Q4 2023 Flushing Financial Corp Earnings Call

Presentation

Operator

Welcome to the financials. First excuse me, Flushing Financial Corporation's Full Year and Fourth Quarter 2023 earnings conference call. Hosting the call today are John Buran, President and Chief Executive Officer, Tom Buonaiuto, Senior Executive Vice President, Chief of Staff, and Deposit Channel Executive; and Susan Cullen, Senior Executive Vice President, Chief Financial Officer, and Treasurer.
Today's call is being recorded and 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 telephone keypad. To withdraw your question, please press star then two, 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 flushing, Banc.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 US 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 US Securities and Exchange Commission to which we refer you during this call, references will be made to non-GAAP financial measures as supplemental measures to review and assess operating performance. These non-GAAP financial measures are not intended to be considered in isolation or as a substitute for the financial information prepared and presented in accordance with U.S. GAAP. For information about these non-GAAP measures and for a reconciliation to GAAP, please refer to the earnings release and or to 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.

Thank you, operator. Good morning, and thank you for joining us for our full year and fourth quarter 2023 earnings call.
Before reviewing the highlights of the quarter, I wanted to spend a minute discussing the restatement announced yesterday. As we previously disclosed, we have received approximately $7 million or about $0.17 per share of employee retention tax credit payments in 2023. In keeping with our conservative risk profile, we fully reserved for this amount, given the uncertainty in the government program, which arose late in 2023. This is despite our belief that more likely than not we will recognize these payments. The 2023 quarters have been restated to account for this change, and this reserve is included in both GAAP and core earnings.
Now moving to the highlights of the quarter, company reported fourth quarter 2023 GAAP EPS of $0.27 and core EPS of $0.25. For the year, GAAP EPS was $0.96 and core EPS was nine $0.83. Gaap and core NIM expanded by seven and 18 basis points, respectively. In the fourth quarter, core loan yields increased 33 basis points. We run a conservative balance sheet and our office real estate exposure is low with minimal loans in Manhattan. Our liquidity profile has also improved with over 4 billion of undrawn lines and resources or 48% of total assets. Overall, the quarter showed progress on how we're managing this challenging environment.
Turning to slide 4, I wanted to provide additional detail on how the company has changed over the past year and how it should remain the same. Our interest rate risk position has moved closer to neutral. This provided immediate income in 2023 when rates increased rapidly. The move to neutral positions the bank to manage future changes in rates while reducing earnings volatility overall different rate cycles, we have options to modify the rate position as appropriate, but do not expect to operate at the level of liability sensitivity as we did in the past, what has remained the same is our low level of risk in our loan portfolio. We are a conservative lender our percentage of office loans to total loans is at the low end of our peer group. About a third of these loans are medical offices and less than 1% of loans are secured by Manhattan office buildings. We're very happy with our low risk profile as it has served us well through many cycles.
Slide 5 depicts how we have executed our action plan and how we will adjust our priorities in 2020 for our action plan as both focused on moving towards interest rate neutral, which we largely completed using interest rate hedges and adding floating rate assets. These actions also had a significant positive impact on our net interest income as we will review in detail later in the presentation.
Another one of our objectives was to increase the focus on risk-adjusted returns and improving lending spreads. While we achieved progress in this area with loan yields expanding, we recognize we have more work to do in 2024. We also had a goal of deepening customer relationships. Our growth in non-interest bearing deposits in the second half of the year underscores our progress in this area, and we expect this momentum to continue into 2024. Given our significant progress to date, we're expanding our areas of focus to ensure our long-term success. The first area of focus is on increasing the NIM. and reducing volatility. While this is a multiyear initiative, we achieved progress in the fourth quarter of 2023 as our NAM excluding the episodic item items mentioned on this slide, expanded five basis points quarter over quarter. We also focused on maintaining our credit discipline. Our credit profile has always been conservative and our risk profile will not change as we advance our lending strategy.
Building on this, we will preserve our strong liquidity and capital profile. We have a strong financial position today with over 4 billion of undrawn lines and resources. We will continue to build on this foundation in 2024.
Lastly, in 2023, we tightened expenses significantly where we could and this will be an even greater or greater focus in 2024. While fourth quarter expenses were higher than expected, they were driven by increasing DDA balances and strong loan production, the good type of expenses. We will continue to review our cost structure to look for opportunities to become more efficient as we move through the year. Overall, these expanded areas of focus will allow us to navigate the current environment while positioning the Company for long-term profitability.
Our loan portfolio is outlined on Slide 6, where a low risk lender was 89% of the portfolio secured by real estate. Our high-quality multifamily and investor commercial real estate loans comprised 67% of the total portfolio. As a reminder, these two portfolios have a weighted average debt service coverage ratio of 1.8 times and a weighted average loan to value of less than 50%. We have minimal exposure to Manhattan office buildings, which represent approximately six tenths of a percent of net loans. In general, the real estate portfolio has strong sponsor support and excellent credit performance. We remain very comfortable with the quality of our loan portfolio and our stress test. I've indicated that our borrowers are resilient. I want to provide context on how we approach our real estate portfolio and why we're so confident in this stability.
Slide 7 shows two types of multifamily buildings, which, as you can see, are on opposite ends of the spectrum. The picture on the left is similar to the typical multifamily building in our portfolio. This is a building that has a mix of rent-regulated apartments and market rents. The average monthly rent in our portfolio is approximately 1,600, $45 compared to over $3,000 for market rents. The total portfolio for these types of buildings is approximately $3 billion with an average loan size of just over 1 million and a weighted average loan to value of 56%, implying a granular mix simply put the type of building we have in our portfolio is stable, low risk and resilient to market volatility. Contrast this with a building on the right, which does not match our risk profile. While this building might look flashy, it's also more upmarket and as greater swings in monthly rent rates, this type of multifamily building is more exposed to market cycles. We have a history of conservative underwriting on multifamily properties when interest rates were low during the pandemic of 2020. We have never underwrote these loans with cap rates of 5% or higher, which provides a cushion in value when rates rise and cap rates increase. Also, we underwrite loans at origination to absorb higher interest rates and each loan and stress test. This is one of the reasons why our weighted average debt service coverage ratios are at 1.8 times for this portfolio. This high level of coverage reduces risk in this portfolio. As I just mentioned, many of our buildings have a mix of market and rent regulated apartments. Regulated apartment rents are subject to the rent guideline Standards Board approve annual increases, which is why we prioritize having buildings with a mix of market and rent regulated units. Loans that include rent-regulated apartments are about 65% of multi-family loans. We have not had annual net charge-offs of more than five basis points since 2014. In this portfolio, our conservative underwriting has and will continue to serve us well.
Slide 8 shows the types of office properties we lend against and the types we do not. We lend against medical and healthcare offices and largely out of borough single and multi-tenant properties. Again, these types of properties have much more stability through market cycles. We do not lend against high-rise office buildings that have much more volatility as evidenced by recent market dynamics. The total office portfolio is approximately $257 million was $118 million of multi-tenant, $96 million of health care medical and $43 million of single-tenant. Our average office loan is about $3 million with a weighted average loan to value of 50% and a weighted average debt service coverage ratio of 1.8 times. We have zero nonaccrual office loans.
Slide 9 shows examples of the retail commercial real estate we lend to and the types of properties we do not. This portfolio is about $900 million with a significant portion located in Queens Brooklyn and the Bronx. These properties are typically strip malls rather than large shopping malls. The businesses are usually vital to the communities that they serve. The portfolio has a weighted average loan-to-value of 53% and debt service coverage ratio of approximately 1.9 times. The average loan is about $2 million. Credit performance is solid and less than 20% of the loan portfolio has rate resets through at the end of 2024. We believe this high-quality portfolio plays a vital role in servicing the needs of local communities on a day-to-day basis. As you can see across our real estate portfolio, we prioritize the same key factors, limited risk exposure, resilience and strong and stable borrowers. Our disciplined risk management approach gives us confidence in the long-term success of our real estate portfolio.
Turning to slide 10, you can see the results of our underwriting over time. Our net charge-off history is shown on the left, we have a strong history of achieving net charge-off levels that are significantly better than the industry. The same can be said about our level of noncurrent loans compared to the industry. We have been and continue to be a conservative underwriter of credit in a stress scenario, consisting of a 200 basis point increase in rates, a 10% increase in operating expenses. Our loan portfolio has a 1.2 times debt service coverage ratio. Given this, we continue to expect minimal loss content within the portfolio.
Slide 11 shows our other credit metrics with year-over-year declines in nonperforming assets and an increase in the nonperforming loan coverage ratio. Criticized and classified loans were relatively flat during the quarter, and we expect the criticized and classified loans to gross loans to remain below peer levels. Our allowance for credit losses as presented by loan segment in the bottom right chart overall, the allowance for credit losses to loans ratio was stable at 58 basis points during the quarter. We remain very comfortable with our credit risk profile.
I'll now turn it over to Tom to provide more detail on our other financial metrics. Tom?

Thank you, John. I will begin on slide 12, which outlines the net interest income and margin trends. Gaap net interest margin expanded seven basis points to 2.29% during the first fourth quarter, while the core net interest margin increased 18 basis points to 2.31%, contributing to the GAAP and core NIM expansion were $3 million of prepayment penalty income, net reversals and recovered interest from nonaccrual loans, purchase accounting accretion and customer swap termination fees in the fourth quarter compared to 2.6 million in the third quarter. Absent these items, the NIM. expanded five basis points quarter over quarter, which is the first time the quarterly name expanded sequentially since the second quarter of 2022. There are two primary factors that should drive the NIM. in the near term. First is the level of loan originations and repricing. Second is how well we retain and reprice maturing CDs with the market expecting rate cuts this year, we estimate every 25 basis point reduction in rates would impact net interest income by approximately 1.4 million on an annualized basis, assuming no deposit rate lag for the fifth consecutive quarter, yields on loan closings exceeded yields on satisfactions, and this spread increased in every quarter.
Turning to slide 13, as John mentioned previously, we added interest rate hedges in 2023 to help neutralize the balance sheet to increases in interest rates. The overall interest rate hedge portfolio is approximately 2 billion and does not have any significant maturities in 2024. These interest rate hedges provided immediate income and help navigate the rapidly rising rate environment in a falling rate environment. The income from the interest rate hedges will decline, but there are potential offsets in the balance sheet bottom line, the interest rate hedges helped mitigate new compression from rising rates and provided immediate income.
Slide 14 provides more detail on our deposits. Average deposits increased 3% year over year and 1% quarter over quarter. The quarterly increase was partially attributable to seasonality and our focus on non-interest bearing deposits. Average non-interest bearing deposits increased 22 million or 3% quarter over quarter and remains a top priority for the company. Average CDs increased 2% quarter over quarter to 2 billion. Checking account openings declined 7% in the quarter, but increased 6% in 2023. Overall, we are seeing strong account opening trends and are confident we will continue to build our customer base next year. Our loan to deposit ratio has improved to 101% from 107% a year ago.
Slide 15 provides more detail on our CD portfolio. Total CDs or over 2 billion or 34% of total deposits at December 31st, 2023. Cds helped to lengthen the duration of our funding over 1.5 billion of retail CDs are expected to mature in 2024 at a rate of 4.1%. We expect to retain a high percentage of our CDs as we retained 78% of the retail CDs that matured in the fourth quarter. Current CD rates ranged from 5% to 5.45%. All else equal, CD repricing is one of the factors that could pressure our net interest margin.
Slide 16 provides more detail on the contractual repricing of the loan portfolio, approximately $1.3 billion or 18% of loans reprice with each Fed move. Our interest rate hedge position on these loans increases this percentage to 25% for 2024, 744 million is due to reprice at 174 basis points higher than the current yield in 2025 and 2026, a combined 1.5 billion of loans will break reprice about 200 basis points higher. These rates are based on the underlying index value at December 31st, 2023, and do not consider any future rate moves. This repricing should drive net interest margin expansion once funding costs stabilize.
Our capital position is shown on Slide 17. Book value and tangible book value per share increased year over year. And during the fourth quarter, we repurchased approximately 39,000 shares at an average price of $15.8, which is a 33% discount to tangible book value. The tangible common equity ratio increased slightly to 7.64% quarter over quarter. Overall, we view our capital base as a sort of source of strength and a vital component of our conservative balance sheet.
Slide 18 provides detail on our Asian markets, which account for a third of our branches. We have over 1.3 billion of deposits and 759 million of loans in these markets. These deposits are 19% of our total deposits. And while we have only a 3% market share of this $41 billion market. There is substantial room for growth. Our approach our approach to this market is supported by our multilingual staff, our Asian advisory board and support of cultural activities throughout through participation in corporate sponsorships. This market continues to be an important opportunity for us and one that we we will drive our success moving forward.
On slide 19, you can see community involvement is a key part of our strategy beyond just our Asian franchise. As outlined previously, during the fourth quarter, we participated in numerous local events to strengthen our ties to our customer base. Some of our recent highlights include hosting a ribbon-cutting ceremony at our Benson Hurst branch, which opened in late September and participating in the trunk or treat and hubbub and Toys for Tots and Chinatown. Participating in these types of initiatives has served as a great way to further integrate ourselves within our local communities while driving customer loyalty.
Slide 20 outlines the growth of our digital banking platforms. We continue to see double digit growth rates in monthly mobile deposit users, users with active online banking status and digital banking enrollment numerator platform, which digitally originate small dollar loans as quickly as 48 hours continues to grow. We originated approximately 19 million of commitments in 2023, and these loans have an average rate greater than the overall loan portfolio yield building off the success we had with Zelle. We continue to explore other fintech product offerings and partnerships to further enhance our digital banking platform and customers period.
Slide 21 provides our outlook. While we do not provide guidance, we want to share our high-level perspective on performance in the current environment, we continue to expect stable loan balances. As is typical, we expect certain deposits to experience normal seasonality in the winter months and decline in the summer. As discussed previously, the two biggest drivers of net interest margin are first, the level of loan originations and repricing, and second, the retention of CDs. And at what rate for modeling purposes, we suggest starting with NIM. in the two 15 range. As this excludes the outsized prepayment penalty and other episodic fees. We expect some proof of pressure from this level of the net interest margin in the near term, driven from CD repricing exceeding loan originations. Noninterest income should benefit from the back-to-back swap loan closings, while noninterest expenses were higher than expected in the fourth quarter, we are bending the expense curve in the first quarter. We have an increase due to seasonal expenses, but these expenses are expected to be less than half of the $4.1 million recorded in the first quarter of 2023. For the past five years, non-interest expenses grew at a 5.6% compounded annual growth rate in 2024. This growth rate is expected to be in the low to mid single digits from a base of approximately 151 million. We are controlling the expenses we can and disciplined expense management remains one of our top priorities in 2024. As we look to drive operating efficiencies, while tax rates can fluctuate, we expect a mid 20s effective tax rate for 2024.
I will now turn it back over to John.

Thank you, Tom. On slide 22, I will wrap up with our key takeaways. We established our action plan or early 2023 and executed well against it to help create a stronger base to improve profitability over the longer term. Given our successful execution. So far, we're shifting our areas of focus to increasing them and reducing volatility, maintaining our credit discipline, preserving our strong liquidity and capital and bending the expense curve in short, we're trying to improve near-term performance for the areas that we control amid the persistent challenging environment. We believe these actions will allow us to navigate the current environment and improve overall performance in the long term.
Operator, I'll turn it over to you to open up the line for questions.

Question and Answer Session

Operator

(Operator Instructions) Mark Fitzgibbon with Piper Sandler.

Hey, guys. Good morning. Happy Friday. First question is just some clarification on the comments you made around margin. Did you say that you should start with a margin level of 215 in the first quarter and then assume there will be compression from there? Is that correct?

So that's the core margin that we have that we're at as of as of the fourth quarter. So what's happening in the first in the first quarter is the number of CDs that are Rob that are repricing will exceed the loan. The loans that are repricing. So we could we could see some of some small margin compression in the first quarter. So by the middle of the year, that should abate and start moving the other way as well as loans, the loan repricing exceeds the liability repricing.

Okay. And then, John, I think in your comments you suggested that you're continuing to reduce liability sensitivity. I guess I'm wondering if if it looks like we're getting close to the Fed cutting rates and clearly the balance sheet benefits, as you've described, you know, 1.1 million for some for each 25 basis point cut. Why continue to reduce liability sensitivity now why not wait until rates come down and benefit near ride the wave? So to speak.

I don't think we're looking to reduce it any further. We're comfortable being being neutral at this point in time. And obviously, the market hasn't done such a great job of predicting the number of rate cuts or ROE or increases. And so given the fact that historically our balance sheet, we had a heavy liability sensitivity and still does today at its core basis. So I think that though we have options to increase the liability sensitivity in the balance sheet, should we see some certainty with respect to the Fed moves and we're exploring those options. So we haven't made any decisions as to the timing and magnitude of some of rate cuts at this point in time. And we're watching very carefully what's happening in the market, but we've been disappointed before in terms of the Fed making a make making cuts. So we wanted to position ourselves to be successful in either environment.

Okay. And then just just to be clear, the restatement that you did this morning, that sort of puts this issue completely behind. There's no residual expense impact or anything like that?

That's correct. Mark. It puts the whole issue behind us and we move forward from here.

Okay. And then just on credit on you guys have done a nice job and certainly your balance sheets held up well, I guess at a high level, I was curious of sort of two things. What do you guys worry about for the industry with respect to credit not necessarily flushing, but just credit in general. And you see commercial real estate borrowers out there that are really struggling to find a home for their loans are being pushed out by their existing banks.

We're starting to see somewhat of that activity. Certainly, there's been in the commentary in the press of various banks pulling back in the commercial real estate areas certainly the office market continues to be a soft market throughout the entire industry. So I think those two things are clearly occurring and we're watchful for opportunities to have and to be a little bit more focused on some on the loan portfolio in the in the coming quarters? I mean, obviously, we've been kind of flattish over 2023.

Thank you.

Thanks, Mark.

Operator

Steve Moss, Raymond James.

This is Thomas on for Steve guys. Appreciate it. Appreciate all the color you guys provided on CDs, but I think money market deposit growth resumed after several quarters of decline and the average yield on that looks like it ticked up about 25 bps to around at 3.88%, which looks like to be on the higher end of from what I've seen in our coverage. All that said, is it fair to say, especially with rate cuts likely on the horizon here that the money market deposit bucket is likely near a peak in terms of yield. And I guess piggybacking off that thought how much of your deposit base is indexed and would potentially immediately reprice downwards with a move in short-term rates? Thank you.

It is a relatively small portion that is indexed. We just and started a program, I guess in the last quarter or so and limited to certain that certain customer, a certain customer segments are being very watchful of that. Obviously, given the fact that our rum, the or the alternatives out there in the CD market are have a five handle. We're very, very happy to get a three handle in money markets. And that's that's growing.

Okay. Appreciate that. And just one more here. Shifting onto fees. I'm just wondering kind of what is the outlook here on the back-to-back loan swaps. I see that the pipeline looks like it was down with the recent move in rates. So where could we see that, that line item normalize down to in 2024? Thanks.

I think some customers in general are a little bit on the sidelines as there're the uncertainties and possibly the expectation of rate decreases are Rob are still out there and swirling in sterling in the market. So depending upon how quickly the Fed starts to move, we may see the of a more near term jump in back-to-back swap activity. We were very, very successful in this area in 2023, but it clearly is an area that is and that is driven by our expectation of rate movements at any given point in time. So we have the product we know we can turn on very, very quickly in the event that rates or rates are in a favorable position. But given expectations that rates may be coming down, some some borrowers are just kind of holding tight at this point in time.

Okay. I appreciate all that color that that covers it for me. I'll step back in the queue. Thanks, everyone.

Operator

Chris O'Connell, KBW.

Just wanted to follow up on one of the comments in the prepared remarks, I think it was for each 25 basis point reduction in rates is an impact of 1.4 million on the annualized IIM, that's a positive impact, correct?

Correct. And that's assuming there's no lag or 100% beta in the deposit repricing.

Got it. But it is considering the impact of the swaps. Right?

Yes.

Great. And then if you guys have like are getting into 2025, I know there's not a ton maturing in 2020 for Q4. And as of just the maturity schedule on the funding side swaps.

The funding -- in 2025, what form but 400 million, I think, matures in 2025.

Got it.

(multiple speakers) So it sounds like I should deal, I guess what I'm getting on. Clearly, I think the general comment and you're going to we may be a little off on the number, but the general comment is we're going to have a bigger opportunity in 2025 to have to manage an asset versus liability sensitivity because we do have a fair number of swaps coming off.

Yeah, I guess that's what I was getting at is like that's probably one of the arrows in your guys' quiver that you have over time to maybe increase liability sensitivity and if it becomes certain that the Fed is going to be consistently cutting for it.

Correct. That's a good statement, Chris.

Great. And then I know you guys gave a lot of good color on the expenses and the relative change from in the past for for the overall just cadence is there's still going to be, I think, a fairly sizable drop down in the Q1 to Q2 rate and then usually it's fairly flattish after that.

So we expect the seasonal expenses in the first quarter, Chris, to be about $2 million versus a little over $4 million in the first quarter of 2023. But yes, that $2 million will then start to fall off in the subsequent quarters of '24.

Great. And it's Audrey, and thank you for expressing interest.

Operator

Manuel Navas, D.A. Davidson.

Prepayment penalties were a little bit elevated in the fourth quarter. Any color there and do you have any early indications of where they could land in the next couple of quarters? Do you have any sightline to that?

They were elevated in the quarter. We had a couple of large loans that had swaps associated with the payoff of foreseeing prepayments. About seven 500 to 750,000 would be a normalized or normalized rate we're forward.

Okay. And then, Liam, the color on the CD repricing, you had a current CD rates around five to five 45. That's your CD rates. What is kind of the high in the area?

550-ish.

Okay. That's why it's so you generally can keep on because you're right, right, where right, the market is.

Right in the ballpark.

We'll give me an update on the swap maturities there, about 325 million of swap maturities taking place in 2025.

Okay. I know your guidance kind of encompasses the swaps and that is are you just looking at the swaps and you have some rate cuts, where does the net benefit move to right now? The net benefits like a 2.56% if there's 25 basis point cut, where is it move to?

We had a $1.4 million on a 25 basis point cut.

Assuming 100% beta.

Just keep it on the overall guidance. And then and and any shift in the buyback appetite?

No, not really. We can continue with our capital plans we've always had at the first. We want to invest profitably into the company, second return through dividends and the buybacks.

Okay. I appreciate the comments. Thank you.

Operator

This concludes our question and answer session. I would like to turn the conference back over to John Buran for any closing remarks.

Thank you, operator, and thank you all for attending the conference today. We look forward to presenting to you at the end of the second quarter. And as always, if analysts have any additional questions will be make ourselves available Thank you very much.

Thank you.

Operator

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