Flushing Financial Corp Q4 FY2021 Earnings Call

Welcome to the Flushing Financial Corporation's Fourth Quarter 2021 Earnings Conference Call. Hosting the call today are John Buran, President and Chief Executive Officer; Susan Cullen, Senior Executive Vice President, Chief Financial Officer, and Treasurer; and Mike Bingold, Senior Executive Vice President, Chief Retail and Client Development Officer. Today's call is being recorded. After today's presentation, there will be an opportunity to ask questions. A copy of the earnings press release and slide presentation that the company will be referencing today are available on its Investor Relations website at flushingbank.com. Before we begin, the company would like to remind you that discussions during this call contain forward-looking statements made under the Safe harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. Such statements are subject to risks, uncertainties, and other factors that may cause actual results to differ materially from those contained in any such statements, including as set forth in the company's filings with the U.S. Securities and Exchange Commission, to which we will refer. During this call, references will be made to non-GAAP financial measures as supplemental measures to review and assess operating performance. These non-GAAP financial measures are not intended to be considered in isolation or as a substitute for the financial information prepared and presented in accordance with U.S. GAAP. For information about these non-GAAP measures and for a reconciliation to GAAP, please refer to the earnings release and or the presentation. I'd now like to introduce John Buran, President and Chief Executive Officer, who will provide an overview of the strategy and results. Please go ahead.

Thank you, Operator. Good morning, everyone. And thank you for joining us at our fourth-quarter and FY2021 earnings call. On today's call, I'll discuss fourth-quarter earnings and ongoing strategic objectives before turning the call over to Mike Bingold, Chief Retail and Client Development Officer, and Susan Cullen, Chief Financial Officer. Following our prepared remarks, we will answer your questions. There are two main items I want to talk to you about today. First, a review of our record earnings for 2021 and second, the outlook for 2022. For the fourth quarter, GAAP and core return on average assets increased 71 and 12 basis points year-over-year respectively. And GAAP and core return on average equity increased 850 and 82 basis points respectively. The net interest margin improved 21 basis points on a GAAP basis, and 18 basis points on a core basis. We remain focused on executing on our strategic objectives, and we're pleased with our performance in the fourth quarter of '21, and very happy with the full-year results. The first objective is to ensure appropriate risk-adjusted returns for our loans while optimizing the cost of funds. The average non-interest-bearing deposits increased 34%. We had record low cost of deposits at 25 basis points. Loan yields were compressed by 2 basis points, quarter-over-quarter. The second objective is to maintain strong historical loan growth. Loan closings were up significantly by 49% for the linked quarter. Loans, excluding PPP, increased 3.7% annualized quarter-over-quarter. The loan pipeline began to season after a record third quarter level and ended the year at a very solid $429 million. Excluding the effects of PPP loan forgiveness, we expect positive loan growth in 2022. The third objective is to enhance core earnings power by improving scalability and efficiency. Earnings per share improved by 427% year-over-year on a GAAP basis and 16% on a core basis. Our digital banking efforts continue to gain traction with customers. And we're seeing opportunities to expand technology supported products and services. There is a significant organic growth opportunity over the next 12 to 18 months from merger disruption, and so far, we've added 24 people from these institutions, nine of whom are revenue producers. Our fourth strategic objective is to manage asset quality with consistent and disciplined underwriting. We have low levels of non-performing assets, and criticized and classified loans are only 87 basis points of loans. We have reserve coverage of nearly 250%, and greater than 87% of our loans are real estate-based. And those loans have an average loan-to-value of less than 38%. We have a low level of credit risk in our portfolio as a result. On Slide 4, we outline our strategic objectives for 2022. Most objectives are the same as in past years as we want to improve the funding mix, generate appropriate loan growth and maintain strong asset quality. We also recognize the need to invest in the long term while managing short-term results. Examples include enabling customers to transact in Bitcoin and eliminating consumer overdraft fees, both of which should help expand our non-interest-bearing demand deposits. Also, through our small business lending platform, we're improving the customer experience through automation and faster decision-making. Merger disruption is one of the most significant opportunities presented to us over the next 12 to 18 months, as shown on Slide 5. As these mergers get approved and integration begins, we expect to add people and new business. In 2021, we added 24 people from the institutions on this slide, nine of whom are revenue producers. We expect to focus on organic growth opportunities. We had a record loan pipeline at the end of the third quarter, as shown in Slide 6. The loan pipeline is balanced between real estate and business banking, as business banking activity has increased significantly. Prepayment speeds rose over 50% in 2021 and nearly doubled in the fourth quarter. With the yield curve steepening, we expect refinancing volume to slow in 2022. So between the strong pipeline and the shape of the curve, we expect loan growth to improve. I will now turn it over to Mike Bingold to provide more details on our digital banking strategies. And then Susan will follow with more details on key financial metrics.

This investment allows for an early look at emerging technology, and we are excited about the offerings we have seen so far. In the fourth quarter, we launched an enumerated platform to digitally originate small-dollar SBA loans, and to date, we're pleased with the offering. We recently announced our plan to enable customers the ability to transact Bitcoin through a partnership with NYDIG. We will have an opportunity to acquire new customers and grow non-interest-bearing deposits while generating non-interest income. NYDIG acts as a custodian and executes the trades. The bank will not hold any Bitcoin or have any price risk. We view this as an attractive opportunity as interest in Bitcoin remains strong. According to research, customers who want to transact in Bitcoin prefer to do business through a bank. We are working on several other digital initiatives as well. I will now turn the call over to Susan to discuss the key financial metrics.

Thank you, Mike. I'll begin on Slide 8. Average non-interest-bearing and total deposits increased 34% and 17% respectively year-over-year and comprised 15% of average deposits, an improvement from 13% in the fourth quarter of 2020. We continue to focus on optimizing the deposit mix and look for ways to reduce the cost of funds. The cost of deposits decreased four basis points quarter-over-quarter, and 22 basis points over the past 12 months to a record low of 25 basis points. Branch business activity continues to pick up with fourth quarter checking account openings up 35% year-over-year and 13% from the fourth quarter of 2019. Slide 9 outlines a loan portfolio and yields. Loans excluding PPP increased 3.7% annualized quarter-over-quarter. With a strong pipeline and a steepening yield curve, we are optimistic that loan growth will improve in 2022. The steepening of the yield curve should help rates on loan originations to move higher over time. Core loan yields, which include prepayment penalty income, decreased four basis points quarter-over-quarter, while base loan yields remained stable. However, there is still pressure on loan yields as the yield on satisfactions exceeded the yield on loan closings by 40 basis points in the fourth quarter. PPP loans declined 41%, or $77 million during the quarter as the SBA continues to forgive loans. During the quarter, the company recognized approximately $1 million of PPP fees. Slide 10 outlines net interest income and margin trends. GAAP net interest margin was 3.29% and declined 5 basis points during the quarter. Net interest income declined 1% to $63 million. Core net interest income, which removes the impact of net gains from fair value adjustments and purchase accounting accretion, also declined, with core net interest margin compressing 6 basis points to 3.21% in the fourth quarter. Excluding the impact from net prepayment penalty income, net gains from fair value adjustments, and purchase accounting accretion, which total 16 basis points in the fourth quarter, and 19 basis points in the third quarter, the net interest margin declined by 2 basis points quarter-over-quarter. For modeling purposes, we encourage you to start with the base net interest margin of 313, which includes three basis points of positive PPP impact, and then add in your own assumptions for the adjustments previously mentioned. Slide 11 discusses our current balance sheet position. Assuming the yield curve at year-end in a static balance sheet, net interest income would increase over time. This increase is primarily driven by the repricing of the funding of the swaps, slightly lower funding costs, and higher rates on originations given the steepening yield curve. This is shown by the light blue bar. We are adding more floating-rate assets to the balance sheet. Depending on the timing of adding floating-rate assets, net interest income is projected to increase by $3 million to $12 million annually and help negate the liability sensitivity position. This is depicted by the dark blue bar. Turning to Slide 12, we provide more detail on the impact of rising rates. The timing and pace of rising rates are key drivers for net interest income. The slower the rate increase over a longer period of time is better than an immediate shock of 100 basis points, for example. Currently, approximately 25% of loans mature or reprice within one year, while our liabilities tend to reprice quicker. The chart on the left depicts the impact of a 200 basis point increase in rates over the first two years, without any balance sheet growth in the base case, and adding the floating rate initiative in the other scenario. Clearly, the floating rate asset initiative benefits net interest income and helps reduce the liability sensitivity. We are also emphasizing the growth of non-interest-bearing deposits. While our net interest margin may compress in the near term with these rate increases, we expect to see net interest income growth in 2022, driven by the expansion of the balance sheet. The modeling on this slide is based on lightning deposit rate increases and the Fed funds curve as of early December 2021. Moving onto Slide 13, net charge-offs were only five basis points for 2021, and we had net recoveries of $29,000 for the fourth quarter. Historically, our losses have been better than the industry, and we expect this to continue. Our underwriting is conservative and we are not a price leader. The average loan-to-value on our real estate portfolio is less than 38%, and less than 1% of the loan portfolio has an LTV of 75% or more. Slide 14 outlines the Company's solid credit metrics. Non-performing assets declined 26% linked quarter, and the LTV on these assets is 30%. The company increased reserves in the fourth quarter related to the current period loan originations and the increased risk from the Omicron variant of COVID-19. While the overall reserve-to-loans ratio is 56 basis points, in the bottom right of this slide you can see the reserves by loan type. Overall, we remain very comfortable with our credit risk profile and continue to expect minimal loss contact. Slide 15 shows our strong capital ratios. Book value and tangible book value per share increased 11% each in 2021. The tangible common equity ratio improved 18 basis points during the fourth quarter to 8.22%. During the quarter, the company repurchased 151,000 shares at an average price of $23.75, resulting in 56% of the company's earnings being returned to the shareholders during the quarter. Our capital priorities are unchanged and are to profitably grow the balance sheet, pay dividends to shareholders, and opportunistically repurchase shares. We view the stock as attractively priced given the approximately 3.4% dividend yield and the significant opportunity for future growth. Slide 16 outlines the key points in the outlook for the first quarter of 2022 and for the full year. We start with net interest income and net interest margin. While there are many moving pieces, overall, we expect growth in net interest income in 2022 based on rate increases and profitably growing the balance sheet. Core net interest margin will depend on the level of loan growth, deployment of liquidity, and the pace of floating-rate asset additions. The fourth-quarter reported margin includes elevated levels of purchase accounting accretion, net prepayment penalty income, and positive fair value marks. While PPP fees added 3 basis points to margin in the fourth quarter as well. We expect these items to normalize in 2022. Loan growth, excluding PPP, should improve in 2022 given the strong pipeline. There are two items of note for non-interest income. First, there was a $2 million dividend received on retirement plan investment in the fourth quarter that is not expected to repeat. Second, the elimination of overdrafts, insufficient funds, and transfer fees on consumer checking accounts is expected to reduce non-interest income by $200,000 in 2022. Fourth-quarter non-interest expense includes a one-time $4 million increase in compensation and benefits for all employees as a reward for achieving record earnings and for their performance during the pandemic. We're continuing to invest in the franchise and our people, resulting in high single-digit percent core expense growth year-over-year. For modeling purposes, first-quarter core expenses should increase low single-digit percentage compared to the fourth quarter due to normal growth of the bank and seasonal expenses largely offsetting the one-time compensation and benefit increase. Expenses for the remainder of 2022 should follow the normal seasonal patterns, with some of the seasonal expenses in the first quarter falling out in the second. Lastly, the effective tax rate for 2022 should approximate 26.5% to 27%. I'll now turn it back over to John.

Thank you, Susan. On Slide 17, we provide our key messages. Loan growth is expected to increase in 2022, as we have a strong pipeline and the economy is growing. We're benefiting from the merger disruption as we've added 24 people, nine of whom are revenue producers in 2021. We expect to add more as deals close and the integration begins. We are investing in the business and our people. New services in Bitcoin and reduction in overdraft fees are set to launch in 2022. Our employees are our competitive advantage and we are rewarding them for their efforts during the pandemic. Our expense base will be higher as we invest in the company in 2022. We're preparing for rising rates. We're adding floating-rate assets immediately and floating-rate loans over time will be emphasized along with low-cost deposit growth. These initiatives should improve our interest rate risk profile. Overall, we expect to grow net interest income in 2022 based on expected balance sheet growth. We have a low-risk business model with conservative average LTVs, low credit risk, and a stock that has an approximate 3.4% dividend yield. We'll be maintaining through the cycle return on average assets and return on average equity goals. We have several initiatives in place to help drive results over the long term. Operator, I'll now turn it over to you to open up the lines for questions.

Thank you, ladies and gentlemen. We will now begin our question-and-answer session. At this time, we will pause momentarily to assemble the roster. And our first question will come from Chris O'Connell of KBW. Please go ahead.

Hi. How are you?

Morning, Chris.

Morning. So I just wanted to confirm the expense guide here. I thought you said just in the prepared comments, the first quarter to be up low single-digit and then I think the thing I'm seeing in the slides, high mid-single-digit inflation plus the $45 million of the 34, $44 million base. Just hoping to confirm kind of where we're starting off the year here.

I'm having a bit of difficulty speaking this morning. The $4 million one-time compensation expense from the fourth quarter should largely offset the seasonal expenses we anticipate in the first quarter of 2022. We also expect growth in expenses to be higher than normal, likely in the high single digits, as we continue to invest in the company.

Okay. And so just to put it all together, if I'm reading it right, I think the fourth quarter shakes out to somewhere plus or minus a bit in the $41 million range. And then usually you guys have, I think typically in the past, you said about a $3.5 million drop-down in the second quarter of seasonality, or maybe it's, I guess, $4 million to $5 million now?

Right. It depends on what the stock does. Where that will be between 3.5 and 4, or 4.5. It's somewhere in that range.

Got it. Okay. Perfect.

And then 80% drops off in the second quarter of 2022 roughly.

Yes. So about 3.5 million or so, 3.5 to 4 million drops off. Okay, great. Perfect.

Yup.

And usually it's seasonally flattish plus or minus.

Right. On a quarterly basis, right. Correct.

Thereafter, gotcha. Okay. Great. And then I was hoping to just get some color around slides 11 and 12, as far as I guess, on Slide 11, that just chart on the left, what would the line look like before a third line that's not using the forward curve on the NII. Just trying to get a frame of maybe like what 125 basis point Fed hike does to NII or how that looks.

Obviously, what it would look like would also depend on what assumptions we put in there. As we said, the slide was built on lagging deposit cost. If we were to continue to lag deposit cost, I would not expect a 25 basis point increase to have much of an effect on our net interest income because we would lag those deposit betas as we said, and it would depend on what the shape of the yield curve did, whether the low end rose or if the back end rose as well.

Okay. I understand. It seems that based on Slide 12, the pressure on the margin for net interest income starts after two or three points, correct?

Yes.

Yes.

Okay. Great. I will step out for now. Thank you.

Great. Thanks, Chris.

Great. To clarify, regarding Slide 12, we are not factoring in any loan growth in that structure, but there is loan growth. Consequently, net interest income will improve.

That's on both sides, Chris. Both slides assume a static balance sheet.

And once again, we will pause momentarily to assemble our roster.

We're done.

There appear to be no further questions at this time. I will turn the conference back over to John Buran for any closing remarks.

Thank you. It looks like we have no other questions. Once again, thank you very, very much for your attention and we look forward to updating you in the future about our continued strong results.

Thank you.

The teleconference is now concluded. Thank you for attending today's presentation and you may disconnect your lines.