BankFinancial Corporation (NASDAQ: BFIN) reported earnings of $0.16 per share in the second quarter, almost unchanged from the first quarter of 2020. The earnings were stable because a drop in provision expense made up for a decline in fee income from deposit services. Earnings will likely continue to remain mostly stable in the year ahead. The provision expense will likely increase as credit losses will arise in the second half of the year. Moreover, the net interest margin will likely continue to decline, which will pressurize earnings. On the other hand, a recovery in non-interest income will drive earnings up in the remainder of the year. Overall, I’m expecting earnings in the second half of the year to be just 2.5% below the earnings for the first half. For the full year, I’m expecting BFIN to report earnings of $0.62 per share, down 17% from last year. The June 2021 target price suggests a high upside from the current market price; therefore, I’m bullish on the stock for a holding period of at least nine months. However, BFIN is currently facing high credit risks that will likely keep the stock price subdued. Hence, I’m adopting a neutral rating on BFIN for the near-term.

Non-residential Real Estate Portfolio a Major Contributor to Credit Risks

Due to the COVID-19 pandemic, BFIN allowed modification of around 11% of its total loan portfolio, according to details given in the second quarter’s 10-Q filing. The company’s exposure to the non-residential real estate segment is particularly problematic. The segment made up 12% of total loans at the end of the last quarter, according to details given in the 10-Q filing. Additionally, around 39% of the non-residential real estate portfolio was under forbearance at the end of the last quarter. The health care segment, which made up 1.2% of total loans, is also problematic as the pandemic significantly slowed down business in the segment. On the plus side, BFIN had no exposure to hospitality, oil and gas, and travel/leisure industries that are quite sensitive to the COVID-19 pandemic, as mentioned in the 10-Q filing.

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BFIN has not yet adopted the new accounting standard for credit losses called Current Expected Credit Losses, or CECL. Instead of CECL, the company is still using the old incurred loss model to determine the provisioning requirement. As a result, BFIN’s provision expense will likely increase in the year ahead as credit losses increase, unlike other banks that are using the expected credit losses model and which have most likely already experienced the worst of the provisioning. Considering these factors, I’m expecting BFIN to report a provision expense of $400 thousand in the second half of the year compared to $513 thousand in the first half.

Margin Compression and Slight Loan Decline to Pressurize Net Interest Income

BFIN net interest margin (NIM) declined by 35bps in the second quarter following the 150bps federal funds rate cuts in March. NIM will likely further decline in the year ahead because the management expects to maintain high liquidity due to the pandemic, as mentioned in the 10-Q filing. Business activity will remain low amid the pandemic, which will limit the availability of high-yielding lending opportunities. Therefore, BFIN will likely continue to park the excess funds in lower-yielding securities. Considering these factors, I’m expecting BFIN’s NIM to decline by 6bps in the third quarter and by 5bps in the fourth quarter of 2020. Further, I’m expecting the average NIM for 2021 to be 18bps below the average for 2020.

As mentioned in the 10-Q filing, BFIN funded $10.9 million of loans under the Paycheck Protection Program (PPP). As the amount is quite small relative to BFIN’s asset size, PPP will not have much of an impact on net interest income or loan balance. Assuming fees of 3.2% and funding cost of 0.35%, PPP will likely add only $311 thousand to the net interest income over the life of the loans.

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Apart from NIM compression, BFIN’s net interest income will likely suffer from a slight decline in the loan balance as well. The company’s loans declined by 6% in the second quarter on a linked-quarter basis. Loans will likely decline slightly further in the year ahead because BFIN focuses on commercial real estate loans, the demand for which is likely to remain lackluster amid the pandemic. As a result, I’m expecting BFIN to end the year with a loan balance of $1.07 billion, down 0.4% from the June-end balance, and down 7.7% from the end of last year. The following table shows my estimates for loans and other balance sheet items.

BankFinancial Corporation Balance Sheet Forecast

Expecting Full-Year Earnings to Decline by 17%

The elevated provision expense and NIM compression will likely keep earnings under pressure in the year ahead. On the other hand, non-interest income will likely recover after the plunge in the second quarter, which will drive earnings in the year ahead. Deposit service charges declined in the second quarter because of a slowdown in customer transactions amid the pandemic, which led to a decline in non-interest income. I’m expecting a gradual recovery in deposit service charges in the coming quarters as the economy will pick up. Overall, I’m expecting earnings to be more or less stable in the second half of the year, declining by just 2.5% from the first half’s earnings. For the full year, I’m expecting BFIN to report earnings of $0.62 per share, down 17% from last year. The following table shows my income statement estimates.

BankFinancial Corporation Income Forecast

Actual earnings may differ materially from estimates because of the uncertainties related to the COVID-19 pandemic.

Offering a Decent Dividend Yield of 5.3%

I’m expecting BFIN to maintain its quarterly dividend at the current level of $0.10 per share, which implies a leading dividend yield of 5.3%. The earnings and dividend estimates suggest a payout ratio of 71% for 2021, which is higher than the average of 49% for the last five years. Nevertheless, I’m not expecting a dividend cut because the payout ratio is manageable. Moreover, BFIN’s capital position is comfortable enough to bear a high payout ratio. The company reported a common equity tier I ratio of 15.63% in the second quarter, which is far above the minimum regulatory requirement of 6.5%.

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Risks Likely to Overshadow the Attractive Valuation

I’m using the historical average price-to-book method (P/B) to value BFIN. The stock has traded at an average P/B ratio of 0.84 in the first half of 2020. Multiplying the average P/B multiple with the June 2021 forecast book value per share of $11.7 gives a target price of $9.8. This price target is 31% above BFIN’s September 11 closing price. The following table gives the sensitivity of the target price to the P/B ratio.BankFinancial Corporation Valuation Sensitivity

Due to the price upside, I’m bullish on BFIN for a holding period of at least nine months. For the remainder of this year, however, I’m expecting the heightened risk level to overshadow the attractive valuation and constrain the stock price. As discussed above, a large portion of loans is under payment deferral or modification, which reflects the high credit risk. Additionally, BFIN has not yet adopted the expected credit losses model; therefore, it’s at greater risk of a provision expense surprise than other banks that have adopted CECL. Based on the high-risk level, I’m adopting a neutral rating on BFIN.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Disclaimer: This article is not financial advice. Investors are expected to consider their investment objectives and constraints before investing in the stock(s) mentioned in the article.