Flushing Financial Corporation

Welcome to the Flushing Financial Corporation Second Quarter 2022 Earnings Conference Call. Hosting the call today are John Buren, President and Chief Executive Officer, and Susan Cullen, Senior Executive Vice President, Chief Financial Officer, and Treasurer. Today's call is being recorded. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star, then 1 on a touchtone phone. To withdraw your question, please press star, then two. 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 as a substitute for the financial information prepared and presented in accordance with U.S. GAAP. For information about these non-GAAP measures and for reconciliation to GAAP, please refer to the earnings release and or the presentation. I would now like to introduce John Buren, 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 gap earnings per share of 81 cents and core EPS of 70 cents. This translated to a return on assets of 122 and a return on equity of 15%. Core return on assets was 105 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 seven basis points. This resulted in a stable net interest margin quarter over quarter. Average non-interest bearing deposits reached a new record at one 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 non-performing 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 four 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 activity is having a positive impact on our business. On slide five, 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. the significant move in rates, loan closings could start to slow, but satisfactions which remain elevated should also start to decline. Slide six 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 Zelle usage by our customers as this product continues to gain traction. The Numerator platform, which digitally originates small dollar loans as quickly as 48 hours, continues to grow. We originated approximately $11 million of commitments in the first half of the year with a weighted average yield of over 6% while adding 30 new relationships. We continue to explore other fintech offerings and partnerships. The second quarter had several important events to highlight, as you can see in slide seven. We opened a new branch in Elmhurst, Queens, which expanded our Asian market footprint. This branch is staffed by employees who were previously with one of the banks involved in the 10 mergers in our markets. Growth and activity in the branch has exceeded our expectations. We also signed a lease to open in Hoppog, Suffolk County on Long Island. HOPOG is one of the key business centers in our area. The company issued its inaugural environmental, social, and governance report, and our complete checking account product received Bank On certification. We participated in many community events this quarter, including support of the United Way, New York City Rise, and Neighborhood Housing Services of Queens. Importantly, Flushing Bank employees completed a very successful food drive for Island Harvest and participated in Brooklyn's Cinderella Project to provide Prometire for young women and men. These events are an important part of how Flushing Bank supports its communities and shows how the environment is adapting to the COVID-19 pandemic. I'll now turn it over to Susan Cullen to provide more detail on our key financial metrics. Susan?

Thank you, John. I'll begin on slide eight. Growing noninterest-bearing deposits is a priority for us. Average noninterest-bearing deposits increased 13% year-over-year and comprised over 16% of average deposits compared to 14% a year ago. Our teams continue to open new checking accounts, which were up 18% year-over-year. The growth in 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 eliminating deposit rate increases so far in 2022. Deposit costs increased eight basis points, 29 basis points in the second quarter, compared to 21 basis points in 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 were 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 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 be priced 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 30th, 2022. For example, in 2023, nearly $1 billion of loans should reprice 154 basis points higher based on the contractual rates as of June 30th. While we expect the loans to reprice the contractual rate repricing would depend on the then current market rates and competition. If the indices continue to rise as the Fed increases rates, repricing rates will continue to move higher. Our loans will reprice over a 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 basis 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 base points to 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 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 30th, 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 in previously charged off tax and 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 multifamily 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 borrower has sufficient repayment capacity in a rising rate environment. For these portfolios that are due to be priced over the next three years, the weighted average pro forma debt service coverage would still be greater than 1.25 times with the 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 rates and the 10% increase in operating expenses, The pro forma weighted average debt service ratio would still remain over 1.15 times. In all scenarios, these borrowers would be able to make payments. We remain comfortable with the low level of risk in the loan portfolio. Slide 14 outlines 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 devalue of the non-performing assets is less than 51%. Credit size on 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 of the 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 shareholders through dividends and share repurchases. The company repurchased over $8 million of common stock from the quarter, and the board of directors increased the share repurchase authorization by a 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 to an 8% tangible capital ratio. Before I turn it back to John, I want to provide some color on the outlook. The net interest income is a function of the 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 and 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 non-interest expense to increase by mid-single digits given the results of the first half of the year. Quarterly non-interest expenses are expected to follow prior seasonal patterns. Lastly, the effective tax rate for 2022 should approximate 28%. With that, I'll turn it back over to John.