Flushing Financial Corp Q2 FY2021 Earnings Call

Welcome to Flushing Financial Corporation's Second Quarter 2021 Earnings Conference Call. Hosting the call today are John Buran, President and Chief Executive Officer; Susan Cullen, Senior Executive Vice President, Treasurer and Chief Financial Officer; and Frank Korzekwinski, Senior Executive Vice President and Chief of Real Estate Lending. Today's call is being recorded. 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 the 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 the 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.

Thank you, operator. Good morning everyone. And thank you for joining us for our second quarter of 2021 earnings call. On today's call, I will discuss the second quarter highlights and strategic objectives before turning the call over to our CFO, Susan Cullen, to provide greater detail on our financial performance. Following our prepared remarks, we will address your questions along with our Chief Real Estate Lending Officer, Frank Korzekwinski. It goes without saying that the pandemic has affected our personal and work lives. It has brought us masks, social distancing, vaccines, and stay-at-home entertainment. In the banking business, it has brought forth challenges, but it has also presented opportunities. In the case of Flushing Financial, it allowed us to demonstrate how strong our management team is and how well we respond to adversity and challenges. We emerge from the dark days of the pandemic as a much stronger company than we were at the end of 2019, the last pre-pandemic year. We have a bigger balance sheet. As we completed our acquisition of Empire National Bank during the height of the pandemic, we are now $1 billion larger in assets. We have more earnings power. Earnings per share for all of 2019 were $1.44. Earnings per share for the first half of this year are already $1.21. We have a better net interest margin today than we had at the end of 2019. As throughout our history, credit has remained strong with minimal charge-offs. We have a better efficiency ratio, a better loan-to-deposit ratio, a higher tangible book value, and with New York recently reopening, we have better economic prospects than just a few months ago. Recognizing this opportunity and the improving strength of the Company, the Board has authorized an increase in share repurchase to take advantage of our attractive low price and strong dividend. Turning to Slide 4, the second quarter of 2021 was an important period as we executed well on our strategic objectives, and the New York City economic region started its recovery. We reported GAAP EPS of $0.61 and Record Core EPS of $0.73. GAAP return on average assets and return on average equity total 93 basis points and 12% respectively. On a core basis, these ratios were 111 basis points and 14%, both of which exceeded our through-the-cycle targets of 1% and 10% respectively. The strong results for the second quarter helped boost the tangible common equity ratio to 7.8%. This slide outlines our strategic objectives and how we performed against them. The first objective is to ensure appropriate risk-adjusted returns for loans while optimizing the costs of funds. The second quarter was our fifth consecutive quarter of record net interest income. While GAAP NIM declined by 4 basis points quarter-over-quarter, Core NIM rose by 8 basis points. Average non-interest bearing deposits continue to rise and improved 65% year-over-year, now representing 14% of average deposits.

Thank you, John. I'll begin on Slide 5. The first strategic objective is to ensure appropriate risk-adjusted returns for loans while optimizing costs of funds. Average deposits grew 29% year-over-year, and excluding Empire, growth was approximately 13%. Average non-interest bearing deposits increased 65% from a year ago. Average core deposits comprise 84% of average deposits, an improvement from 77% in the second quarter of 2020. Total cost of deposits continues to move lower, falling 5 basis points in the quarter and 45 basis points over the past year. Slide 6 outlines the net interest income and margin trends. Our net interest margin has moving parts, including fair value adjustments and net amortization of purchase accounting adjustments. To make the analysis clear, these items, plus the effects of prepayment penalties and the net reversals of interest recoveries from nonaccrual loans, are removed in the base net interest margin. We encourage you to start with the base net interest margin for modeling purposes and then add in your own assumptions for the items previously mentioned. Base net interest income includes PPP loans and fees, which I will detail shortly. Overall net interest income was a record for the fifth consecutive quarter despite the slight decline in average loans and the net interest margin when compared to the first quarter. However, core net interest margin was 3.14%, an improvement of 8 basis points during the quarter, but included net prepayment penalty, income and PPP fees of 16 basis points, compared to 8 basis points in the first quarter. Base net interest margin rose by 3 basis points, sequentially. This was achieved by the 34% increase in average short-term funds. We expect the $242 million of average interest-earning deposits and fed funds in the second quarter, which yielded only 8 basis points, to decline as loan growth improves. As a reminder, we have $592 million of effective swaps that cost 103 basis points, pulling down the net interest margin, the majority of which mature by the end of 2023. These swaps will largely be replaced with $405 million of swaps that cost 71 basis points. The repricing of the swaps, absent any other interest rate changes, should provide a benefit to the net interest margin. Slide 7 discusses the strategic objective of maintaining strong historical loan growth. As previously mentioned, loan growth was challenging in the second quarter due to PPP forgiveness. Period-end loans declined less than 2% annualized quarter-over-quarter but grew 13% year-over-year. We chose to stick to our disciplined underwriting and pricing standards. Loan pipelines in line utilization improved during the quarter, bolstering our confidence that non-PPP loan growth should accelerate in the second half of 2021. Base loan yields increased by 1 basis point in the second quarter but decreased by 11 basis points from a year ago. This spread between the yield on loan originations and loan satisfactions, excluding the PPP loans, narrowed during the quarter but remained negative. Slide 8 details the PPP portfolio. PPP loans totaled $197 million at the end of the second quarter with associated fees of $4 million. The yield on the PPP loans increased approximately 3% in the second quarter from nearly 2% in the previous quarter. As we disclosed on July 8th, total net deferred PPP fees recognized in the second quarter were $1.2 million, up from $500,000 in the first quarter.

Thank you, Susan. On Slide 13, we provide our outlook. We expect loan growth, excluding PPP, to accelerate in the second half of 2021 as the local economy fully reopens, and we fund our loan pipeline. PPP forgiveness will pose a headwind. Core net interest income will benefit from loan growth and the redeployment of PPP forgiveness and short-term liquidity. Tangible common equity continues to rise and is near our 8% target. We will remain opportunistic with our increased share repurchase authorization. We have a low-risk business model and have demonstrated over many credit cycles that our losses are well below the industry. In our view, we're a stronger company than we were pre-pandemic, and our low-risk business model is now properly reflected in our stock valuation. We believe our stock is attractively priced, especially with the approximate 4% dividend yield. Through-the-cycle goals of a 1% plus return on average assets and a 10%-plus return on average equity remain, and we exceeded these goals in the second quarter, both with and without the reserve release.

Our first question comes from Mark Fitzgibbon of Piper Sandler.

Susan, just a real quick clarification question. Banking services fees were down a bit from the last couple of quarters. I'm curious, is that because swap fees were lower or swap fees in that line?

Yes, they are.

They are?

It was driving that, yes.

That was what drove it. Okay, great. And then secondly, how much of the $246 million of loan deferrals that you have out there mature this year? Most of them?

Yes. Most of them do. The vast majority of them mature within the coming quarter or the coming year.

Okay, great. And then, Susan, you gave a lot of detail on the things that are likely to affect the NIM in coming quarters. Can you help us kind of distill that all down to sort of a bottom-line margin impact in, say, 3Q?

Well, I would, if I could, Mark, but I don't have a crystal ball just to know what the marks will be on our swaps that flow through there or how our prepayment penalties are going to come through. So I think our core NIM, if we talk about that, that's probably a better spot to start or even our base NIM that is net of all of those items.

Okay. And so the core NIM, you think will be under a little bit of pressure?

Yes, yes, we do. As we've talked about in the past that we had a greater opportunity to reprice liabilities. And as you saw, we only had a 5 basis points decrease in the costs this quarter. The assets are holding their own, but we're not going to have as much opportunity to reprice liabilities as we've had.

Okay. And then lastly, you say on Slide 3 of the slide deck that you're in the early stages of tech enhancements. I guess I'm curious what that means, what kind of timing we're looking at, what kinds of maybe products or services you're looking to add? And is this a major cost initiative?

We are focused on our successful collaboration with our vendor on PPP loans and are considering expanding that relationship for greater efficiencies in lending. Over the past year, we have completely revamped our mobile and online banking services, and we anticipate continued growth in their usage among our customers. Additionally, we have been collaborating with a group of banks and JAM FINTOP to gain insights into emerging technologies, especially those that improve efficiency and reduce friction for our customers. We expect to benefit from these efforts, and we have various initiatives at different stages, from which we hope to see advantages over time.

Our next question will come from Chris O'Connell of KBW.

I was just hoping for one quick clarification question on the PPP NIM impact. I think a couple of times, you said it was no impact on the NIM this quarter, but then at one point in the earnings release, you might have said there was a 6 basis point NIM impact for 2Q '21. Just a little bit of clarification on that.

I believe there is some confusion between the yield on the PPP loans and the impact on the net interest margin. The yield increased compared to the first quarter of 2021, but since those amounts are relatively small within our overall interest income, they did not significantly affect the net interest margin. There is no impact on the net interest margin.

Got it. Great. As for loan growth, the pipeline has increased significantly both quarter-over-quarter and year-over-year. The outlook appears strong for the second half of the year. I would like to get some insight into where you are seeing that growth originate. It seems from the presentation that line utilizations have rebounded in the second quarter, but I noticed that CNI loans were down on a period basis. Could you clarify the change in line utilizations or if that improvement occurred after the second quarter?

So the line utilizations are mostly post Q2, but they are where they are. The loan growth, we expect to be very strong, given our strong pipeline and our historical average pull-through of those loans. Remember, we're talking ex-PPP loans. Those PPP forgiveness will be a headwind that we'll have to fight against, but every dollar we replace with PPP loans with a loan yielding 3.5% or so has a much better impact on our NIM going forward.

Got it. And it looked like there was a pretty solid mix shift out of cash into the securities book this past quarter. Maybe just quantifying what the level of that mix shift will be going forward and what the new yields are on the securities that you're playing on the book?

So we don't expect, given our optimism over second-half loan growth, that we would need to redeploy the excess liquidity into the securities book. We're very comfortable with our securities book where it is for liquidity and other reasons. So that's where we would stay with the liquidity.

Okay, understood. Lastly, regarding the overall trends in reserve and credit quality, it appears to be moving in a positive direction this quarter. Given that you maintain a very clean book overall, where do you believe the lowest point could be for the reserve loans? How much more can you reduce that from its current level?

Well, Chris, that will all depend on our loan mix, the economic environment, and whether we have another headwind from the delta COVID variant, if we will have to factor that into our considerations. All those items will come into play. We continue to underwrite very conservatively, and we're very comfortable with where we are. I wouldn't want to make a prediction as to what the lowest number we could go to would be.

Okay, got it. And just, I guess, one final one, if I could. As far as the buyback authorization increase, what would drive that going forward? Can you just talk a little bit about maybe what the drivers are of that appetite? As for the pricing dynamics, do you get more aggressive or less aggressive versus tangible book value or regarding capital levels?

Well, look, I think by any stretch of the imagination, given our performance recently, the stock has been trading at a very, very low level, just slightly above tangible book. With a strong dividend yield, we felt very confident throughout this time period that we would see. We did have some very nice growth in terms of the stock price over the past year or so. We also feel that given all of the economic factors improving, and the fact that the company is performing much better than it did pre-pandemic, all those stars are aligned well for us to go out and to grab some additional shares of stock, particularly if the market is not grabbing them. We certainly see a strong return coming out of that.

There are no further questions at this time, and I would like to turn the conference back over to John Buran for closing remarks.

Thank you very much, operator. Well, thank you all for your attention. As I said earlier, we're very pleased with the quarter and the prospects for the future of the Company. So thank you again for your attention, and everyone stay safe.

Thank you.

Bye.

The conference has now concluded. Thank you for attending today's presentation, and you may now disconnect.