Welcome to Flushing Financial Corporation's First Quarter 2019 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. All participants will be in a listen-only mode.

[Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] 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 US 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 the Company's filings with the US 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 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 as a substitute for the financial information prepared and presented in accordance with US GAAP. For information about these non-GAAP measures and for a reconciliation to GAAP, 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..

Thank you. Good morning, everyone and thank you for joining us for our first quarter 2019 earnings call. On today's call as always, we hope to provide additional insight into our consistent positive earnings power, business strategy and sustainable competitive advantage.

I'll begin with our first quarter highlights and then provide an overview of the strategies we are executing to continue to create long-term shareholder value. Then our CFO, Susan Cullen will review our financial performance in greater detail. Following our prepared remarks, Susan and I will address your questions.

Beginning on Slide 3, the first quarter of 2019 GAAP diluted EPS was $0.25 and core diluted EPS was $0.33. Included in GAAP diluted EPS is $3 million in seasonal expenses, $2 million of fair value adjustments, $500,000 of one-time expenses related to the death of an officer, and a $1 million provision for loan losses.

Core diluted EPS excludes the fair value adjustments and the one-time expenses related to the death of an officer. The result is an $0.08 difference between GAAP and core diluted earnings per share. A detailed reconciliation between GAAP and core diluted EPS can be found on Pages 18 and 19 of the slide presentation.

While quarterly results were impacted by seasonal expenses, fair market value adjustments and provision expense, we were pleased to see several positive trends, including net interest margin stabilization, loan yield improvement, loan pipeline growth, continued growth in the C&I portfolio and deposits, particularly in the Flushing market.

The most significant positive trend was the stabilization of the net interest margin, which was flat in the first quarter of 2019, compared to the prior quarter. While core net interest margin increased 3 basis points, the first such increase since the first quarter of 2017.

Importantly, the pace of the increase in the cost of funds has slowed by 23 basis points compared to the increase recognized between the second and third quarters of 2018. The yield on interest earning assets has increased gradually over the same periods as a result of our strategic initiative of focusing on rate over volume.

Contributing to the continuation of the NIM stabilization is the $2 billion of loans contractually scheduled to upwardly reprice through 2021. As a result, we expect to earn a premium to market rates on these real estate loans. Our swaps strategy helped in stabilizing the net interest margin.

For the first quarter of 2019, the swaps totaling $726 million, provided a benefit of 6 basis points. Our strategy on loan growth is to move our balance sheet toward more floating rate C&I business, while simultaneously focusing on yield over volume on our mortgage business.

During the first quarter of 2019, our C&I loan closings totaled over $130 million, representing over 65% of our total loan closings. This performance was part of a trend that we've seen over the past four quarters. During that time, C&I loans, which are primarily adjustable rate represented 43% of new loan closings.

Additionally, the loan pipeline improved significantly in the first quarter of 2019, growing 40% to $275 million. Loan pipeline has an average yield of 4.8% providing for additional yield growth in the portfolio. 53% of our pipeline is adjustable rate loans at March 31, 2019.

Our strategic focus on yield over volume in loan pricing continues to aid in stabilizing the net interest margin as the yield on loan closings increased 12 basis points during the first quarter of 2019, and 75 basis points from the first quarter of 2018.

On the mortgage side, the yield on loan closings increased 35 basis points in the first quarter of 2019 from the fourth quarter of 2018, and 99 basis points from the first quarter of 2018.

Mortgage loan closings were down in the first quarter of 2019, primarily due to the pipeline at December 31, 2018 being lower than historical norms, particularly in commercial real estate. Total deposits increased $94 million, or approximately 2% non-annualized quarter-over-quarter.

The majority of this increase was transaction deposits, which increased approximately 4%, again non-annualized quarter-over-quarter. The Win Flushing program, which focuses on increasing our deposit market share in the Asian Community of Flushing, Queens was the centerpiece of our retail deposit growth of $72 million quarter-over-quarter.

At the end of the first quarter, we have captured $175 million of deposits, exceeding our target of $160 million. The program was predicated on the conversion of Flushing branches to the Universal Banker model, which allows staff to spend more time with customers, increasing sales opportunities.

In the branches that have been converted, we experienced an increase of approximately 100% in transactions processed at ATMs, to almost 55% of all branch transactions, reducing our customer's reliance on tellers.

As a result, branch sales have increased over 30%, as sales per employee increased approximately 50% due to our branch staff focusing more time on sales opportunities. As previously discussed, we expect to have the remaining branches converted to the Universal Banker model by the end of 2019.

At the end of the quarter, we had 15 out of our 19 total branches operating under this model. Credit quality remained strong, as non-accrual and non-performing loans decreased by 3% in the first quarter of 2019. The quarter's $0.9 million in charge-offs were mainly isolated to one commercial business loan relationship.

The loan-to-value on our non-performing real estate loans at the end of the quarter remained conservative at approximately 34%.

Referring now to Slide 4, we remain focused on these key areas, exceeding customer expectations, enhancing earnings power, strengthening our commercial bank balance sheet and maintaining our strong risk management philosophy.

Our sustainable competitive advantage includes our ongoing focus on developing and maintaining a multilingual brand staff to serve our diverse customers in the New York City market area.

The Asian banking market surrounding our branches has very attractive business dynamics, including a high degree of savings, available deposits and a significant number of small business owners. We have a strong focus on this community where we have over $650 million in deposits. These deposits have a lower cost of funds than our total cost of funds.

Overall, we remain very well positioned to further deliver profitable growth and long-term value to our shareholders as we continue to execute on our strategic objectives, which are summarized on Slide 5.

Increase core deposits and continue to improve funding mix, manage net loan growth and focus on yield versus volume, enhance core earnings power by improving scalability and efficiency, profitable growth and expansion through new distribution channels and business lines, manage credit risk, and to remain well capitalized under all stress test scenarios.

Overall, our focus on our strategic objectives enables us to further deliver profitable growth and long-term value to shareholders. Now, 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 were $5.6 billion of approximately 1% quarter-over-quarter and 5% year-over-year as we continue to focus on the origination of commercial business loans with a full banking relationship. These originations totaled over 65% of loan production for the quarter and over 43% for the past year.

Commercial business balances have grown 22% year-over-year to approximately 17% of gross loans as of March 31.

The growth in the C&I portfolio continues to offer several advantages to the Company, primarily continued diversification of the loan portfolio, and as these are primarily adjustable rate loans, the yield offers more stability to the net interest margin. At March 31, our loan pipeline totaled $275 million, which is up 40% from the last quarter.

The composition of the pipeline was 53% adjustable rate product. The interest rate on the mortgage loans, the pipeline decreased from last quarter, but increased from the prior year to 4.80%.

Loan to value 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 multi-family, commercial real estate and one-to-four family mixed-use loans is 171%. We continue to underwrite the stress test each individual loan using a cap rate in excess of the mid fives.

Slide 7 highlights the evolution of our funding mix. As funding has grown over the years, the percentage related to CDs and borrowings has decreased. When the need arises to access the wholesale funding markets, we can advantageously latter out liabilities for longer terms.

Core deposits increased 4% quarter-over-quarter and 12% year-over-year, totaling 70% of all deposits at March 31, compared to 37% at December 31, 2006. On Slide 8, you'll see that deposits increased 2% quarter-over-quarter and 8% year-over-year.

We continue to focus on the growth of core deposits with an emphasis on non-interest bearing deposit accounts, which increased 6% year-over-year. Non-interest bearing deposits of nearly $400 million represent 8%of total deposits. Although, we've seen some easing the pace of the cost deposit, we continue to encounter strong competition.

The quarterly cost of funds increased 3 basis points from the prior quarter. We remain disciplined in terms of pricing, our deposits will remain competitive within our market. Turning to Slide 9, net interest income for the first quarter of 2019 was nearly $42 million, up 3% quarter-over-quarter.

The net interest margin at 2.57% was flat quarter-over-quarter, core net interest margin was 2.52%, an increase of 3 basis points quarter-over-quarter. On Slide 10, we discuss the strategies we're using to continue the NIM stabilization. One component of the yield -- of the NIM stabilization is related to the increasing yield on the loan portfolio.

As John highlighted, over $2 billion of loans are scheduled to upwardly reprice through 2021 at an average rate of 96 basis point. However, given the current rate environment, we've recognized that the full contractual repricing may not be recognized, so we expect the rate between the contractual rate and the current market rate.

The second component of the yield stabilization relates to our swaps strategy. As John highlighted, the net interest margin was also aided in the first quarter by interest rate swaps totaling to $726 million by 6 basis points.

As a result of the slowing pace of the cost of deposits, our overall cost of funds for the quarter was 1.80%, an increase of 3 basis points quarter-over-quarter. This was the smallest increase in the cost of funds in two years. As a result of our strategic objectives, the NIM has stabilized for this quarter.

For the seventh consecutive quarter, the yield on loan originations has exceeded the quarterly yield on the loan portfolio, net a prepayment penalties from loans, recovered interest from delinquent loans, and losses from fair value adjustments on qualifying hedges.

Loan origination yields have increased 12 basis points from the fourth quarter of 2018, and originations of commercial business loans, which are primarily adjustable rate loans totaled over 65% the current quarter's originations, and now comprise 17% of the loan portfolio.

Although, we have seen NIM stabilized for one quarter, we actively managed funding costs and continue to evaluate strategies to mitigate our liability sensitive balance sheet.

While the NIM -- while the net interest margin is showing signs of stabilizing, we will continue to focus on driving net interest income by executing our mitigation strategy against the cost of funds, coupled with leveraging loan pricing opportunities and the portfolio mix.

Moving to Slide 11, first quarter expenses increased approximately 4% year-over-year, driven by increase in salary employee benefits, occupancy and equipment, and depreciation expense due to growth of the Bank.

The first quarter of 2019 includes seasonal expenses totaling $3 million and one-time expenses totaled $500,000 from the acceleration of employee benefits due to an officer's death.

The ratio of non-interest expense to average assets was 1.89% in the first quarter of 2019, compared to 1.54% in the fourth quarter of 2018, and 1.95% in the first quarter of 2018. The Company has historically maintained relatively stable ratio of non-interest expense to average assets.

The efficiency ratio was 70% in the first quarter of 2019, compared to 59% in the fourth quarter of 2018, and 69% in the first quarter of 2018. Increasing the net interest margin will assist us in achieving our long-term goal of an annual efficiency ratio in the low to mid-50s.

We remain focused on continuous improvement and new opportunities in our operations versus efficiency gains. Regarding taxes, the effective tax rate was approximately 25% in the first quarter of 2019, which includes the vesting of restricted stock awards, which are just treated as discrete items.

Excluding that, the effective tax rate was approximately 24% in the first quarter and for 2019, we approximate an effective tax rate between 22% and 25%. Now, turning to credit quality on Slide 12. Our credit metrics remained excellent this quarter.

As a reminder, we are historical seller of non-performing credits and recording charge-offs early in the delinquency process. Our strong credit quality metrics result a coverage ratio increasing to a 134% from 129% as of December 31, 2018.

Looking forward with expected loan growth, we anticipate recording provision for loan losses proportion with that growth in future quarters in order to maintain an adequate reserve level. On Slide 13, non-performing loans were under $16 million, down 3% from over $16 million at December 31, 2018, as credit quality remains one of our core strengths.

The average loan-to-value of our non-performing real estate loans was approximately 34%, based upon the value with underlying collateral at origination and we did not adjust appraised values for increases. Given a low loan-to-value associated with our non-performing real estate loans, we do not foresee an increase in related expenses.

In the first quarter, we recorded a provision of $1 million in net charge-offs of $900,000, which includes the charge-off totaling $1.1 million in one commercial business relationship. After charge-offs, the remaining book balance of this one relationship was $900,000 at March 31, 2019.

Slide 14 shows 90-day delinquencies as a percentage of loans originated by year. You can see the results of our strong underwriting discipline as there a just nine loans delinquent greater than 90 days for the last 10 vintage years. Overall, our credit quality remains pristine. I'll now turn it back to John for some closing comments..

Thank you, Susan. On Slide 15, I would like to conclude by reviewing why we believe we are well-positioned for continued, consistent and profitable growth. We articulated our strategic objective to focus on yield rather than volume in the loan portfolio.

The yield on our new loan originations for the first quarter of 2019 increased 12 basis points from the fourth quarter of 2018, and 75 basis points from the first quarter of 2018. We have talked about controlling net interest margin pressure.

The core net interest margin increased 3 basis points from the core net interest margin recorded in the fourth quarter of 2018. We have targeted reducing the loan-to-deposit ratio through deposit growth.

The increase in the deposit balances, especially in the retail sector resulted in an improvement of the loan-to-deposit ratio to 110% from 112% in the prior quarter, and 113% in the prior year. We have contained non-interest expenses in this low rate environment.

The ratio of non-interest expense to average assets was 1.89% in the first quarter of 2019, compared to 1.54% in the fourth quarter of 2018, and 1.95% in the first quarter of 2018.

The Win Flushing program established to increase our market share in our home market has been very successful as we've gathered to-date a $170 million -- $175 million of new deposits, exceeding our original target of $160 million. The investment in the Universal Banker model is paying dividends.

The Universal Banker is spending more time with customers. The additional time has resulted in brand sales increasing over 30% and approximately 50% per branch employee.

Our vision remains the same and that is to be the preeminent community financial services company in our multicultural market by exceeding customer expectations and leveraging our strong banking relationships. The New York City market with its strong Asian customer base continues to represent a significant opportunity for us.

In summary, our strong balance sheet, risk management philosophy, capital levels, ability to grow deposits, investments in talent, innovation and cyber security, all position the Company very well to deliver consistent profitable growth, and long-term value to our shareholders. We will now open it up for questions. Operator, I'll turn it over to you..

Thank you. Ladies and gentlemen, we'll now begin our question-and-answer session. [Operator Instructions] The first question comes from Mark Fitzgibbon of Sandler O'Neill & Partners. Please go ahead..

Good morning..

Morning..

Morning..

First, Susan, a couple of questions related to modeling stuff.

The expense run rate presumably comes back down next quarter to sort of roughly -- am I right at around $28.5 million?.

I didn't model it out by quarter, Mark. I just know that it'll be about 3% to 5% greater than it was in 2018, all-in. There's the $3.5 million worth of one-time expenses in the salaries and the other expense line items....

Okay..

...combined..

That will not be repeated..

That will not be repeated..

Okay. And then the -- your comments about provisioning.

So the $1 million provision you had this quarter was largely a function of that one charge-off -- commercial charge-off that you had at $1.1 million, should we assume provisioning is going to come back down to sort of a couple of $100,000 a quarter sort of level, which is where you've been providing for loan growth previously?.

Yes. Yes, I would anticipate that..

Okay.

And it sounds like the core margin is bottoming, what are your thoughts on prepayment penalty income in -- over the next couple of quarters?.

Go ahead..

Yes. We don't see a great upsurge in prepayment penalty income. I think it's going to be relatively consistent with what we saw last year.

Okay. And then lastly, it look like C&I volumes were really strong this quarter.

Could you share with us maybe is that coming from a particular industry or niche, or type of company?.

No. We've remained pretty well diversified in our focus on C&I -- the C&I business..

Thank you..

The next question comes from Steven Comery of G. Research. Please go ahead..

Hey, good morning..

Good morning..

So looking at Slide 10, it looks like a lot of the repricing opportunities to some extent front loaded to 2019.

Just kind of with that in mind and kind of the smaller increase in deposit pricing you saw this quarter, how do you think about previous comments about NIM declining throughout 2019?.

Well, at our last earnings call, our expectation was that the rates will continue to rise through 2019 and squeeze our core NIM through 2020. But with these repricing of the loans and the slowdown of the pace of the pricing deposits and that altering their position.

Given everything being equal as it is this quarter, we'd expect the rate environment to remain beneficial to us..

So should I read that as stable NIM or are you saying there could be upside?.

Relatively stable..

Okay. Okay, very good. Thanks. And then just on the deposit pricing, very -- kind of a big step down in the rate of increase there.

Is there anything sort of different from a competitive perspective, going on, or are your sort of deposit sales kind of just catching up and improving the pricing you're getting there?.

I think it's a combination of things. But probably the most significant thing is that the Fed reducing its incessant quarter-by-quarter drumbeat on raising rates that is just temper the market..

Okay, very good.

And then on the deposit sort of balances, can you kind of remind us or update us on sort of expectations for seasonality? And does the Win Flushing program and kind of the inroads you guys have made their change the seasonal pattern of deposit mix?.

It's certainly -- there's a couple of factors there. I think the -- our ability to gather deposits in these ethnic neighborhoods is one that we can we can focus on. Chinatown is a new branch for us and our expectation there is very, very strong where we're doing very well versus our budgeted expectations.

So I think that we can mute some of those -- some of that movement. But I think by and large you're going to see some pullback in the municipal balances in the summer with a return of those municipal balances coming in the fall, consistent with what we've seen every year.

But I do think that some of it is muted by these other factors that I just spoke about..

Okay. Yes, that makes sense. And then just one more for me on the efficiency ratio.

Susan, I think, during your prepared comments, you mentioned a low to mid-50s efficiency ratio goal; I'm just kind of wondering what the timeline is on that? Is that something we should look for full year 2020, or is that kind of a quarterly rate in 2019?.

That will be a -- that's a longer term goal that we would like to see. And again it's going to be dependent on the NIM -- growing the NIM..

Okay.

So sort of further out than 2019?.

Yes..

Okay, fair enough. That's all I have. Thanks, guys..

Thank you..

The next question comes from Collyn Gilbert of KBW. Please go ahead..

Thanks. Good morning..

Good morning..

Just to go back to the deposit discussion for a minute. So it looked like -- you know, the big slug of the deposits that came in this quarter were -- was kind of in the now category and it -- that looked like that was the product saw the biggest increase in rates.

Just curious as to the timing on that and maybe what the impact could be on the -- kind of funding costs next quarter..

Yes. I guess an answer to the latter part of your question that there is -- as long as we remain in this kind of more stable rate environment, we see less pressure on the funding costs in general. So we're assuming betas that are similar to what we experienced this past quarter.

The movement in the now has been associated with the business now rising predominantly..

Okay. And then just on the NIM discussion, Susan, do you have a target you know, kind of NII growth as -- I mean it sounds like strategically that's the objective to grow NII.

Do you think that you will be able to do that in 2019, and if so kind of what levels are you thinking you should be able to grow NII?.

We do believe we will grow NII. As we've talked about, we were able to grow it this quarter of interest income. And it's hard to forecast and predict given the rate environment. Everything being equal, I would expect net interest income growth to be consistent with what we saw this quarter..

Okay. And then just going back to the expense discussion. So I know you had said, you're still on track to -- for 3% to 5% increase in expenses off of the 2018 level. That would imply it even backing out the $3.5 million of non-recurring expense this quarter, that still implies a pretty significant reduction going forward.

So are there other things, other initiatives that you have going on where you're anticipating to get those expenses that much lower than where they were this quarter?.

So some of the expenses were a little bit front loaded in this particular quarter, so I think we're going to see some leveling out of some of these expenses going forward..

Okay. And then you guys have referenced kind of your OpEx to average asset target number.

And it was -- do you have a target for what you want that to be for the year? I know, first quarter obviously it's elevated at 19, last quarter it was 15, where do you sort of see that level leveling out for the year?.

We think that will be pretty well consistent with what last year's performance came in at..

Okay.

And then just on the tax rate, the range of the 22% to 25%, is there -- what are some of the assumptions that go into that for the -- sort of the variability of that range is like what would get you guys to the low end and then what would cause you guys to be at the high end?.

The apportionment as we've discussed in the past will move the tax rate. Once we finalize our 2018 tax returns, the apportionment will move that..

Okay. I'll leave it there. Thank you..

Thank you..

[Operator Instructions] The next question comes from Matthew Breese of Piper Jaffray. Please go ahead..

Good morning..

Good morning..

Good morning, Matt..

Just going back to Slide 10 and the repricing opportunity, the current rate for 2019, the 4.81% versus this quarter's origination yield of 5.02%, which like a 20 basis point pickup.

Is that consistent with the pipeline as well as -- is the pipeline still at an 5% range?.

Pipeline is 4.80%, I believe..

4.80%, okay.

And where are you seeing the most compression, is it in the mortgage or the non-mortgage side in the pipeline?.

I would say that there is a lot still -- in the pipeline that's probably a little bit more on the mortgage side..

Okay. And as we think about the incremental cost deposits, I'm assuming there's still some upside there. Can we just kind of flesh out the -- if the current rate is 4.80%, your pipeline rate is 4.80% versus increasing deposit cost.

I think that would imply some NIM compression from here, could we just kind of square that?.

Sure. So look at these loans that repriced, the 4.80% here and then we believe that the vast majority of the increasing cost of liabilities has already been baked into the numbers. There will be -- there might be a basis point or two, but not much....

Okay..

...increasing cost of the deposits given that what's rolling off..

Okay. And you did note that there's been some relief on the deposit competition side.

As we think about your deposit gathering vehicles outside of the Flushing brand, you have the iGObanking and the BankPurely platforms, have you taken any strategic actions to be a little bit less aggressive on pricing there, and could you share with us some examples if you have?.

We have been a little bit less aggressive as the need for additional deposits was a little bit more muted this quarter..

Okay.

Is it on the CD front or the money market front, where are we taking our foot off the gas pedal there?.

On the CD front and the money market front..

Okay.

And then just thinking about the charge-off, just curious what was the nature of that relationship, was it -- I think it was in the C&I category, what was the industry and the collateral behind it?.

It was the pharmaceutical industry and the issues were related to a one-time event associated with an employee that we believe was rectified..

Understood, okay.

And then my last one, just thinking about the swaps, I know derivatives are tough to quickly summarize, but can you just talk about the interest rate scenarios where the swaps are on the books or in the best position versus the worst position? What needs to happen for them to potentially cause you harm versus provided a benefit?.

Any rising rate environment causes us benefit on the swaps. So inversely any declining market would hurt us on the swaps..

Okay.

And is that tied more to the short end or what part of the curve that tied to?.

Well, as we've talked about in the past, we put about $450 million on starting last January of 2018 on the five-year spot on the curb. And the loans are about on the same spot or maybe a little bit longer. That's the vast majority of the swaps..

Okay, understood. Okay.

Now, the curve has come in quite a bit this quarter, especially the five-year part, should we expect the same benefit from the swaps this quarter as the first quarter?.

Everything else being equal, yes..

Understood. Okay. That's all I have. Thank you..

Thank you..

This concludes our question-and-answer session. I would like to turn the conference back over to John Buran for any closing remarks..

I just want to thank everybody for participating on the call. And once again, I believe that we're moving in the right direction as it relates to NIM. And some of the strategies that we put in place over the last couple of years as we've seen this declining rate environment appear to be paying off for us.

So thank you again and we will talk to you in the future. If anybody has any additional questions or comments, you know where to find us. Thank you..

Thank you..

This concludes today's teleconference. You may now disconnect your lines. And we thank you for your participation..