Flushing Financial Corporation

Welcome to the Flushing Financial Corporation's third quarter 2022 earnings conference call. Hosting the call today are John Burren, President and Chief Executive Officer, and Susan Cullen, Senior Executive Vice President, Chief Financial Officer, and Treasurer. Today's call is being recorded. All participants are in a listen-only mode. Should you need assistance, please press star, then zero. Following today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star, then 1 on your telephone keypad. To withdraw your question, please press star, then 2. 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'd now like to introduce John Burren, President and Chief Executive Officer, who will provide an overview of the strategy and results.

Thank you, operator. Good morning, everyone, and thank you for joining us for our third quarter 2022 earnings call. Following my prepared remarks, Susan will review the financial trends, and we will then answer any questions. The local economy was generally positive in the third quarter as New York City continued to recover from the pandemic, which led to solid loan growth. On the other hand, the Fed aggressively raised rates, which pressured funding costs while also increasing loan origination yields. Given this environment, we remain focused on executing on our strategic objectives. We reported GAAP earnings per share of 76 cents and core EPS of 62 cents. This translated to a return on assets of 1.11 percent and a return on equity of nearly 14 percent. Core return on assets was 90 basis points and core return on equity was over 11 percent. These returns are within range of our stated through the cycle goals of 1 percent and 10 percent, respectively. Core loan yields increased 20 basis points quarter over quarter, while core deposit yields expanded 47 basis points, resulting in net interest margin compression of 28 basis points on a reported basis and 30 basis points on a core basis. In a period of rate rises, The general trend in our net interest margin is expected to be shaped like a V. When the Fed is raising rates, funding costs reprice faster than assets. When the Fed stops raising rates, then assets are expected to increase faster than funding costs over a period of time, and then the NIM begins to recover. In the near term, The net interest margin should have pressure and then, over time, expand once loan repricing accelerates. Average non-interest-bearing deposits reached a new record at $1.1 billion for the quarter and increased 13 percent year over year. Loan closings were a strong $464 million in the quarter. The loan pipeline declined to $309 million as we've become more selective in terms of rates and collateral type as borrowers adjusted to the higher rate environment. We continue to focus on total relationships versus transactional business. Asset quality is a hallmark of this company. During the quarter, our non-performing assets, which have a loan to value of less than 51 percent, were stable at 58 basis points. We continue to invest in the future as we hired 46 people from institutions within our markets that are involved in a merger, 20 of those being revenue producers. Overall, we're managing the balance sheet to deal with the rising rate environment while maintaining our focus on credit quality. Slide four outlines the merger disruption that continues in our markets. During the quarter, we hired an additional four people, including two revenue producers from banks participating in mergers. 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 organic growth opportunities. The merger activity is having a positive impact on our business. On slide five, it depicts the strong loan closings for the quarter. Pull-through rates increased after bottoming out in the third quarter of 2021. The loan pipeline has declined after record levels the prior two quarters by the decisions we're making on rates, collateral type, and full relationship focus. Additionally, borrowers are adjusting to a higher rate environment. Given the significant move in rates, loan closings could slow. However, satisfactions should also decline. Slide six depicts the growth in our low-cost delivery channel, our digital banking platforms. We continue to see high growth rates in monthly mobile active users, users with active status, and digital banking enrollment. The numerated platform, which digitally originates small-dollar loans as quickly as 48 hours, continues to grow. We originated approximately $16 million of commitments in the first nine months of the year. Most of these commitments have a weighted average rate that is greater than the overall loan portfolio yield. We continue to explore other FinTech product offerings and partnerships. The third quarter has several important events to highlight, as you can see on slide seven. We signed a lease for Brooklyn Branch, which will expand our Asian banking footprint. As a reminder, last quarter, we signed a lease in Hoppog, which is expected to open by year end We successfully issued 65 million of subordinated debt. This additional capital provides flexibility to lower our CREE concentration ratio, and we timed it well as subsequent offerings have had higher rates. On the product side, last month, we launched contactless-enabled ATM debit cards. We participated in many community events this quarter, including supporting the Dragon Boat Race Festivals in Flushing and Port Jefferson. We also hosted a Harvest Moon reception for our Asian banking customers. These events are examples of how Flushing Bank supports our communities. 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 eight. Growing non-interest-bearing deposits is a priority for us. Average non-interest-bearing deposits increased 13% year-over-year and comprise nearly 17% of average deposits compared to approximately 15% a year ago. Our teams continue to open new checking accounts, which were up 26% year-over-year. The growth in non-interest-bearing deposits helps mitigate the overall rise in deposit rates. Our incentive plans are focused on increasing non-interest-bearing deposits. We are also growing CDs to lengthen our duration. Slide 9 shows how our deposit rates move compared to Fed funds. Our ability to control deposit rate increases is a key factor in the net interest margin outlook due to our liability-sensitive balance sheet. We have done a good job of limiting deposit rate increases so far in 2022. From the fourth quarter of 2021 through the third quarter of 2022, interest-bearing deposit yields increased 63 basis points compared to the 211 basis point rise in average fund rates, implying a deposit beta of 30% compared to 43% in the prior cycle. We expect the cumulative deposit betas to continue to rise as rates increase. Slide 10 outlines loan portfolio yields. Net loans, excluding the PPP loans, increased nearly 7% year-over-year. With the exception of the PPP loans, loan growth occurred both in mortgage loans, which increased nearly 4% year-over-year, and commercial business loans, which rose over 18%. Loan portfolio yields increased 23 base points during the quarter. Notably, yields on a loan pipeline increased 117 base points during the quarter. Pre-payment penalty income declined to $1.3 million in the third quarter compared to $2.3 million the prior quarter and $1.8 million a year ago. Slide 11 provides more detail on the repricing of the loan portfolio. While a portion of the loan portfolio reprices with each Fed move, the majority reprices over time. We have approximately $1 billion, or 15% of loans, that should largely reprice with the Fed moves. An additional $1.9 billion, or 27% of loans, were repriced through 2024. As of September 30th, these loans are expected to reprice 200 base points higher. This does not take into account any future Fed moves, which could push repricing rates up further. Importantly, once a real estate loan reprices, our prepayment structure resets to the original terms. Slide 12 outlines the net interest income and margin trends. The GAAP net interest margin was 3.07% and decreased 28 basis points during the quarter. Net interest income decreased 5% quarter-over-quarter to $61 million. Core net interest income, which removes the impact of net gains from fair value adjustments and purchase accounting accretion, decreased 6% quarter-over-quarter as the core net interest margin declined 30 basis points to 3.03%. This rate cycle has been different from the past cycles given the pace and magnitude of rate moves. However, our deposit beta has been lowered this cycle. As John said previously, in a rising rate environment, the path of net interest income is expected to look like a V with compression from rising funding costs when the Fed increases rates followed by expansion over time as loans reprice. Moving on to asset quality on slide 13, we have a long history of strong credit quality, primarily due to our low-risk credit profile and conservative underwriting. For the quarter, net charge-offs were only two basis points. Our low-risk credit profile and conservative underwriting has served us well through many cycles. As you can see, our losses have been well below the industry. We remain comfortable with the credit quality and allowance for credit losses. We believe there is limited loss content in the loan portfolio if there is an economic downturn due to greater than 88% of loan portfolio secured by real estate with an average LTV less than 37%. Less than 1% of our loans have a loan to value of 75% or more. And the weighted average debt service coverage is 1.8 times and over 1.15 times in stress scenarios. for our multifamily and investor commercial real estate portfolios, which comprise 65% of total loans. These factors contribute to our expectation of low loss content within the portfolio. Additionally, on slide 14, our allowance for credit loss is presented by loan segment. Our allowance is different from peers, largely due to loan mix, as we have a higher percentage of real estate collateral at low average loan to values. Overall, the allowance for credit losses to loans increased one basis point to 59 basis points during the quarter. Non-performing assets were stable at 58 basis points, and the loans of value on these assets is less than 51%. Criticized and classified loans increased slightly to 89 basis points of loans compared to 85 basis points in the prior quarter. The coverage ratio is 142%. meaning we have approximately $1.40 reserved for each dollar of non-performing assets. 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 $15 million increase and accumulated other comprehensive loss. We took advantage of the attractive stock price and repurchased nearly 131,000 shares during the quarter and returned 40% of earnings through dividends and share repurchases. The tangible common equity ratio declined to 7.62%, driven mostly by the incremental 18 basis points of accumulated other comprehensive loss. In the short and the medium term, the company will maintain its target 8% tangible capital ratio while balancing the attractiveness of share repurchases. Before I turn the call back to John, let me provide some additional color on the outlook. With the liability-sensitive balance sheet, controlling the cost of funds is paramount. The passage of time should allow for the accumulation of loan repricing to exceed the cumulative effect of the increases on the funding. In addition, we have $592 million of swaps on funding that will be priced to our benefit in 2023. The net interest margin will remain under pressure over the short term and then should expand in the medium term and beyond from loan repricing. Non-interest expenses are now expected to increase low single digits in 2022 from the core base of $144 million as year-to-date expenses were better than expected. Finally, the effective tax rate should approximate 28% for 2022. With that, I'll turn it back over to John.