continued targeted portfolio reductions within the commercial real estate portfolio through the first quarter of 2013, potentially fully offset by improved loan origination volumes. Commercial and industrial loan balances declined primarily for cyclical reasons due to state government health care payables practices and due to quarter-end activity on commercial lease bridge lines of credit; we expect these balances to return gradually to their customary balances over the next three to six months. Commercial lease origination volumes improved during the quarter; we expect this portfolio to return to positive growth in the fourth quarter of 2012. Our focus for the remainder of 2012 will be to maintain current overall loan portfolio levels and to more aggressively increase originations in certain selected loan categories such as residential loans, multifamily loans, commercial loans and commercial leases consistent with market opportunities. We engaged in the accelerated disposition of certain OREO assets during the third quarter of 2012. Our evaluation methodology involves an assessment of the disposition strategy that provides the highest cash proceeds within a defined period of time. During the third quarter of 2012, we changed our disposition strategy on certain income-producing OREO assets from an ordinary-liquidation pricing model to an aggressive pricing model designed to stimulate market demand. For the third quarter of 2012, we closed $2.4 million in total OREO sales and had accepted offers on an additional $4.3 million in OREO balances; the total activity represented 38.6% of our June 30, 2012 OREO balances. Our third quarter of 2012 results reflect the write-downs and expenses related to OREO transfers and sales.
Management is evaluating, but not yet finalized or presented to the Board for approval, a more comprehensive plan to reduce nonperforming assets through accelerated dispositions during the fourth quarter of 2012. In this regard, we continued evaluations of certain non-performing loans and OREO for which a targeted disposition strategy aimed at long-term equity investors may be the most appropriate strategy. If approved by the Board, the objectives of such a plan would be to achieve a meaningful reduction of non-performing loans and OREO by the end of 2012 such that the future potential impacts to earnings in 2013 and future years from credit-related costs are materially diminished. Our general loan loss reserve requirement remained stable in the third quarter of 2012 due principally to a reduction of loan portfolio balances offset by increased reserves for residential and home-equity loans pursuant to new regulatory standards. Pursuant to newly-applicable OCC guidance, we charged off $10.8 million of our specific valuation allowances during the quarter and recorded $3.8 million in additional charge-offs related to updated appraisals received on non-performing loans.
Given our excess liquidity position, we continued to reduce our competitive posture with respect to pricing on single-service certificate of deposit accounts, which has been successful in producing a decline in these account balances. Pricing conditions for local deposits, whether low-balance core deposits, certificates of deposit or high-balance, high-yield transaction accounts, remained generally favorable due to very low market yields and continued weak industry-wide loan demand.
Our net interest spread and net interest margin declined due to declines in loan yields and the decline in loan balances. We anticipate that current market conditions on new loans and leases and lower effective yields resulting from scheduled loan repayments and loan renewals will likely cause some additional compression of our net interest margin and net interest spread; however, we believe that the preponderance of portfolio yield reductions have already occurred and we may be able to offset some of the impact of lower market yields with loan growth in the coming quarters. Given the quantity and volatility of the variables affecting our net interest margin and net interest spread, we are unable to confidently predict what the Company's net interest margin and net interest spread will be for the remainder of 2012 and 2013.
Non-interest income was higher in the third quarter of 2012 due to stabilization in deposit service fees and other non-interest income categories. Non-interest expense was materially higher due to factors relating to non-performing asset / OREO management and valuations; however, our core non-interest expense was stable.


Table of Contents

Selected Financial Data
The following tables summarize the major components of the changes in our
balance sheet at September 30, 2012 and December 31, 2011, and in our statement
of operations for the three and nine month periods ended September 30, 2012 and
September 30, 2011.

                           September 30,
                                2012          December 31, 2011       Change
                                         (Dollars in thousands)

Total assets              $     1,499,872    $         1,563,575    $ (63,703 )
Cash and cash equivalents         236,729                120,704      116,025
Securities                         81,748                 92,832      (11,084 )
Loans receivable, net           1,080,489              1,227,391     (146,902 )
Deposits                        1,278,196              1,332,552      (54,356 )
Borrowings                          6,946                  9,322       (2,376 )
Stockholders' equity              197,997                199,857       (1,860 )



                             Three months ended September 30,               Nine months ended September 30,
                            2012             2011         Change           2012            2011         Change
                                                         (Dollars in thousands)
Selected Operating
Data:
Interest income        $    14,468       $   17,990     $  (3,522 )   $    46,926       $  52,338     $  (5,412 )
Interest expense             1,036            1,629          (593 )         3,388           5,535        (2,147 )
Net interest income         13,432           16,361        (2,929 )        43,538          46,803        (3,265 )
Provision for loan
losses                       4,453            7,384        (2,931 )         7,194          12,983        (5,789 )
Net interest income
after provision for
loan losses                  8,979            8,977             2          36,344          33,820         2,524
Noninterest income           1,831            1,863           (32 )         5,081           5,313          (232 )
Noninterest expense         16,032           14,637         1,395          43,512          43,515            (3 )
Loss before income
taxes                       (5,222 )         (3,797 )      (1,425 )        (2,087 )        (4,382 )       2,295
Income tax benefit               -           (1,901 )       1,901               -          (2,735 )       2,735
Net loss               $    (5,222 )     $   (1,896 )   $  (3,326 )   $    (2,087 )     $  (1,647 )   $    (440 )


                                     Three months ended September 30,       Nine months ended September 30,
                                           2012                2011               2012                2011
Performance Ratios:
Return on assets (ratio of net loss
to average total assets) (1)                (1.39 )%             (0.46 )%         (0.18 )%            (0.14 )%
Return on equity (ratio of net loss
to average equity) (1)                     (10.20 )              (3.01 )          (1.36 )             (0.88 )
Net interest rate spread (1) (2)             3.69                 4.19             3.97                4.06
Net interest margin (1) (3)                  3.76                 4.29             4.04                4.17
Average equity to average assets            13.62                15.25            13.40               15.41
Efficiency ratio (4)                       105.04                80.32            89.50               83.50
Noninterest expense to average total
assets (1)                                   4.26                 3.54             3.81                3.57
Average interest-earning assets to
average interest-bearing liabilities       123.54               122.52           123.16              122.62

(1) Ratios are annualized.

(2) The net interest rate spread represents the difference between the yield on average interest-earning assets and the cost of average interest-bearing liabilities for the period.

(3) The net interest margin represents net interest income divided by average total interest-earning assets for the period.

(4) The efficiency ratio represents noninterest expense divided by the sum of net interest income and noninterest income.


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                                                          At September    At December 31,
                                                            30, 2012            2011
Selected Financial Ratios and Other Data:
Asset Quality Ratios:
Nonperforming assets to total assets                          5.07 %             6.36 %
Nonaccrual loans to total loans                               5.55               6.11
Allowance for loan losses to nonperforming loans             33.73              41.25
Allowance for loan losses to total loans                      1.87               2.52
Capital Ratios:
Equity to total assets at end of period                      13.20              12.78
Tier 1 leverage ratio (Bank only)                            11.13              10.48
Other Data:
Number of full service offices                                  20                 20
Employees (full-time equivalent basis)                         347                357

Comparison of Financial Condition at September 30, 2012 and December 31, 2011 Total assets decreased $63.7 million, or 4.1%, to $1.500 billion at September 30, 2012, from $1.564 billion at December 31, 2011. Cash and cash equivalents increased $116.0 million, or 96.1%, to $236.7 million at September 30, 2012, from $120.7 million at December 31, 2011, as a result of the decreases in investment securities and loans. Securities decreased by $11.1 million, or 11.9%, to $81.7 million at September 30, 2012, from $92.8 million at December 31, 2011, primarily due to cash flows in our residential mortgage-backed and collateralized mortgage obligation portfolio. Net loans receivable decreased $146.9 million, or 12.0%, to $1.080 billion at September 30, 2012, from $1.227 billion at December 31, 2011, due in part to loan payoffs, and intense pricing and underwriting competition for multi-family and commercial real estate loans and commercial and industrial loans.
Total liabilities decreased by $61.8 million, or 4.5%, to $1.302 billion at September 30, 2012, from $1.364 billion at December 31, 2011. Total deposits decreased $54.4 million, or 4.1%, to $1.278 billion at September 30, 2012, from $1.333 billion at December 31, 2011, primarily due to our decision to reduce our competitive posture with respect to pricing on single-service certificate of deposit accounts. Certificates of deposit decreased $51.3 million, or 14.1%, to $313.1 million at September 30, 2012, from $364.4 million at December 31, 2011. Core deposits increased to 75.5% of total deposits at September 30, 2012, from 72.6% of total deposits at December 31, 2011. Noninterest-bearing demand deposits decreased $7.6 million, or 5.4%, to $134.5 million at September 30, 2012, from $142.1 million at December 31, 2011. Savings accounts decreased $1.3 million, or 0.9%, to $143.2 million at September 30, 2012, from $144.5 million at December 31, 2011. Money market and interest-bearing NOW accounts increased $5.9 million, or 0.9%, to $687.4 million at September 30, 2012, from $681.5 million at December 31, 2011.
Total stockholders' equity decreased $1.9 million to $198.0 million at September 30, 2012, compared to $199.9 million at December 31, 2011. The decrease was primarily due to the net loss of $2.1 million. The unallocated shares of common stock that our ESOP owns were reflected as a $12.5 million reduction to stockholders' equity at September 30, 2012.
Operating Results for the Three Months Ended September 30, 2012 and 2011 Net Loss. We had a net loss of $5.2 million for the three months ended September 30, 2012, compared to a net loss of $1.9 million for the three months ended September 30, 2011. Our loss per share of common stock was $0.26 per basic and fully diluted share, respectively, for the three months ended September 30, 2012 compared to $0.10 per basic and fully diluted share for the three-month period ended September 30, 2011.
Net Interest Income. Net interest income was $13.4 million for the three months ended September 30, 2012, a decrease of $2.9 million, or 17.9% from $16.4 million for the same period in 2011. The decrease reflected a $3.5 million decrease in interest income and a $593,000 decrease in interest expense. The decrease in net interest income was primarily attributable to a lower level of average interest-earning assets. Total average interest-earning assets decreased $94.0 million, or 6.2%, to $1.420 billion for the three months ended September 30, 2012, from $1.514 billion for the same period in 2011. Our net interest rate spread decreased by 50 basis points to 3.69% for the three months ended September 30, 2012, from 4.19% for the same period in 2011. Our net interest margin decreased by 53 basis points to 3.76% for the three months ended September 30, 2012, from 4.29% for the same period in 2011. The decrease in the net interest spread and margin was a result of lower yields on interest earning assets, which was partially offset by a lower cost of funds. The yield on interest earning assets decreased 66 basis points to 4.05% for the three months ended September 30, 2012, from 4.71% for the same period in 2011, and the cost of interest bearing liabilities decreased 16 basis points to 0.36% for the three months


Table of Contents

ended September 30, 2012, from 0.52% for the same period in 2011.

Average Balance Sheets
The following table sets forth average balance sheets, average yields and costs,
and certain other information for the periods indicated. No tax-equivalent yield
adjustments were made, because the effect of these adjustments would not be
material. Average balances are daily average balances. Nonaccrual loans have
been included in the computation of average balances, but have been reflected in
the table as loans carrying a zero yield. The yields set forth below include,
where applicable, the effect of deferred fees and expenses, discounts and
premiums, and purchase accounting adjustments that are amortized or accreted to
interest income or expense.
                                                 Three months ended September 30,
                                        2012                                           2011
                       Average                                        Average
                     Outstanding                     Yield/Rate     Outstanding                     Yield/Rate
                       Balance        Interest          (1)           Balance        Interest          (1)
                                                      (Dollars in thousands)
Interest-earning
Assets:
Loans               $ 1,125,600     $    13,978          4.94 %    $ 1,304,805     $    17,350          5.28 %
Securities               74,260             342          1.83           97,984             566          2.29
Stock in FHLB             9,614               8          0.33           16,346               4          0.10
Other                   210,355             140          0.26           94,681              70          0.29
Total
interest-earning
assets                1,419,829          14,468          4.05        1,513,816          17,990          4.71
Noninterest-earning
assets                   84,609                                        137,899
Total assets        $ 1,504,438                                    $ 1,651,715
Interest-bearing
Liabilities:
Savings deposits        143,248              37          0.10      $   143,289              46          0.13
Money market
accounts                346,523             318          0.37          354,150             391          0.44
Interest-bearing
NOW accounts            335,346             106          0.13          328,494             115          0.14
Certificates of
deposit                 316,738             549          0.69          399,435           1,041          1.03
Total deposits        1,141,855           1,010          0.35        1,225,368           1,593          0.52
Borrowings                7,449              26          1.39           10,220              36          1.40
Total
interest-bearing
liabilities           1,149,304           1,036          0.36        1,235,588           1,629          0.52
Noninterest-bearing
deposits                135,352                                        140,347
Noninterest-bearing
liabilities              14,925                                         23,857
Total liabilities     1,299,581                                      1,399,792
Equity                  204,857                                        251,923
Total liabilities
and equity          $ 1,504,438                                    $ 1,651,715
Net interest income                 $    13,432                                    $    16,361
Net interest rate
spread (2)                                               3.69 %                                         4.19 %
Net
interest-earning
assets (3)          $   270,525                                    $   278,228
Net interest margin
(4)                                                      3.76 %                                         4.29 %
Ratio of
interest-earning
assets to
interest-bearing
liabilities              123.54 %                                       122.52 %

(1) Annualized.

(2) Net interest rate spread represents the difference between the yield on average interest-earning assets and the cost of average interest-bearing liabilities.

(3) Net interest-earning assets represents total interest-earning assets less total interest-bearing liabilities.

(4) Net interest margin represents net interest income divided by average total interest-earning assets.


Table of Contents

Provision for Loan Losses. We establish provisions for loan losses, which are charged to operations to maintain the allowance for loan losses at a level we consider necessary to absorb probable incurred credit losses in the loan portfolio. In determining the level of the allowance for loan losses, we consider past and current loss experience, evaluations of real estate collateral, current economic conditions, volume and type of lending, adverse situations that may affect a borrower's ability to repay a loan and the levels of nonaccrual and other classified loans. The amount of the allowance is based on estimates and the ultimate losses may vary from such estimates as more information becomes available or later events change. We assess the allowance for loan losses on a quarterly basis and make provisions for loan losses in order to maintain the allowance.
Based on our evaluation of the above factors, we recorded a $408,000 provision to the general portion of the allowance for loan losses. In Call Report preparation guidance issued in connection with the transition of federal savings banks from OTS to OCC supervision, the OCC announced that the specific valuation allowances that the OTS' accounting guidance historically permitted federal savings banks to maintain for collateral dependent loans should be eliminated. We adopted this methodology in the third quarter 2012 and charged off $10.8 million of specific valuation allowances. This one time charge did not impact earnings or the provision for loan losses for the quarter ended September 30, 2012; however, the $10.8 million of specific valuation allowance charge-offs were included in total charge-offs for the quarter ended September 30, 2012 and reduced our recorded balances for loans, the allowance for loan losses, nonaccrual loans and impaired loans.
A loan balance is classified as a loss and charged-off when it is confirmed that there is no readily apparent source of repayment for the amount of the loan that is classified as loss. Confirmation can occur upon the receipt of updated third-party appraisal valuation information indicating that there is a low probability of repayment upon sale of the collateral, the final disposition of collateral where the net proceeds are insufficient to pay the loan balance in full, our failure to obtain possession of certain consumer-loan collateral within certain time limits specified by applicable federal regulations, the conclusion of legal proceedings where the borrower's obligation to repay is legally discharged (such as a Chapter 7 bankruptcy proceeding), or when it appears that further formal collection procedures are not likely to result in net proceeds in excess of the costs to collect.

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