Flushing Financial Corporation (NASDAQ:FFIC) Q2 2024 Results Conference Call July 30, 2024 9:00 AM ET
Company Participants
John Buran - President and CEO
Susan Cullen - Senior EVP, CFO and Treasurer
Conference Call Participants
Steve Moss - Raymond James
Mark Fitzgibbon - Piper Sandler
Manuel Navas - D. A. Davidson
Chris O'Connell - KBW
Operator
Welcome to Flushing Financial Corporation's Second Quarter 2024 Earnings Conference Call. Hosting the call today are John Buran, President and Chief Executive Officer; and Susan Cullen, Senior Executive Vice President, Chief Financial Officer and Treasurer [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 Web site 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 and 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 a reconciliation to GAAP, please refer to the earnings release and/or the presentation. I would now like to introduce John Buran, President and Chief Executive Officer, who will provide an overview of the strategy and results. Please go ahead.
John Buran
Thank you, operator. Good morning. And thank you for joining us for our second quarter 2024 earnings call. The operating environment in the second quarter was highlighted by similar themes that have impacted the industry and our markets for the past couple of quarters. Changing expectations on Fed rate moves, weak but marginally improving loan demand and aggressive deposit pricing by one of our largest competitors that is dealing with business model and personnel changes. Against this backdrop, the company reported second quarter 2024 EPS of $0.18. It remains a challenging rate environment but I'll provide an update on the progress we've made on our four areas of focus. The first objective is to increase the NIM and reduce its volatility. Net interest income increased about 1% quarter-over-quarter despite NIM compressing 1 basis point. We’re implementing several strategies to help the NIM in future periods and I believe it is close to a bottom. Susan will provide further details but the NIM should begin to expand once funding costs stabilize. The second objective is to maintain our credit discipline. Flushing Bank has a long history of low risk credit profile due to our conservative underwriting and strong portfolio management. Overall credit metrics remain solid with 61 basis points of non-performing assets, 113 basis points of criticized and classified loans and 1 basis point of net recoveries during the quarter.
Our loan portfolio remains well collateralized as the average LTV in the real estate portfolio is less than 36% and the debt coverage ratios are 1.8 times for our multifamily and investor commercial real estate portfolios. Our exposure to Manhattan office buildings is about 50 basis points of gross loans. There are zero non-performing office loans and zero non-performing non-residential commercial real estate loans. Our third objective is to preserve our strong liquidity and capital. Our available liquidity was $3.1 billion as of June 30th and our level of uninsured and uncollateralized deposits remains low. Our capital ratios remain solid. The fourth objective is to bend the expense curve. The market provided an opportunity to add banking professionals in new branches so we made a strategic decision to invest in the franchise. This drove non-interest expense growth for the first half of 2024 compared to the same period in 2023 to about 6%. We expect overall expense growth in 2024 to be in line with our historical averages of mid-single digits. Overall, we're navigating the environment from building a foundation to achieve our long term goals and improve overall profitability.
Slide 4 demonstrates Flushing's credit performance versus the industry. Our underwriting has outperformed over time often by a wide margin. Our conservative credit culture has been proven in many rate and economic cycles and our commitment to our low risk credit profile is unwavering. Our charge-off history is shown in the chart on the left. We expect our net charge offs to remain well below industry levels. For the first half of 2024, we had net recoveries of $88,000. Our level of non-current loans to total loans is also favorable compared to the industry. In a stress scenario, consisting of a 200 basis point increase in rates and a 10% increase in operating expenses, our loan portfolio has a debt coverage ratio of 1.3 times. Given this, we're expecting minimal loss content within the portfolio. Slide 5 depicts additional credit metrics that support our conservative risk culture. Non-performing assets to assets totaled 61 basis points with LTVs of low 44%. Our level of criticized and classified assets remain solid and we expect them to continue to be below peer levels again for the quarter. 30 to 89 day past dues are only 35 basis points of loans indicating a low level of potential future problems. Our allowance for credit losses is presented by loan segment in the bottom right chart and the ratio to overall loans increased 1 basis point to 61 basis points quarter-over-quarter. These items altogether keep us very confident of our low risk credit profile.
Slide 6 outlines some key credit metrics at a more granular level. Our multifamily portfolio comprises 39% of gross loans and has strong credit metrics like a weighted average LTV of 44% and a weighted average debt coverage ratio of 1.8 times. Non-performing loans in this portfolio are only 52 basis points in criticized and classified loans or only 67 basis points of loans. The average loan size is $1.2 million in this $2.6 billion portfolio. Investor commercial real estate loans totaled 28% of gross loans and have similar credit metrics as our multifamily loans with no non-performing loans. Only 36 basis points of criticized and classified loans and an average loan size of $2.5 million. Our exposure to office loans is small at less than 4% and Manhattan office building exposure is about 50 basis points to gross loans. There are zero non-performing loans in the office portfolio and the debt coverage ratio is 1.9 times. These metrics provide a clear representation of our conservative and strong credit culture that has and continues to perform well over time. Slide 7 provides further context on the risk in our multifamily portfolio and a comparison versus peers. As of March 31, 2024, our criticized and classified multifamily loans were only 54 basis points, the third best in the peer group. At the end of the second quarter, this ratio was 67 basis points. Multifamily reserves to criticized and classified multifamily loans were 75%, which is the fourth best in the peer group in the first quarter and 61% in the second quarter. 30 to 89 day past dues in our multifamily portfolio were only 21 basis points. With these credit metrics, we see limited risk and loss content on the horizon. I'll now turn it over to Susan to provide more detail on our other financial metrics. Susan?
Susan Cullen
Thank you, John. I'll begin on Slide 8, which provides more detail on our deposits. Average deposits increased 4% year-over-year and 2% quarter-over-quarter. The growth in deposits came from both retail and broker CDs as we utilized them to fund approximately $300 million in the growth of floating rate securities for the quarter and to replace anticipated normal flows of the government deposit portfolio. We expect those latter deposits to return in the fall. Average non-interest bearing deposits were 11% of total average deposits compared to 12% a year ago. Our loan to deposit ratio has improved to 98% from 102% a year ago. The cost of deposits increased 11 basis points in the quarter compared to 17 basis points in the first quarter and 16 basis points in the fourth quarter of 2023. Slide 9 outlines the net interest income and margin trends. The GAAP and core net interest margin comprised 1 and 3 basis points respectively to 2.05% and 2.03%. Absent episodic items, the NIM increased 1 basis point quarter-over-quarter. Our net interest margin is partially reflective of the spread between the one month SOFR relative to the five year Federal Home Loan Bank advance rate, which at the end of June was a negative 82 basis points. Once the spread begins to turn positive, our NIM should improve over time. We expect our NIM is near bottom absent any changes in interest rates. The bottom will largely be determined by stabilization of the cost of funds, which will then allow the natural repricing of our loan portfolio to drive NIM expansion. With a parallel shift in today's inverted yield curve by 100 basis points, our model indicates a roughly 1% benefit to net interest income. On the other hand, a steepening of the yield curve by 100 basis points with the short end declining and the long end remaining stable should benefit net interest income by greater than $15 million over time.
Slide 10 provides more detail on our CD portfolio. Total CDs are over $2 billion or 35% of total deposits at quarter’s end. It is the growth in repricing of CDs which will drive the direction and magnitude of cost of deposits. About $1.4 billion of retail CDs are expected to mature over the next three quarters at a weighted average rate of 4.86%, which compares to current APYs of [4.85 to 5.40]. We expect the cost of deposits will increase at a slower pace in third quarter compared to the second quarter. Slide 11 provides more detail on the contractual repricing of the loan portfolio. Approximately $1.2 billion or 18% of gross loans are repriced to a short term index. Our interest rate hedge position increases as a percentage to 26%. For the remainder of 2024 $383 million of loans are due to reprice 242 basis points higher than the current coupon rate. In 2025, approximately $765 million of loans are scheduled to reprice 226 basis points higher. These rates are based on underlying index value at June 30, 2024. It is this loan pricing that should drive net interest margin expansion once funding costs stabilize or decline. Turning to Slide 12, which outlines our interest rate hedging portfolio. This portfolio totaled to $1.7 billion and underlying financial instruments are investment securities, loans and funding. These hedges have a positive impact in asset and funding yields and are additive to the net interest margin. There are no maturities in 2024 with 22% of the portfolio maturing in 2025. As mentioned previously, if the curve steepens with the Fed reducing short term rates, our net interest margin should benefit over time.
Our capital position is shown on Slide 13. Book value and tangible book value per share was stable year-over-year and quarter-over-quarter. The leverage ratio was over 8% while the tangible common equity ratio remains about 7%. Overall, we view our capital base as a source of strength and a vital component of our conservative balance sheet. Slide 14 provides detail on our Asian markets, which account for a third of our branches. We have over $1.3 billion of deposits and $746 million of loans in these markets. These deposits are 18% of total deposits and while we have only 3% market share of this $41 billion market implying there's substantial room for growth. Our approach to this market is supported by our multilingual staff, our Asian Advisory Board and support of cultural activities through participation and corporate sponsorships. We look forward to participating in the Dragon Boat Festival this coming weekend, which is attended by thousands of people in Flushing Meadow Park. This market with its dense population and a high number of small businesses continues to be an important opportunity for us and one that we believe will drive our success moving forward.
On Slide 15, you can see community involvement is a key part of our strategy beyond just our Asian franchise. During the second quarter, we participated in numerous local events to strengthen our ties to our customer base. Participating in these types of initiatives have served us as a great way to further integrate ourselves within our local communities while driving customer loyalty. Slide 16 provides a high level perspective on performance in the current environment. We continue to expect stable loan balances and a continued emphasis on improving the funding mix. The net interest margin is expected to be close to bottom but influenced by the mix of the assets and liabilities, the shape of the yield curve and pricing of financial instruments. The increase in loan pipeline should help increase asset yields while the cost of funding rises at a slower pace than previous quarters. When the cost of funds stabilize, our net interest margin should bottom out and then start to increase. Non-interest income should be aided by the closing of back to back swap loans that are in the pipeline. As John mentioned previously, we have made the strategic decision to invest in the business by adding people and branches. Core non-interest expense is expected to increase mid single digits in 2024. While the quarterly tax rates can fluctuate, we expect the mid-20s effective rate for 2024. I'll now turn it back over to you, John.
John Buran
Thank you, Susan. On Slide 17, I will conclude with our key takeaways. Our near term priorities remain on our four areas of focus to help build a strong foundation for improved long term profitability. The net interest margin is nearing the bottom and should begin to expand. There's no change in our credit discipline or our low risk credit profile. Capital and liquidity are strong. We are mindful of expenses but we'll continue to invest in the franchise to improve the long term profitability and value. While the rate environment remains challenging, we're controlling what we can control and setting the foundation for a better future. Operator, I'll turn it over to you to open the lines for questions.
Question-and-Answer Session
Operator
[Operator Instructions] Today's first question comes from Steve Moss at Raymond James.
Steve Moss
Maybe just starting off with the loan pipeline here, John, pretty big increase quarter-over-quarter, and wondering just give some color about the drivers you're seeing there?
John Buran
Basically what's occurring is that the market appears to be opening up somewhat. We are maintaining our disciplined focus with respect to credit perspective and also with respect to rates. But it just appears that we've just seen some opening up of the market. I think borrowers maybe are waiting a little -- or are getting a little bit tired of waiting on the sidelines. And also we've seen some activity in doing back to back swaps. The rate environment got a little bit better for that and I think that has generated some additional interest as well.
Steve Moss
And just curious is it more C&I versus CRE, just kind of curious about that mix there?
John Buran
More C&I than what we've historically been doing.
Steve Moss
And then in terms of the multifamily non-performers this quarter, just curious what color you can give around what caused those issues and how you're thinking about resolution there?
John Buran
So we're pretty confident that there's very low loss content here. One of the items, it's $9 million for loans. One of the items is a loan that's gone past maturity and we're working on the extension now. And then the largest of the loans has a 21% loan to value. So we're very confident there as well.
Susan Cullen
And that just went dark for a while. So we're getting our -- we'll be collecting our default interest on that given loan to value on that property.
John Buran
Default interest by the way is 24%…
Steve Moss
And then in terms of just the multifamily loans that are coming up for renewal and resetting at a higher rate here. Just kind of curious, what's kind of the blended debt service coverage ratio? I know you guys have a 1.3 example in the deck. Is that kind of basically reflective of the entire pool that's repricing in the quarter?
John Buran
Yes, that's the entire portfolio that's repricing, it's 1.3.
Steve Moss
And just one last one from me. I noticed that investment securities were up meaningfully this quarter. Just kind of curious what types of securities you bought and the coupon there?
Susan Cullen
We've purchased adjustable rate mortgage backed and CLOs that have average rate of a little over 6.5% right now, closer to 6.75%
Operator
And our next question today comes from Mark Fitzgibbon with Piper Sandler.
Mark Fitzgibbon
I guess I was curious, how much in multifamily in CRE loans do you have maturing in the second half of '24? And maybe if you could give us a sense for what the average rate on those looks like?
Susan Cullen
So it's about $350 million and they'd be priced upwards of 200 basis points, it's about [$383 million].
Mark Fitzgibbon
So you think they'll reprice -- the commercial real estate multifamily up about 200 basis points on average?
Susan Cullen
Yes, looking at Slide 11 of our deck Mark, if you want complete color, it's about 242 basis points using the June 30th five year Federal Home Loan Bank rate.
Mark Fitzgibbon
And Susan, can you give us a sense for what you think each 25 basis point rate cut would do to your net interest margin, what kind of impact roughly that would have?
Susan Cullen
I think, we've said in the past that if we reprice everything immediately it would be about $1 million.
Mark Fitzgibbon
For each 25 basis points?
Susan Cullen
For each 25 basis points.
Mark Fitzgibbon
That would be over time though, right, that's not an immediate $1 million impact that would be when the whole book reprice?
Susan Cullen
Right, it would be over time and assuming that we were able to -- there's no lag on cutting the cost on the liabilities.
Mark Fitzgibbon
And then on -- I guess, I was curious why grow the securities portfolio almost $400 million if your pipelines are so strong, why not sort of wait and book loans at better spreads?
John Buran
Well, we decided to -- when we started that process of purchasing securities, the loan pipeline was just beginning to grow. So we're looking at the securities since they're floating rate securities as being a potential source of liquidity going forward as the loan pipeline begins to close. There's a fair amount of uncertainty about closing of loans even though the pipeline is up roughly 88%. So there's been a little bit of a longer tail than what we've seen in the past.
Susan Cullen
We don't anticipate any [Indiscernible] growth, Mark. So as John said, those pipeline starts to close when they shed some of those securities.
Mark Fitzgibbon
And then last question sort of year-to-date the dividend payout ratio has been about 148%. At what point do you think about reducing the dividend?
John Buran
We're a well capitalized low risk business. We see ourselves closer to the end rather than the beginning of our earnings pressure given the natural repricing of loans and also let's say heightened potential for Fed easing. So our focus is going to be on working on the earnings and maintaining our strong commitment to return value to the shareholders.
Mark Fitzgibbon
Correct me if I'm wrong though, there's a regulatory requirement after a certain number of quarters and not earning the dividend where you're basically precluded from keeping it at that level. Is that -- could you remind us what that is?
John Buran
That's not correct. We're not precluded. There's open dialog and two way communication going on with the regulators on a regular basis and the criteria I'm sure are associated with our capitalization. The fact that we have enough cash at the holding company to allow us to pay a dividend without constricting bank capital at all. And once again, we see the situation has improved from where it was a number of quarters ago as earnings -- NIM is closer to a bottom.
Operator
And our next question today comes from Manuel Navas with D. A. Davidson.
Manuel Navas
Did you talk about the near term NIM outlook a little bit? I know there's a little better seasonality of deposits coming in, that pipeline is going to help on the loan growth side or at least replacing some loans with higher yields. Can you just talk through the near term NIM movements?
John Buran
I think in the near term, we may see a little bit more pressure before the actual turnaround but we're very close to a bottom. Clearly this particular quarter some of the increases in the funding costs were associated with some aggressive competition that was taking place from one of our major competitors. That may be in the background. And if that's the case, we'll continue to see better opportunities to reduce or -- maintain or reduce our funding costs. And that's really the major -- has been the major driver of the NIM compression for us. So again, we're close to a bottom and we're seeing the next few quarters as being able to actualize that and move forward with some NIM improvement. Incidentally, the NIM improvement with a reduction on the short end of the curve could yield us over time and 100 basis points drop on the short end of the curve over time can yield us as much as $15 million in net interest income.
Manuel Navas
Is that more weighted to the third and fourth cut? How should I think about the initial cuts with that benefit? Could you just talk through that a little bit?
John Buran
It's dependent upon the movement of the curve. So as the curve, let's say, flattens out if the Fed decides to reduce the short end or as it steepens, it's really the pitch of that curve is going to give us the greatest opportunity.
Manuel Navas
You talked about a little bit better maybe just activity in market on the loan growth side. Did you get a sense that a rate cut would even boost that further, does it depend on a rate cut? Just kind of thoughts on just kind of the origination side for loans.
John Buran
Clearly, there are borrowers on the sidelines due to the rate environment, which obviously any changes could be helpful. Although, if the longer end of the curve doesn't move, we may be in a similar situation as we are today. But there would be opportunities with respect to maybe shorter duration credits. For example, the C&I portfolio or three year rather than five year resets.
Operator
And our next question today comes from Chris O'Connell with KBW.
Chris O’Connell
So I was hoping you could start off with just on the securities investments from the quarter. Were those locked in against a certain rate on the borrowing side? And if so can you disclose what rate?
Susan Cullen
No, they were not locked in into anything particular.
Chris O’Connell
So just regular short term borrowings?
Susan Cullen
There are deposit growth and there are short term borrowings, but as we said they are floating rate securities.
Chris O’Connell
And what portion after last couple of quarters of investments is the total floating rate or adjustable rate portion of the securities portfolio?
Susan Cullen
About two thirds.
Chris O’Connell
And thinking about longer term strategy a little bit more broadly. One, do you guys -- can you guys say when your last regulatory exam was and whether the discussions with the regulators in the recent exam from the past couple has changed at all on the CRE concentration ratios? And just any color around that discussion with regulators relative to what it's been in the past given kind of the heightened industry concern more recently?
Susan Cullen
Chris, we continue to have conversations with our regulators, we don't necessarily disclose once we've had our exams and something came out of that as we said we filed 8-K. But our conversations around our CRE concentration have not changed much over the years even given this heightened environment.
Chris O’Connell
And is there a level of -- a target level either medium term or longer term that you guys want to get to on the kind of terminal mix for the loan portfolio?
Susan Cullen
The real estate will -- yes, we do want to bring in more C&I loans and bring the CRE concentration down. But as we talked about, we’ve moved $90 million out of the bank to the holding company late last year. So by natural attrition accretion of capital that ratio will come down. That being said, we do want to focus on the C&I business as we move forward, recognizing that real estate is still a really great asset and it's done very well for us. We have great credit metrics but the market's changed a little bit and we're going to adapt to that.
Chris O’Connell
And did you guys have what the June spot margin was?
Susan Cullen
There is some [Indiscernible] for the quarter.
Chris O’Connell
And thinking about the margin as we get further along into 2025 and if there's rate cuts occurring. And even if you don't have kind of the exact amount, but how much do you think that 25 basis points -- I think, it was about $1 million of annual NII changes as some of the swaps and hedges that are on if they were to roll off later in the year into 2025?
Susan Cullen
I think, it would benefit us because those are -- we have the funding tight though, so if we did need the funding we can let that go. The rate cuts will benefit, it will let those swaps roll off.
Chris O’Connell
But I mean it would improve that impact, correct [Technical Difficulty]…
Susan Cullen
Any more questions Chris?
Chris O’Connell
No, I was just saying as the hedges roll off, the impacts from a 25 basis point cut would improve?
Susan Cullen
Correct.
John Buran
Yes, that’s right.
Operator
And ladies and gentlemen, this concludes our question-and-answer session. I'd like to turn it back over to Mr. Buran for any closing remarks.
John Buran
Well, I thank you all for your attendance and your interest in Flushing Financial. And enjoy the rest of your summer. Thank you.
Operator
Thank you sir. This concludes today's teleconference. You all may disconnect your lines and we thank you for your participation. Have a wonderful rest of your day.