Welcome to Flushing Financial Corporation's First Quarter 2023 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. Today's call is being recorded. [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 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 prefer 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 US 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.

Thank you, operator. Good morning, and thank you for joining us for our first quarter 2023 earnings call. Following my prepared remarks, Susan will review the financial trends, and we will then answer any questions. The company reported first quarter 2023 GAAP EPS of $0.17 and core EPS of $0.10. The quarterly results were impacted by net interest margin compression and a charge-off of a previously identified credit placed on non-accrual in the second quarter of 2022. We were disappointed with these results, and we've implemented an action plan to enhance the resilience of our business model and improve future profitability. First, we're taking significant steps to move the balance sheet to more interest rate risk neutral, and have already achieved 40% of our goal. Second, we are increasing our focus on risk-adjusted returns and overall profitability. While this will take some time, we're encouraged by the results seen so far. Third, we're looking to expand our client base and build loyalty by emphasizing our brand of customer service and deep community relationships, while capitalizing on the recent market disruptions. Our bankers are seeing more activity in gathering both loans and deposits. Fourth, we are tightening up on expenses. We've taken actions to reduce non-interest expense growth, and will continue to focus on reducing discretionary expenses. Fifth, we are preparing for the next credit cycle. We are focusing more on recession-proof industries, and we'll continue to take early actions on weaker credits. Sixth, we will continue to focus on our strong liquidity and capital. Deposits are up for the quarter, and we have $3.7 billion of available liquidity. Overall, we expect these decisive actions to result in an improved earnings profile over time. These actions, along with our strong liquidity, will also allow us to continue our long track record…

Thank you, John. I'll begin on Slide 11. Deposit growth has been a challenge for the industry as the Fed raises rates and recent bank failures tighten financial conditions. Despite this backdrop, we were able to increase average total deposits 2% during the quarter, and 6% year-over-year. As expected, balance growth was driven by CDs, which help extend our funding to better match the duration of the assets. While growing non-interest-bearing deposits is a priority for us, it has become more challenging, given the higher rate environment. Average non-interest-bearing deposits declined both quarter-over-quarter and year-over-year. However, checking account openings increased 30% year-over-year. The recent market disruption has provided opportunities to attract more deposits and customers. The increase in the deposit base assisted in lowering the loan to deposit ratio to 102% from 107% at the end of the year. In terms of mix, about half of our deposits are from consumers, and the other half are from business and government. I also want to note that we have seasonality in certain segments of our deposit base, and the summer months are generally lower than the rest of the year. On Slide 12 outlines our loan portfolio in the yields. Net loans increased 5% year-over-year, but were down less than 1% quarter-over-quarter. Loan closings were lower than the recent run rate, but the yield on the closings was over 7% for the quarter. Core loan yields increased 17 basis points during the quarter, and for the second consecutive quarter, yields on loan closings exceeded the yields on the satisfactions by 113 basis points. Prepayment penalty income declined to $610,000 in the quarter from $1.2 million in the fourth quarter, and $1.6 million from a year ago. There's been some disruption in the market as a major competitor has exited, contributing to…

Thank you, Susan. On Slide 21, I'll wrap up with our key messages. Results in the first quarter were below our expectations, and we have implemented an action plan and areas of focus to help improve profitability in the short and medium term, and build on our foundation for long-term success. We're looking to position the balance sheet to become more neutral to changes in interest rates. We will continue to take advantage of market opportunities, including a major competitor leaving the market, which should provide opportunities for loans and deposits. Our liquidity and capital are strong. We remain comfortable with the low-risk loan portfolio, as criticized and classified assets and delinquencies improved. While the environment is challenging, we expect these decisive actions we are taking to improve the overall performance and allow us to continue our long and consistent track record of dividend payments. Operator, I'll turn it over to you to open the lines for questions.

Thank you. [Operator Instructions]. Our first question comes from Mark Fitzgibbon with Piper Sandler. Please go ahead.

John. Susan, good morning. The first question I had for you, I wondered how much more in C&I loan participations you all have, and maybe what your largest C&I participations are, how large?

First of all, it's minimal. Most of what we do is in-market and real estate-based, as you know. The largest is probably this loan.

I think so. I think that's right. And then we engage in - when we get into a participation, Mark, we re-underwrite the loan to our own conservative underwriting standards before we agree to participate in the credit.

Yes. I just want to emphasize, this is a very unusual set of circumstances where involved in a war and a sanction that is clearly not typical of what we do on a day-to-day basis, so highly unusual.

But in total, roughly what are the C&I participations?

They're about less - right around 5% of the portfolio.

5% of total loans or 5% of C&I loans?

Total loans, excuse me. 5% of total loans.

Okay. Secondly, you had talked about in the past having a target TCE ratio of around 8%. I guess, I'm curious if that's, A, still your target, and, B, if it is, should we assume that buybacks will slow or cease in coming quarters since you're below that?

We'll probably slow down buyback activity, but we're obviously always alert for what's going on in the market. I would say that 8% we've viewed as being a more intermediate term goal.

Okay. And then Susan, just following up on your margin comment, assuming that we sort of follow the forward curve and given the balance sheet changes that you're making, where do you think the margin sort of bottoms out, roughly what level?

Well, we ended March with - for the month, NIM about 217. But that does not include the full run rate of about $350 million worth of swaps we put on. So, everything else being equal, Mark, I would think maybe a couple more basis points down from where we are. But I think the Fed is mostly finished raising rates, at least I hope they are, or closer to the end than the beginning, and I think the majority of the NIM compression is baked in, but there's still potential a little bit more to go.

I would also add that in the last quarter or so, there's been very, very intense competition associated with two players in the market that we're trying to get out of the crypto exposure, one of which is no longer out there. So, I think we'll see a little bit less intensity in terms of the deposit competition. These are direct competitors of ours.

Okay. And then given your comments about the Fed being close to the end, and we've already got rates up, what, 475 basis points, it strikes me that this is an odd time to be changing your liability-sensitive position. Wouldn't it be arguably the worst time to becoming less liability-sensitive?

So, when you look at our balance sheet, as Susan mentioned, we've got assets that that reprice quite a bit more slowly than the liabilities. So, we think over time we need to bring those things more into alignment. Certainly, we're going to be cognizant of what's happening on a day-to-day basis as we move toward a more intermediate term goal. But we do want to have a more balanced balance sheet, a more safe interest rate risk position. And as you know, none of us know where rates are going to go. They certainly can go down shortly. And they could clearly go up again if inflation rears its head again. But the hedging is very, very valuable to us. One of the other positive aspects of our hedging strategy is that it has protected us from an AOCI perspective as well. So, all in all, we think there's been great benefit with our hedging strategy that now has about $1.6 billion, $1.7 billion worth of protection in place.

Thank you.

Our next question comes from Chris O'Connell with KBW. Please go ahead.

Hey, good morning. Just following up on one of the last questions, if I heard right, did you say only two basis points give or take of margin compression expected beyond the 217 NIM at March?

No, I did not say that. I wouldn’t put a quantity on it, Chris. There are some moving parts, as we talked about. John mentioned the lessening of competition or - but there's rate moves still to occur. The Fed’s closer to the end than the beginning, but I think there's still some compression to come in our NIM, but it won't be as great as what we've seen in the past.

Got it. And how late in the quarter were the hedges in the derivatives put on?

The second half of March, really. So, they only have a couple of weeks baked in.

Okay, great. And I was just hoping you could provide a little bit more color as to the overall expense plan that you're taking a look at, and what areas you're looking to keep expenses more contained versus previously, and perhaps if there's any further opportunities that you'd be looking at as you get further on into the year, into 2024.

So - oh, go ahead, John.

I mean, there's a series of initiatives that we will either - that we've either canceled or delayed to a later date. Clearly, all of our compensation structures are associated with performance. So, that would be impacted. We're reducing marketing expenses. We're reducing compensation expenses. There's a whole variety of more discretionary expenses that we're able to reduce without really disrupting the core of the business. We do have a very valuable franchise that we’re looking ahead to 2024 and making sure that we are in a good position to take advantage of a better environment.

Got it. Thanks. And then just on the credit commentary, I believe you said there's $4 million specific reserve this quarter for line of credit. Is that fully reserved for?

Yes. At this point, there was a little bit of provision taken in prior quarters, but it is now fully - has a specific allowance associated with it for the full $4 million.

Okay. Got it. And I know you guys said you've taken a closer look at kind of overall credit quality and risk framers going forward. Just maybe any details as to what specifically you're looking at, and any kind of color you could give there?

Obviously, we’re very focused on looking at recession-proof industries and maintaining our traditional strong standards with respect to real estate, which we're very, very comfortable with. I think it's mostly in the area of anticipating possible recessions and staying away from industries that - travel, discretionary spending industries. We don't have any exposure to consumer. We have very, very limited exposure to Midtown Manhattan office space, less than 0.001%. So, in general, we're in very good shape in that regard, but there's always little nuances that take places associated with what's going on in the market on a day-to-day basis.

Great. And then last one for me, just switching back to the balance sheet, I think you mentioned a little bit of seasonality in the deposits for the summer periods. If you could just go over and remind us as to what that seasonality is, and maybe obviously a difficult environment, but what type of moves kind of you're expecting there for the next couple of quarters, that'd be great.

So, there's seasonality in our government banking portfolio, Chris. A lot of places get the money and then it flows back out. So, the summer months are just a low period for us historically because of the government funding.

Yes. Any quantitative qualifiers as to what the typical impact is as far as outflows?

I want to say - I would have to go back and look to be sure, but it seems to me that last year for the second quarter, our loan to deposit ratio was probably the highest it was all of last year. So, I would have that same expectation this quarter.

Okay. All right. Thanks for taking my questions.

Our next question comes from Manuel Navas with D.A. Davidson. Please go ahead.

Hey, good morning. So, if the Fed pauses as kind of expected and there's a lag before your NIM starts to benefit, how fast or how quickly could the NIM benefit when it does start to move up on a pause?

We expect within a couple of quarters that we can start to see the NIM start to recover.

Historically, it's been about two quarters, so we don't say any reason why that - why history would not repeat itself, to give you some context.

Is this speed going to be similar to the past or can we put out like five to 10 basis points, or what would be - after those two quarters, in the third quarter, how fast could the NIM rise?

It depends on what it stops and what we have repricing on the loan side, but it's not going to be a sharp V up. It's going to be a longer slope to get us back up on the NIM side.

Okay. Did any of your actions slow that slope, like moving to neutral, adding hedges, or are you trying to thread a needle where you can still have that same slope recovery of NIM with your current hedging action?

So, that slope that we're talking about, in the absence of a reduction in the Fed's rates, is really dependent upon the movement of our contractual loan repricing. If you're talking about the Fed reducing rates in the end of the quarter, our liability sensitivity would override any type of hedging strategy that we put in place over that time period. So, we would expect - in an environment where the Fed reduced rates, we would expect that the margin improvement would accelerate.

Okay. And that acceleration …

If it makes a stop, it'll be that slower movement. Sorry. I'm sorry.

No, no. I'm just wondering because there is tradeoffs to some of your actions. I'm just trying to identify if there's any loss of potential recovery down the road and if there's any way to quantify it, like NIM recovery down the road.

If rates are reduced - so nothing that we're doing should impact our ability to recover the contractual repricing of the loan portfolio. On the other hand, if some of the funding swaps that we put in place could somewhat mute the ability to gain from the repricing downward that the Fed might take. However, given the degree of liability sensitivity, that liability sensitivity, even today, far outweighs the - and would give a much more significant benefit than any hedging strategy that we put in place. So, the net-net would be a positive for us.

So, Manuel, if we look at like the funding swaps, we are - the underlying is at 484, and we're paying 255. So, the Fed would have to drop rates 230 basis points, if my math is correct, before we had any detriment to our earnings stream for that specific hedge item. So, you're right. There are tradeoffs, but when we put this on, we very carefully evaluate in various rate scenarios what would happen with the various actions we’re taking.

Okay. I appreciate that. That's good. To shift topic a little bit, is the line of credit that has come up in questions, is that the - where that 9% reserve on $23 million in SBA loans sit? If not, any color on that high reserve portion for that portfolio.

No. It is not in that. That portfolio has a high reserve ratio because of the amount of losses we have historically had in that before we - there was an older program we were in, and the losses are encapsulated in there and it's still bleeding, if you will, through the CECL calculation.

Got it. Okay. And then …

Our SBA portfolio, by the way, is very small.

It's small.

Yes, it is very small, and you've fully reserved there. It’s just sitting there.

Yes.

Okay. And then my last question is, is there any ability to time some of the Signature benefits? Your pipeline's already going up on the loan side. It seems like you believe that deposit competition might come down a bit on the pricing side, and then there's talent out there. Am I thinking about it the right way for those three dimensions, and can you speak to the timing of those three dimensions for the Signature benefit?

So, I don't think we can really talk specifically about the timing, but we are seeing activity in all three of those dimensions at this time.

Thank you. I appreciate that.

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

Well, thank you, everybody, for joining us today on our first quarter 2023 earnings call. We appreciate your continued support of Flushing Financial Corporation, and we look forward to talking to you next quarter. Thank you again. Bye.

Thank you.

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