Welcome to Flushing Financial Corporation's fourth quarter and full year 2022 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. 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 touch-tone phone. 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 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 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'd now like to introduce John Buran, President and Chief Executive Officer, who will provide an overview of the strategy and results. You may begin.
Thank you, operator. Good morning, everyone. Thank you for joining us for our fourth quarter and full year 2022 earnings call. Following my prepared remarks, Susan will review the financial trends. We will then answer any questions. The company recorded its second-best historical earnings for 2022 behind the record-breaking 2021 earnings. In spite of aggressive Fed movements and resulting net interest margin compression. For the year, GAAP return on assets was 93 basis points, with a return on equity at 11.4%, while core return on assets totaled 92 basis points, with return on equity at 11.4%. Returns were within our goals of 1% and 10%, respectively. We executed well on our strategic objectives for the year. Average non-interest-bearing deposits increased 10% year-over-year.
Period-end loans expanded by 4%, and net charge-offs were only 2 basis points for the year. We capitalized on the merger disruption in our market by adding 51 people from merged or merging institutions. Trends in the fourth quarter were more challenging given the rate environment. We reported GAAP earnings per share of $0.34 and core EPS of $0.57. This translated to a return on assets of 48 basis points and a return on equity of 6% on a GAAP basis and 82 basis points and 11.4% respectively on a core basis. The primary difference between GAAP and core earnings is the approximate $11 million loss on the sale of securities that yielded approximately 1%.
Core loan yields increased 28 basis points quarter-over-quarter, while core deposit yields expanded 87 basis points, resulting in net interest margin compression of 37 basis points on a reported basis and 40 basis points on a core basis. After a lag, we expect the net interest margin to expand from contractual loan repricing. The yield on the originated loans increased 150 basis points quarter-over-quarter and 259 basis points year-over-year. Loan closings and the loan pipeline have declined from record levels earlier in 2022 due to higher rates suppressing demand and our greater emphasis on full banking relationships. For the quarter, average non-interest-bearing deposits increased slightly year-over-year, and the overall deposit mix has shifted more to CDs.
The loan to deposit ratio improved to 107% as of December 31st, compared to 114% at the end of the third quarter as deposits grew more quickly than loans. Asset quality remains solid with low charge-offs, Non-Performing Assets of only 63 basis points, strong debt service coverage ratios, and low average loan to value ratios. We continue to hire people from institutions within our markets that are or were involved in a merger. We're managing the balance sheet to deal with the rising rate environment while maintaining our focus on credit quality. On slide four, you can see the annual trends for the past six years. We feel looking at annual trends provide a better perspective compared to the quarter-over-quarter volatility. You can see, we reported record levels of GAAP and core earnings in 2021.
Coming off this record level in 2022, we reported the second highest GAAP in core earnings. As we've said many times, credit quality is important to our company and the trends remain solid as net charge-offs were below 10 basis points for the past five years. We continue to prudently manage and have the appropriate levels of capital. Book value and tangible book value per share grew every year except when we acquired Empire in 2020. We recaptured the effects on tangible book value for the Empire purchase in approximately nine months. We believe this is a good view of our track record and our ability to adapt to different environments. Slide five shows what we believe are the three important macro issues facing the banking industry today. Credit quality, liquidity, and interest rates. Flushing Bank has a long history of sound credit quality over several cycles.
Our conservative underwriting standards have served us well in the past and will continue to serve us well in the future. The combination of low average loan to values and high debt service coverage ratios means our borrowers have substantial investment in their properties and have the ability to make payments even with a significant increase in rates. We are also conservative in liquidity management. We have over $3 billion of unused lines of credit available, and our liquidity to assets ratio at the bank is 43%. Unlike others, we were able to grow period end deposits both quarter-over-quarter and year-over-year. Interest rates are pressuring our net interest margin in the short term. After the Fed stops raising rates and a lag, the funding pressure should ease and the benefits from contractual loan repricing should become more evident.
In the meantime, we're becoming more disciplined on originations to ensure risk-adjusted returns are achieved. Over time, we expect our interest rate positioning to move towards neutral. Bottom line, while the macro environment is becoming more challenging for the industry, our balance sheet today is well-positioned to handle the credit quality and liquidity challenges with the outlook for interest rates expected to move in our favor shortly after the Fed stops raising rates. Slide six depicts the growth in our digital banking platforms. We continue to see high growth rates in monthly mobile deposit active users with active online banking status, and digital banking enrollment. The Numerator platform, which digitally originates small dollar loans as quickly as 48 hours, continues to grow. We originated approximately $23 million of commitments in 2022. Most of these commitments have an average rate that is greater than the overall portfolio yield.
We continue to explore other fintech product offerings and partnerships. Fourth quarter has several important events to highlight, as you can see on slide 7. We signed a lease for a Bensonhurst branch, which expands our Asian banking footprint. This branch is expected to open in 2023. We maintained our investment grade rating from Kroll Bond Rating Agency. Community support is one of the key pillars of the bank, and we're proud to contribute to transforming Queens into a leading hub of innovation and technology. Lastly, we were very happy to participate in the ribbon-cutting ceremony for the Charles B. Wang Community Health Center as we were a significant participant in the financing. I'll now turn it over to Susan to provide more detail on our key financial metrics. Susan?
Thank you, John. I'll begin on slide eight. As John mentioned, deposit growth is a challenge for the industry as the Fed raises rates and liquidity leaves the banking system. Our results are contrary to this trend by growing average deposits 3% year-over-year and 6% quarter-over-quarter. 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 increased slightly year-over-year and comprise nearly 15% of average deposits. Our teams continue to open new checking accounts, which were up 41% year-over-year. Our incentive plans place greater emphasis on increasing non-interest bearing deposits. CDs continue to expand as customers are seeking higher yields.
The increase in the deposit base assisted in lowering the loan to deposit ratio to 107% from 114% at the end of the third quarter. Slide nine shows how our deposit rates change compared to Fed Funds. For 2022, our cumulative interest-bearing deposit beta was just over 45%, which has exceeded the previous rising rate cycle. The key difference in this cycle versus the prior one is the magnitude and frequency of rate increases. In this cycle so far, average Fed Funds have increased 357 basis points compared to only 226 basis points in the previous cycle. We expect the cumulative deposit betas to rise as rate increases continues. We expect the majority of deposit pricing will be included in the cost when the Fed stops increasing rates.
Slide 10 outlines our loan portfolio and yields. Net loans increased 4% year-over-year. As expected, loan closings and the loan pipeline have declined from the record levels seen in previous quarters. Core loan yields increased 28 basis points during the quarter, and the yields on loan closings exceeded the yields on satisfactions by 47 basis points. Loan repayment speeds also declined year-over-year and quarter-over-quarter as higher rates are impacting refinancing activity. Prepayment penalty income declined slightly to $1.2 million in the fourth quarter from $1.5 in the quarter a year ago. Slide 11 provides more detail on the contractual repricing of the loan portfolio. A little over $1 billion or 15% reprices with each Fed move, the majority of the loan portfolio reprices over time.
Another approximate $1 billion or 14% of loans will reprice in 2023, followed by $758 million or 11% in 2024. As of December 31st, 2022, these loans are expected to reprice over 200 basis points higher. This does not consider any future Fed rate moves, which could push the contractual repricing rates up even further. This repricing is what should drive net interest margin expansion once funding costs stabilize. Slide 12 outlines the net interest income and margin trends. The GAAP net interest margin declined 37 basis points to 2.7% during the fourth quarter. Net interest income decreased 11% quarter-over-quarter to $54 million.
Core net interest income, which removes the impact of net gains from fair value adjustments and purchase accounting accretion, decreased 12% quarter-over-quarter as the core net interest margin declined 40 basis points to 2.63%. Core deposit yields increased 87 basis points this quarter compared to a 28 basis point increase in core loan yields. We often get asked when the net interest margin will bottom out and when it will start to expand. On slide 13, we provide a look at what happened during the last rising rate cycle. The net interest margin bottomed out approximately two quarters after the Fed stopped raising rates. We are expecting a similar path this cycle, there are important differences. First, the Fed raised rates over a longer time in the prior cycle. Second, the amounts the Fed increases are greater this cycle.
Thirdly, the magnitude of the rate increases has been greater this cycle versus last. All of these items will have an impact on when and where the net interest margin will bottom out. Additionally, loan growth and the competitive environment for incremental funding will be important considerations in the margin recovery. On slide 14, we outline our funding swap portfolio, which is in place to help mitigate the impact on net interest margin from rising rates. As we have talked about in prior quarters, we have funding swaps that will mature and will be replaced with other swaps at lower funding rates. By the end of 2023, $600 million of swaps will reprice 65 basis points lower.
During the fourth quarter, we terminated certain swaps and locked in a six and a half million dollar gain that will be amortized into net interest income over the original swap life. This transaction had the effect of locking in gains while pulling some of the benefit forward. We also have $384 million of swaps converting fixed rate loans into floating. Moving on to asset quality on slide 15, we have a long history of solid credit quality as a result of our low risk credit profile and conservative underwriting. Net charge-offs were only 5 basis points for the quarter and 2 basis points for the year. Our low risk credit profile and conservative underwriting has served us well through many cycles. As you can see, our losses have been well below the industry.
We expect limited loss content in the loan portfolio if there is an economic downturn due to greater than 88% of the loan portfolio is secured by real estate with an average loan to value of less than 37%, and the weighted average debt service coverage ratio is 1.7x and over 1.15x in a stress scenario for our multifamily and investor commercial real estate portfolios. These factors contribute to our expectation of low loss content within the portfolio. Slide 16, our allowance for credit losses is presented by loan segment. Overall, the allowance for credit losses to loans ratio decreased 1 basis point to 58 basis point during the quarter. Non-Performing Assets increased slightly during the quarter, and the loan to value on these assets is 52%.
Criticized and classified loans decreased to 98 basis points at the end of the quarter compared to 89 basis points for the prior quarter. As you can see, our levels of criticized and classified loans are at lower levels than our peers. The coverage ratio is 125%, meaning we have approximately $1.25 reserved for each dollar of Non-Performing Assets. Because all of these factors, our allowance differs from peers largely due to low mix, as we have a higher percentage of real estate collateral at a low average loan to value. We remain very comfortable with our credit risk profile and continue to expect minimal loss content. Our capital position is shown on slide 17. Book value and tangible book value per share increased during the quarter.
We took advantage of the attractive stock price in repurchasing nearly 375,000 shares during the quarter and returned 71% of annual earnings through dividends and share repurchases. The tangible common equity ratio increased 20 basis points quarter-over-quarter to 7.82%. In the short-medium term, the company will maintain its target of 8% tangible capital ratio while balancing the attractiveness of share repurchases. Slide 18 outlines the notable pre-tax effective items for the fourth quarter. First, we sold $84 million of low-yielding mortgage-backed securities for a loss of approximately $11 million. We are currently reinvesting these proceeds and expect to have an earn back period of three years or less.
Second, we received an employee retention tax credit refund under the CARES Act of approximately $1.4 million, which was partially offset by an increase in professional fees paid to obtain the refund. A lower discount rate was required for certain benefit plans, creating a $2.8 million expense reduction. These two expense reduction items are included in core expenses. Absent these two items, non-interest expenses would have totaled $37.9 million. Turning to slide 19, I'll provide some color on the outlook. As a reminder, we do not provide guidance, so this is meant to write our thinking in this challenging environment. With higher interest rates and greater emphasis on full banking relationships, loan closings are expected to decline versus 2022. However, we expect prepayment speeds to continue to decrease as well.
Overall, loan growth is expected to be tempered in 2023. There will be less need to grow funding with limited loan growth. As we have outlined in the past, we have a liability-sensitive balance sheet and expect the interest rate margin will remain under pressure as long as the Fed continues to raise rates. While we have a significant benefit from contractual loan repricing over the next several years, there will be a lag from when the Fed stops raising and the net interest income bottoms out. Non-interest expense is positively impacted by several benefits in the fourth quarter, but there will be headwinds in 2023 from increased FDIC deposit and medical insurance premiums. Overall, non-interest expense is expected to increase by low double-digit percentage points in 2023 off the reported base of $144 million.
As a reminder, we have 3 million- $3.5 million of seasonal expenses in our first quarter compared to the fourth quarter. We expect the tax rate for 2023 to approximate 24%-25%. I'll now turn it back over to John.
Thank you, Susan. Slide 20 shows our strategic objectives for 2023. As Susan just outlined, the environment is challenging, but we will navigate through and focus on what we can control. We're looking to expand our funding sources with a particular emphasis on non-interest-bearing accounts. We will place greater emphasis on full relationships across business units while generating appropriate risk-adjusted returns. We will not change our underwriting model as credit quality is an important metric for us. Lastly, we'll continue to expand our technology platform to drive engagement and upgrade where appropriate. On slide 21, I'll wrap up our key messages. While 2022 was an unprecedented year, given the pace of Fed rate increases, we had our second highest annual earnings. Strong credit quality is a pillar of the bank, and our conservative underwriting should help to protect us from significant losses even during times of stress.
We are managing through the higher rate environment and should start to benefit after a lag once the Fed stops raising rates. There's a greater emphasis on full banking relationship lending and achieving proper returns. Our stock has a strong dividend that approximates 4.5%, and we will continue to balance repurchasing shares with a desire to move toward an 8% tangible common equity ratio. Operator, I'll turn it over to you to open up the lines for questions.
Thank you. We will now begin the question-and-answer session. To ask a question, you may press star then one on your touch-tone phone. If you're using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then two. At this time, we will pause momentarily to assemble our roster. Our first question will be from Mark Fitzgibbon from Piper Sandler. Please go ahead.
Hey, good morning, everyone. This is Greg-
Good morning, Mark.
Morning.
It's actually Greg. I was stepping in for Mark at the moment, but...
Oh, hi.
Oh, hey.
How are you?
Do you think there are any more security portfolio sales likely in the coming quarters ahead?
We continually evaluate the portfolio in light of the market. You know, if we see an opportunity that presents itself, I wouldn't say no, but at this point, there's no plans on the table.
Okay. How low do you think the NIM goes if the Fed follows the forward curve? A rough ballpark, do you think?
You know, as we talked about, the NIM has many moving components. It's, you know, our loans repricing, the swaps, the local market competition and what the Fed does, you know. Where we bottom out will all depend on where the Fed moves rates and how quickly they stop raising rates. Then we'll have that slight lag before we start coming back to expanding NIM.
Okay. Lastly, if growth tapers, how do you think we should think about provisioning over the coming quarters? Thanks.
If loan growth tapers, we will expect the, you know, the allowance always depends on the economic forecast as we do the CECL modeling and the mix of our loans. It, you know, if the economy continues on this uncertain path, we may see more provisioning. Next question, please.
Mark.
Our next question is from Christopher O'Connell with KBW. Please go ahead.
Hello, Chris.
Hi, Chris.
Hey, good morning. Just on the, just to nail down the operating expense guidance, and the seasonality for the first quarter, Well, I guess, first off, how much is the additional FDIC impact for next year?
The FDIC raised the premium across all banks as the Deposit Insurance Fund is underfunded. All of us will be increasing the insurance premium from 1 basis point- 2 basis points on deposits.
Got it. Do you know what the dollar impact is?
We won't give that type of guidance, Chris, but, you know.
Should be able to figure that out.
It should pretty much double.
Yeah.
Okay, great. Just kind of putting, you know, it all together with some of the kind of one-time stuff, from this quarter, is, like, 41.5 a good expense number for the first quarter with the seasonality?
Yeah, that would be about right, I think.
37 + 3.5
[3.4]
3.5
Yeah. low forties, yes.
Okay. Got it. you know, appreciate the color on the, you know, overall NIM trajectory, just trying to, you know, figure out, you know, how big the moves are in the near term, do you guys have a spot rate for the end of quarter NIM at the end of the fourth quarter?
Yeah, we have not provided that as we may have in the past because we don't think it's representative necessarily of what our GAAP NIM will be or what our reported even core NIM will be. You know, we will not be providing that information.
Okay. I mean, any color that you can give on kind of the sense of the magnitude of the compression, you know, just in the immediate near term?
I mean, you have a, you have a move that, I mean, looked for a while like it was gonna be 25 basis points in February. Now there's even talk of it might be 50. You have that uncertainty to begin with. We do have within our market, a couple of, you know, crypto related banks that have upped the ante in terms of in terms of looking over, you know, looking for deposits. I, I think quite frankly, there's too many factors going on and too many moving parts to give, you know, to give any reasonable, you know, reasonable guidance. I think your assessments on these, on these things and these activities are no better, no worse than ours at this point.
You know, I think the important thing to remember about us, and you can kind of watch it as time goes on, is that, it's unclear, how much and how long the Fed will raise rates. We've got some projections, but those projections, you know, run from the Fed to the market. Futures contracts look like the bulk of the rate increases have already happened. After fully absorbing the December rate increase, the incremental pressure might in fact ease, as the Fed raises rates by smaller amounts than the 75 basis points that we've seen for the bulk of 2022.
We're kind of looking at the possibility of a declining, you know, maybe some declining pressure, although continued, you know, continued pressure, maybe declining magnitude, let's say, or declining incrementals. You know, the market believes that the rate and the magnitude of the Fed rate increase should slow. That should help slow the pressure on our funding costs. You know, we think after the first quarter, a lot of this will be behind us. You know, we may see another quarter or so of, you know, clearly, there's a lot of speculation about that. You know, one thing is certain, and that's the structure of our balance sheet.
You know, Fed increases don't last forever. This one looks like it's coming more to a close than to a beginning. I think we're in a very, very good position toward the latter half of the year to see some better movement in the margin, whether it's stabilization or increase as a matter of what's happening in the market.
Yep, got it. Understood. As far as, you know, the current CD offering rates, you know, where are those at right now?
We have a 13 month at four to quarter, 4.60.
Okay. That's the primary product for you guys?
Our primary product's probably the money market.
Money markets.
Where are those at?
They're like 3.25 .
3:35.
Okay, great. Then for the securities move, this quarter, you know, what's the timing of the, you know, reinvestments of what was paid off? I guess, like what's the assumed spread or what's the, you know, assumed rate that those are coming on at and where they're being funded at?
We have already purchased about $10 million of floaters with a yield of about 5.5, their SBA floating bonds. The expectation is that they will continue to come on in that range or even higher. Again, we are ensuring that we are keeping within the three-year payback period.
Got it. What's the spread or I guess the assumed, you know, funding for those?
Well, we took off securities that had a yield of 1.17, so we're bumping up the NIM, you know, by that differential, 430 basis points, rough and tough.
Okay. Got it. I mean, are you guys locking in, like in particular, any, you know, type of funding, you know, directly tied to those or just in general, like the overall new funding costs?
We have a variety of funding sources that, obviously we have a good deal of flexibility in matching the, you know, matching the assets.
Okay. Got it.
When we sold these securities, we didn't pay off any funding. Most of the funding or the proceeds are sitting in the Federal Reserve Bank yielding 4.4% versus, you know, the 1.17% that we were getting on the security.
Got it. Got it.
We're already making-
That's helpful. Any update as the progress towards resolution of the, you know, larger NPA that came on a couple quarters ago?
We're still working through those. I'm glad you asked this question, Chris. We did, you know, even though some classifieds and criticized ticked up 9 basis points, approximately $7 million of that has resolved itself subsequent to quarter end. Our NPAs, as we're sitting here today, are really down 1% quarter-over-quarter.
Okay, great.
I'm sorry. I misspoke. Our criticized classifieds are down 1% quarter-over-quarter.
Got it. Is that $7 million related to that particular credit or just any update, I guess, on that, you know, relationship?
The $7 million is not related to the big held to maturity security that is driving the increase in our NPAs. That is still working its way through the process. We're still very careful with that security/loan, and we don't have any further details on any resolution at this point.
Okay. Got it. Thanks for taking my questions.
Thanks, Chris.
If you would like to ask a question, please press star then one. The next question is from Manuel Navas from D.A. Davidson. Please go ahead.
Good morning.
Hey, good morning.
Good morning. I really like the slide four and slide 13. I just wondered, if the scenario is a little different, what happens if the Fed pauses and then holds? Basically, do you need the Fed to actually start declining for your NIM to have that kind of inflection? Just kind of talk about that scenario where the Fed holds for a bit.
The Fed-- the loans will continue to be coming on. Right now, loans are either being rolled-- they're either rolling off or at, you know, for example, at a three handle because we've been put on for quite a while. The loans that we're putting on right now, this past quarter had a six handle. We're talking about a very, very nice increase in the NIM just by stability taking place. I didn't mean to say an increase in the NIM, but obviously the a positive pressure in the NIM. Let's just say that. Obviously-
Got it.
that's part of it.
Okay. It seems like it kind of really took off once the Fed declined. You know, there's a number of different factors at play. Do you have a update on? With the current market offers you have out there, are you seeing success? You talked a little bit about, you had success this past quarter. Are you seeing continued success, and you're talking about kind of, competition shifting a little bit? You're seeing more players competing for deposits. Can you just kinda talk about those two items?
Sure. Look, it's always a competitive environment in New York. You know, this one has been heightened due to the Fed activity and the removal of liquidity from the market. You know, we're looking at other vehicles to compete in maybe areas that might be a little bit less competitive, you know, outside of the New York metropolitan area as a means of, let's say, compensating for the intense level of competitiveness in New York. You know, I think it's always a competitive market here.
There's a couple of, you know, a couple of things that I think are probably going to right themselves in a few, you know, in a couple of quarters in terms of the extreme competitiveness. You know, at the end of the day, most of the market in New York is controlled by a few very, very large banks. They have a lot to protect in terms of their cost of funds. That always has a little bit of a dampening effect, although we haven't quite seen it yet. I expect that we will see it going forward.
I appreciate that. Thank you.
Ladies and gentlemen, this concludes our question and answer session. I would like to turn the conference back over to John Buran for any closing remarks.
Well, once again, I thank you all for your attention and for calling in and for the questions. Just again, I think that our net message is that we've got a very strong balance sheet, very strong credit quality. You know, this environment doesn't last forever, and we're looking forward to a better opportunity as the Fed starts to reduce some of its aggressive moves. Thank you again for your attention, and look forward to talking to you all soon.
Have a nice weekend. Thank you.
Bye now.
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.