FFIC - NASDAQ

Welcome to Flushing Financial Corporation's Second Quarter 2022 Earnings Conference Call. Hosting the call today are John Buran, President and Chief Executive Officer; and Susan Cullen, Senior Executive Vice President, Chief Financial Officer and Treasurer. Today's call is being recorded. A copy of the earnings press release and slide presentation that the company will be referencing today are available on its Investor Relations website at flushingbank.com. Before we begin, the company would like to remind you that discussions during this call contain forward-looking statements made under the safe harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. Such statements are subject to risks, uncertainties and other factors that may cause actual results to differ materially from those contained in any such statements, including as set forth in the company's filings with the U.S. Securities and Exchange Commission, to which we refer you. During this call, references will be made to non-GAAP financial measures as supplemental measures to review and assess operating performance. These non-GAAP financial measures are not intended to be considered in isolation or a substitute for the financial information prepared and presented in accordance with U.S. GAAP. For information about these non-GAAP measures and for a reconciliation to GAAP, please refer to the earnings release or the presentation. I'd now like to introduce John Buran, President and Chief Executive Officer, who will provide an overview of the strategy and results. Please go ahead.

Thank you Operator, good morning everyone and thank you for joining us for our second quarter 2022 earnings call. On today's call, I'll discuss second quarter highlights and ongoing strategic objectives before turning the call over to Susan Cullen, Chief Financial Officer. Following our prepared remarks, we will answer your questions. The company performed very well during the second quarter. We focused on executing on our strategic objectives as the macro environment becomes more challenging with rising rates and concerns about a potential recession. We reported GAAP earnings per share of $0.81 and core EPS of $0.70. This translated to a return on assets of 122 basis points and return on equity of 15%. Core return on assets was 105 basis points and core return on equity was 13%. These returns are within range of our stated through the cycle goals of 1% and 10%. Core loan yields increased 11 basis points, while core deposit yields increased only 7 basis points. This resulted in a stable net interest margin quarter-over-quarter. Average non-interest bearing deposits reached a new record at $1 billion for the quarter and increased 13% year-over-year. Loan closings were a record $504 million and the loan pipeline while down from record levels last quarter is still the second highest reported level at $583 million. Asset quality is a hallmark of this company. During the quarter, our nonperforming assets rose to only 59 basis points of assets. The increase was from three relationships migrating to non-accrual driving the bulk of the increase. One relationship totaling $2 million was resolved after the quarter end. The largest relationship totaling $24 million has a combined LTV of 63%. The third relationship totaling $10 million is an export business that is impacted by macro factors. We view these items as one-offs rather than fundamental portfolio issues. We continue to invest in the future, as we hired 42 people from institutions within our markets that are involved in a merger and 18 of those people are revenue producers. Overall, I'm pleased with our execution on our strategic objectives and the returns we are generating for our shareholders. Slide 4 outlines the merger disruption that's occurring in our markets. During the quarter, we hired 12 additional people, including six revenue producers. The M&A activity in our market is in various stages of integration and we expect to add more people and profitable banking relationships as conversions occur and strategies change. Given this environment, we expect to remain focused on the organic growth opportunity. The merger activities, having a positive impact on our business on Slides 5, you'll see the loan pipeline is at the second highest level in our history, although down from the record level last quarter. Loan closings accelerated to a record $504 million this quarter and pull-through rates have returned to normal levels after bottoming out in the third quarter of 2021. Given the significant move in rates, loan closings could start to slow, but satisfactions which are remain elevated should also start to decline. Slide 6, depicts the growth in our digital banking platforms. We continue to see high growth rates in monthly mobile active users, online banking users and digital banking enrollment. We're pleased with

Thank you, John. I'll begin on Slide 8. Growing non-interest bearing deposits is a priority for us. Average non-Interest bearing deposits increased 13% year-over-year and comprised over 16% of average deposits compared to 14% a year ago. Our teams continued open new checking accounts which were up 18% year-over-year. The growth of non-interest bearing deposits is helping to mitigate the overall rise in deposit costs. Slide 9 shows our deposit rates move compared to the fed funds. Last quarter, we outlined that because of our liability sensitivity, our ability to control deposit rate increases is a key factor in the net interest margin outlook. We have done a good job of limiting deposit rate increases so far in 2022. Deposit costs increased 8 basis points, 29 basis points in second quarter, compared to 21 basis points of the first quarter. This implies deposit beta of less than 9% compared to over 40% for the last cycle. The pace and magnitude of rate increases this cycle will pressure deposit costs and we expect deposit betas will rise at a faster rate in the next quarter. Slide 10 outlines loan portfolio and yields. Net loans, excluding PPP loans, increased 3% year-over-year. With the exception of the PPP loans, which continue to be forgiven, loan growth is broad based with real estate and business banking loans each rising 3% quarter-over-quarter. The loan pipeline of $583 million is up 35% year-over-year and remains near record levels. Over the past year, loan yields are flat but increased in the second quarter. Core loan yields increased 11 basis points, while base loan yields grew seven basis points quarter-over-quarter. Additionally, the spread between the yield on the originations and satisfactions excluding PPP turned positive for the first time since the Fed cut rates at the start of the pandemic. Slide 11 provides more detail on the repricing of the loan portfolio. We have nearly $1 billion of loans that are hedged or tied to short-term rates like Prime, LIBOR and SOFR, which will reprice within the next quarter and at least twice in 2022. Approximately $320 million of the remaining portfolio reprices through the end of the year. This $1.3 billion of loans represents approximately 25% of interest bearing deposits, which serves as a natural hedge for Fed rate moves. An additional $980 million of loans will reprice in 2023. This chart also shows the current rate for the maturity repricing bucket and the contractual repricing rate based on the indices as of June 30, 2022. For example, in 2023, nearly $1 billion of loans should reprice 154 basis points higher based on the contractual rates as of June 30. While we expect the loans to reprice the contractual rate, repricing current market rates and competition. If the indices continue to raise as Fed increases rates, repricing rates will continue to move higher. Our loans will repriced over longer time, and that is why it is imperative we manage our deposit pricing. Slide 12 outlines the net interest income and margin trends. The GAAP net interest margin was 3.35% and decreased one base point during the quarter. Net interest income increased 2% quarter-over-quarter to a record $65 million. Core net interest income, which removes the impact of net gains from fair value adjustments and purchase accounting accretion increased 3% quarter-over-quarter as the core net interest margin expanded two basis points 3.33%. This rate cycle has been different from past cycles, given the pace and magnitude of rate moves. So I wanted to provide some color on the net interest margin outlook. While core loan yields rose faster than the core deposit yields in the second quarter, this positive spread will be challenging to achieve going forward as the magnitude of the rate moves is expected to pressure deposit rates. Second, the base net interest margin for the second quarter was 3.22%. At June 30, the base net interest margin is approximately 20 basis points lower. To conclude, while we did a good job of maintaining the net interest margin to date in this rising rate cycle, it will become challenging given the pace and magnitude of future rate increases. Moving on to asset quality on Slide 13, we have a long history of strong credit quality primarily due to our low credit risk profile and conservative underwriting. This has served us well through many cycles. And as you can see, our losses have been well below the industry and any asset class that caused a rise in losses in the past have been exited or underwriting has been significantly tightened. For the quarter, net recoveries were three basis points driven largely by recoveries and previously charged off taxi medallion loans. We remain comfortable with the overall risk of the portfolio and the increase in non-performing assets starts from a very low base. Generally, there are two sources of repayment for real estate loans. The first source is the cash flows from the net operating income of the building with the second being the collateral. Greater than 87% of the loan portfolio is secured by real estate with an average loan to value less than 38% and only $22 million or less than 1% has a loan to value of 75% or more. For these reasons, we are comfortable with the credit quality and the limited loss content if there is an economic downturn affecting the credit markets. The multi-family commercial real estate loans are 65% of total loans. These portfolios have strong cash flows with a weighted average debt service coverage ratio of 1.8 times. During underwriting, the rate on these loans is shocked 200 basis points to determine if the borrow has sufficient repayment capacity in a rising rate environment. For these portfolios that are due to reprice over the next three years, the weighted average pro forma debt service coverage would still be greater than 1.25 times with a 200 basis point rate shock. We also stress test this portfolio for rising operating costs. Assuming a 10% increase in operating expenses, the weighted average debt service ratio would remain over 1.5 times. Combining the 200 basis point increase in rate and the 10% increase in operating expenses, the pro forma weighted average debt service ratio would still remain over 1.15 times. And all scenarios, these borrowers would be able to make payments. We remain comfortable with the low level of risk and the loan portfolio. Slide 14 outlined some additional credit metrics. Non-performing assets increased to a still low 59 basis points of assets, largely due to the three relationships previously discussed. The loan to value of the non-performing assets is less than 51%. Criticized and classified loans declined 4% quarter-over-quarter. The allowance for credit losses to loans ratio increased one basis point to 58 basis points. And the allocation reserves by loan type is depicted in the bottom right chart. Overall, we remain very comfortable with our credit risk profile and continue to expect minimal loss content. Our capital position is shown on Slide 15. Book value and tangible book value per share increased during the quarter. Despite the accumulated other comprehensive loss doubling during the quarter from the effects of the higher interest rates on the investment securities portfolio, 61% of earnings were returned to shareholder through dividends and share repurchases. The company repurchased over $8 million of common stock in the quarter. And the Board of Directors increase the share repurchase authorization by 1 million shares. The tangible common equity ratio declined to 7.82% driven mostly by higher rates. In the short and medium term, the company will manage with 8% tangible capital ratio. Before I turn it back to John, I wanted to provide some color on the outlook. The net interest income is a function of net interest margin and the balance sheet growth. With the pace and magnitude of interest rate increases, deposit costs are expected to rise at a higher pace than seen in the second quarter and thus we expect NIM pressure. Loan growth is dependent on the rate in economic environment and estimates remain in the low single digits. We previously expected core non-interest expense to increase by high single digits in 2022 from a base of $144 million. We now expect core noninterest expense to increase by mid-single digits given the result of the first half of the year. Quarterly noninterest expenses are expected to follow prior seasonal patterns. Lastly, the detective effective tax rate for 2022 should approximate 28%. With that, I’ll turn it back over to John.

Thank you, Susan. On Slide 16, we wrap up our key messages. Loan growth turned positive this quarter as the strong pipeline resulted in originations greater than satisfactions. Over time, higher rates are expected to negatively impact origination volumes, but satisfactions should also decline. While it’s difficult to predict we expect loan growth will remain in the low-single digits for the remainder of the year. While the company did a good job of managing interest rates in the second quarter, the pace and magnitude of rate increases this cycle will make this more challenging in the future. Deposit betas are expected to rise off of low levels. While there’s some offset from loan repricing there is a lag, NIM compression is likely. Flushing Bank has a long history of superior credit quality driven by our conservative credit culture. We have a low risk loan portfolio as proven by the high percentage secured by real estate, low loan to values and high debt service coverage ratios. We are well prepared to handle any potential economic downturn affecting credit markets. We’ve been attracting talent as we added 42 people from mergers, 18 of which are revenue producers. Capital return was 61% this quarter and while book and tangible book value per share increased rising rates impacted tangible capital ratio levels slightly below our internal target. Going forward, the company will balance the capital return with the desire to increase the tangible common equity ratio to 8%. Overall, the company performed well versus is through the cycle return on average assets and return on average equity goals in the second quarter. Operator, I’ll turn it over to you to open up the lines for questions.

Thank you. Our first question comes from Mark Fitzgibbon of Piper Sandler. Please go ahead.

Hey guys. Good morning.

Good morning, Mark.

Good morning.

Hey Susan, just a couple clarifications on some of your comments. I think you said the effective tax rate going forward will be around 28%. I’m just curious why did it sort of nudge up from that, 26 percentage kind of rate that we’ve been running at for a while?

So there is a tax deduction. This is gets a little in the weeds, Mark. So bear with me for a second. There’s a tax deduction that we had availed ourself to in our tax average assets were less than $8 billion based on analysis completed in the quarter. We don’t believe that will continue. So we need to take that into account.

Okay, thanks. And then should we take from your comments about the base net interest margin compressing by 20 basis points at the end of the quarter that we could see the core NIM down somewhere in that, that kind of range is that?

Yes. Mark. That’s what – it would at least be that much. We believe given the rate and we’re expecting another 75 basis points today. That’s early into the quarter.

Okay. And then I wondered if you could maybe just give us any additional color on those loans that – loans in security that went delinquent this quarter, any details on expected timing or resolution, any loss content, anything at all on those would be helpful? Thank you.

Sure. So let’s start with the easy one that resolved itself after the quarter end. So there’s – the $2 million loan is no longer on our books. And it’s been accounted for. The biggest piece of that’s a $24 million bond and loan and it was underwritten as a loan and then they wrapped it, so that it gets treatment as an investment security that there’s a school in Manhattan that is collateralized by a commercial condominium that has a combined 63% LTV. So we don’t believe there’s any loss content there. The third loan is an exporter and there is over collateralization on that loan as well. So we don’t believe there’s any additional loss content on either of the two remaining, the two outstanding loans as of today.

Okay, great. And those, you think some of these will get resolved before the end of the year?

We certainly hope so. But there’s real estate involved, so it could be a little bit longer. But we think by the end of the year is a good estimate.

Thank you.

Multi a little bit less than that.

I think for the most part that will be somewhere between the contractual rate and the market rate, because it’s very expensive for our borrowers to refinance, and we’ll be closer to the contractual rate as we move forward.

So remember for this year, Chris, the larger proportion is actually a floating proportion. So $986 million that is going to go up consistent with the move that the Fed makes, because those are either floating rate tied to an index LIBOR predominantly but also some SOFR. And some are hedge, which are also tied to LIBOR. So that’s $986 million that will move consistent with the move in Fed rates more or less.

More or less, those repriced quarterly. So we should get two repricings through on that $986 million at least two repricings on that through the end of the year, some of them are 30-day.

There $200,000?

Thanks, Chris.

Our next question comes from Manuel Navas with D.A. Davidson. Please go ahead.

Hi man.

Hey, good morning. A lot of my questions have been answered. But I'm just kind of thinking if the fed goes to 350 by the end of the year, where could you see the NIM approach kind of just big picture?

It would approach somewhere between 250 to 275 big picture as we're sitting here right now, but again, that's all dependent on the growth of non-interest bearing deposits, the re-pricing of the $980 billion worth of loans we've talked about and the product mix on both the loan and liability side.

That makes sense. You've been holding onto DDA. Is there any starting movements to see kind of flow out from DDA anywhere in whether in your competition anywhere in the market?

Our DDA balance actually grew about $200 million for the quarter, a little over $200 million.

You're holding it well. Is there any pressure? Do you expect any pressure there?

No.

No. I think we've got some programs in place that are been successful and we'll continue those.

Okay.

Our account openings have been very strong on the DDA front. And we expect that to continue as well.

And you noted the offers you're putting out there for deposits. Do you feel like you're at the top of the market, what are you seeing competition doing in comparison to your offers?

We're rarely at the top of the market, but we're trying to be more – a little bit more competitive.

Okay. That's helpful. Thank you.

Thank you.

Thanks.

There are no more questions in the queue I would now like to turn the call back to John for closing remarks.

So we're very, very happy with the quarter as you can see from our presentation, we do have some challenges ahead with respect to the NIM that we've outlined, but I think we've got a number of levers to pull in order to help us particularly on the loan side. I want to thank everybody for attending this call and look forward to seeing you in next quarter. Thank you.

Thank you.