Welcome to Flushing Financial Corporation's 2018 Second Quarter Earnings Conference Call. Hosting the call today are John Buran, President and Chief Executive Officer; and Susan Cullen, Senior Executive Vice President, Treasurer and Chief Financial Officer. Today's call is being recorded.

[Operator Instructions] A copy of the second quarter earnings release and slide presentation that the Company will be referencing today are available on its Investor Relations website at www.flushingbank.com.

Before beginning, 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. Such factors are included in our filings with the U.S. Securities and Exchange Commission.

Flushing Financial Corporation does not undertake any obligation to update any forward-looking statements, except as required under applicable law. During this call, references to several non-GAAP financial measures as supplemental measures to review and assess operating performance will be made.

These non-GAAP financial measures are not intended to be considered in isolation or as a substitute for the financial information prepared and presented in accordance with U.S. GAAP. For any information about these non-GAAP measures and reconciliation to GAAP measures, please refer to the earnings release.

I'd now like to introduce John Buran, President and Chief Executive Officer, who will provide an overview of the strategy and results..

increase core deposits and continue to improve funding mix, increase net interest income by leveraging loan pricing opportunities, enhance core earnings power by improving scalability and efficiency, manage credit risk and to remain well-capitalized under all stress test scenarios.

We remain focused on these strategic objectives to achieve profitable growth and maximize shareholder value. During the second quarter, we repurchased 227,581 treasury shares at an average cost of $26.04 per share.

And as of June 30, 2018, up to 809,000 shares remain under the current authorized stock repurchase program, which has no expiration or maximum dollar limit. We remain well capitalized and positioned to deliver profitable growth and long-term value to our shareholders as we continue to execute on our strategic objectives.

At this point, I'll turn the call over to Susan, to discuss the quarter's financial results in greater detail..

Thank you, John. I'll begin on Slide 6. Total loans are $5.3 billion, up for 0.4% quarter-over-quarter and 6% from the second quarter of 2017, as we continue to focus on the origination of multifamily commercial real estate and commercial business loans with full banking relationships.

We continue to diversify our loan portfolio as C&I originations totaling $89 million for the quarter were 35% of total originations. Loan originations and purchase of multifamily commercial real estate and commercial business loans were 88% of our total loan production.

Over the last 5 quarters, our C&I origination and purchases have averaged approximately 35% of quarterly loan production, resulting in commercial business balances growing over 20% during the same period to approximately 15% of gross loans at June 30, 2018.

The growth in the C&I portfolio offer several advantage to the Company, primarily continued diversification of the portfolio, and as these are primarily adjustable-rate loans, the yield offers some protection in a rising rate environment.

Overall, the total loan growth is on pace to meet the lower end of the expectation of high single digit growth while we continue to emphasize rate over volume. At June 30th, our loan pipeline was strong and totaled $323 million, which is relatively flat from last quarter but up from a year ago.

The interest rate on mortgage loans for the pipeline increased to 4.67% from an average rate of 4.41% for the linked quarter.

The LTV on our real estate portfolio at quarter end remains a modest 39%, and the debt service coverage ratio for the current quarter's originations of multifamily commercial real estate and one to four family mixed use loans is 186%. We underwrite and stress each individual loan using a cap rate in excess of mid 5%.

Slide 7, depicts the composition of our funding mix. As funding has grown over the years, the percentage related to CDs and borrowings has decreased.

However, when the need arises to access the wholesale funding markets, there are advantages as we can ladder out the liabilities for longer terms, where the consumer does not want to tie up the money for much longer than 18 months. On Slide 8, deposits decreased 2% quarter-over-quarter, and it increased 8% year-over-year.

The quarter-over-quarter decrease was due to the redemption of broker deposit, while the year-over-year growth was primarily driven by money market, CD and NOW accounts. We continue to focus on the growth of core deposits with an emphasis on non interest-bearing deposit accounts, which increased to 11% year-over-year.

Non interest-bearing deposits totaled $388 million and represent 9% of total deposits. We continue to see rate pressure with increased competition for deposits. The quarterly cost of deposits increased 19 basis points from the prior quarter. We continue to remain disciplined in terms of deposit pricing while remaining competitive within our market.

Turning to Slide 9, the net interest income for the second quarter of 2018 was $43 million, flat quarter-over-quarter and down 2% year-over-year. The net interest margin at 276, decreased 3 basis points quarter-over-quarter and 19 basis points year-over-year.

Excluding prepayment penalty income and recovered interest from delinquent loans, the net interest margin would have been 264, a decline of 8 basis points quarter-over-quarter, and 19 basis points year-over-year.

As John, noted in his remarks, the yield on the new loans increased 30 basis points from the first quarter and 53 basis points from the same quarter of 2017. This trend should continue as we have approximately $2 billion of loans repricing through 2020.

Our overall cost of funds for the quarter was 1.41% an increase of 14 basis points quarter-over-quarter, and 36 basis points year-over-year, driven by an increase in rates paid on money markets and CDs. In order to partially mitigate the increase in the cost of funds, we have taken the following steps which are highlighted on Slide 10.

For the fourth consecutive quarter, the yield on loan originations have exceeded the quarterly yield on loan portfolio, net of prepayment penalties and recovered interest from delinquent loans. We entered into approximately $450 million of forward swaps using the Federal Home Loan bank borrowings, which we believe will be beneficial to net income.

The funded portion of the swap has compressed the NIM for the first half of 2018, but we have recently seen a monthly benefit of the swap to the NIM, which we anticipate will continue. Loan originations have increased 30 basis points from linked quarter and 53 basis points from the second quarter of 2017.

Originations of commercial business loans, which are primarily adjustable-rate loans, totaled 35% of the current quarter originations and now comprise 15% of loan portfolio. Loan swaps provide a minimal effect on the net interest margin in the current quarter. We believe that these swaps will enhance earnings as rates continue to rise.

We actively manage funding costs and continue to evaluate strategies to mitigate our liability-sensitive balance sheet.

While the net interest margin will likely remain somewhat pressured, we will continue to focus on driving net interest income by executing on the previously noted steps, coupled with leveraging loan pricing opportunities and the portfolio mix.

On Slide 11, we reported noninterest income for the second quarter of $3.2 million, while core noninterest income was $3.7 million, which excludes the net loss from the fair value adjustments. The core noninterest income increase year-over-year, was driven partly by the $400,000 gain on the sale of loans.

Moving to Slide 12, we anticipate 2018, annual expenses to increase approximately 3% to 5% for 2017, driven by the growth of the bank. Overall, the efficiency ratio was just under 60% in the second quarter of 2018 compared to 69% in the first quarter of 2018, and 56% in the second quarter 2017.

As John, previously mentioned, our long-term goal is to maintain efficiency ratio in the low to mid-50s. We remain focused on continuous improvements and new opportunities in our operations for efficiency gains.

Regarding taxes, effective tax rate for the second quarter of 2018 was 24%, and we anticipate effective tax rate to be 22% to 25% for all of 2018. Moving to Slide 13, we did not record a provision for loan losses in the second quarter due to our strong credit quality.

We did however have net charge-offs of $322,000 for the quarter which reflect the change in the fair value of the Chicago taxi medallions from $60,000 $25,000 per medallion based upon recent sales transactions.

Currently, the Chicago taxi medallion portfolio totals $200,000, and our total portfolio of both New York City and Chicago medallions totals $6 million, which is 12 basis points of total loans. Our coverage ratio of 137% has been increasing year-over-year due to improving credit quality and our reserve build.

The allowance to gross loans represents 38%, is relatively flat from the prior quarter. Now turning to credit quality on Slide 14, our credit quality metrics remained excellent this quarter. As a reminder, we are a historic seller of nonperforming credits and record charge-offs early in the delinquency process.

Average LTV of our nonperforming real estate loans was approximately 35% based upon the value of the underlying collateral at origination, and we did not adjust the appraised values for increases. Nonperforming loans totaled $15 million, down 4% year-over-year, and 11% quarter-over-quarter, as credit quality remains one of our core strengths.

Slide 15, highlights the effects of our strong underwriting discipline with our history of minimal 90 day delinquencies as a percentage of loans originated by year. As you can see, there are only 6 loans delinquent greater than 90 days for the vintage years after 2009.

Looking forward with expected loan growth, we anticipate recording provision for loan losses proportion with that growth in future quarters to maintain an adequate ratio. As always we monitor credit quality very closely to ensure that we have an appropriate loan loss reserve. With that I’ll turn it back to John for some closing comments..

Thank you, Susan. Wrapping up Slide 16 provides a summary of why we believe we remain well-positioned for continued strategic and profitable growth. To reiterate, our vision is to be the preeminent community financial services company in our multicultural market area by exceeding customer expectations and leveraging our strong banking relationships.

The New York City market and strong Asian customer base in Flushing continues to represent a significant opportunity for us. We remain focused on providing a superior and consistent experience at every touch point for our customers and maximizing shareholder value.

Those of you that have held our stock over the last five years know that our total shareholder return has been 83% and since our IPO in 1995 total shareholder return has been 1044%.

In conclusion, we have a strong foundation with attractive markets and customers, a proven track record as seasonal leadership team to execute our strategy with a commitment to drive continued profitable growth. We will now take questions as time permits, operator I’ll turn it over to you..

[Operator Instructions] Our first question today comes from Mark Fitzgibbon from Sandler O'Neill and Partners. Please go ahead with your question..

Susan, I know - I heard your comments about the margin and I know you've got quite a few number of moving parts.

Can you help us think about the magnitude of the margin compression in the back half of the year?.

We've looked at that Mark and everything being equally we’ll expect compression to continue for the remainder of the year to be in the 5 to 7 basis point range..

For the remainder of the year?.

For the remainder of the year..

And then secondly I think you detailed somewhere in the press release that you had six business loan relationships that were downgraded.

What were the loan covenants that - did they trigger I guess I’m curious?.

There was a variety - there were some leverage situations there - of the top of my head - I can’t remember but I know leverage was clearly one of them. And there were also - it’s pretty much leverage I think on all of them or there could have been some delay in financial statements on a couple as well.

The important thing about those is that - they remain nonaccrual they're paying as agreed. So I think these are - these look like to us that they are technical violations rather than extreme issues with respect to credit..

And then I’m curious your tangible common equity ratio, I know your regulatory ratios are strong but the TCE ratio getting down towards sort of 8% given the growth that you’re forecasting.

How low might you be willing to take that capital ratio down?.

I think we can dip below 8% with that - we got a much of an issue given the risk dynamics of the company. We're dealing with a loan-to-value in the overall portfolio that is less than 50%. Clearly there is a - even on a non-performers, non-performers have a loan-to-value of less than 40%. So we really don't see a lot of risk in the portfolio.

So we feel comfortable bringing that cap rate down a little bit - bringing the TCE down a little bit..

Our next question comes from Steven Comery from Gabelli. Please go ahead with your question..

I was just wondering about the - noninterest deposits number looks like it was up - it’s been growing pretty well recently.

I was wondering if you guy attribute that to kind of your expansion in the C&I business and then sort of your general expectations there?.

Yes, so there is a number of factors going on here. I think I would focus and clearly on the C&I business which has been strong for us if you look at that at the C&I originations and that's kind of in the - other the loan category. We’re up - we are increase in that group in originations and participations like about 80% year-over-year.

So it’s a very, very strong focus of ours and obviously as Susan mentioned, 35% of our total originations have come out of the C&I world. So we’re getting the deposits.

We put in place about a year and a half ago a new team to be working on the commercial real estate customer and we're getting a lot more deposits - coming out of the commercial real estate area.

And then I have to say that the Win Flushing business the Win Flushing initiative that we put in place is also putting us in contact with a lot of small business people and consequently additional non-interest-bearing deposits. So combination of things all moving in the right direction for us..

So and then kind of on price I mean you guys seems to be doing a pretty good job taking price both in mortgage and non-mortgage looking at the origination yields.

Is there anything changing in the competitive environment there or is it just the whole markets moving up?.

I think we were one of the first movers in trying to stay disciplined in this area, but actually in the last month we've seen a little bit more movement in the market as a whole.

So I think everybody is starting to be a little bit more cognizant of this - the dynamics of the ongoing dynamics in this market and are focusing on better yields or more profitable yields. I would want to point out again to the group that $116 million.

So if you think about our business, we have a baseline of commercial real estate that is going to roll over by contract over the next two and a half years or so through 2020, that’s $2 billion that is - has three to four handle and we're looking at five handles coming out of that based upon our contractual.

So in this particular case we had $116 million of commercial real estate at 441 moving up to five plus.

So that is kind of built-in baseline for us that we look to build upon as we take on additional higher yielding loans in the C&I area and the commercial real estate area as we remain disciplined on our originations, but again I want to emphasize that there is this baseline of contractually repricing commercial real estate loans are going to help us as long as we stay disciplined and that’s what our intention is..

And there is sort of one more from me. On originations look like they were down versus the previous quarter, but they were about flat versus the June quarter of last year.

So I was just wondering how much of the change in origination volume is due to seasonality versus just other factors?.

Its predominantly seasonality the pipeline remains strong, pipeline is growing. So I think we're in - I think we’ll see that come back..

Our next question comes from Collyn Gilbert from KBW. Please go ahead with your question..

Just a follow-up on the loan growth question, so it looks like you guys perhaps are revising a little bit lower in your loan growth target. I think you had said it's high single digit, low double-digit growth rate for 2018 before and now just lowering that to sort of single digit.

Could you just talk about what's driving that, the mix of the growth that you're seeing and then also do you anticipate further loans participation that you can push out or loan sales or anything more to do on that kind of yield improvement strategy?.

So, let's just talk about specific transactions. Some of that $70 million, we think a small proportion of it may be renegotiated at a better rate and we may be able take, bring some of that on in the next quarter or so.

But to the more critical question about loan growth going forward, I think that the market while it remains competitive, again, there are signs of much more rationality in terms of pricing on the commercial real estate side. And we do have a continuing build up of strength on the C&I side.

So, I think the economic forecast for this coming quarter are right around 4% and we're certainly feeling that type of additional economic power with our ability to find more C&I growth. And as I said, the C&I growth has really been fueling our business in the last couple of quarters.

And incidentally that C&I growth, if you look at the yield there, the yield there for three months ending June, was like for 4.70%-some odd. So, the degree to which we can continue to get that 35% plus percentage of originations on the C&I area will help yield as well the loan growth.

So, I think there's lot of emerging trends that are - that look like they're moving in a positive direction. Hopefully they'll continue..

And then just taking that, aligning that with kind of the margin outlooks, Susan, that you had given.

I mean, do you think you can grow net interest income on a quarter-to-quarter basis, and if so, to what degree are you sort of seeing that trend?.

I believe that it will stay, will go a little bit but it'll be very nominal depending on how the repricing comes in on the loans and the growth..

So, do you - again, sort of targeted - I know you kind of gave a longer-term efficiency target, but an ROA target either in the near-term or longer-term because obviously, again, the strategy that you guys are employing should theoretically help to improve that ROA, but just curious if you got any targets to that?.

You know our target is to get up to 1% ROA. Clearly, we've been hovering - some quarters we hover close to that, other quarters we've missed it. So, over the long haul, we'd want to get to 1% ROA and then maintain the 10% ROE..

And then just finally, I don't if you said it, I apologize, but the tax rate that we should be using going forward is what?.

We said 20% to 25% range. We had 24% for current quarter..

And then - and again, if you covered this, I apologize. But share repurchases that you bought some back this quarter.

How are you thinking about that activity going forward?.

We look at that opportunistically. So we believe the market has undervalued our shares more than normal, then we'll go in and then repurchase shares..

Did you say what the average price was of the other repurchases that you did this quarter?.

It was around $26 a share..

[Operator Instructions] Our next question comes from Matthew Breese from Piper Jaffray..

Just one question from turning to Page 10, where you outlined the amount of loan repricing from now through 2012.

Is that enough to drive a margin inflection point over the next 2 years or in 2019 perhaps?.

So, I think that you've got to look at this like a layer. So this is - that's for us is kind of a baseline layer. Will we always get the maximum contractual rate? Not always, there are relationship elements that are clearly in play over here.

But by and large, we will - as we got this $160 million moving up significantly this particular quarter, I think we're going to see a substantial proportion of that moving up to the 5% area. So, that provides the baseline. I guess the projection for us or the item that we need to continue to work on is building that C&I business.

And also frankly our mixed-use business as well, where the yields are very strong. So, I think layering those together, we do think that we - there in an inflection point, I guess it's going to be highly dependent upon where we're at with respect to deposit pricing. But in terms of loan yields, we're optimistic about loan yields for sure..

And ladies and gentlemen, at this time I'm showing no additional questions. I'd like to turn the conference call back over to Management, for any closing remarks..

Yes. So, I think the important things to remember about the Company at this point in time, is that we are moving in a more positive direction.

And I think we've kind of turned - we've definitely turned the corner in terms of loan yields, and the market looks like it's turned the corner in terms of a little bit more pricing rationality in our commercial real estate and multifamily business. And then of course, we have some swaps that are helping us through this sensitive yield situation.

And then, I think that the business is very solid. New York remains a very strong economic environment for us and we're optimistic about the future. And, I'll leave it at that, and thank you all for your participation. And if there are any additional comments or calls, you know how to get to us, and we look forward to the coming quarters.

Thank you, again..

Thank you..

Ladies and gentlemen, with that we'll conclude today's conference call. We do thank you for attending today's presentation. You may now disconnect your lines..