Flushing Financial Corporation

Welcome to Flushing Financial Corporation's first quarter 2023 earnings conference call. Hosting the call today are John Murin, President and Chief Executive Officer, and Susan Collins, Senior Executive Vice President, Chief Financial Officer, and Treasurer. Today's call is being recorded. All participants will be in listener mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After 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 discussion during this call contains 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 could 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 on these non-GAAP measures and for reconciliation to GAAP, please refer to the earnings release or the presentation. I'd now like to introduce John Buren, President and Chief Executive Officer, who will provide an overview of the strategy and results.

Thank you, Operator. Good morning, and thank you for joining us for our first quarter 2023 earnings call. Following my prepared remarks, Susan will review the financial trends, and we will then answer any questions. The company reported first quarter 23 gap EPS of 17 cents and core EPS of 10 cents. The quarterly results were impacted by net interest margin compression and a charge off of a previously identified credit placed on non-accrual in the second quarter of 2022. We were disappointed with these results and we've implemented an action plan to enhance the resilience of our business model and improve future profitability. First, we're taking significant steps to move the balance sheet to more interest rate risk neutral and have already achieved 40% of our goal. Second, we are increasing our focus on risk adjusted returns and overall profitability. While this will take some time, we're encouraged by the results seen so far. Third, We're looking to expand our client base and build loyalty by emphasizing our brand of customer service and deep community relationships while capitalizing on the recent market disruptions. Our bankers are seeing more activity in gathering both loans and deposits. Fourth, we are tightening up on expenses. We've taken actions to reduce non-interest expense growth and will continue to focus on reducing discretionary expenses. Fifth, we are preparing for the next credit cycle. We are focusing more on recession-proof industries and will continue to take early actions on weaker credits. Sixth, we will continue to focus on our strong liquidity and capital. Deposits are up for the quarter, and we have $3.7 billion of available liquidity. Overall, we expect these decisive actions to result in an improved earnings profile over time. These actions, along with our strong liquidity, will also allow us to continue our long track record of dividend payments into the future. Please turn to slide four. The actions we are taking will also allow us to advance our four areas of focus for long-term success. We incurred a $9.2 million loss on a business participation, which was placed on non-accrual in the second quarter of 2022. This domestic borrower has a customer who shipped products to Russia that were canceled due to sanctions. The credit protection for the shipper's receivables that was in place became more questionable during the quarter. So we decided to charge off the loan. Absent this isolated credit, we would have recorded small net recoveries for the quarter. Credit quality is one of the foundational pillars of the bank. Our loan portfolio overall 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 37%. Current debt service coverage ratio has improved to 1.9 times. Midtown Manhattan office space exposure is only one-tenth of a percent of the loan portfolio. Interest rate risk is another priority, and I outlined our actions on the previous slide. While I also touched on liquidity on the previous slide, I want to highlight the liquidity is strong. We increased deposits by nearly $250 million during the quarter. Our liquidity is over three times the uninsured and uncollateralized deposits. Customer experience and our ties to the communities are also key to our success. Due to a major competitor signature bank leaving the market, additional opportunities are emerging, particularly with shared relationships. We are also expanding our Asian banking franchise and see nice deposit growth there. Our digital engagement is strong and growing. These areas of focus will position the company to withstand the short-term macro turmoil while rebuilding our foundation for long-term success. Slide five highlights our performance for the quarter. Average deposits increased 6% year-over-year and 2% during the quarter, a positive metric for Flushing Financial given the current banking environment. Our uninsured and uncollateralized deposits are only 16% of total deposits. Analysts have noted that we're one of the strongest versus peers. We expect a similar or better position this quarter. The cost of deposits reached 2.29% and the overall cost of funds was 2.47%. As we indicated last quarter, loan growth is expected to be challenging. Loans were flat quarter over quarter. While loan closings were lower than recent quarters, yields increased to over 7% and the loan pipeline increased 6% quarter over quarter. We expect the market disruptions will provide opportunities for loans, especially given the absence of a major competitor. Core loan yields expanded 17 basis points during the quarter due to higher rates, repricing of the real estate loans and new loans coming on at rates above the portfolio yield. Non-performing assets declined 21% and criticizing classified assets decreased quarter over quarter. Additionally, delinquencies, which were already low, declined 16 basis points during the quarter. We continue to realize strong growth in digital engagement by leveraging our technology platform. In fact, in the first quarter, we originated approximately $7 million of loan commitments through our digital platform. We also expanded our relationships with FinTech players as we have partnered to offer customers assistance with filing and processing, employee retention, tax credit refunds. Earnings from this partnership will be realized once the customer receives the refund, to date pleased with the activity. As outlined previously, we put in place several steps to improve overall earnings performance. The market believes the Fed is nearing the end of its increasing cycle, which implies margin improvement on the horizon for us. Additionally, there are opportunities due to the market disruption and the absence of a major competitor. Slide six presents our liquidity profile. We have $3.7 billion of available liquidity from a variety of sources, including Federal Home Loan Bank, the Federal Reserve Bank, cash on hand, and unpledged securities. Additionally, we have relationships with Intrify Network and others to offer customers greater FDIC insurance versus the $250,000 minimum. We are working to expand borrowing capacity from existing relationships by pledging different types of collateral. Deposit flows over the course of the quarter were similar to past trends. Uninsured and uncollateralized deposits totaled about 16% of total deposits. Our available liquidity is over three times the amount of uninsured and uncollateralized deposits. We have a high degree of comfort in the stability of funding due to deposit stability and available liquidity. Our loan portfolio is outlined on slide seven. As you can see, 65% of the loan portfolio is concentrated in multifamily and investor commercial real estate. Our overall office portfolio is about 4% of loans with Midtown Manhattan office space exposure at one-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 our loan portfolio due to an average loan-to-value of less than 37 percent and a debt service coverage ratio of 1.9 times for the multifamily and investor commercial real estate portfolios. Slide eight provides a detail on our Asian markets. About a third of our branches are in Asian markets where we have $1.2 billion of deposits and $810 million of loans. These deposits are 18% of total deposits, and we have only 3% market share, so there's plenty of opportunity. Our approach to this market is supported by our staff that speaks many different languages, our Asian Advisory Board, and support of cultural activities. This market continues to be an important opportunity for us. Slide nine depicts the growth in our digital banking platforms. We continue to see high growth rates in monthly mobile deposit users, users with active online banking status, and digital banking enrollment. Based upon data from our service provider for 2022, we had above median enrollment growth and top quartile performance for active users' annual growth and mobile remote deposit capture annual growth. compared to the 26 banks in our peer group of assets of $5 to $10 billion. The enumerated platform, which digitally originates small dollar loans as quickly as 48 hours, continues to grow. We originated approximately $7 million of commitments in the first quarter. These commitments have an average rate greater than the overall portfolio rate. We continued to explore other FinTech product offerings and partnerships. On slide 10, first quarter had several important events to highlight. As pictured, our employees participated in the Lunar New Year parade, which is great visibility to our Asian markets. We were involved in other community events, including Manhattan Neighborhood Network ribbon cutting, and providing scholarships for NYC Kids Rise. Our new HOPOG branch in a major Long Island industrial park opened during the quarter, and we expect Bensonhurst, which extends our Asian business, to open later this year. Participating in these types of initiatives builds on our already strong ties with our local communities, which is a key differentiator for our business, enabling us to drive customer loyalty. I will now turn it over to Susan to provide more detail on our key financial metrics. Susan?

Thank you, John. I'll begin on slide 11. Deposit growth has been a challenge for the industry as the Fed raises rates and recent bank failures tighten financial conditions. Despite this backdrop, we were able to increase average total deposits 2% during the quarter and 6% year over year. As expected, balanced growth was driven by CDs, which help extend our funding to better match the duration of the assets. While growing non-interest-bearing deposits is a priority for us, and has become more challenging given the higher rate environment. Average non-interest-bearing deposits declined both quarter over quarter and year over year. However, checking account openings increased 30% year over year. The recent market disruptions provided opportunities to attract more deposits and customers. The increase in the deposit base assisted in lowering the loan-to-deposit ratio to 102% from 107% at the end of the year. In terms of mix, about half of our deposits are from consumers, and the other half are from business and government. I also want to note that we have seasonality in certain segments of our deposit base, and the summer months are generally lower than the rest of the year. On slide 12 outlines our loan portfolio and the yields. Net loans increased 5% year over year, but were down less than 1% quarter over quarter. Loan closings were lower than the recent run rate, but the yield on the closings was over 7% for the quarter. Core loan yields increased 17 basis points during the quarter, and for the second consecutive quarter, yields on loan closings exceeded the yields on the satisfactions by 113 basis points. Pre-payment penalty income declined to $610,000 in the quarter from $1.2 million in the fourth quarter and $1.6 million from a year ago. There's been some disruption in the market as a major competitor has exited, contributing to the increased activity resulting in the loan pipeline that increased 6% during the quarter. Slide 13 provides more detail on the contractual repricing of the loan portfolio. Approximately $1.1 billion, or 16%, reprices with each Fed move. In the first quarter, approximately $272 million of real estate loans repriced upwards of 193 basis points to 6.63%. For the remainder of 2023, another $660 million is due to reprice at a rate 184 basis points higher than the current yield. Another $765 million, or 11% of loans, will reprice in 2024 with a similar amount in 2025. These values are based on the underlying index value as of March 31, 2023, and do not consider any future rate moves. This repricing is what should drive net interest margin expansion once funding costs stabilize. Slide 14 outlines the net income and margin trends. The GAAP net interest margin declined 43 basis points to 2.27% during the quarter. As we stated previously, we expect the NIM will continue to compress as long as the Fed raises rates. After a lag, we expect the NIM would begin to expand as the pressure on funding costs ease and loans continue to reprice higher. Of course, if the Fed cuts rates, our funding costs should reprice lower, faster than the declines on the asset yields. Turning to slide 15, one of our goals for 2023 is to significantly move towards more interest rate neutral. The goal for the balance sheet is to match the duration of our assets more closely, which is approximately three to four years, and the duration of our funding, which is about one to two years. The asset swaps convert fixed rate assets of 3.17% into floating rate assets of 5.62%, and the effective funding swaps go from 4.84% to 2.55%. We added some swaps late in the quarter, so the full benefit has not been realized in the run rate. and the forward funding swaps will be priced lower during the year. We expect to continue to monitor market opportunities to take additional actions if warranted to help close the duration gap. Slide 16 shows there's another benefit to the swaps portfolio as it serves as a mitigant for changes in interest rates that flow through AOCI. The change in the value of the swap portfolio is generally the inverse of the change in the value of the available for sale securities As you can see, this has been our history and has helped to keep our tangible capital ratio stable versus others who have experienced more pressure from the rising rate environment. Slide 17 outlines our high quality and liquid investment security portfolio. The overall investment security portfolio is $886 million or just over 10% of assets. Our securities portfolio is mostly classified as available for sale so the value is largely reflected in our tangible capital. About 53% of the portfolio was floating rate, which includes the $200 million of fair value swap added during the quarter. Security yields increased 44 base points quarter over quarter to 3.15%. Moving on to net charge-offs on slide 18, we have a long history of solid credit quality as a result of our low-risk credit profile and conservative underwriting. Net charge-offs were 54 basis points for the quarter, which primarily relates to the one business credit John mentioned earlier. Absent this credit, we would have reported small net recoveries for the quarter. During the quarter, we provided additional provisioning to fully reserve for previously identified $4 million line of credit. Historically, loss has been well below the industry due to our low-risk credit profile and conservative underwriting. We expect limited loss content in the loan portfolio if there's an economic downturn given that greater than 88% of the portfolio is secured by real estate, with an average loan-to-value less than 37%. Additionally, the weighted average debt coverage ratio is 1.9 times and over 1.15 times the stress scenario. The stress scenario consists of a 200 basis point increase in the rate and a 10% increase in operating expenses for our multifamily and investor commercial real estate loans. These factors contribute to our expectation of low loan loss content within the portfolio. Slide 19 shows our credit metrics that are trending in the right direction with declines in non-performing assets, lower criticized and classified assets, and increases in the non-performing loan coverage ratio. Our allowance for credit losses is presented by a 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 loan ratio decreased two basis points to 56 basis points during the quarter. Despite the significant charge off this quarter, we remain very comfortable with our credit risk profile. Our capital position is shown on slide 20. Book value and tangible book value per share increased year over year. We took advantage of the stock price trading below tangible book value to repurchase approximately 160,000 shares during the quarter. The tangible capital equity ratio decreased nine base points quarter over quarter to 7.73%. Our regulatory capital ratios are strong. Overall, we view our capital base as a strength and a vital component of our conservative balance sheet. Before turning over to John, let me provide some color on our revised outlook. As a reminder, we do not provide guidance, so this discussion is meant to provide a high-level perspective on performance in the current environment. We expect loan growth to remain challenging given the high rate environment and our increased emphasis on risk-adjusted returns. While we have a liability-sensitive balance sheet, we are taking more actions to shift the portfolio towards neutral. As John mentioned, we achieved approximately 40% of this goal during the first quarter. With that said, the NIM is likely to continue to compress as long as the Fed is raising rates. At this point, we expect the Fed to increase by 25 basis points in May. The core NIM in March was 2.17%, and with the lack of loan growth, there is no pressure to fund the balance sheet growth at high rates. Given these assumptions, we believe the amount of NIM compression going forward has the potential to be significantly lower than seen in prior quarters. Overall, the longer term, we expect the NIM will benefit from the contractual repricing of the loan portfolio. Last quarter, we mentioned that non-interest expense was expected to increase by low double-digit percentage points. Given the actions we have taken to improve the outlook, we are now expecting 2023 expenses to remain flattish versus 2022. As a reminder, we had $4.1 million of seasonal expenses in the first quarter that are not expected to repeat and a $1.7 million benefit related to employee retention tax credit refunds. Lastly, the effective tax rate should approximate 24 to 26% for 2023. I'll now turn it back over to you, John.