Flushing Financial - Q2 2023
July 26, 2023
Transcript
Operator (participant)
Welcome to the Flushing Financial Corporation second quarter 2023 earnings conference call. All participants will be in listen-only 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 one on your touchtone phone. To withdraw your question, please press star then two. Please note, this event is being recorded. I would now like to turn the conference over to Mr. John Buran, President and CEO. Please go ahead, sir.
John Buran (President and CEO)
Thank you, operator. Good morning, and thank you for joining us for our second quarter 2023 earnings call. Following my prepared remarks, Susan will review the financial trends, and we will then answer any questions. During the first quarter, the company instituted a six-step action plan to enhance the resilience of our business model and strengthen our financial performance. We executed this plan well during the second quarter and are pleased with the progress we have made so far on key points. First, to move more towards interest rate neutral, we added more than $400 million of asset swaps. Additionally, $250 million of funding swaps became effective during the quarter. We're also increasing the percentage of back-to-back swap loans. These loans are over 35% of our loan pipeline, and total floating rate loans are approximately 50%.
These actions significantly reduced our interest rate sensitivity position while providing additional income. Second, we increased our focus on risk-adjusted returns and overall profitability. As a result, yields on the loan pipeline rose 20 basis points, and yields on loan closings increased 13 basis points. In addition, our loan pipeline increased 56% quarter-over-quarter. While it will take time for new and repriced loans to have a significant impact on overall loan yields, we are encouraged by the results so far. Third, we're looking to expand our client base and build loyalty by emphasizing our excellent brand of customer service and deep community relationships. Late in the quarter, we hired a team of commercial real estate lenders with considerable experience and robust client rosters. We also continue to see high single-digit growth in checking account openings and robust CD growth.
Fourth, we reviewed new and existing relationships, resulting in improved credit metrics and normalized net charge-offs. We also added further layers of analysis to our review process for any future deals. This review and actions reinforced our comfort with the low-risk profile of our loan portfolio. Fifth, we are preserving strong liquidity and capital. We are looking for ways to expand our liquidity sources despite having available liquidity of nearly $4 billion. Average deposits increased both year-over-year and quarter-over-quarter. Capital ratios were also stable during the quarter. Sixth, we are tightening our expense controls by placing greater scrutiny on operating and discretionary expenses. In a period of high inflation, second quarter 23 core expenses are down approximately 1% year-over-year. Overall, we expect these decisive actions to result in an improved financial profile over time.
These actions, along with our strong liquidity, will also allow us to continue our long history of dividend payments into the future. In addition to our action plan, slide four outlines our four areas of focus for long-term success. First, interest rate risk is a priority. The actions we have taken have resulted in a 64% reduction in this risk over the past year. This is important given the outlook on rates. Second, we are focused on maintaining our credit quality. Our loan portfolio 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 36%. The current debt service coverage ratio is 1.8x for our multifamily and investor commercial real estate portfolios. The third area of focus is liquidity, which I touched on in a previous slide.
We have significant liquidity and are looking to fully utilize our balance sheet to add more. The last area of focus is customer experience. Central to our ability to deliver exceptional services is our ties to our local communities. About a third of our branches are in Asian markets, and we continue to implement community engagement initiatives and grow our presence in these areas to build on our loyal customer base. We also continue to enhance our digital banking solutions, which create a more convenient experience and allows us to engage with customers more seamlessly. We're confident that these four areas of focus will position the company to achieve long-term success. Slide five represents our liquidity profile. We have approximately $3.7 billion of available liquidity from a variety of sources, including the Federal Home Loan Bank of New York, other commercial banks, cash on hand, and free securities.
Today, our available liquidity is 44% of assets. We're working to expand borrowing capacity from existing relationships by pledging several types of collateral. As a result, we have a high degree of comfort in the stability of funding and available liquidity. Our loan portfolio is outlined on slide six. We have structured our real estate loan portfolio to ensure stability with multifamily and investor commercial real estate comprising 66% of the total portfolio. Manhattan office buildings are approximately 0.6% 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 the loan portfolio. Slide seven provides the detail on our Asian markets. Once the Bensonhurst branch in Brooklyn opens later this year, a third of our branches will be in predominantly Asian markets.
We have $1.2 billion of deposits and $764 million of loans in Asian markets. These deposits are 18% of our total deposits, and we have only a 3% share of market, so there's substantial room for growth. Our approach to this market is supported by our multilingual staff, our Asian Advisory Board, and our support of cultural activities. This market, which has total deposits of $36 billion, continues to be an important opportunity for us. Slide eight depicts the growth of our digital banking platforms. We continue to see high growth rates in monthly mobile deposit users with active online banking status, and digital banking enrollment. The Numerated, which digitally originates smaller dollar loans as quickly as 48 hours, continues to grow.
We originated approximately $10 million of commitments in the first half of the year, which have an average rate greater than the overall loan portfolio yield. We continue to explore other fintech product offerings and partnerships to further enhance our digital banking platform and customer experience. The second quarter had several notable events to highlight, as you can see on slide nine. As pictured, we hosted a ribbon cutting ceremony at our Hauppauge branch, which opened late in the first quarter in a vibrant industrial park. Community involvement is what separates us from other banks. Here's a sample of the events we participated in during the quarter. Participating in these types of initiatives builds on our already strong ties with our local communities and drives customer loyalty. I'll now turn it over to Susan to provide more detail on our key financial metrics. Susan?
Susan Cullen (Senior EVP and CFO)
Thank you, John. I'll begin on slide 10. The company reported second quarter 2023 GAAP earnings per share of $0.29 and core earnings per share of $0.26. The quarterly results were significantly improved compared to the first quarter. Average total deposits increased 7% year-over-year and 1% during the quarter. We continue to grow our CD portfolio, which is now 30% of average deposits. The cost of deposits totaled 2.68%, while the cost of funds was 2.8%. As expected, loan growth is muted, increasing only 1% year-over-year. The loan pipeline increased 56% quarter-over-quarter, with pipeline yields and core loan yields also expanding. Non-Performing Assets declined 6% during the quarter, reflecting our conservatively underwritten loan portfolio.
Overall, the second quarter results were an improvement versus the first as we continue to adjust to the higher rate environment. Slide 11 depicts our deposit portfolio. Despite the Fed raising rates and industry deposits declining, our average deposits have increased 7% year-over-year and 1% quarter-over-quarter. The growth is driven by the 150% year-over-year and 22% quarter-over-quarter increase in CDs, which lengthen the duration of our liabilities, thus reducing our liability sensitivity. Growing non-interest-bearing deposits is challenging in this high rate environment, but remains a focus. Average non-interest-bearing deposits declined both quarter-over-quarter and year-over-year, though checking account openings increased 10% year-over-year. Our loan to deposit ratio has improved 102% from 105% a year ago.
As a reminder, we generally have seasonality in certain segments of our deposit base, and the summer months balances are generally lower than the remainder of the year. Slide 12 outlines our loan portfolio and yields. Net loans increased 1% year-over-year, but were down 1% quarter-over-quarter. Loan closings also declined year-over-year and quarter-over-quarter as customers adapt to the increased rate environment, but the yield on the closings was over 7% for the second consecutive quarter. Core loan yields increased 19 basis points during the quarter, and for the third consecutive quarter, yields on the loan closings exceeded the yields on the satisfactions at an accelerating pace.
Prepayment and penalty income declined to $278,000 in the quarter from $2.3 million a year ago, and $610,000 in the prior quarter. The loan pipeline increased 56% quarter-over-quarter, with over 35% of the pipeline consisting of attractive back-to-back swap loans and approximately 50% are floating rate loans. Slide 13 provides more detail on the contractual repricing of the loan portfolio. Approximately $1.1 billion or 16% reprices with each Fed move. During the quarter, we added $400 million of interest rate hedges on loans, which effectively increases the amount of loans that will reprice with every Fed move to $1.5 billion, or over 21% of the loan portfolio.
For the remainder of 2023, another $458 million is due to reprice at a rate of 210 basis points higher than the current yield. In 2024 and 2025, about $1.5 billion of loans will reprice 220 to 230 basis points higher. These values are based on the underlying index value at June 30th, 2023, and do not consider any future rate moves. This repricing should drive net interest margin expansion once funding costs stabilize. Slide 14 outlines the net interest income and margin trends. The GAAP net interest margin declined only nine basis points to 2.18% during the second quarter. This is the lowest amount of compression over the past four quarters and is consistent with the NIM for the month of March.
We expect the NIM will remain under pressure as long as the Fed raises rates, but the pressure should be more manageable based on the current forecasted rate hikes through the remainder of the year. After a lag, we expect the NIM would begin to expand as the pressure on funding costs ease and loans continue to reprice higher. Turning to slide 15, as John mentioned, one of our goals for 2023 is to significantly move more towards interest rate neutral. The goal for the balance sheet is to better match the duration of our assets, which is three to four years, more closely to the duration of our funding, which is about one to two years. We have made considerable progress over the past year. For an immediate rise of 100 basis points in rates, our net interest income would decline by 3%.
A year ago, this impact was a 9% decline or almost a two-thirds improvement. The addition of interest rate hedges and more floating rate assets is key drivers of the reduced sensitivity. The interest rate hedges are particularly important as they provide immediate income in addition to moving the balance sheet more towards neutral. Bottom line, we executed well on this strategy and expect to continue to improve in this area. Slide 16 provides more detail on our CDs. Total CDs are about $2 billion, or a third of the total deposits at June 30, 2023. CDs helped to lengthen the duration of our funding to match the duration of our assets more closely. Excluding CDs with interest rate hedges, about 60% of our CD portfolio will reprice higher over the next year. We expect to retain a high percentage of our CDs.
Our current CD rates range from 4.5%-5.25%. All else equal, we expect the CD repricing to pressure our net interest margin. Our net charge-off history is on slide 17. As you can see, we have a long history of solid asset quality because of our low risk credit profile and conservative underwriting. Net charge-offs of nine basis points returned to normalized levels this quarter. We expect minimal losses in the loan portfolio if there's an economic downturn, given the large percentage of our loan portfolio is secured by real estate with a low average loan to value.
Additionally, the weighted average debt service coverage is 1.8x in the multifamily and investor real estate portfolios, and 1.2x in a stress scenario consisting of a 200 basis point increase in the rate and a 10% increase in operating expenses. These factors contribute to our expectation of minimal loss content within the loan portfolio. Slide 18 shows our credit metrics trending in the right direction, with declines in NPAs and an increase in the non-performing loan coverage ratio. Criticized and classified assets decreased during the quarter to a low 71 basis points. Historically, these levels have been significantly below our peers. Our allowance for credit losses is presented by 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 loans ratio increased to 57 basis points during the quarter. We remain very comfortable with our credit risk profile. Our capital position is shown on slide 19. Book value and tangible book value per share increased year-over-year. We repurchased nearly 530,000 shares at an average price of $12.94, which is a 43% discount to our tangible book value. The tangible common equity ratio was stable at 7.71%. Our regulatory capital ratios are strong. Overall, we view our capital base as a strength and a vital component of our conservative balance sheet. Slide 20 provides our outlook. We do not provide guidance. This discussion is meant to give our high level perspective on performance in the current environment.
Despite the robust increase in the loan pipeline, we expect loan growth to remain challenging. However, the higher percentage of back-to-back swap loans in the pipeline will add more floating rate assets to our balance sheet, and these assets have rates at 7% or higher. As a reminder, certain deposits are seasonally lower in the summer months before increasing by year-end. There are several factors that will affect the net interest margin. First is the pressure from the Fed raising rates and the natural shift in the deposit mix. Second is the size and growth of the loan portfolio. Third is the repricing of both CDs and certain loans. Fourth, our interest rate hedges were favorable in the second quarter, and an increase in rates by the Fed will benefit this portfolio.
Overall, we expect net interest margin pressure as the Fed increases rates, but all else equal, the pressure should be lower than what was experienced in the second half of 2022 and the first quarter of 2023. The core net interest margin was 2.19% for the month of June. Non-interest income should benefit from the back-to-back swap loan closings. Non-interest expenses were well controlled in the second quarter, and extra scrutiny is placed on all expenses. We expect the operating expenses to follow normal seasonal patterns. Lastly, the effective tax rate should approximate 26%-28% for 2023. I will now turn it back over to John.
John Buran (President and CEO)
Thank you, Susan. On slide 21, I'll wrap up with our key takeaways. We continue to execute our action plan, which is improving our profitability in the short and medium term and establishing a foundation for long-term success. We're happy with the limited NIM compression for the quarter and have significantly improved our sensitivity to higher rates. Our asset quality and liquidity are conservative and sound. We continue to serve our clients and deepen relationships. Our overall financial metrics improved during the quarter. We're remaining cautious given the environment. The decisive actions we are taking to improve the overall performance will allow us to continue our long and consistent record of dividend payments. Operator, I'll turn it over to you to open up the lines for questions.
Operator (participant)
Thank you. We will now begin the question-and-answer session. To ask a question, you may press star then one on your touch-tone phone. If you're using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press star then two. At this time, we'll pause momentarily to assemble our roster. The first question comes from Mark Fitzgibbon with Piper Sandler. Please go ahead, sir.
Mark Fitzgibbon (Managing Director and Head of FSG Research)
Hey, guys. Good morning.
Susan Cullen (Senior EVP and CFO)
Morning, Mark.
John Buran (President and CEO)
Hello, Mark.
Mark Fitzgibbon (Managing Director and Head of FSG Research)
Hey, Susan, just to clarify, one of your comments about the margin. You sort of talked about the pressure being more manageable than what we saw in the second half of 2022 and the first quarter of 2023. Should we take that to mean that the margin you think will be down this quarter, something in the neighborhood of what we saw in the second quarter, assuming the Fed raises rates 25 basis points later today?
Susan Cullen (Senior EVP and CFO)
You know, given where the Fed is in their rate raising cycle, that's a primary driver of that comment. I would expect, you know, some co- compression, probably closer to what we've seen in the second quarter than what we had seen in the previous three quarters.
Mark Fitzgibbon (Managing Director and Head of FSG Research)
Okay, great. Secondly, I wondered if you could share with us, what iGO balances were at the end of the quarter?
Susan Cullen (Senior EVP and CFO)
Uh, about-
John Buran (President and CEO)
There's around $200 million.
Mark Fitzgibbon (Managing Director and Head of FSG Research)
$200 million. Okay, great. John, I wondered if you had any targets for either Tangible Common Equity or CET1 going forward?
John Buran (President and CEO)
Well, I think we wanna stay close to that 8% range. Obviously, we're not there at this point in time, but we're very cognizant of the importance there. I think that, you know, the Fed stopping its its rise in interest rates could help us a little bit there in terms of the securities portfolio valuations. You know, we're comfortable where we are right now for the present. I think we'd like to move it up a little bit more.
Mark Fitzgibbon (Managing Director and Head of FSG Research)
Okay. I know I saw that you had hired a team from Signature Bank. I guess I was curious, roughly how large was their book of business and maybe how long you think it takes for them to be able to bring that, you know, over to Flushing?
John Buran (President and CEO)
We're really not disclosing that, but it's a group that has a significant basis, for their success in the past.
Mark Fitzgibbon (Managing Director and Head of FSG Research)
Okay. Last question. I wonder if you could share with us the 30-89 day delinquencies. I know they come out in the cube, but if you had those handy, that would be great.
Susan Cullen (Senior EVP and CFO)
They're down significantly from where they were in the prior period.
Mark Fitzgibbon (Managing Director and Head of FSG Research)
Okay, thank you.
Susan Cullen (Senior EVP and CFO)
I don't have them right at my fingertips.
Mark Fitzgibbon (Managing Director and Head of FSG Research)
Thank you.
Susan Cullen (Senior EVP and CFO)
Thank you, Mark.
Operator (participant)
Our next question comes from Chris O'Connell with KBW. Please go ahead, sir.
Chris O'Connell (Director of Equity Research)
Hi, yeah, just to follow up on the on the margin discussion. Do you have the spot NIM for June?
Susan Cullen (Senior EVP and CFO)
Yeah, June was 219. Good morning, Chris.
Chris O'Connell (Director of Equity Research)
Morning. Okay, great. As far as the hedges that were put on this quarter, what was the timing?
Susan Cullen (Senior EVP and CFO)
What do you mean?
Chris O'Connell (Director of Equity Research)
Of when they were put on the quarter?
Susan Cullen (Senior EVP and CFO)
Are you looking for the duration or, which month they were put on? You know, what do you mean by the timing?
Chris O'Connell (Director of Equity Research)
Yeah. Yeah. well, I believe last quarter the hedges were put on pretty late in the quarter, the impact-.
John Buran (President and CEO)
Well, here again, they're put on pretty late. They were put on in May, predominantly.
Chris O'Connell (Director of Equity Research)
Okay. Do you have the duration?
John Buran (President and CEO)
Beginning, middle to the end of May.
Chris O'Connell (Director of Equity Research)
Okay. Do you have the duration?
Susan Cullen (Senior EVP and CFO)
They're primarily five years. 3.5-5.
Chris O'Connell (Director of Equity Research)
Great. Do you have the rate as well?
Susan Cullen (Senior EVP and CFO)
I think if you look at the presentation.
Chris O'Connell (Director of Equity Research)
Okay.
Susan Cullen (Senior EVP and CFO)
We have, you know, we have those all the swaps all broken out in there. Chris, on, I'm flipping through the presentation because I know it's in here. Oh, we don't. Look at, like, page 15 or so. That has a lot of the information on the swaps that you may be looking for.
Chris O'Connell (Director of Equity Research)
Okay, thanks. On the credit side, can you just provide any color around the, like, $1.7 million, I think, or so, of C&I net charge-offs this quarter?
Susan Cullen (Senior EVP and CFO)
It was one relationship that had been downgraded, and, you know, we've been watching very carefully over the last, you know, six to nine months. You know, additional information became available that made us realize that, you know, the collectibility was questionable, and we charged it off.
Chris O'Connell (Director of Equity Research)
Okay, got it. Is that fully charged off?
Susan Cullen (Senior EVP and CFO)
Yes.
Chris O'Connell (Director of Equity Research)
Great. I noticed, I think, the Manhattan office exposure increased to 0.6% of loans from 0.1% last quarter, which is.
John Buran (President and CEO)
The differential is, the number we had been quoting in the past was Midtown Manhattan office, which is that 1/10 of a percent. You know, we've expanded it to include really all of Manhattan, so that's what the larger number is.
Chris O'Connell (Director of Equity Research)
All right. Got it. That makes sense. for the, office-
John Buran (President and CEO)
We're not doing it. We're not doing office space, just for the record.
Chris O'Connell (Director of Equity Research)
I figured. Yeah, that's why it struck my eye. As far as the office exposure, I know it's pretty low. I think ballpark, $150 million or so. Was just wondering if you had, like, the maturity schedule, how much is coming due, say, over the next, you know, 12-18 months, and if you have, you know, a specific reserve number against it?
John Buran (President and CEO)
I don't think we have a reserve against any of it at this time.
Susan Cullen (Senior EVP and CFO)
Not any additional reserve other than what we have against the CRE portfolio, in total. You know, we know when these loans will be repricing, et cetera, but that's not information we're sharing at this time. They all have a nice debt coverage ratio and are, have low LTVs.
John Buran (President and CEO)
There's nothing unusual about the structure. It's typical, our typical five year.
Susan Cullen (Senior EVP and CFO)
Right. They also have very strong sponsors behind these buildings.
Chris O'Connell (Director of Equity Research)
Great. It sounds like based on the loan pipeline, you know, that the, you know, it with all the, you know, swaps in the pipeline, that, you know, banking, you know, service fees, you know, could remain strong year after the pickup quarter-over-quarter, this quarter. Would you expect it to kind of remain in a similar range that where you saw in 2Q or could it move up a little bit more, or was 2Q particularly strong?
Susan Cullen (Senior EVP and CFO)
I think if you're looking at our core, that we would expect them to go up. Obviously, our GAAP non-interest income has the fluctuations for the market valuations included in there. We would expect our core fees to increase with the number of swaps deals we've been transacting.
Chris O'Connell (Director of Equity Research)
Okay, great. Great. I mean, you know, based on what you were discussing on, you know, the TC target, you know, and relatively low balance sheet growth here, and where the stock's trading, I mean, how are you thinking about buyback utilization going forward?
Susan Cullen (Senior EVP and CFO)
Our capital planning has not changed at all, Chris. We still think the best thing to do with our excess capital is to redeploy it into the business to grow, followed by, you know, returning to shareholders through the form of dividends and finally share repurchases. you know, we always take, look at it and opportunistically take a look at the market and see if that's the best place to deploy our capital. Again, growing the business is the first priority with capital.
Chris O'Connell (Director of Equity Research)
Got it. Just, you know, taking a step back and kind of thinking about things more strategically, I mean, obviously this quarter, you know, you had good coverage. You know, but if NIM is, you know, down similar to Q2 levels, you know, things become a little tighter, it seems like in the back half of the year. I mean, how are you guys thinking about, you know, dividend coverage going forward? You know, just, you know, strategically, you know, what are the decision-making factors kind of around that?
John Buran (President and CEO)
We don't see any reason to change our dividend, our dividend policy at this point in time.
Chris O'Connell (Director of Equity Research)
Okay, got it. That's all I had for now. Thank you.
Susan Cullen (Senior EVP and CFO)
Thanks, Chris.
John Buran (President and CEO)
Thanks, Chris.
Operator (participant)
Our next question comes from Manuel Navas with D.A. Davidson. Please go ahead, sir.
Manuel Navas (Senior Research Analyst and Managing Director)
Hey, good morning. Most of my questions have been answered.
Susan Cullen (Senior EVP and CFO)
Good morning.
Manuel Navas (Senior Research Analyst and Managing Director)
Most of my questions have been answered, but just kind of, can you remind me the expected size of deposit seasonality? Is it just gonna follow past year trends?
John Buran (President and CEO)
The typical trend, is a downturn in seasonal balances in the summer months, anywhere from $150 million-$200 million. Then as we approach the fall, that starts to increase.
Susan Cullen (Senior EVP and CFO)
Rebound.
John Buran (President and CEO)
That starts to rebound. Thank you.
Manuel Navas (Senior Research Analyst and Managing Director)
What are your kind of current offers on the deposit side in the market?
Susan Cullen (Senior EVP and CFO)
Our CD offerings are about 4.5%-5.25%.
Manuel Navas (Senior Research Analyst and Managing Director)
Okay. You're still seeing solid flows on your offers?
Susan Cullen (Senior EVP and CFO)
Yes.
Manuel Navas (Senior Research Analyst and Managing Director)
I guess you talked about the CRE team. What's kind of the pipeline going forward and kind of what are the opportunities you're seeing, in marketplace for talent?
John Buran (President and CEO)
We're always on the outlook. I think that there's from what we understand, there may be some situations with respect to payments to individuals that may be coming to an end, that may present an opportunity for additional staff to come our way.
Manuel Navas (Senior Research Analyst and Managing Director)
Okay. I appreciate the comments. Thank you.
Susan Cullen (Senior EVP and CFO)
Well, Manuel, I just want to emphasize that this team also is deposit gatherers. They're not just loan gatherers. I think that's an important distinction.
Manuel Navas (Senior Research Analyst and Managing Director)
Okay. I appreciate that.
Susan Cullen (Senior EVP and CFO)
Thank you.
Operator (participant)
Ladies and gentlemen, if you have a question, please press star then one. Further questions, this concludes our question-and-answer session. I would like to turn the conference back over to John Buran for any closing remarks.
John Buran (President and CEO)
Well, thank you, everybody, for joining us today on our second quarter 2023 earnings call. We appreciate your continued support of Flushing Financial and look forward to talking to you again next quarter. Thank you very much.
Susan Cullen (Senior EVP and CFO)
Thank you.
Operator (participant)
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.