FFIC - NASDAQ

Good day and welcome to the Flushing Financial Corporation Second Quarter 2023 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Mr. John Buran, President and CEO. Please go ahead, sir.

Thank you, operator. Good morning, and thank you for joining us for our Second Quarter 2023 Earnings Call. Following my prepared remarks, Susan will review the financial trends and we will then answer any questions. During the first quarter, the company instituted a six step action plan to enhance the resilience of our business model and strengthen our financial performance. We executed this plan well during the second quarter and are pleased with the progress we have made so far on key points. First, to move more towards interest rate neutral, we added more than $400 million of asset swaps. Additionally, $250 million of funding swaps became effective during the quarter. We're also increasing the percentage of back-to-back swap loans. These loans are over 35% of our loan pipeline and total floating rate loans are approximately 50%. These actions significantly reduced our interest rate sensitivity position while providing additional income. Second, we increased our focus on risk adjusted returns and overall profitability. As a result yields on the loan pipeline rose 20 basis points and yields on loan closings increased 13 basis points. In addition, our loan pipeline increased 56% quarter-over-quarter. While it will take time for new and repriced loans to have a significant impact on overall loan yields, we are encouraged by the results so far. Third, we're looking to expand our client base and build loyalty by emphasizing our excellent brand of customer service and deep community relationships. Late in the quarter, we hired a team of commercial real estate lenders with considerable experience and robust client rosters. We also continue to see high single digit growth in checking account openings and robust CD growth. Fourth, we reviewed new and existing relationships resulting in improved credit metrics and normalized net charge offs. We also added further layers of analysis to our review process for any future deals. This review and actions reinforced our comfort with a low risk profile of our loan portfolio. Fifty, we are preserving strong liquidity and capital. We are looking for ways to expand our liquidity sources despite having available liquidity of nearly $4 billion. Average deposits increased both year-over-year and quarter-over-quarter. Capital ratios were also stable during the quarter. Sixth, we are tightening our expense controls by placing greater scrutiny on operating and discretionary expenses. In a period of high inflation second quarter 2023 core expenses are down approximately 1% year-over-year. Overall, we expect these decisive actions to result in an improved financial profile over time. These actions along with our strong liquidity will also allow us to continue our long history of dividend payments into the future. In addition to our action plan, Slide 4 outlines our four areas of focus for long term success. First interest rate risk is a priority and the actions we have taken have resulted in a 64% reduction in this risk over the past year. This is important given the outlook on rates. Second, we are focused on maintaining our credit quality. Our loan portfolio comprises low risk loans to stable borrowers. Over 88% of the loan portfolio is secured by real estate with an average loan to value of less than 36%. The current debt service coverage ratio is 1.8 times for our multifamily and investor commercial real estate portfolios. The third area of focus is liquidity, which I touched on in a previous slide. We have significant liquidity and are looking to fully utilize our balance sheet to add more. The last area of focus is customer experience. Central to our ability to deliver exceptional services is our ties to our local communities. About a third of our branches are in Asian markets and we continue to implement community engagement initiatives and grow our presence in these areas to build on our loyal customer base. We also continue to enhance our digital banking solutions which create a more convenient experience and allows us to engage with customers more seamlessly. We're confident that these four areas of focus will position the company to achieve long term success. Slide 5 represents our liquidity profile. We have approximately $3.7 billion of available liquidity from a variety of sources, including the Federal Home Loan Bank of New York, other commercial banks, cash on hand and free securities. Today our available liquidity is 44% of assets and we're working to expand borrowing capacity from existing relationships by pledging several types of collateral. As a result, we have a high degree of comfort in the stability of funding and available liquidity. Our loan portfolio is outlined on Slide 6. We have structured our real estate loan portfolio to ensure stability with multifamily and investor commercial real estate comprising 66% of the total portfolio. Manhattan office buildings are approximately six-tenth of 1% of net loans. In general, the real estate portfolio has strong sponsor support and excellent credit performance. Overall, we remain very comfortable with the quality of the loan portfolio. Slide 7 provides the detail on our Asian markets. Once the Bensonhurst branch in Brooklyn opens later this year, a third of our branches will be in predominantly Asian markets. We have $1.2 billion of deposits and $764 million of loans in Asian markets. These deposits are 18% of our total deposits and we have only a 3% share of market. So there's substantial room for growth. Our approach to this market is supported by our multilingual staff, our Asian Advisory Board and our support of cultural activities. This market, which has total deposits of $36 billion, continues to be an important opportunity for us. Slide 8 depicts the growth of our digital banking platforms. We continue to see high growth rates and monthly mobile deposit users, users with active online banking status and digital banking enrollment. The numerator platform, which digitally originates small dollar loans as quickly as 48 hours continues to grow. We originated approximately $10 million of commitments in the first half of the year, which have an average rate greater than the overall loan portfolio yield. We continue to explore other fintech product offerings and partnerships to further enhance our digital banking platform and customer experience. The second quarter had several notable events to highlight, as you can see on Slide nine. As pictured, we hosted a ribbon cutting ceremony at our Hauppauge branch which opened late in the first quarter in a vibrant industrial park. Community involvement is what separates us from other banks. Here's a sample of the events we participated in during the quarter. Participating in these types of initiatives builds on our already strong ties with our local communities and drives customer loyalty. I'll now turn it over to Susan to provide more detail on our key financial metrics. Susan?

Thank you, John. I’ll begin on Slide 10. The company reported second quarter 2023 GAAP earnings per share of $0.29 and core earnings per share of $0.26. The quarterly results were significantly improved compared to the first quarter. Average total deposits increased 7% year-over-year and 1% during the quarter. We continue to grow our CD portfolio, which is now 30% of average deposits. The cost of deposits totaled 2.68%, while the cost of funds was 2.8%. As expected, loan growth was muted, increasing only 1% year-over-year. However, the loan pipeline increased 56% quarter-over-quarter with pipeline yields and core loan yields also expanding. Non-performing assets declined 6% during the quarter, reflecting our conservatively underwritten loan portfolio. Overall, the second quarter results were an improvement versus the first as we continue to adjust to the higher rate environment. Slide 11 depicts our deposit portfolio. Despite the Fed raising rates and industry deposits declining, our average deposits have increased 7% year-over-year and 1% quarter-over-quarter. The growth is driven by the 150% year-over-year and 22% quarter-over-quarter increase in CDs, which lengthened the duration of our liabilities, thus reducing our liability sensitivity. Growing non-interest bearing deposits is challenging in this high rate environment, but remains a focus. Average non-interest bearing deposits declined both quarter-over-quarter and year-over-year, though checking account openings increased 10% year-over-year. Our loan to deposit ratio has improved to 102% from 105% a year ago. As a reminder, we generally have seasonality in certain segments of our deposit base and the summer months balances are generally lower than the remainder of the year. Slide 12 outlines our loan portfolio and yields. Net loans increased 1% year-over-year, but were down 1% quarter-over-quarter. Loan closings also declined year-over-year and quarter-over-quarter as customers adapt to the increased rate environment, but the yield on the closings was over 7% for the second consecutive quarter. Core loan yields increased 19 basis points during the quarter and for the third consecutive quarter yields on the loan closings exceeded the yields on the satisfactions at an accelerating pace. Prepayment penalty income declined to $278,000 in the quarter from $2.3 million a year ago and $610,000 in the prior quarter. The loan pipeline increased 56% quarter-over-quarter with over 35% of the pipeline consisting of attractive back to back swap loans and approximately 50% of floating rate loans. Slide 13 provides more detail on the contractual repricing of the loan portfolio. Approximately $1.1 billion or 16% reprices with each Fed move. During the quarter, we added $400 million of interest rate hedges on loans, which effectively increases the amount of loans that will reprice the Fed move $1.5 billion or over 21% of the loan portfolio. For the remainder of 2023 another $458 million is due to reprice at a rate of 210 basis points higher than the current yield. In 2024 and 2025, about $1.5 billion of loans will reprice 220 basis points to 230 basis points higher. These values are based on the underlying index value at June 30th, 2023 and do not consider any future rate moves. This repricing should drive net interest margin expansion once funding costs stabilize. Slide 14 outlines the net interest income and margin trends. The GAAP net interest margin declined only 9 basis points to 2.18% during the second quarter. This is the lowest amount of compression over the past four quarters and is consistent with the NIM for the month of March. We expect that NIM will remain under pressure as long as the Fed raises rates, but the pressure should be more manageable based on the current forecasted rate hikes through the remainder of the year. After a lag, we expect the NIM would begin to expand as the pressure on funding costs ease and loans continue to reprice higher. Turning to Slide 15. As John mentioned, one of our goals for 2023 is to significantly move more towards interest rate neutral. The goal for the balance sheet is to better match the duration of our assets, which is three to four years, more closely to the duration of our funding, which is about one to two years. We have made considerable progress over the past year. For an immediate rise of 100 basis points in rates, our net interest income would decline by 3%. A year ago this impact was a 9% decline or almost a two-third improvement. The addition of interest rate hedges and more floating rate assets are the key drivers of the reduced sensitivity. The interest rate hedges are particularly important as they provide immediate income in addition to moving the balance sheet more towards neutral. Bottom line, we executed well on this strategy and expect to continue to improve in this area. Slide 16 provides more detail on our CDs. Total CDs are about $2 billion or third of the total deposits at June 30th 2023. CDs helped to lengthen the duration of our funding to match the duration of our assets more closely. Excluding CDs with interest rate hedges, about 60% of our CD portfolio will reprice higher over the next year. We expect to retain a high percentage of our CDs. Our current CD rates range from 4.5% to 5.25%. All else equal, we expect the CD repricing to pressure our net interest margin. Our net charge off history is on Slide 17. As you can see, we have a long history of solid asset quality because of our low risk credit profile and conservative underwriting. Net charge offs of 9 basis points returned to normalized levels this quarter. We expect minimal losses in the loan portfolio if there's an economic downturn. Given the large percentage of our loan portfolio is secured by real estate with a low average loan to value. Additionally, the weighted average debt service coverage is 1.8 times in the multifamily and investor real estate portfolios and 1.2 times in a stress scenario, consisting of a 200 basis point increase in the rate and a 10% increase in operating expenses. These factors contribute to our expectation of minimal loss content within the loan portfolio. Slide 18 shows our credit metrics trending in the right direction with declines in NPAs and an increase in the non-performing loan coverage ratio. Criticized and classified assets decreased during the quarter to a low 71 basis points. Historically, these levels have been significantly below our peers. Our allowance for credit losses is presented by loan segment in the bottom right chart. The higher risk portfolios have reserves greater than 1% of that portfolio. Overall, the allowance for credit losses to loans ratio increased to 57 basis points during the quarter. Remain very comfortable with our credit risk profile. Our capital position is shown on Slide 19. Book value and tangible book value per share increased year-over-year. We repurchased nearly 530,000 shares at an average price of $12.94, which is a 43% discount to our tangible book value. The tangible common equity ratio was stable at 7.71%. Our regulatory capital ratios are strong and overall we view our capital base as a strength and a vital component of our conservative balance sheet. Slide 20 provides our outlook. We do not provide guidance. This discussion is meant to give our high level perspective on performance in the current environment. Despite the robust increase in the loan pipeline, we expect loan growth to remain challenging. However, the higher percentage of back to back swap loans in the pipeline will add more floating rate assets to our balance sheet and these assets have rates at 7% or higher. As a reminder, certain deposits are seasonally lower in the summer months before increasing by year end. There are several factors that will affect the net interest margin. First is the pressure from the Fed raising rates and the natural shift in the deposit mix. Second is the size and growth of the loan portfolio. Third is the repricing of both CDs and certain loans. Fourth, our interest rate hedges were favorable in the second quarter and an increase in rates by the Fed will benefit this portfolio. Overall, we expect net interest margin pressure as the Fed increases rates, but all else equal, the pressure should be lower than what was experienced in the second half of 2022 and the first quarter of 2023. The core net interest margin was 2.19% for the month of June. Non-interest income should benefit from the back to back swap loan closings. Non-interest expenses were well controlled in the second quarter and extra scrutiny is placed on all expenses. We expect the operating expenses to follow normal seasonal patterns. Lastly, the effective tax rate should approximate 26% to 28% for 2023. I’ll now turn it back over to John.

Thank you, Susan. On Slide 21, I'll wrap up with our key takeaways. We continue to execute our action plan, which is improving our profitability in the short and medium term and establishing a foundation for long term success. We're happy with the limited NIM compression for the quarter and have significantly improved our sensitivity to higher rates. Our asset quality and liquidity are conservative and sound. We continue to serve our clients and deepen relationships. Our overall financial metrics improved during the quarter, but we're remaining cautious given the environment. The decisive actions we are taking to improve the overall performance will allow us to continue our long and consistent record of dividend payments. Operator, I'll turn it over to you to open up the lines for questions.

Thank you. We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Mark Fitzgibbon with Piper Sandler. Please go ahead, sir.

Hi, guys. Good morning.

Good morning, Mark.

Good morning, Mark.

Hey, Susan, just to clarify one of your comments about the margin, you sort of talked about the pressure being more manageable than what we saw in the second half of 2022 and the first quarter of 2023. Should we take that to mean that the margin you think will be down this quarter or something in the neighborhood of what we saw in the second quarter assuming the Fed raises rates 25 basis points later today?

Given where the Fed is in their rate raising cycle, that's a primary driver of that comment. But I would expect some compression probably closer to what we've seen in the second quarter than what we had seen in the previous three quarters.

Okay. Great. And then secondly, I wondered if you could share with us what iGO balances were at the end of the quarter?

We are around $200 million.

$200 million. Okay. Great. And John, I wondered if you had any targets for either tangible common equity or CET1 going forward?

Well, I think we want to stay close to that 8% range. Obviously, we're not there at this point in time, but we're very cognizant of the importance there. I think that the Fed stopping its rise in interest rates could help us a little bit there in terms of the securities portfolio valuations. But we're comfortable where we are right now for the present. I think we'd like to move it up a little bit more.

Okay. And then -- I know -- I saw that you had hired a team from Signature Bank. I guess, I was curious roughly how large was their book of business? And maybe how long you think it takes for them to be able to bring that over to Flushing?

We're really not disclosing that. But it's a group that has a significant basis for their success in the past.

Okay. And last question. I wonder if you could share with us the 30 to 89 day delinquencies? I know they come out in the Q, but if you had those handy that would be great?

They're down significantly from where they were in the prior period. I don't have them right at my fingertips.

Thank you.

Thank you, Mark.

I don't think we have a reserve against any of it.

Not any additional reserve other than we have against the CRE portfolio in total. We know when these loans will be repricing, et cetera. That's not information we're sharing at this time. They all have a nice debt coverage ratio and have low LTVs.

And there's nothing unusual about the structure, it's typical. Our typical five year.

Thanks, Chris.

Thanks, Chris.

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

Hey, good morning. Most of my questions have been answered, but just kind of can you remind me the expected size of deposit seasonality? Is it just going to follow past year trends?

So the typical trend is a downturn of seasonal balances in the summer months anywhere from $150 million to $200 million. And then as we approach the fall, that starts to rebound. Thank you.

What are your current offers on the deposit side in the market?

Our CD offerings are about 4.5% to 5.25%.

Okay. And you're still seeing solid flows on your offers?

Yes.

I guess you talked about the CRE team. What's kind of the pipeline going forward and kind of what are the opportunities you're seeing in marketplace for talent?

We're always on the outlook. I think that there's -- from what we understand, there may be some situations with respect to payments to individuals that may be coming to an end that may present an opportunity for additional staff to come our way.

Okay. I appreciate the comments. Thank you.

Manuel, I just want to emphasize that this team also is deposit gatherers. They're not just loan gatherers. So I think that's an important distinction.

Okay. I appreciate that.

Thank you.

[Operator Instructions] No further questions. This concludes our question-and-answer session. I would like to turn the conference back over to John Buran for any closing remarks.

Well, thank you, everybody, for joining us today on our second quarter 2023 earnings call. We appreciate your continued support of Flushing Financial and look forward to talking to you again next quarter. Thank you very much.

Thank you.