2023-07-27 09:51:00 ET
Summary
- Flushing Financial saw its net interest margin decrease by 8 bps on a QoQ basis.
- This could be the sign of a bottom, but about $425M of time deposits will become due in the next six months.
- The increased interest expenses from those time deposits could be covered by the repricing of almost $500M in loans.
- Don't expect too much from this year's EPS, but it looks like the worst is behind us.
Introduction
In my previous article on Flushing Financial ( FFIC ) I was caught between a rock and a hard place as the bank was getting very interesting from a balance sheet perspective (trading at just 50% of its tangible book value) but I expected the earnings to remain under pressure. While the net interest margin is definitely still contracting, it's starting to look like the bottom might be in. This still means the full-year EPS will be rather disappointing but I think we can expect an expanding net interest margin again in 2024 which will ultimately fuel the earnings. And of course, with a real estate loan book with an average LTV ratio of less than 40%, I’m not worried about the quality of the loan book.
The Net Interest Margin decreased less than I had feared
It probably isn’t a surprise the focus this earnings season is on the net interest margin as this ultimately drives the net income as banks like Flushing Financial usually do not generate any non-interest income.
And the net interest margin did indeed decrease again but the move was smaller than I had anticipated. While the net interest margin was down about 116 bps versus one year ago , the QoQ decrease was just 8 basis points. While the net interest income still decreased, it looks like we're now rapidly reaching a turning point. As you can see below, the total interest income increased by almost 5% on a QoQ basis while the interest expenses increased by about 15%. In absolute terms, the net interest income decreased by just $2M on a QoQ basis, which definitely is a slowdown compared to the $7M decrease in Q4 2022 followed by a $9M net interest income decrease in the first quarter of this year.
The income statement also shows the bank reported a net non-interest expense of just over $30M which is an improvement compared to the first quarter of this year. This brought the pre-tax and pre-provision income to $13.2M, which is still lower than the $14.5M in Q1, but at least this decrease is manageable. And exactly because the loan loss provisions were lower in the second quarter compared to the first quarter, the pre-tax income increased to $11.8M on a reported basis which resulted in a net income of $8.6M which represented an EPS of $0.29.
This brings the H1 EPS to $0.46 per share and the Q3 result immediately puts one of the main questions I had in my previous article to rest. I wasn’t quite sure if Flushing should continue to pay its dividend at the current rate of $0.22 per share per quarter. While the dividend was indeed not covered in the first quarter, it was definitely covered in the second quarter, and even if you’d look at the results of the first six months of the year, the dividend was covered during that six month time frame.
And it’s not really a surprise to see the provision for loan losses decrease. After all, Flushing Financial’s loan portfolio is very robust. First of all, as you can see below, the majority consists of residential real estate.
While I like that, I also acknowledge there has been some uncertainty around the New York housing prices but I don’t expect Flushing to run into any issues there as the average LTV ratio of its loan book is less than 36% . And even in the non-owner occupied Commercial Real Estate portfolio, the LTV ratio is just 50%. This means the $1.9B in loans is backed by $3.8B in collateral. Even if that collateral would lose 40% of its value since underwriting the loans, the bank would still be able to recoup its entire investment. Also important: Manhattan office loans represent just 0.6% of the net loans.
FFIC Investor Relations
The clock is ticking (in a good way): $2B of loans will be repriced within the next 2.5 years
One of the main reasons why I'm bullish on Flushing Financial was the deep discount to its tangible book value. And even after the bank’s recent share price increase, there still is a double digit discount to the tangible book value of $22.51/share. Based on the current share price of around $16, the stock is currently trading at just over 0.7 times the tangible book value.
I also expect the net interest margin and net interest income to bottom out relatively soon. As you can see below, about $ 458M in loans will be repriced before the end of this year which should result in a 200 bp increase in the cost of debt, adding about $9M in interest income.
A similar spread could be expected in the next two years when an additional $1.5B in loans will have to be repriced likely at a 220-230 bp increase . Even if I’d use an increase of just 200 bp, this would add about $30M in interest income. While the interest expenses of Flushing will likely also increase, the additional $40M in interest income (which works out to about $10M per quarter) will definitely be helpful).
Investment thesis
While I still don’t think we will see a full-year EPS of in excess of $1 (except in the scenario where the bank’s loan loss provisions would drop to zero or where some of the H1 provisions will be reversed), I do expect the EPS to increase again in 2024 on the back of the gradual repricing of the loan book.
I think the dividend will now be covered on a full-year basis, and I still think the loan book with an average LTV ratio of less than 40% offers an additional margin of safety. And as the stock is still trading at a discount of approximately 30% to its tangible book value, Flushing Financial is still appealing. I currently have a long position in Flushing Financial and am now satisfied with the financial performance.
For further details see:
Flushing Financial: Trading At 0.7x TBV, 5.4% Yield Is Covered