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FLUSHING FINANCIAL CORP - Quarter Report: 2014 June (Form 10-Q)

f10q_081114.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2014

Commission file number 001-33013

FLUSHING FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)

Delaware
(State or other jurisdiction of incorporation or organization)

11-3209278
(I.R.S. Employer Identification No.)

1979 Marcus Avenue, Suite E140, Lake Success, New York 11042
(Address of principal executive offices)

(718) 961-5400
(Registrant's telephone number, including area code)

 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.       X  Yes          No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).      X   Yes           No
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer __
Non-accelerated filer   __
Accelerated filer     X
Smaller reporting company  __
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).          ___Yes      X   No

The number of shares of the registrant’s Common Stock outstanding as of July 31, 2014 was 30,194,640.

 
 

 
TABLE OF CONTENTS

 
PAGE
 
 
 
 
 
 
 
i
 
 

 
PART I – FINANCIAL INFORMATION

FLUSHING FINANCIAL CORPORATION and SUBSIDIARIES
Consolidated Statements of Financial Condition
(Unaudited)
Item 1. Financial Statements
 
(Dollars in thousands, except per share data)
 
June 30,
2014
   
December 31,
2013
 
ASSETS
           
Cash and due from banks
  $ 36,982     $ 33,485  
Securities available for sale:
               
Mortgage-backed securities ($5,182 and $7,119 at fair value pursuant to the fair value option at June 30, 2014 and December 31, 2013, respectively)
    770,545       756,156  
Other securities ($33,718 and $30,163 at fair value pursuant to the fair value option at June 30, 2014 and December 31, 2013 respectively)
    288,137       261,634  
Loans held for sale
    -       425  
Loans:
               
Multi-family residential
    1,784,111       1,712,039  
Commercial real estate
    510,224       512,552  
One-to-four family ― mixed-use property
    581,207       595,751  
One-to-four family ― residential
    192,895       193,726  
Co-operative apartments
    9,885       10,137  
Construction
    4,717       4,247  
Small Business Administration
    7,543       7,792  
Taxi medallion
    25,291       13,123  
Commercial business and other
    405,853       373,641  
Net unamortized premiums and unearned loan fees
    10,811       11,170  
Allowance for loan losses
    (29,235 )     (31,776 )
Net loans
    3,503,302       3,402,402  
Interest and dividends receivable
    17,524       17,370  
Bank premises and equipment, net
    19,779       20,356  
Federal Home Loan Bank of New York stock
    51,407       46,025  
Bank owned life insurance
    111,137       109,606  
Goodwill
    16,127       16,127  
Other assets
    38,872       57,915  
Total assets
  $ 4,853,812     $ 4,721,501  
                 
LIABILITIES
               
Due to depositors:
               
Non-interest bearing
  $ 213,263     $ 197,343  
Interest-bearing:
               
Certificate of deposit accounts
    1,159,897       1,120,955  
Savings accounts
    254,665       265,003  
Money market accounts
    272,679       199,907  
NOW accounts
    1,297,480       1,416,774  
Total interest-bearing deposits
    2,984,721       3,002,639  
Mortgagors' escrow deposits
    40,987       32,798  
Borrowed funds ($29,388 and $29,570 at fair value pursuant to the fair value option at June 30, 2014 and December 31, 2013, respectively)
    966,202       856,822  
Securities sold under agreements to repurchase
    146,000       155,300  
Other liabilities
    42,132       44,067  
Total liabilities
    4,393,305       4,288,969  
                 
Commitments and contingencies (Notes 4 & 5)
               
                 
STOCKHOLDERS' EQUITY
               
Preferred stock ($0.01 par value; 5,000,000 shares authorized; None issued)
    -       -  
Common stock ($0.01 par value; 100,000,000 shares authorized; 31,530,595 shares issued at June 30, 2014 and December 31, 2013; 30,185,040 shares and 30,123,252 shares outstanding at June 30, 2014 and December 31, 2013, respectively)
    315       315  
Additional paid-in capital
    205,322       201,902  
Treasury stock, at average cost (1,345,555 shares and 1,407,343 shares at June 30, 2014 and December 31, 2013, respectively)
    (22,048 )     (22,053 )
Retained earnings
    276,269       263,743  
Accumulated other comprehensive (loss) income, net of taxes
    649       (11,375 )
Total stockholders' equity
    460,507       432,532  
                 
Total liabilities and stockholders' equity
  $ 4,853,812     $ 4,721,501  

The accompanying notes are an integral part of these consolidated financial statements
 
 
-1-

 
PART I – FINANCIAL INFORMATION

FLUSHING FINANCIAL CORPORATION and SUBSIDIARIES
Consolidated Statements of Income
(Unaudited)

   
For the three months
ended June 30,
   
For the six months
ended June 30 ,
 
(Dollars in thousands, except per share data)
 
2014
   
2013
   
2014
   
2013
 
                         
Interest and dividend income
                       
Interest and fees on loans
  $ 42,489     $ 42,861     $ 84,609     $ 85,801  
Interest and dividends on securities:
                               
Interest
    6,867       7,174       13,742       14,128  
Dividends
    195       236       384       411  
Other interest income
    18       24       45       41  
Total interest and dividend income
    49,569       50,295       98,780       100,381  
                                 
Interest expense
                               
Deposits
    7,670       8,093       15,388       16,384  
Other interest expense
    5,070       4,906       10,076       12,555  
Total interest expense
    12,740       12,999       25,464       28,939  
                                 
Net interest income
    36,829       37,296       73,316       71,442  
(Benefit) provision for loan losses
    (1,092 )     3,500       (2,211 )     9,500  
Net interest income after provision for loan losses
    37,921       33,796       75,527       61,942  
                                 
Non-interest income (loss)
                               
Other-than-temporary impairment ("OTTI") charge
    -       (1,221 )     -       (1,221 )
Less: Non-credit portion of OTTI charge recorded in Other Comprehensive Income, before taxes
    -       718       -       718  
Net OTTI charge recognized in earnings
    -       (503 )     -       (503 )
Banking services fee income
    867       1,228       1,576       2,268  
Net gain on sale of loans
    -       152       -       143  
Net gain from sale of securities
    -       18       -       2,876  
Net loss from fair value adjustments
    (402 )     (308 )     (1,046 )     (431 )
Federal Home Loan Bank of New York stock dividends
    430       401       981       815  
Bank owned life insurance
    755       841       1,531       1,666  
Other income
    336       370       654       713  
Total non-interest income
    1,986       2,199       3,696       7,547  
                                 
Non-interest expense
                               
Salaries and employee benefits
    11,944       10,961       24,522       23,194  
Occupancy and equipment
    1,919       1,856       3,954       3,716  
Professional services
    1,527       1,515       2,737       3,133  
FDIC deposit insurance
    673       786       1,370       1,777  
Data processing
    1,042       1,099       2,110       2,142  
Depreciation and amortization
    717       734       1,432       1,501  
Other real estate owned/foreclosure expense
    279       444       535       1,112  
Other operating expenses
    2,523       2,818       6,057       6,057  
Total non-interest expense
    20,624       20,213       42,717       42,632  
                                 
Income before income taxes
    19,283       15,782       36,506       26,857  
                                 
Provision for income taxes
                               
Federal
    5,513       4,663       10,271       8,124  
State and local
    2,085       1,492       4,254       2,350  
Total taxes
    7,598       6,155       14,525       10,474  
                                 
Net income
  $ 11,685     $ 9,627     $ 21,981     $ 16,383  
                                 
                                 
Basic earnings per common share
  $ 0.39     $ 0.32     $ 0.73     $ 0.54  
Diluted earnings per common share
  $ 0.39     $ 0.32     $ 0.73     $ 0.54  
Dividends per common share
  $ 0.15     $ 0.13     $ 0.30     $ 0.26  
 
The accompanying notes are an integral part of these consolidated financial statements.

 
-2-

 
PART I – FINANCIAL INFORMATION

FLUSHING FINANCIAL CORPORATION and SUBSIDIARIES
Consolidated Statements of Comprehensive Income
(Unaudited)
 
 
   
For the three months ended
June 30,
   
For the six months ended
June 30,
 
(Dollars in thousands)
 
2014
   
2013
   
2014
   
2013
 
                         
                         
Comprehensive Income
                       
Net income
  $ 11,685     $ 9,627     $ 21,981     $ 16,383  
Amortization of actuarial losses
    98       174       161       348  
Amortization of prior service credits
    (7 )     (6 )     (10 )     (12 )
OTTI charges included in income
    -       283       -       283  
Unrealized gains (losses) on securities, net
    6,513       (15,634 )     11,873       (19,837 )
Comprehensive income (loss)
  $ 18,289     $ (5,556 )   $ 34,005     $ (2,835 )
 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
 
-3-

 
PART I – FINANCIAL INFORMATION

FLUSHING FINANCIAL CORPORATION and SUBSIDIARIES
Consolidated Statements of Cash Flows
(Unaudited)
 
   
For the six months ended
June 30,
 
(Dollars in thousands)
 
2014
   
2013
 
CASH FLOWS FROM OPERATING ACTIVITIES
           
Net income
  $ 21,981     $ 16,383  
Adjustments to reconcile net income to net cash provided by operating activities:
               
(Benefit) provision for loan losses
    (2,211 )     9,500  
Depreciation and amortization of bank premises and equipment
    1,432       1,501  
Net gain on sale of loans
    -       (143 )
Net gain on sale of securities
    -       (2,876 )
Amortization of premium, net of accretion of discount
    3,582       3,750  
Net loss from fair value adjustments
    1,046       431  
OTTI charge recognized in earnings
    -       503  
Income from bank owned life insurance
    (1,531 )     (1,666 )
Stock-based compensation expense
    3,135       2,400  
Deferred compensation
    (1,486 )     (509 )
Amortization of core deposit intangibles
    -       234  
Excess tax benefit from stock-based payment arrangements
    (748 )     (324 )
Deferred income tax provision
    2,745       148  
Decrease in prepaid FDIC assessment
    -       3,287  
Increase in other liabilities
    1,948       7,307  
Decrease in other assets
    1,489       572  
Net cash provided by operating activities
    31,382       40,498  
                 
CASH FLOWS FROM INVESTING ACTIVITIES
               
Purchases of bank premises and equipment
    (855 )     (381 )
Net purchase of Federal Home Loan Bank of New York shares
    (5,382 )     (5,083 )
Purchases of securities available for sale
    (70,871 )     (303,694 )
Proceeds from sales and calls of securities available for sale
    1,871       106,914  
Proceeds from maturities and prepayments of securities available for sale
    47,535       75,567  
Net originations of loans
    (90,946 )     (77,337 )
Purchases of loans
    (12,884 )     (452 )
Proceeds from sale of real estate owned
    2,034       2,834  
Proceeds from sale of delinquent loans
    7,332       20,891  
Net cash used in investing activities
    (122,166 )     (180,741 )
                 
CASH FLOWS FROM FINANCING ACTIVITIES
               
Net increase in non-interest bearing deposits
    15,920       18,164  
Net increase (decrease) in interest-bearing deposits
    (18,405 )     28,362  
Net increase in mortgagors' escrow deposits
    8,189       8,245  
Net proceeds from short-term borrowed funds
    109,000       38,000  
Proceeds from long-term borrowings
    -       149,837  
Repayment of long-term borrowings
    (9,300 )     (79,911 )
Purchases of treasury stock
    (3,285 )     (13,363 )
Excess tax benefit from stock-based payment arrangements
    748       324  
Proceeds from issuance of common stock upon exercise of stock options
    429       235  
Cash dividends paid
    (9,015 )     (7,879 )
Net cash provided by financing activities
    94,281       142,014  
                 
Net increase in cash and cash equivalents
    3,497       1,771  
Cash and cash equivalents, beginning of period
    33,485       40,425  
Cash and cash equivalents, end of period
  $ 36,982     $ 42,196  
                 
SUPPLEMENTAL CASH FLOW DISCLOSURE
               
Interest paid
  $ 25,172     $ 28,319  
Income taxes paid
    12,236       10,732  
Taxes paid if excess tax benefits were not tax deductible
    12,984       11,056  
Non-cash activities:
               
Loans transferred to real estate owned
    655       2,758  
Loans provided for the sale of real estate owned
    308       2,583  
Loans held for investment transferred to available for sale
    -       7,525  
Loans held for sale transferred to loans held for investment
    -       2,214  

The accompanying notes are an integral part of these consolidated financial statements.
 
 
-4-

 
PART I – FINANCIAL INFORMATION

FLUSHING FINANCIAL CORPORATION and SUBSIDIARIES
Consolidated Statements of Changes in Stockholders’ Equity
(Unaudited)
 
 
   
For the six months ended
June 30,
 
(Dollars in thousands, except per share data)
 
2014
   
2013
 
             
Common Stock
           
Balance, beginning of period
  $ 315     $ 315  
No activity
    -       -  
Balance, end of period
  $ 315     $ 315  
Additional Paid-In Capital
               
Balance, beginning of period
  $ 201,902     $ 198,314  
Award of common shares released from Employee Benefit Trust (129,694 and 137,346 common shares for the six months ended June 30, 2014 and 2013, respectively)
    1,975       1,556  
Shares issued upon vesting of restricted stock unit awards (2,500 and 120,014 common shares for the six months ended June 30, 2014 and 2013, respectively)
    9       160  
Issuance upon exercise of stock options (100,625 and 96,925 common shares for the six months ended June 30, 2014 and 2013, respectively)
    296       116  
Stock-based compensation activity, net
    392       (192 )
Stock-based income tax benefit
    748       324  
Balance, end of period
  $ 205,322     $ 200,278  
Treasury Stock
               
Balance, beginning of period
  $ (22,053 )   $ (10,257 )
Purchases of shares outstanding (108,120 and 806,092 common shares for the six months ended June 30, 2014, and 2013, respectively)
    (2,143 )     (12,609 )
Shares issued upon vesting of restricted stock unit awards (188,480 and 176,456 common shares for the six months ended June 30, 2014 and 2013, respectively)
    2,972       2,335  
Issuance upon exercise of stock options (100,625 and 151,355 common shares for the six months ended June 30, 2014 and 2013, respectively)
    1,608       2,056  
Purchases of shares to fund options exercised (63,732 and 112,332 common shares for the six months ended June 30, 2014 and 2013, respectively)
    (1,290 )     (1,750 )
Repurchase of shares to satisfy tax obligations (55,465 and 49,103 common shares for the six months ended June 30, 2014 and 2013, respectively)
    (1,142 )     (754 )
Balance, end of period
  $ (22,048 )   $ (20,979 )
Retained Earnings
               
Balance, beginning of period
  $ 263,743     $ 241,856  
Net income
    21,981       16,383  
Cash dividends declared and paid on common shares ($0.30 and $0.26 per common share for the six months ended June 30, 2014 and 2013, respectively)
    (9,015 )     (7,879 )
Issuance upon exercise of stock options (7,200 and 54,160 common shares for the six months ended June 30, 2014 and 2013, respectively)
    (45 )     (69 )
Shares issued upon vesting of restricted stock unit awards (185,980 and 56,242 common shares for the six months ended June 30, 2014 and 2013, respectively)
    (395 )     (99 )
Balance, end of period
  $ 276,269     $ 250,192  
Accumulated Other Comprehensive Income (Loss)
               
Balance, beginning of period
  $ (11,375 )   $ 12,137  
Change in net unrealized gains (losses) on securities available for sale, net of taxes of approximately ($9,141) and $14,140 for the six months ended June 30, 2014 and 2013, respectively
    11,873       (18,218 )
Amortization of actuarial losses, net of taxes of approximately ($189) and ($270) for the six months ended June 30, 2014 and 2013, respectively
    161       348  
Amortization of prior service credits, net of taxes of approximately $13 and $10 for the six months ended June 30, 2014 and 2013, respectively
    (10 )     (12 )
OTTI charges included in income, net of taxes of approximately ($220) for the six months ended June 30, 2013
    -       283  
Reclassification adjustment for gains included in net income, net of tax of approximately $1,257 for the six months ended June 30, 2013
    -       (1,619 )
Balance, end of period
  $ 649     $ (7,081 )
                 
Total Stockholders' Equity
  $ 460,507     $ 422,725  
 
The accompanying notes are an integral part of these consolidated financial statements.

 
-5-

 
PART I – FINANCIAL INFORMATION

FLUSHING FINANCIAL CORPORATION and SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
 
1.
Basis of Presentation
 
The primary business of Flushing Financial Corporation (the “Holding Company”), a Delaware corporation, is the operation of its wholly-owned subsidiary, Flushing Bank (the “Bank”).
 
The unaudited consolidated financial statements presented in this Quarterly Report on Form 10-Q (“Quarterly Report”) include the collective results of the Holding Company and its direct and indirect wholly-owned subsidiaries, including the Bank, Flushing Preferred Funding Corporation, Flushing Service Corporation, and FSB Properties Inc., which are collectively herein referred to as “we,” “us,” “our” and the “Company.”
 
The Holding Company also owns Flushing Financial Capital Trust II, Flushing Financial Capital Trust III, and Flushing Financial Capital Trust IV (the “Trusts”), which are special purpose business trusts. The Trusts are not included in the Company’s consolidated financial statements as the Company would not absorb the losses of the Trusts if any losses were to occur.
 
The accompanying unaudited consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and general practices within the banking industry. The information furnished in these interim statements reflects all adjustments which are, in the opinion of management, necessary for a fair statement of the results for such presented periods of the Company. Such adjustments are of a normal recurring nature, unless otherwise disclosed in this Quarterly Report. All inter-company balances and transactions have been eliminated in consolidation. The results of operations in the interim statements are not necessarily indicative of the results that may be expected for the full year.
 
The accompanying unaudited consolidated financial statements have been prepared in conformity with the instructions to Quarterly Report on Form 10-Q and Article 10, Rule 10-01 of Regulation S-X for interim financial statements. Accordingly, certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). The unaudited consolidated interim financial information should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2013.
 
2.
Use of Estimates
 
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosure of contingent assets and liabilities at the date of the financial statements, and reported amounts of revenue and expenses during the reporting period. Estimates that are particularly susceptible to change in the near term are used in connection with the determination of the allowance for loan losses (“ALLL”), the evaluation of goodwill for impairment, the evaluation of the need for a valuation allowance of the Company’s deferred tax assets, the evaluation of other-than-temporary impairment (“OTTI”) on securities and the valuation of certain financial instruments. The current economic environment has increased the degree of uncertainty inherent in these material estimates. Actual results could differ from these estimates.
 
3.
Earnings Per Share
 
Earnings per share are computed in accordance with ASC Topic 260 “Earnings Per Share.” Basic earnings per common share is computed by dividing net income available to common shareholders by the total weighted average number of common shares outstanding, which includes unvested participating securities. Unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and as such are included in the calculation of earnings per share. The Company’s unvested restricted stock and restricted stock unit awards are considered participating securities. Therefore, weighted average common shares outstanding used for computing basic earnings per common share includes common shares outstanding plus unvested restricted stock and restricted stock unit awards. The computation of diluted earnings per share includes the additional dilutive effect of stock options outstanding and other common stock equivalents during the period. Common stock equivalents that are anti-dilutive are not included in the computation of diluted earnings per common share. The numerator for calculating basic and diluted earnings per common share is net income available to common shareholders. The shares held in the Company’s Employee Benefit Trust are not included in shares outstanding for purposes of calculating earnings per common share.
 
-6-

 
PART I – FINANCIAL INFORMATION

FLUSHING FINANCIAL CORPORATION and SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
 
Earnings per common share have been computed based on the following:

   
For the three months ended
June 30,
   
For the six months ended
June 30,
 
   
2014
   
2013
   
2014
   
2013
 
   
(In thousands, except per share data)
 
Net income, as reported
  $ 11,685     $ 9,627     $ 21,981     $ 16,383  
Divided by:
                               
Weighted average common shares outstanding
    30,059       30,213       30,022       30,330  
Weighted average common stock equivalents
    31       22       34       27  
Total weighted average common shares outstanding and common stock equivalents
    30,090       30,235       30,056       30,357  
                                 
Basic earnings per common share
  $ 0.39     $ 0.32     $ 0.73     $ 0.54  
Diluted earnings per common share (1)
  $ 0.39     $ 0.32     $ 0.73     $ 0.54  
Dividend payout ratio
    38.5 %     40.6 %     41.1 %     48.1 %

(1)
For the three and six months ended June 30, 2014, there were no options which were considered anti-dilutive. For the three and six months ended June 30, 2013, options to purchase 542,340 shares at an average exercise price of $17.66 were not included in the computation of diluted earnings per common share as they were anti-dilutive.
 
4.
Debt and Equity Securities
 
The Company’s investments in equity securities that have readily determinable fair values and all investments in debt securities are classified in one of the following three categories and accounted for accordingly: (1) trading securities, (2) securities available for sale and (3) securities held-to-maturity.
 
The Company did not hold any trading securities or securities held-to-maturity during the three and six months ended June 30, 2014 and 2013. Securities available for sale are recorded at fair value.
 
The following table summarizes the Company’s portfolio of securities available for sale at June 30, 2014:
 
   
Amortized
Cost
   
Fair Value
   
Gross
Unrealized
Gains
   
Gross
Unrealized
Losses
 
   
(In thousands)
 
Corporate
  $ 110,686     $ 112,577     $ 2,286     $ 395  
Municipals
    133,892       135,262       1,977       607  
Mutual funds
    26,937       26,937       -       -  
Other
    16,343       13,361       -       2,982  
Total other securities
    287,858       288,137       4,263       3,984  
REMIC and CMO
    512,453       514,622       8,616       6,447  
GNMA
    33,588       35,642       2,186       132  
FNMA
    206,666       207,819       4,072       2,919  
FHLMC
    12,236       12,462       267       41  
Total mortgage-backed securities
    764,943       770,545       15,141       9,539  
Total securities available for sale
  $ 1,052,801     $ 1,058,682     $ 19,404     $ 13,523  

 
-7-

 
 PART I – FINANCIAL INFORMATION

FLUSHING FINANCIAL CORPORATION and SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
 
Mortgage-backed securities shown in the table above include three private issue collateralized mortgage obligations (“CMOs”) that are collateralized by commercial real estate mortgages with amortized cost and market values totaling $12.5 million and $12.6 million, respectively, at June 30, 2014.

The following table shows the Company’s available for sale securities with gross unrealized losses and their fair value aggregated by category and length of time the individual securities have been in a continuous unrealized loss position at June 30, 2014:
 
   
Total
   
Less than 12 months
   
12 months or more
 
   
Fair Value
   
Unrealized
Losses
   
Fair Value
   
Unrealized
Losses
   
Fair Value
   
Unrealized
Losses
 
   
(In thousands)
 
Corporate
  $ 49,605     $ 395     $ 9,809     $ 191     $ 39,796     $ 204  
Municipals
    44,859       607       17,307       49       27,552       558  
Other
    6,580       2,982       -       -       6,580       2,982  
Total other securities
    101,044       3,984       27,116       240       73,928       3,744  
REMIC and CMO
    236,976       6,447       89,203       1,022       147,773       5,425  
GNMA
    8,989       132       -       -       8,989       132  
FNMA
    96,273       2,919       -       -       96,273       2,919  
FHLMC
    7,192       41       -       -       7,192       41  
Total mortgage-backed securities
    349,430       9,539       89,203       1,022       260,227       8,517  
Total securities available for sale
  $ 450,474     $ 13,523     $ 116,319     $ 1,262     $ 334,155     $ 12,261  

OTTI losses on impaired securities must be fully recognized in earnings if an investor has the intent to sell the debt security or if it is more likely than not that the investor will be required to sell the debt security before recovery of its amortized cost. However, even if an investor does not expect to sell a debt security, the investor must evaluate the expected cash flows to be received and determine if a credit loss has occurred. In the event that a credit loss has occurred, only the amount of impairment associated with the credit loss is recognized in earnings in the Consolidated Statements of Income. Amounts relating to factors other than credit losses are recorded in accumulated other comprehensive income (“AOCI”) within Stockholders’ Equity.
 
The Company reviewed each investment that had an unrealized loss at June 30, 2014. An unrealized loss exists when the current fair value of an investment is less than its amortized cost basis. Unrealized losses on available for sale securities, that are deemed to be temporary, are recorded in AOCI, net of tax. Unrealized losses that are considered to be other-than-temporary are split between credit related and noncredit related impairments, with the credit related impairment being recorded as a charge against earnings and the noncredit related impairment being recorded in AOCI, net of tax.
 
The Company evaluates its pooled trust preferred securities, included in the table above in the row labeled “Other”, using an impairment model through an independent third party, which includes evaluating the financial condition of each counterparty. For single issuer trust preferred securities, the Company evaluates the issuer’s financial condition. When an OTTI is identified, the portion of the impairment that is credit related, for trust preferred securities, is determined by management by using a discounted cash flow model from an independent third party, with the difference between the present value of the projected cash flows and the amortized cost basis of the security recorded as a credit related loss against earnings.
 
Corporate:
The unrealized losses in Corporate securities at June 30, 2014 consist of losses on six Corporate securities. The unrealized losses were caused by movements in interest rates. It is not anticipated that these securities would be settled at a price that is less than the amortized cost of the Company’s investment. Each of these securities is performing according to its terms and, in the opinion of management, will continue to perform according to its terms. The Company does not have the intent to sell these securities and it is more likely than not the Company will not be required to sell the securities before recovery of the securities’ amortized cost basis. This conclusion is based upon considering the Company’s cash and working capital requirements and contractual and regulatory obligations, none of which the Company believes would cause the sale of the securities. Therefore, the Company did not consider these investments to be other-than-temporarily impaired at June 30, 2014.
 
 
-8-

 
PART I – FINANCIAL INFORMATION

FLUSHING FINANCIAL CORPORATION and SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
 
Municipal Securities:
The unrealized losses in Municipal securities at June 30, 2014, consist of losses on 13 municipal securities. The unrealized losses were caused by movements in interest rates. It is not anticipated that these securities would be settled at a price that is less than the amortized cost of the Company’s investment. Each of these securities is performing according to its terms and, in the opinion of management, will continue to perform according to its terms. The Company does not have the intent to sell these securities and it is more likely than not the Company will not be required to sell the securities before recovery of the securities amortized cost basis. This conclusion is based upon considering the Company’s cash and working capital requirements and contractual and regulatory obligations, none of which the Company believes would cause the sale of the securities. Therefore, the Company did not consider these investments to be other-than-temporarily impaired at June 30, 2014.
 
Other Securities:
The unrealized losses in Other Securities at June 30, 2014, consist of losses on one single issuer trust preferred security and two pooled trust preferred securities. The unrealized losses on these securities were caused by market interest volatility, a significant widening of credit spreads across markets for these securities and illiquidity and uncertainty in the financial markets. These securities are currently rated below investment grade. The pooled trust preferred securities do not have collateral that is subordinate to the classes the Company owns. The Company’s management evaluates the pooled trust preferred securities using an impairment model, through an independent third party, that is applied to debt securities. In estimating OTTI losses, management considers: (1) the length of time and the extent to which the fair value has been less than amortized cost; (2) the current interest rate environment; (3) the financial condition and near-term prospects of the issuer, if applicable; and (4) the intent and ability of the Company to retain its investment in the security for a period of time sufficient to allow for any anticipated recovery in fair value. Additionally, management reviews the financial condition of each individual issuer within the pooled trust preferred securities. All of the issuers of the underlying collateral of the pooled trust preferred securities we reviewed are banks.

For each bank, our review included the following performance items of the banks:
 
Ratio of tangible equity to assets
Tier 1 Risk Weighted Capital
Net interest margin
Efficiency ratio for most recent two quarters
Return on average assets for most recent two quarters
Texas Ratio (ratio of non-performing assets plus assets past due over 90 days divided by tangible equity plus the reserve for loan losses)
Credit ratings (where applicable)
Capital issuances within the past year (where applicable)
Ability to complete Federal Deposit Insurance Corporation (“FDIC”) assisted acquisitions (where applicable)
 
Based on the review of the above factors, we concluded that:
 
All of the performing issuers in our pools are well capitalized banks, and do not appear likely to be closed by their regulators.
 
All of the performing issuers in our pools will continue as a going concern and will not default on their securities.
 
In order to estimate potential future defaults and deferrals, we segregated the performing underlying issuers by their Texas Ratio. We then reviewed performing issuers with Texas Ratios in excess of 50%. The Texas Ratio is a key indicator of the health of the institution and the likelihood of failure. This ratio compares the problem assets of the institution to the institution’s available capital and reserves to absorb losses that are likely to occur in these assets. No issuer in our pooled trust preferred securities had a Texas Ratio in excess of 50%. We concluded that issuers with a Texas Ratio below 50% are considered healthy, and there was minimal risk of default. We assigned a zero percent default rate to these issuers. Our analysis also assumed that issuers currently deferring would default with no recovery, and issuers that have defaulted will have no recovery.
 
 
-9-

 
PART I – FINANCIAL INFORMATION

FLUSHING FINANCIAL CORPORATION and SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
 
We had an independent third party prepare a discounted cash flow analysis for each of these pooled trust preferred securities based on the assumptions discussed above. Other significant assumptions were: (1) one issuer totaling $13.3 million will prepay in the third quarter of 2014; (2) two issuers totaling $21.5 million will prepay in the second quarter of 2015; (3) senior classes will not call the debt on their portions; and (4) use of the forward London Interbank Offered Rate (“LIBOR”) curve. The cash flows were discounted at the effective rate for each security.
 
The Company also owns a single issue security that is carried under the fair value option, where the unrealized losses are included in the Consolidated Statements of Income – Net gain (loss) from fair value adjustments.
 
It is not anticipated at this time that the one single issuer trust preferred security and the two pooled trust preferred securities would be settled at a price that is less than the amortized cost of the Company’s investment. Each of these securities is performing according to its terms and, in the opinion of management and based on the review performed at June 30, 2014, will continue to perform according to its terms. The Company does not have the intent to sell these securities and it is more likely than not the Company will not be required to sell the securities before recovery of the securities’ amortized cost basis. This conclusion is based upon considering the Company’s cash and working capital requirements and contractual and regulatory obligations, none of which the Company believes would cause the sale of the securities. Therefore, the Company did not consider the one single issuer trust preferred security and the two pooled trust preferred securities to be other-than-temporarily impaired at June 30, 2014.
 
At June 30, 2014, the Company held four trust preferred issues which had a current credit rating of at least one rating below investment grade. One of those issues are carried under the fair value option and therefore, changes in fair value are included in the Consolidated Statement of Income – Net gain (loss) from fair value adjustments.

The following table details the remaining three trust preferred issues that were evaluated to determine if they were other-than-temporarily impaired at June 30, 2014. The class the Company owns in pooled trust preferred securities does not have any excess subordination.
 
                                 
Deferrals/Defaults
       
Issuer
Type
 
Class
   
Performing
Banks
   
Amortized
Cost
   
Fair
Value
   
Cumulative
Credit Related
OTTI
   
Actual as a
Percentage
of Original
Security
   
Expected
Percentage
of Performing
Collateral
   
Current
Lowest
Rating
 
               
(Dollars in thousands)
                   
                                                 
Single issuer
  n/a     1     $ 300     $ 290     $ -    
None
   
None
   
BB-
 
Pooled issuer
  B1     16       5,617       3,040       2,383     22.5%     0.0%     C  
Pooled issuer
  C1     15       3,645       3,250       1,355     21.3%     0.0%     C  
Total
              $ 9,562     $ 6,580     $ 3,738                    
 
REMIC and CMO:
The unrealized losses in Real Estate Mortgage Investment Conduit (“REMIC”) and CMO securities at June 30, 2014 consist of 10 issues from the Federal Home Loan Mortgage Corporation (“FHLMC”), 16 issues from the Federal National Mortgage Association (“FNMA”) and four issues from Government National Mortgage Association (“GNMA”).
 
The unrealized losses on the REMIC and CMO securities issued by FHLMC, FNMA and GNMA were caused by movements in interest rates. It is not anticipated that these securities would be settled at a price that is less than the amortized cost of the Company’s investment. Each of these securities is performing according to its terms, and, in the opinion of management, will continue to perform according to its terms. The Company does not have the intent to sell these securities and it is more likely than not the Company will not be required to sell the securities before recovery of the securities’ amortized cost basis. This conclusion is based upon considering the Company’s cash and working capital requirements, and contractual and regulatory obligations, none of which the Company believes would cause the sale of the securities. Therefore, the Company did not consider these investments to be other-than-temporarily impaired at June 30, 2014.
 
GNMA:
The unrealized losses in GNMA securities at June 30, 2014 consist of losses on one security. The unrealized losses were caused by movements in interest rates. It is not anticipated that this security would be settled at a price that is less than the amortized cost of the Company’s investment. This security is performing according to its terms and, in the opinion of management, will continue to perform according to its terms. The Company does not have the intent to sell this security and it is more likely than not the Company will not be required to sell the security before recovery of the security’s amortized cost basis. This conclusion is based upon considering the Company’s cash and working capital requirements and contractual and regulatory obligations, none of which the Company believes would cause the sale of the security. Therefore, the Company did not consider this security to be other-than-temporarily impaired at June 30, 2014.

 
-10-

 
PART I – FINANCIAL INFORMATION

FLUSHING FINANCIAL CORPORATION and SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
 
FNMA:
The unrealized losses in FNMA securities at June 30, 2014 consist of losses on 13 securities. The unrealized losses were caused by movements in interest rates. It is not anticipated that these securities would be settled at a price that is less than the amortized cost of the Company’s investment. Each of these securities is performing according to its terms and, in the opinion of management, will continue to perform according to its terms. The Company does not have the intent to sell these securities and it is more likely than not the Company will not be required to sell the securities before recovery of the securities’ amortized cost basis. This conclusion is based upon considering the Company’s cash and working capital requirements and contractual and regulatory obligations, none of which the Company believes will cause the sale of the securities. Therefore, the Company did not consider these investments to be other-than-temporarily impaired at June 30, 2014.
 
FHMLC:
The unrealized losses in FHMLC securities at June 30, 2014 consist of losses on two securities. The unrealized losses were caused by movements in interest rates. It is not anticipated that these securities would be settled at a price that is less than the amortized cost of the Company’s investment. Each of these securities are performing according to its terms and, in the opinion of management, will continue to perform according to its terms. The Company does not have the intent to sell these securities and it is more likely than not that the Company will not be required to sell the securities before recovery of the securities’ amortized cost basis. This conclusion is based upon considering the Company’s cash and working capital requirements and contractual and regulatory obligations, none of which the Company believes would cause the sale of the securities. Therefore, the Company did not consider these securities’ to be other-than-temporarily impaired at June 30, 2014.
 
The following table details gross unrealized losses recorded in AOCI and the ending credit loss amount on two pooled trust preferred securities, as of June 30, 2014, for which the Company has recorded a credit related OTTI charge in the Consolidated Statements of Income:
 
(in thousands)
 
Amortized Cost
   
Fair Value
   
Gross Unrealized
Losses Recorded
In AOCI
   
Ending Credit
Loss Amount
 
                         
Trust preferred securities (1)
  $ 9,262     $ 6,290     $ 2,972     $ 3,738  
Total
  $ 9,262     $ 6,290     $ 2,972     $ 3,738  
 
(1)
The Company has recorded OTTI charges in the Consolidated Statements of Income on two pooled trust preferred securities for which a portion of the unrealized losses are currently recorded in AOCI.
 
 
-11-

 
PART I – FINANCIAL INFORMATION

FLUSHING FINANCIAL CORPORATION and SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
 
The following table represents the activity related to the credit loss component recognized in earnings on debt securities held by the Company for which a portion of OTTI was recognized in AOCI for the periods indicated:

   
For the three months ended
June 30,
   
For the six months ended
June 30,
 
   
2014
   
2013
   
2014
   
2013
 
   
(In thousands)
 
Beginning balance
  $ 3,738     $ 6,009     $ 3,738     $ 6,178  
                                 
Recognition of actual losses
    -       (319 )     -       (488 )
OTTI charges due to credit loss recorded in earnings
    -       503       -       503  
Securities sold during the period
    -       -       -       -  
Securities where there is an intent to sell or requirement to sell
    -       -       -       -  
Ending balance
  $ 3,738     $ 6,193     $ 3,738     $ 6,193  
 
The following table details the amortized cost and estimated fair value of the Company’s securities classified as available for sale at June 30, 2014, by contractual maturity. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
 
   
Amortized
Cost
   
Fair Value
 
   
(In thousands)
 
             
Due in one year or less
  $ 44,295     $ 44,424  
Due after one year through five years
    41,225       43,266  
Due after five years through ten years
    63,537       63,354  
Due after ten years
    138,801       137,093  
Total other securities
    287,858       288,137  
Mortgage-backed securities
    764,943       770,545  
Total securities available for sale
  $ 1,052,801     $ 1,058,682  
 
The following table represents the gross gains and gross losses realized from the sale of securities available for sale for the periods indicated:
 
   
For the three months ended
June 30,
   
For the six months ended
June 30,
 
   
2014
   
2013
   
2014
   
2013
 
   
(In thousands)
 
Gross gains from the sale of securities
  $ -     $ 18     $ -     $ 3,217  
Gross losses from the sale of securities
    -       -       -       (341 )
Net gains from the sale of securities
  $ -     $ 18     $ -     $ 2,876  
 
 
-12-

 
PART I – FINANCIAL INFORMATION

FLUSHING FINANCIAL CORPORATION and SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)

The following table summarizes the Company’s portfolio of securities available for sale at December 31, 2013:
 
   
Amortized
Cost
   
Fair Value
   
Gross
Unrealized
Gains
   
Gross
Unrealized
Losses
 
   
(In thousands)
 
Corporate
  $ 100,362     $ 101,711     $ 2,316     $ 967  
Municipals
    127,967       123,423       93       4,637  
Mutual funds
    21,565       21,565       -       -  
Other
    18,160       14,935       -       3,225  
Total other securities
    268,054       261,634       2,409       8,829  
REMIC and CMO
    494,984       489,670       6,516       11,830  
GNMA
    38,974       40,874       2,325       425  
FNMA
    217,615       212,322       2,233       7,526  
FHLMC
    13,297       13,290       226       233  
Total mortgage-backed securities
    764,870       756,156       11,300       20,014  
Total securities available for sale
  $ 1,032,924     $ 1,017,790     $ 13,709     $ 28,843  
 
Mortgage-backed securities shown in the table above include three private issue collateralized mortgage obligations (“CMO”) that are collateralized by commercial real estate mortgages with an amortized cost and market value of $13.9 million at December 31, 2013.

The following table shows the Company’s available for sale securities with gross unrealized losses and their fair value, aggregated by category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2013.
 
   
Total
   
Less than 12 months
   
12 months or more
 
   
Fair Value
   
Unrealized
Losses
   
Fair Value
   
Unrealized
Losses
   
Fair Value
   
Unrealized
Losses
 
   
(In thousands)
 
Corporate
  $ 39,033     $ 967     $ 39,033     $ 967     $ -     $ -  
Municipals
    100,875       4,637       95,958       4,187       4,917       450  
Other
    6,337       3,225       -       -       6,337       3,225  
Total other securities
    146,245       8,829       134,991       5,154       11,254       3,675  
                                                 
REMIC and CMO
    298,165       11,830       279,743       10,650       18,422       1,180  
GNMA
    9,213       425       9,213       425       -       -  
FNMA
    139,999       7,526       131,248       6,654       8,751       872  
FHLMC
    7,478       233       7,478       233       -       -  
Total mortgage-backed securities
    454,855       20,014       427,682       17,962       27,173       2,052  
Total securities available for sale
  $ 601,100     $ 28,843     $ 562,673     $ 23,116     $ 38,427     $ 5,727  
 
5. 
Loans
 
Loans are reported at their principal outstanding balance net of any unearned income, charge-offs, deferred loan fees and costs on originated loans and unamortized premiums or discounts on purchased loans. Interest on loans is recognized on the accrual basis. The accrual of income on loans is generally discontinued when certain factors, such as contractual delinquency of 90 days or more, indicate reasonable doubt as to the timely collectability of such income. Uncollected interest previously recognized on non-accrual loans is reversed from interest income at the time the loan is placed on non-accrual status. A non-accrual loan can be returned to accrual status when contractual delinquency returns to less than 90 days delinquent. Subsequent cash payments received on non-accrual loans that do not bring the loan to less than 90 days delinquent are recorded on a cash basis. Subsequent cash payments can also be applied first as a reduction of principal until all principal is recovered and then subsequently to interest, if in management’s opinion, it is evident that recovery of all principal due is unlikely to occur. Loan fees and certain loan origination costs are deferred. Net loan origination costs and premiums or discounts on loans purchased are amortized into interest income over the contractual life of the loans using the level-yield method. Prepayment penalties received on loans which pay in full prior to their scheduled maturity are included in interest income in the period they are collected.
 
 
-13-

 
PART I – FINANCIAL INFORMATION

FLUSHING FINANCIAL CORPORATION and SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
 
The Company maintains an allowance for loan losses at an amount, which, in management’s judgment, is adequate to absorb probable estimated losses inherent in the loan portfolio. Management’s judgment in determining the adequacy of the allowance is based on evaluations of the collectability of loans. This evaluation is inherently subjective, as it requires estimates that are susceptible to significant revisions as more information becomes available. The allowance is established through a provision (benefit) for loan losses based on management’s evaluation of the risk inherent in the various components of the loan portfolio and other factors, including historical loan loss experience (which is updated quarterly), current economic conditions, delinquency and non-accrual trends, classified loan levels, risk in the portfolio and volumes and trends in loan types, recent trends in charge-offs, changes in underwriting standards, experience, ability and depth of the Company’s lenders, collection policies and experience, internal loan review function and other external factors. Additionally, the Company segregated our loans into two portfolios based on year of origination. One portfolio was reviewed for loans originated after December 31, 2009 and a second portfolio for loans originated prior to January 1, 2010. Our decision to segregate the portfolio based upon origination dates was based on changes made in our underwriting standards during 2009. By the end of 2009, all loans were being underwritten based on revised and tightened underwriting standards. Loans originated prior to 2010 have a higher delinquency rate and loss history. Each of the years in the portfolio for loans originated prior to 2010 have a similar delinquency rate. The determination of the amount of the allowance for loan losses includes estimates that are susceptible to significant changes due to changes in appraisal values of collateral, national and local economic conditions and other factors. We review our loan portfolio by separate categories with similar risk and collateral characteristics. Impaired loans are segregated and reviewed separately. All non-accrual loans are classified as impaired loans. The Company’s Board of Directors reviews and approves management’s evaluation of the adequacy of the allowance for loan losses on a quarterly basis.
 
The allowance for loan losses is established through charges to earnings in the form of a provision (benefit) for loan losses. Increases and decreases in the allowance other than charge-offs and recoveries are included in the provision (benefit) for loan losses. When a loan or a portion of a loan is determined to be uncollectible, the portion deemed uncollectible is charged against the allowance, and subsequent recoveries, if any, are credited to the allowance.
 
The Company recognizes a loan as non-performing when the borrower has demonstrated the inability to bring the loan current, or due to other circumstances which, in management’s opinion, indicate the borrower will be unable to bring the loan current within a reasonable time. All loans classified as non-performing, which includes all loans past due 90 days or more, are classified as non-accrual unless there is, in our opinion, compelling evidence the borrower will bring the loan current in the immediate future. Appraisals are obtained and/or updated internal evaluations are prepared as soon as practical, and before the loan becomes 90 days delinquent. The loan balances of collateral dependent impaired loans are compared to the property’s updated fair value. The Company considers fair value of collateral dependent loans to be 85% of the appraised or internally estimated value of the property. The balance which exceeds fair value is generally charged-off.
 
A loan is considered impaired when, based upon current information, the Company believes it is probable that it will be unable to collect all amounts due, both principal and interest, in accordance with the original terms of the loan. Impaired loans are measured based on the present value of the expected future cash flows discounted at the loan’s effective interest rate or at the loan’s observable market price or, as a practical expedient, the fair value of the collateral if the loan is collateral dependent. Interest income on impaired loans is recorded on the cash basis. The Company’s management considers all non-accrual loans impaired.
 
The Company reviews each impaired loan on an individual basis to determine if either a charge-off or a valuation allowance needs to be allocated to the loan. The Company does not charge-off or allocate a valuation allowance to loans for which management has concluded the current value of the underlying collateral will allow for recovery of the loan balance either through the sale of the loan or by foreclosure and sale of the property.
 
The Company evaluates the underlying collateral through a third party appraisal, or when a third party appraisal is not available, the Company will use an internal evaluation. The internal evaluations are prepared using an income approach or a sales approach. The income approach is used for income producing properties and uses current revenues less operating expenses to determine the net cash flow of the property. Once the net cash flow is determined, the value of the property is calculated using an appropriate capitalization rate for the property. The sales approach uses comparable sales prices in the market. When an internal evaluation is used, we place greater reliance on the income approach to value the collateral.
 
-14-

 
PART I – FINANCIAL INFORMATION

FLUSHING FINANCIAL CORPORATION and SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
 
In preparing internal evaluations of property values, the Company seeks to obtain current data on the subject property from various sources, including: (1) the borrower; (2) copies of existing leases; (3) local real estate brokers and appraisers; (4) public records (such as for real estate taxes and water and sewer charges); (5) comparable sales and rental data in the market; (6) an inspection of the property and (7) interviews with tenants. These internal evaluations primarily focus on the income approach and comparable sales data to value the property.
 
As of June 30, 2014, we utilized recent third party appraisals of the collateral to measure impairment for $47.4 million, or 76.2%, of collateral dependent impaired loans, and used internal evaluations of the property’s value for $14.8 million, or 23.8%, of collateral dependent impaired loans.
 
The Company may restructure a loan to enable a borrower experiencing financial difficulties to continue making payments when it is deemed to be in the Company’s best long-term interest. This restructure may include reducing the interest rate or amount of the monthly payment for a specified period of time, after which the interest rate and repayment terms revert to the original terms of the loan. We classify these loans as Troubled Debt Restructured (“TDR”).
 
These restructurings have not included a reduction of principal balance. The Company believes that restructuring these loans in this manner will allow certain borrowers to become and remain current on their loans. Restructured loans are classified as a TDR when the Bank grants a concession to a borrower who is experiencing financial difficulties. All loans classified as TDR are considered impaired, however TDR loans which have been current for six consecutive months at the time they are restructured as TDR remain on accrual status and are not included as part of non-performing loans. Loans which were delinquent at the time they are restructured as a TDR are placed on non-accrual status and reported as non-performing loans until they have made timely payments for six consecutive months. Loans that are restructured as TDR but are not performing in accordance with the restructured terms are placed on non-accrual status and reported as non-performing loans.
 
The allocation of a portion of the allowance for loan losses for a performing TDR loan is based upon the present value of the future expected cash flows discounted at the loan’s original effective rate, or for a non-performing TDR which is collateral dependent, the fair value of the collateral. At June 30, 2014, there were no commitments to lend additional funds to borrowers whose loans were modified to a TDR. The modification of loans to a TDR did not have a significant effect on our operating results, nor did it require a significant allocation of the allowance for loan losses.
 
The Bank did not modify and classify any loans as TDR during the three or six months ended June 30, 2014.

 
-15-

 
PART I – FINANCIAL INFORMATION

FLUSHING FINANCIAL CORPORATION and SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
 
The following table shows loans modified and classified as TDR during the three and six months ended June 30, 2013:
 
   
For the three months ended
June 30, 2013
 
For the six months ended
June 30, 2013
(Dollars in thousands)
 
Number
   
Balance
 
Modification description
 
Number
   
Balance
 
Modification description
                             
                             
Multi-family residential
    -     $ -         1     $ 413  
Received a below market interest rate and the loan amortization was extended
Commercial real estate
    1       488  
Received a below market interest rate, loan amortization was extended, and loan term extended
    2       761  
Received a below market interest rate and the loan amortization was extended
One-to-four family - mixed-use property
    1       390  
Received a below market interest rate, loan amortization was extended, and loan term extended
    1       390  
Received a below market interest rate and the loan amortization was extended
Commercial business and other
    -       -         1       615  
Received a below market interest rate and the loan term was extended
Total
    2     $ 878         5     $ 2,179    
 
The recorded investment of each of the loans modified and classified to a TDR, presented in the table above, was unchanged as there was no principal forgiven in any of these modifications.

The following table shows our recorded investment for loans classified as TDR that are performing according to their restructured terms at the periods indicated:
 
   
June 30, 2014
   
December 31, 2013
 
(Dollars in thousands)
 
Number
of contracts
   
Recorded
investment
   
Number
of contracts
   
Recorded
investment
 
                         
Multi-family residential
    10     $ 3,061       10     $ 3,087  
Commercial real estate
    4       3,652       4       3,686  
One-to-four family - mixed-use property
    7       2,405       8       2,692  
One-to-four family - residential
    1       359       1       364  
Construction
    -       -       1       746  
Commercial business and other
    3       1,066       4       3,127  
Total performing troubled debt restructured
    25     $ 10,543       28     $ 13,702  
 
During the six months ended June 30, 2014, two TDR loans totaling $2.4 million were transferred to non-performing status when they became over 90 days past maturity, which resulted in these loans being included in non-performing loans. These loans were paid in full during the quarter ended June 30, 2014. During the six months ended June 30, 2014, one additional TDR loan for $0.2 million was transferred to non-performing status when it became 90 days past due as to payments. During the six months ended June 30, 2013, there were no loans classified as TDR transferred to non-performing status.

 
-16-

 
PART I – FINANCIAL INFORMATION

FLUSHING FINANCIAL CORPORATION and SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
 
The following table shows our recorded investment for loans classified as TDR that are not performing according to their restructured terms at the periods indicated:
 
   
June 30, 2014
   
December 31, 2013
 
(Dollars in thousands)
 
Number
of contracts
   
Recorded
investment
   
Number
of contracts
   
Recorded
investment
 
                         
Commercial real estate
    1     $ 2,186       1     $ 2,332  
One-to-four family - mixed-use property
    1       187       -       -  
                                 
Total troubled debt restructurings that subsequently defaulted
    2     $ 2,373       1     $ 2,332  
 
The following table shows our non-performing loans at the periods indicated:
 
(In thousands)
 
June 30,
2014
   
December 31,
2013
 
             
Loans 90 days or more past due and still accruing:
           
Multi-family residential
  $ 987     $ 52  
Commercial real estate
    266       -  
One-to-four family - mixed-use property
    1,303       -  
One-to-four family - residential
    14       15  
Commercial Business and other
    410       539  
Total
    2,980       606  
                 
Non-accrual mortgage loans:
               
Multi-family residential (1)
    10,861       13,297  
Commercial real estate
    9,761       9,962  
One-to-four family - mixed-use property
    8,713       9,063  
One-to-four family - residential
    11,346       13,250  
Co-operative apartments
    -       57  
Total
    40,681       45,629  
                 
Non-accrual non-mortgage loans:
               
Commercial Business and other
    2,130       2,348  
Total
    2,130       2,348  
                 
Total non-accrual loans
    42,811       47,977  
                 
                 
Total non-accrual loans and days or more past due and still accruing
  $ 45,791     $ 48,583  

(1)
The table above does not include non-performing Loans held for sale of $0.4 million at December 31, 2013.

 
-17-

 
PART I – FINANCIAL INFORMATION

FLUSHING FINANCIAL CORPORATION and SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
 
The following is a summary of interest foregone on non-accrual loans and loans classified as TDR for the periods indicated:
 
   
For the three months ended
June 30,
   
For the six months ended
June 30,
 
   
2014
   
2013
   
2014
   
2013
 
   
(In thousands)
 
Interest income that would have been recognized had the loans performed in accordance with their original terms
  $ 989     $ 1,697     $ 1,979     $ 3,510  
Less: Interest income included in the results of operations
    151       220       318       496  
Total foregone interest
  $ 838     $ 1,477     $ 1,661     $ 3,014  
 
The following table shows an age analysis of our recorded investment in loans at June 30, 2014:
 
(in thousands)
 
30 - 59 Days
Past Due
   
60 - 89 Days
Past Due
   
Greater
than
90 Days
   
Total Past
Due
   
Current
   
Total Loans
 
                                     
                                     
Multi-family residential
  $ 12,320     $ 1,325     $ 10,860     $ 24,505     $ 1,759,606     $ 1,784,111  
Commercial real estate
    8,615       -       9,762       18,377       491,847       510,224  
One-to-four family - mixed-use property
    14,325       718       8,714       23,757       557,450       581,207  
One-to-four family - residential
    2,363       472       11,136       13,971       178,924       192,895  
Co-operative apartments
    -       -       -       -       9,885       9,885  
Construction loans
    -       -       -       -       4,717       4,717  
Small Business Administration
    108       -       -       108       7,435       7,543  
Taxi medallion
    -       -       -       -       25,291       25,291  
Commercial business and other
    51       -       1,190       1,241       404,612       405,853  
Total
  $ 37,782     $ 2,515     $ 41,662     $ 81,959     $ 3,439,767     $ 3,521,726  
 
The following table shows an age analysis of our recorded investment in loans at December 31, 2013:
 
(in thousands)
 
30 - 59 Days
Past Due
   
60 - 89 Days
Past Due
   
Greater
than
90 Days
   
Total Past
Due
   
Current
   
Total Loans
 
   
(in thousands)
 
                                     
Multi-family residential
  $ 14,101     $ 2,554     $ 13,297     $ 29,952     $ 1,682,087     $ 1,712,039  
Commercial real estate
    5,029       523       9,962       15,514       497,038       512,552  
One-to-four family - mixed-use property
    14,017       1,099       9,063       24,179       571,572       595,751  
One-to-four family - residential
    3,828       518       12,953       17,299       176,427       193,726  
Co-operative apartments
    99       -       144       243       9,894       10,137  
Construction loans
    -       -       -       -       4,247       4,247  
Small Business Administration
    106       -       -       106       7,686       7,792  
Taxi medallion
    -       -       -       -       13,123       13,123  
Commercial business and other
    187       2       1,213       1,402       372,239       373,641  
Total
  $ 37,367     $ 4,696     $ 46,632     $ 88,695     $ 3,334,313     $ 3,423,008  
 
-18-

 
PART I – FINANCIAL INFORMATION

FLUSHING FINANCIAL CORPORATION and SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
 
The following table shows the activity in the allowance for loan losses for the three months ended June 30, 2014:
 
(in thousands)
 
Multi-family
residential
   
Commercial
real estate
   
One-to-four
family -
mixed-use
property
   
One-to-four
family -
residential
   
Co-operative
apartments
   
Construction
loans
   
Small Business
Administration
   
Taxi
medallion
   
Commercial
business
and other
   
Total
 
                                                             
Allowance for credit losses:
                                                           
Beginning balance
  $ 11,103     $ 5,379     $ 7,142     $ 1,944     $ -     $ 40     $ 391     $ 14     $ 4,257     $ 30,270  
Charge-off's
    (69 )     (39 )     (175 )     (37 )     -       -       (49 )     -       (1 )     (370 )
Recoveries
    134       -       95       97       -       -       51       -       50       427  
Provision (benefit)
    (418 )     (13 )     (69 )     (214 )     -       (6 )     (20 )     -       (352 )     (1,092 )
Ending balance
  $ 10,750     $ 5,327     $ 6,993     $ 1,790     $ -     $ 34     $ 373     $ 14     $ 3,954     $ 29,235  
Ending balance: individually evaluated for impairment
  $ 299     $ 197     $ 601     $ 56     $ -     $ -     $ -     $ -     $ 150     $ 1,303  
Ending balance: collectively evaluated for impairment
  $ 10,451     $ 5,130     $ 6,392     $ 1,734     $ -     $ 34     $ 373     $ 14     $ 3,804     $ 27,932  
                                                                                 
Financing Receivables:
                                                                               
Ending balance
  $ 1,784,111     $ 510,224     $ 581,207     $ 192,895     $ 9,885     $ 4,717     $ 7,543     $ 25,291     $ 405,853     $ 3,521,726  
Ending balance: individually evaluated for impairment
  $ 20,613     $ 16,728     $ 16,704     $ 13,505     $ -     $ 570     $ -     $ -     $ 7,899     $ 76,019  
Ending balance: collectively evaluated for impairment
  $ 1,763,498     $ 493,496     $ 564,503     $ 179,390     $ 9,885     $ 4,147     $ 7,543     $ 25,291     $ 397,954     $ 3,445,707  
 
The following table shows the activity in the allowance for loan losses for the three months ended June 30, 2013:
 
(in thousands)
 
Multi-family
residential
   
Commercial
real estate
   
One-to-four
family -
mixed-use
property
   
One-to-four
family -
residential
   
Co-operative
apartments
   
Construction
loans
   
Small Business
Administration
   
Taxi
medallion
   
Commercial
business
and other
   
Total
 
                                                             
Allowance for credit losses:
                                                           
Beginning balance
  $ 12,395     $ 5,660     $ 6,340     $ 2,077     $ 88     $ 67     $ 471     $ 7     $ 3,922     $ 31,027  
Charge-off's
    (1,261 )     (53 )     (529 )     -       -       (70 )     (133 )     -       (560 )     (2,606 )
Recoveries
    54       213       58       75       4       -       30       -       -       434  
Provision (benefit)
    1,770       64       565       (53 )     7       199       129       -       819       3,500  
Ending balance
  $ 12,958     $ 5,884     $ 6,434     $ 2,099     $ 99     $ 196     $ 497     $ 7     $ 4,181     $ 32,355  
Ending balance: individually evaluated for impairment
  $ 272     $ 290     $ 693     $ 60     $ -     $ 34     $ -     $ -     $ 377     $ 1,726  
Ending balance: collectively evaluated for impairment
  $ 12,686     $ 5,594     $ 5,741     $ 2,039     $ 99     $ 162     $ 497     $ 7     $ 3,804     $ 30,629  
                                                                                 
Financing Receivables:
                                                                               
Ending balance
  $ 1,607,090     $ 526,063     $ 605,254     $ 196,318     $ 9,335     $ 11,450     $ 8,565     $ 5,114     $ 306,897     $ 3,276,086  
Ending balance: individually evaluated for impairment
  $ 26,012     $ 34,895     $ 19,146     $ 14,530     $ 266     $ 9,710     $ 483     $ -     $ 7,551     $ 112,593  
Ending balance: collectively evaluated for impairment
  $ 1,581,078     $ 491,168     $ 586,108     $ 181,788     $ 9,069     $ 1,740     $ 8,082     $ 5,114     $ 299,346     $ 3,163,493  
 
 
 
-19-

 
PART I – FINANCIAL INFORMATION

FLUSHING FINANCIAL CORPORATION and SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
 
The following table shows the activity in the allowance for loan losses for the six months ended June 30, 2014:
 
(in thousands)
 
Multi-family
residential
   
Commercial
real estate
   
One-to-four
family -
mixed-use
property
   
One-to-four
family -
residential
   
Co-operative
apartments
   
Construction
loans
   
Small Business
Administration
   
Taxi
medallion
   
Commercial
business
and other
   
Total
 
                                                             
Allowance for credit losses:
                                                           
Beginning balance
  $ 12,084     $ 4,959     $ 6,328     $ 2,079     $ 104     $ 444     $ 458     $ -     $ 5,320     $ 31,776  
Charge-off's
    (674 )     (86 )     (258 )     (79 )     -       -       (49 )     -       (125 )     (1,271 )
Recoveries
    141       382       135       165       7       -       61       -       50       941  
Provision (benefit)
    (801 )     72       788       (375 )     (111 )     (410 )     (97 )     14       (1,291 )     (2,211 )
Ending balance
  $ 10,750     $ 5,327     $ 6,993     $ 1,790     $ -     $ 34     $ 373     $ 14     $ 3,954     $ 29,235  
Ending balance: individually evaluated for impairment
  $ 299     $ 197     $ 601     $ 56     $ -     $ -     $ -     $ -     $ 150     $ 1,303  
Ending balance: collectively evaluated for impairment
  $ 10,451     $ 5,130     $ 6,392     $ 1,734     $ -     $ 34     $ 373     $ 14     $ 3,804     $ 27,932  
                                                                                 
Financing Receivables:
                                                                               
Ending balance
  $ 1,784,111     $ 510,224     $ 581,207     $ 192,895     $ 9,885     $ 4,717     $ 7,543     $ 25,291     $ 405,853     $ 3,521,726  
Ending balance: individually evaluated for impairment
  $ 20,613     $ 16,728     $ 16,704     $ 13,505     $ -     $ 570     $ -     $ -     $ 7,899     $ 76,019  
Ending balance: collectively evaluated for impairment
  $ 1,763,498     $ 493,496     $ 564,503     $ 179,390     $ 9,885     $ 4,147     $ 7,543     $ 25,291     $ 397,954     $ 3,445,707  
 
The following table shows the activity in the allowance for loan losses for the six months ended June 30, 2013:
 
(in thousands)
 
Multi-family
residential
   
Commercial
real estate
   
One-to-four
family -
mixed-use
property
   
One-to-four
family -
residential
   
Co-operative
apartments
   
Construction
loans
   
Small Business
Administration
   
Taxi
medallion
   
Commercial
business
and other
   
Total
 
                                                             
Allowance for credit losses:
                                                           
Beginning balance
  $ 13,001     $ 5,705     $ 5,960     $ 1,999     $ 46     $ 66     $ 505     $ 7     $ 3,815     $ 31,104  
Charge-off's
    (2,749 )     (734 )     (3,135 )     (691 )     (74 )     (304 )     (337 )     -       (864 )     (8,888 )
Recoveries
    65       293       111       106       4       -       60       -       -       639  
Provision (benefit)
    2,641       620       3,498       685       123       434       269       -       1,230       9,500  
Ending balance
  $ 12,958     $ 5,884     $ 6,434     $ 2,099     $ 99     $ 196     $ 497     $ 7     $ 4,181     $ 32,355  
Ending balance: individually evaluated for impairment
  $ 272     $ 290     $ 693     $ 60     $ -     $ 34     $ -     $ -     $ 377     $ 1,726  
Ending balance: collectively evaluated for impairment
  $ 12,686     $ 5,594     $ 5,741     $ 2,039     $ 99     $ 162     $ 497     $ 7     $ 3,804     $ 30,629  
                                                                                 
Financing Receivables:
                                                                               
Ending balance
  $ 1,607,090     $ 526,063     $ 605,254     $ 196,318     $ 9,335     $ 11,450     $ 8,565     $ 5,114     $ 306,897     $ 3,276,086  
Ending balance: individually evaluated for impairment
  $ 26,012     $ 34,895     $ 19,146     $ 14,530     $ 266     $ 9,710     $ 483     $ -     $ 7,551     $ 112,593  
Ending balance: collectively evaluated for impairment
  $ 1,581,078     $ 491,168     $ 586,108     $ 181,788     $ 9,069     $ 1,740     $ 8,082     $ 5,114     $ 299,346     $ 3,163,493  
 
 
-20-

 
PART I – FINANCIAL INFORMATION

FLUSHING FINANCIAL CORPORATION and SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
 
The following table shows our recorded investment, unpaid principal balance and allocated allowance for loan losses, average recorded investment and interest income recognized for loans that were considered impaired at or for the six month period ended June 30, 2014:
 
   
Recorded
Investment
   
Unpaid
Principal
Balance
   
Related
Allowance
   
Average
Recorded
Investment
   
Interest
Income
Recognized
 
                               
   
(In thousands)
 
With no related allowance recorded:
                             
Mortgage loans:
                             
Multi-family residential
  $ 17,252     $ 19,470     $ -     $ 17,670     $ 120  
Commercial real estate
    11,535       11,865       -       14,036       112  
One-to-four family mixed-use property
    13,059       15,221       -       12,987       101  
One-to-four family residential
    13,146       16,119       -       13,363       46  
Co-operative apartments
    -       -       -       -       -  
Construction
    570       570       -       570       14  
Non-mortgage loans:
                                       
Small Business Administration
    -       -       -       -       -  
Taxi Medallion
    -       -       -       -       -  
Commercial Business and other
    5,570       7,159       -       5,467       98  
                                         
Total loans with no related allowance recorded
    61,132       70,404       -       64,093       491  
                                         
With an allowance recorded:
                                       
Mortgage loans:
                                       
Multi-family residential
    3,361       3,361       299       3,086       33  
Commercial real estate
    5,193       5,259       197       4,108       96  
One-to-four family mixed-use property
    3,645       3,732       601       3,396       75  
One-to-four family residential
    359       359       56       361       7  
Co-operative apartments
    -       -       -       -       -  
Construction
    -       -       -       373       86  
Non-mortgage loans:
                                       
Small Business Administration
    -       -       -       -       -  
Taxi Medallion
    -       -       -       -       -  
Commercial Business and other
    2,329       2,329       150       3,560       27  
                                         
Total loans with an allowance recorded
    14,887       15,040       1,303       14,884       324  
                                         
Total Impaired Loans:
                                       
Total mortgage loans
  $ 68,120     $ 75,956     $ 1,153     $ 69,950     $ 690  
                                         
Total non-mortgage loans
  $ 7,899     $ 9,488     $ 150     $ 9,027     $ 125  
 
 
-21-

 
PART I – FINANCIAL INFORMATION

FLUSHING FINANCIAL CORPORATION and SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
 
The following table shows our recorded investment, unpaid principal balance and allocated allowance for loan losses, average recorded investment and interest income recognized for loans that were considered impaired at or for the year ended December 31, 2013:
 
   
Recorded
Investment
   
Unpaid
Principal
Balance
   
Related
Allowance
   
Average
Recorded
Investment
   
Interest
Income
Recognized
 
                               
   
(In thousands)
 
With no related allowance recorded:
                             
Mortgage loans:
                             
Multi-family residential
  $ 18,709     $ 20,931     $ -     $ 22,091     $ 402  
Commercial real estate
    16,721       17,405       -       19,846       266  
One-to-four family mixed-use property
    12,748       15,256       -       13,916       319  
One-to-four family residential
    14,026       17,527       -       14,529       125  
Co-operative apartments
    59       147       -       189       -  
Construction
    -       118       -       4,014       -  
Non-mortgage loans:
                                       
Small Business Administration
    -       -       -       247       -  
Taxi Medallion
    -       -       -       -       -  
Commercial Business and other
    3,225       5,527       -       5,309       268  
                                         
Total loans with no related allowance recorded
    65,488       76,911       -       80,141       1,380  
                                         
With an allowance recorded:
                                       
Mortgage loans:
                                       
Multi-family residential
    3,048       3,049       312       2,892       170  
Commercial real estate
    3,036       3,102       164       6,388       194  
One-to-four family mixed-use property
    4,191       4,221       875       4,041       228  
One-to-four family residential
    364       364       58       368       15  
Co-operative apartments
    -       -       -       -       -  
Construction
    746       746       17       1,929       18  
Non-mortgage loans:
                                       
Small Business Administration
    -       -       -       -       -  
Taxi Medallion
    -       -       -       -       -  
Commercial Business and other
    4,895       4,894       222       4,354       239  
                                         
Total loans with an allowance recorded
    16,280       16,376       1,648       19,972       864  
                                         
Total Impaired Loans:
                                       
Total mortgage loans
  $ 73,648     $ 82,866     $ 1,426     $ 90,203     $ 1,737  
                                         
Total non-mortgage loans
  $ 8,120     $ 10,421     $ 222     $ 9,910     $ 507  
 
In accordance with our policy and the current regulatory guidelines, we designate loans as “Special Mention,” which are considered “Criticized Loans,” and “Substandard,” “Doubtful,” or “Loss,” which are considered “Classified Loans”. If a loan does not fall within one of the previous mentioned categories then the loan would be considered “Pass.” These loan designations are updated quarterly. We designate a loan as Substandard when a well-defined weakness is identified that jeopardizes the orderly liquidation of the debt. We designate a loan Doubtful when it displays the inherent weakness of a Substandard loan with the added provision that collection of the debt in full, on the basis of existing facts, is highly improbable. We designate a loan as Loss if it is deemed the debtor is incapable of repayment. The Company does not hold any loans designated as Loss, as loans that are designated as Loss are charged to the Allowance for Loan Losses. Loans that are non-accrual are designated as Substandard or Doubtful. We designate a loan as Special Mention if the asset does not warrant classification within one of the other classifications, but does contain a potential weakness that deserves closer attention.
 
 
-22-

 
PART I – FINANCIAL INFORMATION

FLUSHING FINANCIAL CORPORATION and SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
 
The following table sets forth the recorded investment in loans designated as Criticized or Classified at June 30, 2014:
 
(In thousands)
 
Special Mention
   
Substandard
   
Doubtful
   
Loss
   
Total
 
                               
Multi-family residential
  $ 9,622     $ 15,905     $ 1,647     $ -     $ 27,174  
Commercial real estate
    10,626       14,339       -       -       24,965  
One-to-four family - mixed-use property
    4,438       14,682       -       -       19,120  
One-to-four family - residential
    2,869       13,146       -       -       16,015  
Co-operative apartments
    -       -       -       -       -  
Construction loans
    -       570       -       -       570  
Small Business Administration
    301       -       -       -       301  
Commercial business and other
    5,262       6,145       50       -       11,457  
Total loans
  $ 33,118     $ 64,787     $ 1,697     $ -     $ 99,602  
 
The following table sets forth the recorded investment in loans designated as Criticized or Classified at December 31, 2013:
 
(In thousands)
 
Special Mention
   
Substandard
   
Doubtful
   
Loss
   
Total
 
                               
Multi-family residential
  $ 9,940     $ 19,089     $ -     $ -     $ 29,029  
Commercial real estate
    13,503       16,820       -       -       30,323  
One-to-four family - mixed-use property
    7,992       14,898       -       -       22,890  
One-to-four family - residential
    2,848       14,026       -       -       16,874  
Co-operative apartments
    -       59       -       -       59  
Construction loans
    746       -       -       -       746  
Small Business Administration
    310       -       -       -       310  
Commercial business and other
    7,314       8,450       50       -       15,814  
Total loans
  $ 42,653     $ 73,342     $ 50     $ -     $ 116,045  
 
The following table shows the changes in the allowance for loan losses for the periods indicated:
 
   
For the three months
ended June 30
   
For the six months
ended June 30
 
(In thousands)
 
2014
   
2013
   
2014
   
2013
 
                         
Balance, beginning of period
  $ 30,270     $ 31,027     $ 31,776     $ 31,104  
Provision (benefit) for loan losses
    (1,092 )     3,500       (2,211 )     9,500  
Charge-off's
    (370 )     (2,606 )     (1,271 )     (8,888 )
Recoveries
    427       434       941       639  
Balance, end of period
  $ 29,235     $ 32,355     $ 29,235     $ 32,355  
 
 
-23-

 
PART I – FINANCIAL INFORMATION

FLUSHING FINANCIAL CORPORATION and SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
 
The following table shows net loan charge-offs for the periods indicated:
 
   
Three Months Ended
   
Six Months Ended
 
(In thousands)
 
June 30,
2014
   
June 30,
2013
   
June 30,
2014
   
June 30,
2013
 
Multi-family residential
  $ (65 )   $ 1,207     $ 533     $ 2,684  
Commercial real estate
    39       (160 )     (296 )     441  
One-to-four family – mixed-use property
    80       471       123       3,024  
One-to-four family – residential
    (60 )     (75 )     (86 )     585  
Co-operative apartments
    -       (4 )     (7 )     70  
Construction
    -       70       -       304  
Small Business Administration
    (2 )     103       (12 )     277  
Commercial business and other
    (49 )     560       75       864  
Total net loan charge-offs (recoveries)
  $ (57 )   $ 2,172     $ 330     $ 8,249  
 
Commitments to extend credit (principally real estate mortgage loans) and lines of credit (principally home equity lines of credit and business lines of credit) amounted to $102.0 million and $168.6 million, respectively, at June 30, 2014.
 
6.
Loans held for sale
 
Loans held for sale are carried at the lower of cost or estimated fair value. At June 30, 2014, the Bank did not have any loans held for sale. At December 31, 2013, the Bank had one multi-family loan held for sale of $0.4 million.
 
The Company has implemented a strategy of selling certain delinquent and non-performing loans. Once the Company has decided to sell a loan, the sale usually closes in a short period of time, generally within the same quarter. Loans designated as held for sale are reclassified from loans held for investment to loans held for sale. Terms of sale include cash due upon the closing of the sale, no contingencies or recourse to the Company and servicing is released to the buyer.
 
The following tables show delinquent and non-performing loans sold during the periods indicated:
 
   
For the three months ended
June 30, 2014
 
(Dollars in thousands)
 
Loans sold
   
Proceeds
   
Net recoveries
   
Net gain (loss)
 
                         
Multi-family residential
    3     $ 1,478     $ 76     $ -  
Commercial real estate
    1       430       -       -  
Total
    4     $ 1,908     $ 76     $ -  
 
-24-

 
PART I – FINANCIAL INFORMATION

FLUSHING FINANCIAL CORPORATION and SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
 
   
For the three months ended
June 30, 2013
 
(Dollars in thousands)
 
Loans sold
   
Proceeds
   
Net charge-offs
   
Net gain (loss)
 
                         
Multi-family residential
    9     $ 2,447     $ (468 )   $ -  
Commercial real estate
    5       2,349       (18 )     -  
One-to-four family - mixed-use property
    24       5,589       (70 )     -  
Total
    38     $ 10,385     $ (556 )   $ -  
 
The above table does not include the sale of one performing commercial real estate loan for $2.4 million, resulting in a net gain of $184,000 during the three months ended June 30, 2013.
 
The following tables show delinquent and non-performing loans sold during the periods indicated:
 
   
For the six months ended
June 30, 2014
 
(Dollars in thousands)
 
Loans sold
   
Proceeds
   
Net (charge-offs)
recoveries
   
Net gain (loss)
 
                         
Multi-family residential
    7     $ 3,216     $ (70 )   $ -  
Commercial real estate
    3       2,047       295       -  
One-to-four family - mixed-use property
    6       2,069       38       -  
Total
    16     $ 7,332     $ 263     $ -  
 
   
For the six months ended
June 30, 2013
 
(Dollars in thousands)
 
Loans sold
   
Proceeds
   
Net charge-offs
   
Net gain (loss)
 
                         
Multi-family residential
    15     $ 7,059     $ (576 )   $ 6  
Commercial real estate
    7       3,464       (94 )     -  
One-to-four family - mixed-use property
    30       7,961       (110 )     (15 )
Commercial business and other
    2       66       (185 )     -  
Total
    54     $ 18,550     $ (965 )   $ (9 )
 
The above table does not include the sale of one performing commercial real estate loan for $2.4 million, resulting in a net gain of $184,000 during the six months ended June 30, 2013.
 
 
-25-

 
PART I – FINANCIAL INFORMATION

FLUSHING FINANCIAL CORPORATION and SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
 
7.
Other Real Estate Owned
 
The following are changes in Other Real Estate Owned (“OREO”) during the periods indicated:
 
   
For the three months ended
June 30,
   
For the six months ended
June 30,
 
   
2014
   
2013
   
2014
   
2013
 
   
(In thousands)
 
                         
Balance at beginning of period
  $ 1,700     $ 2,189     $ 2,985     $ 5,278  
Acquisitions
    491       2,079       606       2,758  
Recovery (write-down) of carrying value
    49       (115 )     (5 )     (180 )
Sales
    (894 )     (1,562 )     (2,240 )     (5,265 )
Balance at end of period
  $ 1,346     $ 2,591     $ 1,346     $ 2,591  

The following table shows the gross gains, gross losses and write-downs of OREO reported in the Consolidated Statements of Income during the periods indicated:

   
For the three months ended
June 30,
   
For the six months ended
June 30,
 
   
2014
   
2013
   
2014
   
2013
 
   
(In thousands)
   
(In thousands)
 
                         
Gross gains
  $ 77     $ 40     $ 131     $ 240  
Gross losses
    -       (66 )     (30 )     (88 )
Recovery (write-down) of carrying value
    49       (115 )     (5 )     (180 )
Total
  $ 126     $ (141 )   $ 96     $ (28 )
 
8.
Stock-Based Compensation

For the three months ended June 30, 2014 and 2013, the Company’s net income, as reported, includes $0.6 million and $0.4 million, respectively, of stock-based compensation costs and $0.2 million and $0.2 million, respectively, of income tax benefits related to the stock-based compensation plans. For the six months ended June 30, 2014 and 2013, the Company’s net income, as reported, includes $3.1 million and $2.4 million, respectively, of stock-based compensation costs and $1.2 million and $0.9 million, respectively, of income tax benefits related to the stock-based compensation plans.
 
The Company estimates the fair value of stock options using the Black-Scholes valuation model. Key assumptions used to estimate the fair value of stock options include the exercise price of the award, the expected option term, the expected volatility of the Company’s stock price, the risk-free interest rate over the options’ expected term and the annual dividend yield. The Company uses the fair value of the common stock on the date of award to measure compensation cost for restricted stock unit awards. Compensation cost is recognized over the vesting period of the award using the straight line method. During the six months ended June 30, 2014 and 2013, the Company granted 264,095 and 243,645 restricted stock units, respectively. There were no restricted stock units granted during the three months ended June 30, 2014 and 2013. There were no stock options granted during the six months ended June 30, 2014 and 2013.
 
 
-26-

 
PART I – FINANCIAL INFORMATION

FLUSHING FINANCIAL CORPORATION and SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
 
The 2014 Omnibus Incentive Plan (“Omnibus Plan”) became effective on May 20, 2014 after approval by the stockholders. The Omnibus Plan authorizes the Compensation Committee of the Company’s Board of Directors (the “Compensation Committee”) to grant a variety of equity compensation awards as well as long-term and annual cash incentive awards, all of which can, but need not, be structured so as to comply with Section 162(m) of the Internal Revenue Code of 1986, as amended (the “Internal Revenue Code”). The Omnibus Plan authorizes the issuance of 1,100,000 shares. To the extent that an award under the Omnibus Plan is cancelled, expired, forfeited, settled in cash, settled by issuance of fewer shares than the number underlying the award, or otherwise terminated without delivery of shares to a participant in payment of the exercise price or taxes relating to an award, the shares retained by or returned to the Company will be available for future issuance under the Omnibus Plan. Although, commencing upon the approval of the Omnibus Plan by stockholders, no further awards may be granted under the Company’s 2005 Omnibus Incentive Plan, 1996 Stock Option Incentive Plan, and 1996 Restricted Stock Incentive Plan (the “Prior Plans”), all outstanding awards under the Prior Plans shall continue in accordance with their terms. At June 30, 2014, there were 1,100,000 shares available for delivery in connection with awards under the Omnibus Plan. To satisfy stock option exercises or fund restricted stock and restricted stock unit awards, shares are issued from treasury stock, if available; otherwise new shares are issued. The exercise price per share of a stock option grant may not be less than the fair market value of the common stock of the Company, as defined in the Omnibus Plan, on the date of grant and may not be re-priced without the approval of the Company’s stockholders. Options, stock appreciation rights, restricted stock, restricted stock units and other stock based awards granted under the Omnibus Plan are generally subject to a minimum vesting period of three years with stock options having a 10-year maximum contractual term. Other awards do not have a contractual term of expiration. The Compensation Committee is authorized to grant awards that vest upon a participant’s retirement. These amounts are included in stock-based compensation expense at the time of the participant’s retirement eligibility.
 
The following table summarizes the Company’s restricted stock unit (“RSU”) awards under the Omnibus Plan and the Prior Plans in the aggregate at or for the six months ended June 30, 2014:

   
Shares
   
Weighted-Average
Grant-Date
Fair Value
 
             
Non-vested at December 31, 2013
    346,584     $ 14.08  
Granted
    264,095       20.18  
Vested
    (200,124 )     16.89  
Forfeited
    (15,356 )     15.38  
Non-vested at June 30, 2014
    395,199     $ 16.68  
                 
Vested but unissued at June 30, 2014
    227,083     $ 16.95  
 
As of June 30, 2014, there was $5.4 million of total unrecognized compensation cost related to RSU awards granted under the Omnibus Plan and the Prior Plans. That cost is expected to be recognized over a weighted-average period of 3.4 years. There were no awards vested during the three months ended June 30, 2014. The total fair value of awards vested for the three months ended June 30, 2013 were $0.2 million. The total fair value of awards vested for the six months ended June 30, 2014 and 2013 were $4.1 million and $2.8 million, respectively. The vested but unissued RSU awards consist of awards made to employees and directors who are eligible for retirement. According to the terms of these awards, which provide for vesting upon retirement, these employees and directors have no risk of forfeiture. These shares will be issued at the original contractual vesting and settlement dates.
 
 
-27-

 
PART I – FINANCIAL INFORMATION

FLUSHING FINANCIAL CORPORATION and SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
 
The following table summarizes certain information regarding the stock option awards under the Omnibus Plan and the Prior Plans in the aggregate at or for the six months ended June 30, 2014:
 
   
Shares
   
Weighted-
Average
Exercise
Price
   
Weighted-Average
Remaining
Contractual
(years)
   
Aggregate
Intrinsic
Value
$(000) *
 
                           
Outstanding at December 31, 2013
    306,630     $ 16.02                
Granted     -                      
Exercised
    (100,625 )     17.08                
Forfeited
    -       -                
Outstanding at June 30, 2014
    206,005     $ 15.49     3.4     $ 1,148  
Exercisable shares at June 30, 2014
    206,005     $ 15.49     3.4     $ 1,148  
 
* The intrinsic value of a stock option is the difference between the market value of the underlying stock and the exercise price of the option.
 
As of June 30, 2014, there is no remaining unrecognized compensation cost related to stock options granted.
 
Cash proceeds, fair value received, tax benefits and the intrinsic value related to stock options exercised during the three and six months ended June 30, 2014 and 2013 are provided in the following table:
 
   
For the three months ended
June 30,
   
For the six months ended
June 30,
 
(In thousands)
 
2014
   
2013
   
2014
   
2013
 
Proceeds from stock options exercised
  $ 87     $ 212     $ 429     $ 235  
Fair value of shares received upon exercised of stock options
    812       937       1,290       1,574  
Tax benefit related to stock options exercised
    24       115       93       168  
Intrinsic value of stock options exercised
    105       203       317       377  
 
Phantom Stock Plan: The Company maintains a non-qualified phantom stock plan as a supplement to its profit sharing plan for officers who have achieved the level of Senior Vice President and above and completed one year of service. However, officers who had achieved at least the level of Vice President and completed one year of service prior to January 1, 2009 remain eligible to participate in the phantom stock plan. Awards are made under this plan on certain compensation not eligible for awards made under the profit sharing plan, due to the terms of the profit sharing plan and the Internal Revenue Code. Employees receive awards under this plan proportionate to the amount they would have received under the profit sharing plan, but for limits imposed by the profit sharing plan and the Internal Revenue Code. The awards are made as cash awards, and then converted to common stock equivalents (phantom shares) at the then current market value of the Company’s common stock. Dividends are credited to each employee’s account in the form of additional phantom shares each time the Company pays a dividend on its common stock. In the event of a change of control (as defined in this plan), an employee’s interest is converted to a fixed dollar amount and deemed to be invested in the same manner as his interest in the Bank’s non-qualified deferred compensation plan. Employees vest under this plan 20% per year for 5 years. Employees also become 100% vested upon a change of control. Employees receive their vested interest in this plan in the form of a cash lump sum payment or installments, as elected by the employee, after termination of employment. The Company adjusts its liability under this plan to the fair value of the shares at the end of each period.
 
 
-28-

 
PART I – FINANCIAL INFORMATION

FLUSHING FINANCIAL CORPORATION and SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
 
The following table summarizes the Phantom Stock Plan at or for the six months ended June 30, 2014:

Phantom Stock Plan
 
Shares
   
Fair Value
 
             
Outstanding at December 31, 2013
    59,323     $ 20.70  
Granted
    8,609       19.89  
Forfeited
    (13 )     21.51  
Distributions
    (668 )     20.10  
Outstanding at June 30, 2014
    67,251     $ 20.55  
Vested at June 30, 2014
    67,066     $ 20.55  
 
The Company recorded stock-based compensation benefit for the Phantom Stock Plan of $25,000 and $21,000 for the three months ended June 30, 2014 and 2013, respectively. The total fair value of the distributions from the Phantom Stock Plan was $7,000 and $8,000 for the three months ended June 30, 2014 and 2013, respectively.
 
For the six months ended June 30, 2014 and 2013, the Company recorded stock-based compensation expense for the Phantom Stock Plan of $17,000 and $78,000, respectively. The total fair value of the distributions from the Phantom Stock Plan during the six months ended June 30, 2014 and 2013 were $13,000 and $8,000, respectively.
 
9.
Pension and Other Postretirement Benefit Plans

The following table sets forth information regarding the components of net expense for the pension and other postretirement benefit plans.
 
   
Three months ended
June 30,
   
Six months ended
June 30,
 
(In thousands)
 
2014
   
2013
   
2014
   
2013
 
                         
Employee Pension Plan:
                       
Interest cost
  $ 223     $ 207     $ 446     $ 414  
Amortization of unrecognized loss
    190       306       380       612  
Expected return on plan assets
    (336 )     (315 )     (672 )     (630 )
Net employee pension expense
  $ 77     $ 198     $ 154     $ 396  
                                 
Outside Director Pension Plan:
                               
Service cost
  $ 13     $ 21     $ 26     $ 42  
Interest cost
    29       24       58       48  
Amortization of unrecognized gain
    (15 )     (9 )     (30 )     (18 )
Amortization of past service liability
    10       9       20       18  
Net outside director pension expense
  $ 37     $ 45     $ 74     $ 90  
                                 
Other Postretirement Benefit Plans:
                               
Service cost
  $ 90     $ 112     $ 180     $ 224  
Interest cost
    63       55       126       110  
Amortization of unrecognized loss
    -       12       -       24  
Amortization of past service credit
    (22 )     (20 )     (43 )     (40 )
Net other postretirement expense
  $ 131     $ 159     $ 263     $ 318  

The Company previously disclosed in its Consolidated Financial Statements for the year ended December 31, 2013 that it expects to contribute $0.2 million and $0.3 million to the Outside Director Pension Plan (the “Outside Director Pension Plan”) and the other postretirement benefit plans (the “Other Postretirement Benefit Plans”), respectively, during the year ending December 31, 2014. The Company does not expect to make a contribution to the Employee Pension Plan (the “Employee Pension Plan”). As of June 30, 2014, the Company has contributed $48,000 to the Outside Director Pension Plan and $34,000 to the Other Postretirement Benefit Plans. As of June 30, 2014, the Company has not revised its expected contributions for the year ending December 31, 2014.

 
-29-

 
PART I – FINANCIAL INFORMATION

FLUSHING FINANCIAL CORPORATION and SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
 
10.
Fair Value of Financial Instruments

The Company carries certain financial assets and financial liabilities at fair value in accordance with ASC Topic 825, “Financial Instruments” (“ASC Topic 825”) and values those financial assets and financial liabilities in accordance with ASC Topic 820, “Fair Value Measurements and Disclosures” (“ASC Topic 820”). ASC Topic 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date, establishes a framework for measuring fair value and expands disclosures about fair value measurements. ASC Topic 825 permits entities to choose to measure many financial instruments and certain other items at fair value. At June 30, 2014, the Company carried financial assets and financial liabilities under the fair value option with fair values of $38.9 million and $29.4 million, respectively. At December 31, 2013, the Company carried financial assets and financial liabilities under the fair value option with fair values of $37.3 million and $29.6 million, respectively. The Company elected to measure at fair value, securities with a cost of $5.0 million that were purchased during the six months ended June 30, 2014. The Company did not elect to carry any additional financial assets or financial liabilities under the fair value option during the six months ended June 30, 2013. During the six months ended June 30, 2014, the Company sold financial assets carried under the fair value option totaling $1.9 million.
 
The following table presents the financial assets and financial liabilities reported at fair value under the fair value option, and the changes in fair value included in the Consolidated Statement of Income – Net gain (loss) from fair value adjustments, at or for the periods ended as indicated:
 
   
Fair Value
Measurements
   
Fair Value
Measurements
   
Changes in Fair Values For Items Measured at Fair Value
Pursuant to Election of the Fair Value Option
 
   
at June 30,
   
at December 31,
   
Three Months Ended
   
Six Months Ended
 
(Dollars in thousands)
 
2014
   
2013
   
June 30, 2014
   
June 30, 2013
   
June 30, 2014
   
June 30, 2013
 
                                     
Mortgage-backed securities
  $ 5,182     $ 7,119     $ 24     $ (169 )   $ 72     $ (531 )
Other securities
    33,718       30,163       172       (220 )     497       53  
Borrowed funds
    29,388       29,570       154       (1,456 )     179       (2,275 )
Net gain (loss) from fair value adjustments (1) (2)
                  $ 350     $ (1,845 )   $ 748     $ (2,753 )
 
(1)
The net gain (loss) from fair value adjustments presented in the above table does not include net gains (losses) of ($0.8) million and $1.5 million for the three months ended June 30, 2014 and 2013, respectively, from the change in the fair value of interest rate caps/Swaps.
 
(2)
The net gain (loss) from fair value adjustments presented in the above table does not include net gains (losses) of ($1.8) million and $2.3 million for the six months ended June 30, 2014 and 2013, respectively, from the change in the fair value of interest rate caps/Swaps.
 
Included in the fair value of the financial assets and financial liabilities selected for the fair value option is the accrued interest receivable or payable for the related instrument. The Company accrues on the financial instruments and reports, as interest income or interest expense in the Consolidated Statement of Income, the interest receivable or payable on the financial instruments selected for the fair value option at their respective contractual rates.
 
The borrowed funds have a contractual principal amount of $61.9 million at both June 30, 2014 and December 31, 2013. The fair value of borrowed funds includes accrued interest payable of $0.1 million at June 30, 2014 and December 31, 2013.
 
The Company generally holds its earning assets, other than securities available for sale, to maturity and settles its liabilities at maturity. However, fair value estimates are made at a specific point in time and are based on relevant market information. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular instrument. Accordingly, as assumptions change, such as interest rates and prepayments, fair value estimates change and these amounts may not necessarily be realized in an immediate sale.
 
Disclosure of fair value does not require fair value information for items that do not meet the definition of a financial instrument or certain other financial instruments specifically excluded from its requirements. These items include core deposit intangibles and other customer relationships, premises and equipment, leases, income taxes and equity.
 
 
-30-

 
PART I – FINANCIAL INFORMATION

FLUSHING FINANCIAL CORPORATION and SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
 
Further, fair value disclosure does not attempt to value future income or business. These items may be material and accordingly, the fair value information presented does not purport to represent, nor should it be construed to represent, the underlying “market” or franchise value of the Company.
 
Financial assets and financial liabilities reported at fair value are required to be measured based on either: (1) quoted prices in active markets for identical financial instruments (Level 1); (2) significant other observable inputs (Level 2); or (3) significant unobservable inputs (Level 3).
 
A description of the methods and significant assumptions utilized in estimating the fair value of the Company’s assets and liabilities that are carried at fair value on a recurring basis are as follows:
 
Level 1 – where quoted market prices are available in an active market. The Company did not value any of its assets or liabilities that are carried at fair value on a recurring basis as Level 1 at June 30, 2014 and December 31, 2013.
 
Level 2 – when quoted market prices are not available, fair value is estimated using quoted market prices for similar financial instruments and adjusted for differences between the quoted instrument and the instrument being valued. Fair value can also be estimated by using pricing models, or discounted cash flows. Pricing models primarily use market-based or independently sourced market parameters as inputs, including, but not limited to, yield curves, interest rates, equity or debt prices and credit spreads. In addition to observable market information, models also incorporate maturity and cash flow assumptions. At June 30, 2014 and December 31, 2013, Level 2 included mortgage related securities, corporate debt and interest rate caps/Swaps.
 
Level 3 – when there is limited activity or less transparency around inputs to the valuation, financial instruments are classified as Level 3. At June 30, 2014 and December 31, 2013, Level 3 included municipal securities and trust preferred securities owned by and junior subordinated debentures issued by the Company.
 
The methods described above may produce fair values that may not be indicative of net realizable value or reflective of future fair values. While the Company believes its valuation methods are appropriate and consistent with those of other market participants, the use of different methodologies, assumptions and models to determine fair value of certain financial instruments could produce different estimates of fair value at the reporting date.
 
The following table sets forth the assets and liabilities that are carried at fair value on a recurring basis and the method that was used to determine their fair value, at June 30, 2014 and December 31, 2013:
 
   
Quoted Prices
in Active Markets
for Identical Assets
(Level 1)
   
Significant Other
Observable Inputs
(Level 2)
   
Significant Other
Unobservable Inputs
(Level 3)
   
Total carried at fair value
on a recurring basis
 
   
June 30,
2014
   
December 31,
2013
   
June 30,
2014
   
December 31,
2013
   
June 30,
2014
   
December 31,
2013
   
June 30,
2014
   
December 31,
2013
 
                                                 
                                                 
Assets:
                                               
Mortgage-backed Securities
  $ -     $ -     $ 770,545     $ 756,156     $ -     $ -     $ 770,545     $ 756,156  
Other securities
    -       -       264,184       237,476       23,953       24,158       288,137       261,634  
Interest rate swaps
    -       -       178       2,081       -       -       178       2,081  
Total assets
  $ -     $ -     $ 1,034,907     $ 995,713     $ 23,953     $ 24,158     $ 1,058,860     $ 1,019,871  
                                                                 
Liabilities:
                                                               
Borrowings
  $ -     $ -     $ -     $ -     $ 29,388     $ 29,570     $ 29,388     $ 29,570  
Interest rate swaps
    -       -       254       -       -       -       254       -  
Total liabilities
  $ -     $ -     $ 254     $ -     $ 29,388     $ 29,570     $ 29,642     $ 29,570  

 
-31-

 
PART I – FINANCIAL INFORMATION

FLUSHING FINANCIAL CORPORATION and SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
 
The following table sets forth the Company's assets and liabilities that are carried at fair value on a recurring basis, classified within Level 3 of the valuation hierarchy for the period indicated:
 
   
For the three months ended
June 30, 2014
 
   
Municipals
   
Trust preferred
securities
   
Junior subordinated
debentures
 
   
(In thousands)
 
                   
Beginning balance
  $ 10,170     $ 13,059     $ 29,541  
Transfer into Level 3
    -       -       -  
Purchases
    475       -       -  
Principal repayments
    (53 )     -       -  
Net gain from fair value adjustment of financial assets
    -       29       -  
Net gain from fair value adjustment of financial liabilities
    -       -       (154 )
Increase in accrued interest payable
    -       -       1  
Change in unrealized gains (losses) included in other comprehensive income
    -       273       -  
Ending balance
  $ 10,592     $ 13,361     $ 29,388  
                         
Changes in unrealized held at period end
  $ -     $ 242     $ -  
 
The following table sets forth the Company's assets and liabilities that are carried at fair value on a recurring basis, classified within Level 3 of the valuation hierarchy for the period indicated:
 
   
For the three months ended
June 30, 2013
 
   
REMIC and
CMO
   
Municipals
   
Trust preferred
securities
   
Junior subordinated
debentures
 
   
(In thousands)
 
                         
Beginning balance
  $ 23,761     $ 9,378     $ 7,427     $ 24,742  
Transfer into Level 3
    -       -       -       -  
Net gain from fair value adjustment of financial assets
    -       -       265       -  
Net loss from fair value adjustment of financial liabilities
    -       -       -       1,456  
Increase in accrued interest payable
    -       -       -       (6 )
Other-than-temporary impairment charge
    (503 )     -       -       -  
Change in unrealized gains (losses) included in other comprehensive income
    (328 )     (51 )     675       -  
Ending balance
  $ 22,930     $ 9,327     $ 8,367     $ 26,192  
                                 
Changes in unrealized held at period end
  $ (42 )   $ (102 )   $ 1,205     $ -  
 
 
-32-

 
PART I – FINANCIAL INFORMATION

FLUSHING FINANCIAL CORPORATION and SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
 
The following table sets forth the Company's assets and liabilities that are carried at fair value on a recurring basis, classified within Level 3 of the valuation hierarchy for the period indicated:
 
   
For the six months ended
June 30, 2014
 
   
Municipals
   
Trust preferred
securities
   
Junior subordinated
debentures
 
   
(In thousands)
 
                   
Beginning balance
  $ 9,223     $ 14,935     $ 29,570  
Transfer into Level 3
    -       -       -  
Purchases
    2,475       -       -  
Principal repayments
    (1,106 )     -       -  
Sales
    -       (1,871 )     -  
Net gain from fair value adjustment of financial assets
    -       55       -  
Net gain from fair value adjustment of financial liabilities
    -       -       (179 )
Decrease in accrued interest payable
    -       -       (3 )
Change in unrealized gains (losses) included in other comprehensive income
    -       242       -  
Ending balance
  $ 10,592     $ 13,361     $ 29,388  
                         
Changes in unrealized held at period end
  $ -     $ 242     $ -  
 
The following table sets forth the Company's assets and liabilities that are carried at fair value on a recurring basis, classified within Level 3 of the valuation hierarchy for the period indicated:
 
   
For the six months ended
June 30, 2013
 
   
REMIC and
CMO
   
Municipals
   
Trust preferred
securities
   
Junior subordinated
debentures
 
   
(In thousands)
 
                         
Beginning balance
  $ 23,475     $ 9,429     $ 6,650     $ 23,922  
Transfer into Level 3
    -       -       -       -  
Net gain from fair value adjustment of financial assets
    -       -       512       -  
Net loss from fair value adjustment of financial liabilities
    -       -       -       2,275  
Increase in accrued interest payable
    -       -       -       (5 )
Other-than-temporary impairment charge
    (503 )     -       -       -  
Change in unrealized gains (losses) included in other comprehensive income
    (42 )     (102 )     1,205       -  
Ending balance
  $ 22,930     $ 9,327     $ 8,367     $ 26,192  
                                 
Changes in unrealized held at period end
  $ (42 )   $ (102 )   $ 1,205     $ -  
 
During the three and six months ended June 30, 2014 and 2013, there were no transfers between Levels 1, 2 and 3.
 
 
-33-

 
PART I – FINANCIAL INFORMATION

FLUSHING FINANCIAL CORPORATION and SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
 
The following table presents the quantitative information about recurring Level 3 fair value of financial instruments and the fair value measurements as of June 30, 2014:
 
June 30, 2014
 
Fair Value
   
Valuation Technique
 
Unobservable Input
 
Range (Weighted Average)
   
(Dollars in thousands)
Assets:
                       
                         
Municipals
  $ 10,592    
Discounted cash flows
 
Discount rate
  0.5% - 4.0% (3.2%)
                           
               
Discount rate
  7.0% - 11.0% (8.5%)
               
Prepayment assumptions
  25.2% - 36.8% (30.8%)
Trust Preferred Securities
  $ 13,361    
Discounted cash flows
 
Defaults
  8.3% - 15.0% (11.6%)
                           
Liabilities:
                         
                           
Junior subordinated debentures
  $ 29,388    
Discounted cash flows
 
Discount rate
    7.0%   (7.0%)
 
The significant unobservable inputs used in the fair value measurement of the Company’s municipal securities valued under Level 3 are the securities’ effective yield. Significant increases or decreases in the effective yield in isolation would result in a significantly lower or higher fair value measurement.
 
The significant unobservable inputs used in the fair value measurement of the Company’s trust preferred securities valued under Level 3 are the securities’ prepayment assumptions and default rate. Significant increases or decreases in any of the inputs in isolation would result in a significantly lower or higher fair value measurement.
 
The significant unobservable inputs used in the fair value measurement of the Company’s junior subordinated debentures under Level 3 are effective yield. Significant increases or decreases in the effective yield in isolation would result in a significantly lower or higher fair value measurement.
 
The following table sets forth the Company’s assets and liabilities that are carried at fair value on a non-recurring basis and the method that was used to determine their fair value, at June 30, 2014 and December 31, 2013:
 
   
Quoted Prices
in Active Markets
for Identical Assets
(Level 1)
   
Significant Other
Observable Inputs
(Level 2)
   
Significant Other
Unobservable Inputs
(Level 3)
   
Total carried at fair value
on a recurring basis
 
   
June 30,
2014
   
December 31,
2013
   
June 30,
2014
   
December 31,
2013
   
June 30,
2014
   
December 31,
2013
   
June 30,
2014
   
December 31,
2013
 
                                                 
Assets:
                                               
Loans held for sale
  $ -     $ -     $ -     $ -     $ -     $ 425     $ -     $ 425  
Impaired loans
    -       -       -       -       33,099       23,544       33,099       23,544  
Other real estate owned
    -       -       -       -       1,346       2,985       1,346       2,985  
Total assets
  $ -     $ -     $ -     $ -     $ 34,445     $ 26,954     $ 34,445     $ 26,954  
 
 
-34-

 
PART I – FINANCIAL INFORMATION

FLUSHING FINANCIAL CORPORATION and SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
 
The following table presents the quantitative information about non-recurring Level 3 fair value of financial instruments and the fair value measurements as of June 30, 2014:
 
June 30, 2014
 
Fair Value
   
Valuation Technique
 
Unobservable Input
  Range (Weighted Average)
   
(Dollars in thousands)
Assets:
                       
                         
Impaired loans
  $ 33,099    
Fair value of collateral
 
Loss severity discount
  0.5% - 94.7% (39.2%)
Other real estate owned
  $ 1,346    
Fair value of collateral
 
Loss severity discount
  0.0% - 24.6% (4.5%)
 
The Company carries its Loans held for sale and OREO at the expected sales price less selling costs.
 
The Company carries its impaired collateral dependent loans at 85% of the appraised or internally estimated value of the underlying property.
 
The Company did not have any liabilities that were carried at fair value on a non-recurring basis at June 30, 2014 and December 31, 2013.
 
The estimated fair value of each material class of financial instruments at June 30, 2014 and December 31, 2013 and the related methods and assumptions used to estimate fair value are as follows:
 
Cash and Due from Banks, Overnight Interest-Earning Deposits and Federal Funds Sold:

The fair values of financial instruments that are short-term or reprice frequently and have little or no risk are considered to have a fair value that approximates carrying value (Level 1).
 
FHLB-NY stock:

The fair value is based upon the par value of the stock which equals its carrying value (Level 2).
 
Securities Available for Sale:
 
The estimated fair values of securities available for sale are contained in Note 6 of Notes to Consolidated Financial Statements. Fair value is based upon quoted market prices (Level 1 input), where available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities and adjusted for differences between the quoted instrument and the instrument being valued (Level 2 input). When there is limited activity or less transparency around inputs to the valuation, securities are valued using (Level 3 input).
 
Loans held for sale:
 
The fair value of non-performing loans held for sale is estimated through bids received on the loans and, as such, are classified as a Level 3 input.
 
Loans:
 
The estimated fair value of loans is estimated by discounting the expected future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and remaining maturities (Level 3 input).
 
For impaired loans, fair value is generally estimated by discounting management’s estimate of future cash flows with a discount rate commensurate with the risk associated with such assets or for collateral dependent loans 85% of the appraised or internally estimated value of the property.(Level 3 input).
 
Due to Depositors:
 
The fair values of demand, passbook savings, NOW, money market deposits and escrow deposits are, by definition, equal to the amount payable on demand at the reporting dates (i.e. their carrying value) (Level 1). The fair value of fixed-maturity certificates of deposits are estimated by discounting the expected future cash flows using the rates currently offered for deposits of similar remaining maturities (Level 2 input).
 
 
-35-

 
PART I – FINANCIAL INFORMATION

FLUSHING FINANCIAL CORPORATION and SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
 
Borrowings:
 
The estimated fair value of borrowings are estimated by discounting the contractual cash flows using interest rates in effect for borrowings with similar maturities and collateral requirements (Level 2 input) or using a market-standard model (Level 3 input).
 
Interest Rate Caps:
 
The estimated fair value of interest rate caps is based upon broker quotes (Level 2 input).
 
Interest Rate Swaps:
 
The estimated fair value of interest rate swaps is based upon broker quotes (Level 2 input).

Other Real Estate Owned:
 
OREO are carried at fair value less selling costs. The fair value is based on appraised value through a current appraisal, or sometimes through an internal review, additionally adjusted by the estimated costs to sell the property (Level 3 input).
 
Other Financial Instruments:
 
The fair values of commitments to sell, lend or borrow are estimated using the fees currently charged or paid to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties or on the estimated cost to terminate them or otherwise settle with the counterparties at the reporting date. For fixed-rate loan commitments to sell, lend or borrow, fair values also consider the difference between current levels of interest rates and committed rates (where applicable).
 
At June 30, 2014 and December 31, 2013, the fair values of the above financial instruments approximate the recorded amounts of the related fees and were not considered to be material.
 
 
-36-

 
PART I – FINANCIAL INFORMATION

FLUSHING FINANCIAL CORPORATION and SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
 
The following table sets forth the carrying amounts and estimated fair values of selected financial instruments based on the assumptions described above used by the Company in estimating fair value at June 30, 2014:
 
   
June 30, 2014
 
   
Carrying
Amount
   
Fair
Value
   
Level 1
   
Level 2
   
Level 3
 
   
(in thousands)
 
Assets:
                             
                               
Cash and due from banks
  $ 36,982     $ 36,982     $ 36,982     $ -     $ -  
Mortgage-backed Securities
    770,545       770,545       -       770,545       -  
Other securities
    288,137       288,137       -       264,184       23,953  
Loans
    3,532,537       3,607,781       -       -       3,607,781  
FHLB-NY stock
    51,407       51,407       -       51,407       -  
Interest rate caps
    -       -       -       -       -  
Interest rate swaps
    178       178       -       178       -  
OREO
    1,346       1,346       -       -       1,346  
Total assets
  $ 4,681,132     $ 4,756,376     $ 36,982     $ 1,086,314     $ 3,633,080  
                                         
                                         
Liabilities:
                                       
Deposits
  $ 3,238,971       3,255,292     $ 2,079,074     $ 1,176,218     $ -  
Borrowings
    1,112,202       1,135,968       -       1,106,580       29,388  
Interest rate swaps
    254       254       -       254       -  
Total liabilities
  $ 4,351,427     $ 4,391,514     $ 2,079,074     $ 2,283,052     $ 29,388  
 
 
-37-

 
PART I – FINANCIAL INFORMATION

FLUSHING FINANCIAL CORPORATION and SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
 
The following table sets forth the carrying amounts and estimated fair values of selected financial instruments based on the assumptions described above used by the Company in estimating fair value at December 31, 2013:
 
   
December 31, 2013
 
   
Carrying
Amount
   
Fair
Value
   
Level 1
   
Level 2
   
Level 3
 
   
(in thousands)
 
Assets:
                             
                               
Cash and due from banks
  $ 33,485     $ 33,485     $ 33,485     $ -     $ -  
Mortgage-backed Securities
    756,156       756,156       -       756,156       -  
Other securities
    261,634       261,634       -       237,476       24,158  
Loans held for sale
    425       425       -       -       425  
Loans
    3,434,178       3,502,792       -       -       3,502,792  
FHLB-NY stock
    46,025       46,025       -       46,025       -  
Interest rate caps
    -       -       -       -       -  
Interest rate swaps
    2,081       2,081       -       2,081       -  
OREO
    2,985       2,985       -       -       2,985  
Total assets
  $ 4,536,969     $ 4,605,583     $ 33,485     $ 1,041,738     $ 3,530,360  
                                         
                                         
Liabilities:
                                       
Deposits
  $ 3,232,780     $ 3,253,261     $ 2,111,825     $ 1,141,436     $ -  
Borrowings
    1,012,122       1,034,799       -       1,005,229       29,570  
Total liabilities
  $ 4,244,902     $ 4,288,060     $ 2,111,825     $ 2,146,665     $ 29,570  
 
11.
Derivative Financial Instruments
 
At June 30, 2014 and December 31, 2013, the Company’s derivative financial instruments consist of purchased options and swaps. The purchased options are used to mitigate the Company’s exposure to rising interest rates on its financial liabilities without stated maturities. The Company’s swaps are used to mitigate the Company’s exposure to rising interest rates on a portion ($18.0 million) of its floating rate junior subordinated debentures that have a contractual value of $61.9 million. Additionally, the Company at times may use swaps to mitigate the Company’s exposure to rising interest rates on its fixed rate loans.
 
At June 30, 2014 and December 31, 2013 derivatives with a combined notional amount of $118.0 million are not designated as hedges. Derivatives with a combined notional amount of $11.1 million and $11.2 million are designated as fair value hedges at June 30, 2014 and December 31, 2013, respectively. Changes in the fair value of the derivatives not designated as hedges are reflected in “Net gain/loss from fair value adjustments” in the Consolidated Statements of Income. The portion of the change in the fair value of the derivative designated as a fair value hedge which is considered ineffective are reflected in “Net gain/loss from fair value adjustments” in the Consolidated Statements of Income.
 
 
-38-

 
PART I – FINANCIAL INFORMATION

FLUSHING FINANCIAL CORPORATION and SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
 
The following table sets forth information regarding the Company’s derivative financial instruments at June 30, 2014:
 
   
At or for the six months ended June 30, 2014
 
                   
   
Notional
Amount
   
Purchase Price
   
Net Carrying (1)
Value
 
   
(In thousands)
 
                   
Interest rate caps (non-hedge)
  $ 100,000     $ 9,035     $ -  
Interest rate swaps (non-hedge)
    18,000       -       7  
Interest rate swaps (hedge)
    11,100       -       (83 )
Total derivatives
  $ 129,100     $ 9,035     $ (76 )
 
(1)
Derivatives in a net positive position are recorded as “Other assets” and derivatives in a net negative position are recorded as “Other liabilities” in the Consolidated Statements of Financial Condition.
 
The following table sets forth information regarding the Company’s derivative financial instruments at December 31, 2013:
 
   
At or for the year ended December 31, 2013
 
                   
   
Notional
Amount
   
Purchase Price
   
 
Value
 
   
(In thousands)
 
                   
Interest rate caps (non-hedge)
  $ 100,000     $ 9,035     $ -  
Interest rate swaps (non-hedge)
    18,000       -       1,681  
Interest rate swaps (hedge)
    11,217       -       400  
Total derivatives
  $ 129,217     $ 9,035     $ 2,081  
 
(1)
Derivatives in a net positive position are recorded as “Other assets” and derivatives in a net negative position are recorded as “Other liabilities” in the Consolidated Statements of Financial Condition.

The following table sets forth the effect of derivative instruments on the Consolidated Statements of Income for the periods indicated:
 
   
For the three months ended
June 30,
   
For the six months ended
June 30,
 
(In thousands)
 
2014
   
2013
   
2014
   
2013
 
                         
Financial Derivatives:
                       
Interest rate caps
  $ -     $ (8 )   $ -     $ (11 )
Interest rate swaps
    (752 )     1,545       (1,794 )     2,333  
Net Gain (loss) (1)
  $ (752 )   $ 1,537     $ (1,794 )   $ 2,322  
 
(1)
Net gains and (losses) are recorded as part of “Net loss from fair value adjustments” in the Consolidated Statements of Income.
 
 
-39-

 
PART I – FINANCIAL INFORMATION

FLUSHING FINANCIAL CORPORATION and SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
 
12.
Income Taxes
 
Flushing Financial Corporation files consolidated Federal and combined New York State and New York City income tax returns with its subsidiaries, with the exception of Flushing Financial Capital Trust II, Flushing Financial Capital Trust III, and Flushing Financial Capital Trust IV, which file separate Federal income tax returns as trusts, and Flushing Preferred Funding Corporation, which files a separate Federal and New York State income tax return as a real estate investment trust.
 
Income tax provisions are summarized as follows:
 
   
For the three months
ended June 30,
   
For the six months
ended June 30,
 
(In thousands)
 
2014
   
2013
   
2014
   
2013
 
Federal:
                       
Current
  $ 5,675     $ 5,187     $ 8,412     $ 8,021  
Deferred
    (162 )     (524 )     1,859       103  
Total federal tax provision
    5,513       4,663       10,271       8,124  
State and Local:
                               
Current
    2,102       1,724       3,368       2,305  
Deferred
    (17 )     (232 )     886       45  
Total state and local tax provision
    2,085       1,492       4,254       2,350  
Total income tax provision
  $ 7,598     $ 6,155     $ 14,525     $ 10,474  
 
The effective tax rate was 39.4% and 39.0% for the three months ended June 30, 2014 and 2013, respectively, and 39.8% and 39.0% for the six months ended June 30, 2014 and 2013, respectively. The increase in the effective tax rate was primarily due to the impact of changes to the New York State tax code passed on March 31, 2014, resulting in a reduction in the Company’s deferred tax assets. We expect to see a small reduction in our effective tax rate beginning in 2015 as a result of the changes in the New York State tax code.
 
The effective rates differ from the statutory federal income tax rate as follows:
 
   
For the three months
ended June 30,
   
For the six months
ended June 30,
 
(dollars in thousands)
 
2014
   
2013
   
2014
   
2013
 
                                                 
Taxes at federal statutory rate
  $ 6,749       35.0 %   $ 5,524       35.0 %   $ 12,777       35.0 %   $ 9,400       35.0 %
Increase (reduction) in taxes resulting from:
                                                               
State and local income tax, net of Federal income tax benefit
    1,355       7.0       970       6.1       2,765       7.6       1,528       5.7  
Other
    (506 )     (2.6 )     (339 )     (2.1 )     (1,017 )     (2.8 )     (454 )     (1.7 )
Taxes at effective rate
  $ 7,598       39.4 %   $ 6,155       39.0 %   $ 14,525       39.8 %   $ 10,474       39.0 %
 
The Company has recorded a deferred tax asset of $25.3 million at June 30, 2014, which is included in “Other assets” in the Consolidated Statements of Financial Condition. This represents the anticipated net federal, state and local tax benefits expected to be realized in future years upon the utilization of the underlying tax attributes comprising this balance. The Company has reported taxable income for federal, state, and local tax purposes in each of the past three fiscal years. In management’s opinion, in view of the Company’s previous, current and projected future earnings trend, the probability that some of the Company’s $19.2 million deferred tax liability can be used to offset a portion of the deferred tax asset, as well as certain tax planning strategies, it is more likely than not that the deferred tax asset will be fully realized. Accordingly, no valuation allowance was deemed necessary for the deferred tax asset at June 30, 2014.
 
 
-40-

 
PART I – FINANCIAL INFORMATION

FLUSHING FINANCIAL CORPORATION and SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
 
13.
Accumulated Other Comprehensive Income:
 
The following table sets forth the changes in accumulated other comprehensive income by component for the six months ended June 30, 2014:
 
   
Unrealized Gains
and (Losses) on
Available for Sale
Securities
   
Defined Benefit
Pension Items
   
Total
 
   
(In thousands)
 
Beginning balance, net of tax
  $ (8,522 )   $ (2,853 )   $ (11,375 )
Other comprehensive income before reclassifications, net of tax
    11,873       -     $ 11,873  
Amounts reclassified from accumulated other comprehensive income, net of tax
    -       151       151  
Net current period other comprehensive income, net of tax
    11,873       151       12,024  
Ending balance, net of tax
  $ 3,351     $ (2,702 )   $ 649  
 
The following table sets forth significant amounts reclassified out of accumulated other comprehensive income by component for the three months ended June 30, 2014:
 
Details about Accumulated Other
Comprehensive Income Components
 
Amounts Reclassified from
Accumulated Other
Comprehensive Income
     
Affected Line Item in the Statement
Where Net Income is Presented
(Dollars in thousands)
             
Amortization of defined benefit pension items:
           
Actuarial losses
  $ (175 ) (1)  
Other expense
Prior service credits
    12   (1)  
Other expense
      (163 )    
Total before tax
      72      
Tax benefit
    $ (91 )    
Net of tax
 
(1)
These accumulated other comprehensive income components are included in the computation of net periodic pension cost (See Note 9 of the Notes to Consolidated Financial Statements “Pension and Other Postretirement Benefit Plans”.)
 
 
-41-

 
PART I – FINANCIAL INFORMATION

FLUSHING FINANCIAL CORPORATION and SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
 
The following table sets forth significant amounts reclassified out of accumulated other comprehensive income by component for the three months ended June 30, 2013:
 
Details about Accumulated Other
Comprehensive Income Components
 
Amounts Reclassified from
Accumulated Other
Comprehensive Income
     
Affected Line Item in the Statement
Where Net Income is Presented
(Dollars in thousands)
Unrealized gains (losses) on available for sale securities:
  $ 18      
Net gain on sale of securities
      (8 )    
Tax expense
    $ 10      
Net of tax
               
               
OTTI charges
  $ (503 )    
OTTI charge
      220      
Tax benefit
    $ (283 )    
Net of tax
               
               
Amortization of defined benefit pension items:
             
Actuarial losses
  $ (309 ) (1)  
Other expense
Prior service credits
    11   (1)  
Other expense
      (298 )    
Total before tax
      130      
Tax benefit
    $ (168 )    
Net of tax
 
(1)
These accumulated other comprehensive income components are included in the computation of net periodic pension cost (See Note 9 of the Notes to Consolidated Financial Statements “Pension and Other Postretirement Benefit Plans”.)
 
The following table sets forth significant amounts reclassified out of accumulated other comprehensive income by component for the six months ended June 30, 2014:
 
Details about Accumulated Other
Comprehensive Income Components
 
Amounts Reclassified from
Accumulated Other
Comprehensive Income
     
Affected Line Item in the Statement
Where Net Income is Presented
(Dollars in thousands)
             
Amortization of defined benefit pension items:
           
Actuarial losses
  $ (350 ) (1)  
Other expense
Prior service credits
    23   (1)  
Other expense
      (327 )    
Total before tax
      176      
Tax benefit
    $ (151 )    
Net of tax
 
(1)
These accumulated other comprehensive income components are included in the computation of net periodic pension cost (See Note 9 of the Notes to Consolidated Financial Statements “Pension and Other Postretirement Benefit Plans”.)
 
 
-42-

 
PART I – FINANCIAL INFORMATION

FLUSHING FINANCIAL CORPORATION and SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
 
The following table sets forth significant amounts reclassified out of accumulated other comprehensive income by component for the six months ended June 30, 2013:
 
Details about Accumulated Other
Comprehensive Income Components
 
Amounts Reclassified from
Accumulated Other
Comprehensive Income
     
Affected Line Item in the Statement
Where Net Income is Presented
(Dollars in thousands)
Unrealized gains losses on available for sale securities:
  $ 2,876      
Net gain on sale of securities
      (1,257 )    
Tax expense
    $ 1,619      
Net of tax
               
               
OTTI charges
  $ (503 )    
OTTI charge
      220      
Tax benefit
    $ (283 )    
Net of tax
               
               
Amortization of defined benefit pension items:
             
Actuarial losses
  $ (618 ) (1)  
Other expense
Prior service credits
    22   (1)  
Other expense
      (596 )    
Total before tax
      260      
Tax benefit
    $ (336 )    
Net of tax
 
(1)
These accumulated other comprehensive income components are included in the computation of net periodic pension cost (See Note 9 of the Notes to Consolidated Financial Statements “Pension and Other Postretirement Benefit Plans”.)
 
 
-43-

 
PART I – FINANCIAL INFORMATION

FLUSHING FINANCIAL CORPORATION and SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
 
14.
Regulatory Capital
 
Under current capital regulations, the Bank is required to comply with three separate capital adequacy standards. As of June 30, 2014, the Bank continues to be categorized as “well-capitalized” under the prompt corrective action regulations and continues to exceed all regulatory capital requirements.
 
Set forth below is a summary of the Bank’s compliance with banking regulatory capital standards.
 
(Dollars in thousands)
 
Amount
   
Percent of Assets
 
             
Tier I (leverage) capital:
           
Capital level
  $ 459,988       9.54 %
Requirement to be well capitalized
    240,978       5.00  
Excess
    219,010       4.54  
                 
Tier I risk-based capital:
               
Capital level
  $ 459,988       14.13 %
Requirement to be well capitalized
    195,385       6.00  
Excess
    264,603       8.13  
                 
Total risk-based capital:
               
Capital level
  $ 489,222       15.02 %
Requirement to be well capitalized
    325,641       10.00  
Excess
    163,581       5.02  

The Holding Company is subject to the same regulatory capital requirements as the Bank. As of June 30, 2014, the Holding Company continues to be categorized as “well-capitalized” under the prompt corrective action regulations and continues to exceed all regulatory capital requirements.
 
Set forth below is a summary of the Holding Company’s compliance with banking regulatory capital standards.
 
 
-44-

 
PART I – FINANCIAL INFORMATION

FLUSHING FINANCIAL CORPORATION and SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
 
(Dollars in thousands)
 
Amount
   
Percent of Assets
 
             
Tier I (leverage) capital:
           
Capital level
  $ 472,547       9.82 %
Requirement to be well capitalized
    240,689       5.00  
Excess
    231,858       4.82  
                 
Tier I risk-based capital:
               
Capital level
  $ 472,547       14.54 %
Requirement to be well capitalized
    195,018       6.00  
Excess
    277,529       8.54  
                 
Total risk-based capital:
               
Capital level
  $ 501,782       15.44 %
Requirement to be well capitalized
    325,031       10.00  
Excess
    176,751       5.44  
 
15.
New Authoritative Accounting Pronouncements

In February 2013, the FASB issued ASU No. 2013-02, which amends the authoritative accounting guidance under ASC Topic 220 “Comprehensive Income.” The amendments do not change the current requirements for reporting net income or other comprehensive income in financial statements. However, the amendments require an entity to provide information about the amounts reclassified out of accumulated other comprehensive income by component. In addition, an entity is required to present, either on the face of the statement where net income is presented or in the notes, significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income but only if the amount reclassified is required under generally accepted accounting principles in the United States of America (“GAAP”) to be reclassified to net income in its entirety in the same reporting period. For other amounts that are not required under GAAP to be reclassified in their entirety to net income, an entity is required to cross-reference to other disclosures required under GAAP that provide additional detail about those amounts. The amendments in this update are effective prospectively for reporting periods beginning after December 15, 2012. Early adoption was permitted. Adoption of this update did not have a material effect on the Company’s consolidated results of operations or financial condition. (See Note 13 of Notes to Consolidated Financial Statements “Stockholders’ Equity”.)

In January 2014, the FASB issued ASU 2014-04 to clarify that when an in substance repossession or foreclosure occurs, a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either (1) the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure or (2) the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. Additionally, the amendments require interim and annual disclosure of both (1) the amount of foreclosed residential real estate property held by the creditor and (2) the recorded investment in consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure according to local requirements of the applicable jurisdiction. ASU 2014- 04 is effective for annual reporting periods beginning after December 15, 2014. Adoption of this update is not expected to have a material effect on the Company’s consolidated results of operations or financial condition.
 
In May 2014, the FASB issued ASU 2014-09 which provides new guidance that supersedes the revenue recognition requirements in ASC Topic 605, Revenue Recognition. The guidance requires an entity to recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. The guidance is effective for interim and annual reporting periods beginning after December 15, 2016. We are currently evaluating the impact of adopting this new guidance on our consolidated results of operations and financial condition.

In June 2014, the FASB issued ASU 2014-11 which amends the authoritative accounting guidance under ASC Topic 860 “Transfers and Servicing.” The amendments require two accounting changes. First, the amendments change the accounting for repurchase-to-maturity transactions to secured borrowing accounting. Second, for repurchase financing arrangements, the amendments require separate accounting for a transfer of a financial asset executed contemporaneously with a repurchase agreement with the same counterparty, which will result in secured borrowing accounting for the repurchase agreement. The amendments also require additional disclosures regarding repurchase agreements. The amendments are effective for the first interim or annual period beginning after December 15, 2014. Entities are required to present changes in accounting for transactions outstanding on the effective date as a cumulative-effect adjustment to retained earnings as of the beginning of the period of adoption. Early adoption is prohibited. The amendments regarding disclosures for certain transactions accounted for as a sale are required to be presented for interim and annual periods beginning after December 15, 2014, and the disclosure for repurchase agreements, securities lending transactions, and repurchase-to-maturity transactions accounted for as secured borrowings are required to be presented for annual periods beginning after December 15, 2014, and for interim periods beginning after March 15, 2015. The disclosures are not required to be presented for comparative periods before the effective date. We are currently evaluating the impact of adopting these amendments on our consolidated results of operations and financial condition.
 
 
-45-

 
PART I – FINANCIAL INFORMATION
FLUSHING FINANCIAL CORPORATION and SUBSIDIARIES
Management’s Discussion and Analysis of
Financial Condition and Results of Operations
 
ITEM 2.    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This Quarterly Report should be read in conjunction with the more detailed and comprehensive disclosures included in our Annual Report on Form 10-K for the year ended December 31, 2013.  In addition, please read this section in conjunction with our Consolidated Financial Statements and Notes to Consolidated Financial Statements contained herein.
 
As used in this Quarterly Report, the words “we,” “us,” “our” and the “Company” are used to refer to Flushing Financial Corporation and its direct and indirect wholly owned subsidiaries, Flushing Bank (the “Bank”), Flushing Preferred Funding Corporation, Flushing Service Corporation, and FSB Properties Inc.

Statements contained in this Quarterly Report relating to plans, strategies, objectives, economic performance and trends, projections of results of specific activities or investments and other statements that are not descriptions of historical facts may be forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.  Forward-looking information is inherently subject to risks and uncertainties and actual results could differ materially from those currently anticipated due to a number of factors, which include, but are not limited to, factors discussed elsewhere in this Quarterly Report and in other documents filed by us with the Securities and Exchange Commission from time to time, including, without limitation, our Annual Report on Form 10-K for the year ended December 31, 2013. Forward-looking statements may be identified by terms such as “may,” “will,” “should,” “could,” “expects,” “plans,” “intends,” “anticipates,” “believes,” “estimates,” “predicts,” “forecasts,” “potential” or “continue” or similar terms or the negative of these terms. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements.  We have no obligation to update these forward-looking statements.
 
Executive Summary
 
We are a Delaware corporation organized in May 1994. The Bank was organized in 1929 as a New York State-chartered mutual savings bank. In 1994, the Bank converted to a federally chartered mutual savings bank and changed its name from Flushing Savings Bank to Flushing Savings Bank, FSB. The Bank converted from a federally chartered mutual savings bank to a federally chartered stock savings bank on November 21, 1995, at which time Flushing Financial Corporation acquired all of the stock of the Bank. On February 28, 2013, the Bank’s charter was changed to a full-service New York State chartered commercial bank, and its name was changed to Flushing Bank. On July 21, 2011, as a result of the Dodd-Frank Wall Street Reform and Consumer Protection Act, the Bank’s primary regulator became the Office of the Comptroller of the Currency and Flushing Financial Corporation’s primary regulator became the Federal Reserve Board of Governors. As a result of the Bank’s change in charter to a full-service New York State chartered commercial bank, the Bank’s primary regulator became the New York State Department of Financial Services (formerly, the New York State Banking Department), and its primary federal regulator became the Federal Deposit Insurance Corporation (“FDIC”). Deposits are insured to the maximum allowable amount by the FDIC. Additionally, the Bank is a member of the Federal Home Loan Bank system. Also in connection with the Merger, Flushing Financial Corporation became a bank holding company. The primary business of Flushing Financial Corporation has been the operation of the Bank. The Bank owns three subsidiaries: Flushing Preferred Funding Corporation, Flushing Service Corporation, and FSB Properties Inc. In November 2006, the Bank launched an internet branch, iGObanking.com®. The activities of Flushing Financial Corporation are primarily funded by dividends, if any, received from the Bank, issuances of junior subordinated debt, and issuances of equity securities. Flushing Financial Corporation’s common stock is traded on the NASDAQ Global Select Market under the symbol “FFIC.”
 
 
-46-

 
PART I – FINANCIAL INFORMATION
FLUSHING FINANCIAL CORPORATION and SUBSIDIARIES
Management’s Discussion and Analysis of
Financial Condition and Results of Operations
 
Our principal business is attracting retail deposits from consumers, businesses and public entities and investing those deposits together with funds generated from ongoing operations and borrowings, primarily in (1) originations and purchases of multi-family residential properties and, to a lesser extent, one-to-four family (focusing on mixed-use properties, which are properties that contain both residential dwelling units and commercial units) and commercial real estate mortgage loans; (2) construction loans, primarily for residential properties; (3) Small Business Administration (“SBA”) loans and other small business loans; (4) mortgage loan surrogates such as mortgage-backed securities; and (5) U.S. government securities, corporate fixed-income securities and other marketable securities. We also originate certain other consumer loans including overdraft lines of credit. Our results of operations depend primarily on net interest income, which is the difference between the income earned on its interest-earning assets and the cost of our interest-bearing liabilities. Net interest income is the result of our interest rate margin, which is the difference between the average yield earned on interest-earning assets and the average cost of interest-bearing liabilities, adjusted for the difference in the average balance of interest-earning assets as compared to the average balance of interest-bearing liabilities. We also generate non-interest income from loan fees, service charges on deposit accounts, mortgage servicing fees, and other fees, income earned on Bank Owned Life Insurance (“BOLI”), dividends on Federal Home Bank of New York (“FHLB-NY”) stock and net gains and losses on sales of securities and loans. Our operating expenses consist principally of employee compensation and benefits, occupancy and equipment costs, other general and administrative expenses and income tax expense. Our results of operations also can be significantly affected by our periodic provision for loan losses and specific provision for losses on real estate owned.
 
Our strategy is to continue our focus on being an institution serving consumers, businesses, and governmental entities in our local markets. In furtherance of this objective, we intend to:
 
 
·
continue our emphasis on the origination of multi-family residential mortgage loans;
 
 
·
continue to transition our balance sheet to a more ‘commercial-like’ banking institution;
 
 
·
increase our commitment to the multi-cultural marketplace, with a particular focus on the Asian community in Queens;
 
 
·
maintain asset quality;
 
 
·
manage deposit growth and maintain a low cost of funds through
 
 
§
business banking deposits,
 
§
municipal deposits through government banking, and
 
§
new customer relationships via iGObanking.com®
 
 
·
cross sell to lending and deposit customers;
 
 
·
take advantage of market disruptions to attract talent and customers from competitors;
 
 
·
manage interest rate risk and capital: and
 
 
·
manage enterprise-wide risk.
 
There can be no assurance that we will be able to effectively implement this strategy. Our strategy is subject to change by the Board of Directors.
 
Our investment policy, which is approved by the Board of Directors, is designed primarily to manage the interest rate sensitivity of our overall assets and liabilities, to generate a favorable return without incurring undue interest rate risk and credit risk, to complement our lending activities and to provide and maintain liquidity. In establishing our investment strategies, we consider our business and growth strategies, the economic environment, our interest rate risk exposure, our interest rate sensitivity “gap” position, the types of securities to be held and other factors. We classify our investment securities as available for sale.
 
 
-47-

 
PART I – FINANCIAL INFORMATION
FLUSHING FINANCIAL CORPORATION and SUBSIDIARIES
Management’s Discussion and Analysis of
Financial Condition and Results of Operations
 
We carry a portion of our financial assets and financial liabilities at fair value and record changes in their fair value through earnings in non-interest income on our Consolidated Statements of Income and Comprehensive Income. A description of the financial assets and financial liabilities that are carried at fair value through earnings can be found in Note 10 of the Notes to the Consolidated Financial Statements.
 
The Bank continues to maintain conservative underwriting standards that include, among other things, a loan-to-value ratio of 75% or less and a debt coverage ratio of at least 125%. Multi-family residential, commercial real estate and one-to-four family mixed-use property mortgage loans originated during the second quarter of 2014 had an average loan-to-value ratio of 46.7% and an average debt coverage ratio of 401%.
 
The continued improvement in credit quality allowed us to reduce our provision for loan losses for the second consecutive quarter. The provision for loan losses was a benefit of $1.1 million for the second and first quarters of 2014, compared to a provision of $1.0 million for the three months ended December 31, 2013.  We continued to see reductions in delinquent loans, non-performing loans, and classified assets. Loans delinquent over 30 days increased $0.4 million, or 0.4%, during the second quarter of 2014 to $82.0 million. Loans delinquent over 90 days decreased $0.3 million, or 0.8%, during the second quarter, and are at their lowest level since the fourth quarter of 2008. Non-accrual loans decreased by $0.4 million, or 0.9%, during the second quarter to $42.8 million, and are at their lowest level since the fourth quarter of 2008.  During the second quarter of 2014 we sold four delinquent loans with a book value at the time of sale of $1.8 million, realizing $1.9 million upon sale, or 105% of book value.
 
Net recoveries for the second quarter of 2014 totaled $0.1 million. We continued our practice of obtaining updated appraisals and recording charge-offs based on these current values as opposed to adding to the allowance for loan losses. This process has ensured that we have kept pace with changing values in the real estate market. The average loan-to-value ratio for our non-performing loans collateralized by real estate was 46.1% at June 30, 2014.
 
Net loans increased $33.9 million, or 1.0%, during the second quarter of 2014, as loan originations for the quarter totaled $191.2 million. Our loan pipeline at June 30, 2014 remained strong at $364.3 million. Our lending departments continue to emphasize full relationship banking with our borrowers. Originations continue to be focused on multi-family and commercial business loans, which represented 56% and 25%, respectively, of loan originations during the second quarter of 2014.
 
Our net interest margin for the second quarter of 2014 was 3.22%, a decrease of three basis points from the first quarter of 2014. The decrease was primarily due to a six basis point decrease in the yield earned from interest-earning assets to 4.33% for the three months ended June 30, 2014, while the cost of interest-bearing liabilities decreased two basis points to 1.23% for the three months ended June 30, 2014. The decline in the yield of interest-earning assets was primarily due to the current interest rate environment, where new loans and securities are added at rates well below our portfolio average yield, and higher yielding loans and securities are prepaying. The decrease in the cost of interest-bearing liabilities was primarily due to decreases of seven basis points and three basis points in certificates of deposit and NOW accounts, respectively, partially offset by an increase of one basis point in the cost of money market accounts during the three months ended June 30, 2014. The yield earned during the three months ended June 30, 2014 was partially supported by additional interest collected on loans which were previously non-accrual and back payments were received. During each of the first two quarters of 2014, the yield included $0.4 million and $0.3 million in additional interest collected from non-accrual loans, respectively. Excluding this additional interest collected from non-accrual loans, the net interest margin would have decreased five basis points to 3.18% for the three months ended June 30, 2014 from 3.23% for the three months ended March 31, 2014. Further excluding prepayment penalty income, the net interest margin would have decreased four basis points to 3.07% for the three months ended June 30, 2014 from 3.11% for the three months ended March 31, 2014.
 
At June 30, 2014, the Bank continues to be well-capitalized under regulatory requirements, with Core, Tier 1 risk-based and Total risk-based capital ratios of 9.54%, 14.13% and 15.02%, respectively.  At June 30, 2014, the Company’s capital ratios for Core, Tier 1 risk-based and Total risk-based capital ratios were 9.82%, 14.54% and 15.44%, respectively.
 
 
-48-

 
PART I – FINANCIAL INFORMATION
FLUSHING FINANCIAL CORPORATION and SUBSIDIARIES
Management’s Discussion and Analysis of
Financial Condition and Results of Operations
 
COMPARISON OF OPERATING RESULTS FOR THE THREE MONTHS ENDED JUNE 30, 2014 AND 2013

General.  Net income for the three months ended June 30, 2014 was $11.7 million, an increase of $2.1 million, or 21.4%, compared to $9.6 million for the three months ended June 30, 2013.  Diluted earnings per common share were $0.39 for the three months ended June 30, 2014, an increase of $0.07, or 21.9%, from $0.32 for the three months ended June 30, 2013.
 
Return on average equity increased to 10.3% for the three months ended June 30, 2014 from 8.8% for the three months ended June 30, 2013. Return on average assets increased to 1.0% for the three months ended June 30, 2014 from 0.8% for the three months ended June 30, 2013.
 
Interest Income.  Total interest and dividend income decreased $0.7 million, or 1.4%, to $49.6 million for the three months ended June 30, 2014 from $50.3 million for the three months ended June 30, 2013. The decrease in interest income was attributable to a 37 basis point decline in the yield of interest-earning assets to 4.33% for the three months ended June 30, 2014 from 4.70% in the comparable prior year period partially offset as a result of an increase of $301.9 million in the average balance of interest-earning assets to $4,578.8 million for the three months ended June 30, 2014 from $4,276.8 million for the comparable prior year period. The 37 basis point decline in the yield of interest-earning assets was primarily due to a 50 basis point reduction in the yield of the loan portfolio to 4.88% for the three months ended June 30, 2014 from 5.38% for the three months ended June 30, 2013, combined with a 17 basis point decline in the yield on total securities to 2.68% for the three months ended June 30, 2014 from 2.85% for the comparable prior year period.  The 50 basis point decrease in the loan portfolio was primarily due to the decline in the rates earned on new loan originations, existing loans modifying to lower rates, and higher yielding loans prepaying. The yield on the loan portfolio, excluding prepayment penalty income, decreased 48 basis points to 4.72% for the three months ended June 30, 2014 from 5.20% for the three months ended June 30, 2013. The 17 basis point decrease in the yield of the securities portfolio was primarily due to the purchase of new securities at lower yields than the existing portfolio.
 
Interest Expense.  Interest expense decreased $0.3 million, or 2.0%, to $12.7 million for the three months ended June 30, 2014 from $13.0 million for the three months ended June 30, 2013. The decrease in interest expense was primarily due to an 11 basis point decrease in interest-bearing liabilities to 1.23% for the three months ended June 30, 2014 from 1.34% for the comparable prior year period. The 11 basis point decrease in the cost of interest-bearing liabilities was primarily due to the Bank reducing the rates it pays on its deposit products. The cost of certificates of deposit, savings accounts and NOW accounts decreased 11 basis points, one basis point and 11 basis points, respectively, partially offset by a seven basis point increase in the cost of money market accounts for the three months ended June 30, 2014 from the comparable prior year period.  The cost was also positively affected by a movement in deposit concentrations as the average balance of lower costing core deposits increased $135.2 million during the three months ended June 30, 2014 to $1,933.7 million from $1,798.5 million for the comparable prior year period, partially offset by an increase of $9.0 million in the average balance of higher costing certificates of deposit to $1,153.0 million for the three months ended June 30, 2014 from $1,144.0 million for the comparable prior year period. These movements resulted in a decrease in the cost of due to depositors of 11 basis points to 0.99% for the three months ended June 30, 2014 from 1.10% for the three months ended June 30, 2013.
 
Net Interest Income.  For the three months ended June 30, 2014, net interest income was $36.8 million, a decrease of $0.5 million, or 1.3%, from $37.3 million for the three months ended June 30, 2013. The decrease in net interest income was primarily attributable to a 26 basis point decrease in the net-interest spread to 3.10% for the three months ended June 30, 2014 from 3.36% for the three months ended June 30, 2013, partially offset by the effect of an increase of $301.9 million in the average balance of interest-earning assets to $4,578.8 million for the three months ended June 30, 2014 from $4,276.8 million for the comparable prior year period.  The yield on interest-earning assets decreased 37 basis points to 4.33% for the three months ended June 30, 2014 from 4.70% for the three months ended June 30, 2013, while the cost of interest-bearing liabilities decreased 11 basis points to 1.23% for the three months ended June 30, 2014 from 1.34% for the comparable prior year period. The net interest margin declined 27 basis points to 3.22% for the three months ended June 30, 2014 from 3.49% for the three months ended June 30, 2013. Excluding prepayment penalty income on loans, the net interest margin would have decreased 25 basis points to 3.10% for the three months ended June 30, 2014 from 3.35% for the three months ended June 30, 2013.
 
Provision for Loan Losses.  The provision for loan losses decreased $4.6 million during the three months ended June 30, 2014 to a benefit of $1.1 million from a provision of $3.5 million during the comparable prior year period. The decrease in the provision was primarily due to the continued improvement in credit conditions. During the three months ended June 30, 2014, the Bank recorded net-recoveries of $0.1 million and non-accrual loans decreased $0.4 million to $42.8 million from $43.2 million at March 31, 2014. The current average loan-to-value ratio for our non-performing loans collateralized by real estate was 46.1% at June 30, 2014. When we have obtained properties through foreclosure, we have been able to quickly sell the properties at amounts that approximate book value. The Bank continues to maintain conservative underwriting standards. We anticipate that we will continue to see low loss content in our loan portfolio. As a result of the quarterly analysis of the allowance for loans losses, a reduction in the allowance was warranted, and as such, the Company recorded a benefit of $1.1 million for the three months ended June 30, 2014. See “-ALLOWANCE FOR LOAN LOSSES.”
 
 
-49-

 
PART I – FINANCIAL INFORMATION
FLUSHING FINANCIAL CORPORATION and SUBSIDIARIES
Management’s Discussion and Analysis of
Financial Condition and Results of Operations
 
Non-Interest Income.  Non-interest income for the three months ended June 30, 2014 was $2.0 million, a decrease of $0.2 million, or 9.7% from $2.2 million for the three months ended June 30, 2013.  Non-interest income declined due to a $0.1 million increase in net losses from fair value adjustments, a $0.4 million decrease in banking service fee income primarily due to reduced ancillary loan fees, and a $0.2 million decrease in net gain on sale of loans, as compared to the three months ended June 30, 2013. These decreases were partially offset by the comparable prior year period including an other-than-temporary impairment (“OTTI”) charge of $0.5 million on private issued collateralized mortgage obligations (“CMOs”).
 
Non-Interest Expense. Non-interest expense was $20.6 million for the three months ended June 30, 2014, an increase of $0.4 million, or 2.0%, from $20.2 million for the three months ended June 30, 2013. The increase was primarily due to an increase of $1.0 million in salaries and employee benefits, partially offset by decreases of $0.2 million in real estate owned/ foreclosure expense primarily due to a reduction in non-performing loans, $0.3 million in other operating expenses, and $0.1 million in FDIC insurance expense primarily due to a reduction in the assessment rate.  The efficiency ratio was 52.9% for the three months ended June 30, 2014 compared to 49.7% for the three months ended June 30, 2013.
 
Income before Income Taxes.  Income before the provision for income taxes increased $3.5 million, or 22.2%, to $19.3 million for the three months ended June 30, 2014 from $15.8 million for the three months ended June 30, 2013 for the reasons discussed above.
 
Provision for Income Taxes.  Income tax expense increased $1.4 million, or 23.4%, to $7.6 million for the three months ended June 30, 2014 from $6.2 million for the three months ended June 30, 2013, primarily due to the increase in income before income taxes as discussed above. The effective tax rate was 39.4% and 39.0% for the three months ended June 30, 2014 and 2013, respectively. The increase in the effective tax rate was primarily due to the impact of changes to the New York State tax code passed on March 31, 2014, resulting in a nominal reduction in the Company’s deferred tax assets.
 
COMPARISON OF OPERATING RESULTS FOR THE SIX MONTHS ENDED JUNE 30, 2014 AND 2013
 
General. Net income for the six months ended June 30, 2014 was $22.0 million, an increase of $5.6 million, or 34.2%, compared to $16.4 million for the six months ended June 30, 2013. Diluted earnings per common share were $0.73 for the six months ended June 30, 2014, an increase of $0.19, or 35.2%, from $0.54 for the six months ended June 30, 2013.
 
Return on average equity increased to 9.9% for the six months ended June 30, 2014, from 7.5% for the comparable prior year period. Return on average assets increased to 0.9% for the six months ended June 30, 2014, from 0.7% for the comparable prior year period.
 
Interest Income.  Total interest and dividend income decreased $1.6 million, or 1.6%, to $98.8 million for the six months ended June 30, 2014 from $100.4 million for the six months ended June 30, 2013. The decrease in interest income was attributable to a 40 basis point decline in the yield of interest-earning assets to 4.36% for the six months ended June 30, 2014 from 4.76% in the comparable prior year period. The decrease in the yield was partially offset as a result of a $316.4 million increase in the average balance of interest-earning assets to $4,532.6 million for the six months ended June 30, 2014 from $4,216.2 million for the comparable prior year period. The 40 basis point decline in the yield of interest-earning assets was primarily due to a 46 basis point reduction in the yield of the loan portfolio to 4.92 % for the six months ended June 30, 2014 from 5.38% for the six months ended June 30, 2013, combined with a 26 basis point decline in the yield on total securities to 2.70% for the six months ended June 30, 2014 from 2.96% for the comparable prior year period. The yield of interest-earning assets was positively impacted as a result of a $250.8 million increase in the average balance of the higher yielding loan portfolio for the six months ended June 30, 2014, partially offset as a result of a $62.4 million increase in the average balance of the lower yielding securities portfolio for the six months ended June 30, 2014. The 46 basis point decrease in the yield of the loan portfolio was primarily due to a decline in the rates earned on new loan originations, existing loans modifying to lower rates, and higher yielding loans prepaying.  The 26 basis point decrease in the yield of the securities portfolio was primarily due to the purchase of new securities at lower yields than the existing portfolio. The yield on the mortgage loan portfolio decreased 42 basis points to 5.10% for the six months ended June 30, 2014 from 5.52% for the six months ended June 30, 2013.  The yield on the mortgage loan portfolio, excluding prepayment penalty income, decreased 41 basis points to 4.94% for the six months ended June 30, 2014 from 5.35% for the six months ended June 30, 2013.
 
 
-50-

 
PART I – FINANCIAL INFORMATION
FLUSHING FINANCIAL CORPORATION and SUBSIDIARIES
Management’s Discussion and Analysis of
Financial Condition and Results of Operations
 
Interest Expense.  Interest expense decreased $3.5 million, or 12.0%, to $25.5 million for the six months ended June 30, 2014 from $28.9 million for the six months ended June 30, 2013. The decrease in interest expense was due to the reduction in the cost of interest-bearing liabilities, which decreased 27 basis points to 1.24% for the six months ended June 30, 2014 from 1.51% for the comparable prior year period and a shifting of deposit concentrations, as higher costing certificates of deposits average balance decreased $53.8 million to $1,131.5 million, while lower costing core deposits average balance increased $227.1 million to $1,933.4 million for the six months ended June 30, 2013. The 27 basis point decrease in the cost of interest-bearing liabilities was primarily attributable to the Bank reducing the rates it pays on its deposit products and a reduction in the cost of borrowed funds. The cost of certificates of deposit, savings accounts and NOW accounts decreased eight basis points, one basis point, and eight basis points, respectively, partially offset by an increase of eight basis points in the cost of money market accounts for the six months ended June 30, 2014 from the comparable prior year period.  This resulted in a decrease in the cost of due to depositors of 13 basis points to 1.00% for the six months ended June 30, 2014 from 1.13% for the six months ended June 30, 2013. The cost of borrowed funds decreased 75 basis points to 2.03% for the six months ended June 30, 2014 from 2.78% for the six months ended June 30, 2013 with the average balance increasing $85.9 million to $990.6 million for the six months ended June 30, 2014 from $904.6 million for the six months ended June 30, 2013. The decline in the cost of borrowed funds was primarily due to the prepayment of $68.5 million in FHLB-NY advances during the first quarter of 2013 at an average cost of 3.21% which was scheduled to mature in 2014 and replacing those borrowings with new long-term advances costing 0.75%, partially offset by a $2.6 million prepayment penalty incurred on the transaction.
 
Net Interest Income.  For the six months ended June 30, 2014, net interest income was $73.3 million, an increase of $1.9 million, or 2.6%, from $71.4 million for the six months ended June 30, 2013. The increase in net interest income was primarily attributable to the prior year period including a $2.6 million prepayment penalty recorded on borrowings.
 
Excluding the $2.6 million prepayment penalty recorded on borrowings during the prior year period, net interest income for the six months ended June 30, 2014 would have decreased $0.7 million, or 1.0%, to $73.3 million from $74.0 million for the six months ended June 30, 2013.  The decrease in net interest income was primarily attributable to a 27 basis point decrease in the net-interest spread to 3.12% for the six months ended June 30, 2014 from 3.39% for the six months ended June 30, 2013, partially offset by the effect of an increase of $316.4 million in the average balance of interest-earning assets to $4,532.6 million for the six months ended June 30, 2014 from $4,216.2 million for the comparable prior year period.  The yield on interest-earning assets decreased 40 basis points to 4.36% for the six months ended June 30, 2014 from 4.76% for the six months ended June 30, 2013, while the cost of interest-bearing liabilities decreased 13 basis points to 1.24% for the six months ended June 30, 2014 from 1.37% for the comparable prior year period. The net interest margin decreased 27 basis points to 3.24% for the six months ended June 30, 2014 from 3.51% for the six months ended June 30, 2013. Excluding prepayment penalty income, the net interest margin would have decreased 27 basis points to 3.12% for the six months ended June 30, 2014 from 3.39% for the six months ended June 30, 2013.
 
Provision for Loan Losses.  The provision for loan losses decreased $11.7 million during the six months ended June 30, 2014 to a benefit of $2.2 million from a provision of $9.5 million during the comparable prior year period. During the six months ended June 30, 2014, non-performing loans decreased $3.2 million to $45.8 million from $49.0 million at December 31, 2013. Net charge-offs for the six months ended June 30, 2014 totaled $0.3 million, or two basis points of average loans. The current loan-to-value ratio for our non-performing loans collateralized by real estate was 46.1% at June 30, 2014. When we have obtained properties through foreclosure, we have been able to quickly sell the properties at amounts that approximate book value. We anticipate that we will continue to see low loss content in our loan portfolio. The Bank continues to maintain conservative underwriting standards. As a result of the quarterly analysis of the allowance for loans losses, a reduction in the allowance was warranted, and as such, the Company recorded a benefit of $2.2 million for the six months ended June 30, 2014. See “-ALLOWANCE FOR LOAN LOSSES.”
 
 
-51-

 
PART I – FINANCIAL INFORMATION
FLUSHING FINANCIAL CORPORATION and SUBSIDIARIES
Management’s Discussion and Analysis of
Financial Condition and Results of Operations
 
Non-Interest Income. Non-interest income for the six months ended June 30, 2014 was $3.7 million, a decrease of $3.9 million from $7.5 million for the six months ended June 30, 2013. The decrease in non-interest income was primarily due to the $2.9 million gain from the sale of mortgage-backed securities during the six months ended June 30, 2013.  Non-interest income also declined due to a $0.6 million increase in net losses from fair value adjustments and a decrease of $0.7 million in banking service fees. These decreases were partially offset by the comparable prior year period including an OTTI charge on private issued CMOs of $0.5 million.
 
Non-Interest Expense. Non-interest expense was $42.7 million for the six months ended June 30, 2014, an increase of $0.1 million, or 0.2%, from $42.6 million for the six months ended June 30, 2013. The increase was primarily due to an increase of $1.3 million in salaries and benefits expense primarily due to annual salary increases and an increase in the cost of grants of annual restricted stock unit awards. This increase was partially offset by decreases of $0.4 million and $0.6 million in FDIC insurance expense and real estate owned/foreclosure expense, respectively. The efficiency ratio was 54.7% for the six months ended June 30, 2014 compared to 53.2% for the six months ended June 30, 2013.
 
Income before Income Taxes.  Income before the provision for income taxes increased $9.6 million, or 35.9%, to $36.5 million for the six months ended June 30, 2014 from $26.9 million for the six months ended June 30, 2013 for the reasons discussed above.
 
Provision for Income Taxes. Income tax expense increased $4.1 million to $14.5 million for the six months ended June 30, 2014 from $10.5 million for the six months ended June 30, 2013.  The effective tax rate was 39.8% and 39.0% for the six months ended June 30, 2014 and 2014, respectively.
 
FINANCIAL CONDITION

Assets.  Total assets at June 30, 2014 were $4,853.8 million, an increase of $132.3 million, or 2.8%, from $4,721.5 million at December 31, 2013. Total loans, net increased $100.9 million during the six months ended June 30, 2014 to $3,503.3 million from $3,402.4 million at December 31, 2013. Loan originations and purchases were $389.2 million for the six months ended June 30, 2014, an increase of $16.1 million from $373.1 million for the six months ended June 30, 2013. During the six months ended June 30, 2014, we continued to focus on the origination of multi-family properties and business loans with a full relationship. Loan applications in process have continued to remain strong, totaling $364.3 million at June 30, 2014 compared to $297.5 million at December 31, 2013 and $342.3 million at June 30, 2013.
 
The following table shows loan originations and purchases for the periods indicated:
 
   
For the three months
ended June 30,
   
For the six months
ended June 30,
 
(In thousands)
 
2014
   
2013
   
2014
   
2013
 
Multi-family residential
  $ 107,197     $ 132,292     $ 165,009     $ 175,217  
Commercial real estate
    18,205       31,612       31,621       38,598  
One-to-four family – mixed-use property
    8,429       7,344       18,428       11,734  
One-to-four family – residential
    6,404       6,380       15,504       12,890  
Co-operative apartments
    -       1,695       -       3,762  
Construction
    300       1,788       997       1,788  
Small Business Administration
    225       210       578       378  
Taxi Medallion
    1,889       -       13,538       -  
Commercial business and other
    48,542       70,361       143,498       128,701  
    Total
  $ 191,191     $ 251,682     $ 389,173     $ 373,068  

(1)
Includes purchases of $1.2 million for the three months ended June 30, 2014.
(2)
Includes purchases of $12.9 million and $0.5 million for the six months ended June 30, 2014 and 2013, respectively.

 
-52-

 
PART I – FINANCIAL INFORMATION
FLUSHING FINANCIAL CORPORATION and SUBSIDIARIES
Management’s Discussion and Analysis of
Financial Condition and Results of Operations
 
The Bank continues to maintain conservative underwriting standards that include, among other things, a loan-to-value ratio of 75% or less and a debt coverage ratio of at least 125%. Multi-family residential, commercial real estate and one-to-four family mixed-use property mortgage loans originated during the second quarter of 2014 had an average loan-to-value ratio of 46.7% and an average debt coverage ratio of 401%.
 
The Bank’s non-performing assets totaled $47.1 million at June 30, 2014, a decrease of $6.7 million from $53.8 million at December 31, 2013. Total non-performing assets as a percentage of total assets were 0.97% at June 30, 2014 compared to 1.14% at December 31, 2013. The ratio of allowance for loan losses to total non-performing loans was 63.8% at June 30, 2014 and 64.9% at December 31, 2013.    See – “TROUBLED DEBT RESTRUCUTURED AND NON-PERFORMING ASSETS.”
 
During the six months ended June 30, 2014, mortgage-backed securities increased $14.4 million, or 1.9%, to $770.5 million from $756.2 million at December 31, 2013. The increase in mortgage-backed securities during the six months ended June 30, 2014 was primarily due to purchases of $47.5 million and an improvement of $14.4 million in the fair value of mortgage-backed securities, partially offset by principal repayments totaling $46.2 million.
 
During the six months ended June 30, 2014, other securities increased $26.5 million, or 10.1%, to $288.1 million from $261.6 million at December 31, 2013. The increase in other securities during the six months ended June 30, 2014 was primarily due to purchases of $23.3 million and an improvement in the fair value of other securities totaling $7.0 million, partially offset by $1.9 million in sales and $1.0 million in maturities. Other securities primarily consist of securities issued by mutual or bond funds that invest in government and government agency securities, municipal bonds and corporate bonds.
 
Banking regulators issued the Volcker Rule in December 2013.  The Volcker Rule, among other things, prohibits banks from owning certain investment securities. We have reviewed our investment portfolio for compliance with the Volcker Rule and in the opinion of management we do not own any securities which are prohibited under the Volcker Rule.
 
Liabilities.  Total liabilities were $4,393.3 million at June 30, 2014, an increase of $104.3 million, or 2.4%, from $4,289.0 million at December 31, 2013. During the six months ended June 30, 2014, due to depositors decreased $2.0 million, or 0.1%, to $3,198.0 million, as a result of a $40.9 million decrease in core deposits partially offset by a $38.9 million increase in certificates of deposit. Borrowed funds increased $100.1 million during the six months ended June 30, 2014.  The decrease in core deposits was a result of a seasonal decrease in deposits from public entities. We expect these deposits to return in the third and fourth quarters. Short term borrowings were obtained at similar rates to replace the government deposits.
 
Equity. Total stockholders’ equity increased $28.0 million, or 6.5%, to $460.5 million at June 30, 2014 from $432.5 million at December 31, 2013. Stockholders’ equity increased primarily due to net income of $22.0 million for the six months ended June 30, 2014, an increase in comprehensive income of $12.0 million primarily due to an increase in the fair value of the securities portfolio and $1.9 million due to the issuance of shares from the annual funding of certain employee retirement plans through the release of common shares from the Employee Benefit Trust. Additionally, the exercise of stock options increased stockholders’ equity by $0.5 million, including the income tax benefit realized by the Company upon the exercise of the options. These increases were partially offset by the declaration and payment of dividends on the Company’s common stock of $9.0 million and the purchase of 108,120 treasury shares at a cost of $2.1 million. Book value per common share was $15.26 at June 30, 2014 compared to $14.36 at December 31, 2013.
 
On May 22, 2013, the Company announced the authorization by the Board of Directors of a new common stock repurchase program, which authorizes the purchase of up to 1,000,000 shares of its common stock.  During the six months ended June 30, 2014, the Company repurchased 108,120 shares of the Company’s common stock at an average cost of $19.82 per share.  At June 30, 2014, 441,750 shares remain to be repurchased under the current stock repurchase program. Stock will be purchased under the current stock repurchase program from time to time, in the open market or through private transactions subject to market conditions and at the discretion of the management of the Company. There is no expiration or maximum dollar amount under this authorization.
 
Cash flow.  During the six months ended June 30, 2014, funds provided by the Company's operating activities amounted to $31.4 million. These funds combined with $94.3 million provided from financing activities were utilized to fund net investing activities of $122.2 million. The Company's primary business objective is the origination and purchase of multi-family residential properties and commercial business loans and to a lesser extent one-to-four family (including mixed-use properties), commercial real estate mortgage loans and SBA loans. During the six months ended June 30, 2014, the net total of loan originations and purchases less loan repayments and sales was $96.5 million. During the six months ended June 30, 2014, the Company also funded $70.9 million in purchases of securities available for sale and repaid $9.3 million in long-term borrowed funds.  During the six months ended June 30, 2014, funds were provided by net increases of $5.7 million in total deposits and $109.0 million in short-term borrowed funds.  Additionally, funds were provided by $49.4 million in proceeds from maturities, sales, calls and prepayments of securities available for sale. The Company also used funds of $9.0 million and $3.3 million for dividend payments and purchases of treasury stock, respectively, during the six months ended June 30, 2014.
 
 
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 PART I – FINANCIAL INFORMATION
FLUSHING FINANCIAL CORPORATION and SUBSIDIARIES
Management’s Discussion and Analysis of
Financial Condition and Results of Operations
 
INTEREST RATE RISK

The Consolidated Statements of Financial Position have been prepared in accordance with generally accepted accounting principles in the United States of America, which require the measurement of financial position and operating results in terms of historical dollars without considering the changes in fair value of certain investments due to changes in interest rates.  Generally, the fair value of financial investments such as loans and securities fluctuates inversely with changes in interest rates.  As a result, increases in interest rates could result in decreases in the fair value of the Company’s interest-earning assets which could adversely affect the Company’s results of operations if such assets were sold, or, in the case of securities classified as available-for-sale, decreases in the Company’s stockholders’ equity, if such securities were retained.
 
The Company manages the mix of interest-earning assets and interest-bearing liabilities on a continuous basis to maximize return and adjust its exposure to interest rate risk. On a quarterly basis, management prepares the “Earnings and Economic Exposure to Changes in Interest Rate” report for review by the Board of Directors, as summarized below.  This report quantifies the potential changes in net interest income and net portfolio value should interest rates go up or down (shocked) 200 basis points, assuming the yield curves of the rate shocks will be parallel to each other. The Company’s regulators currently place focus on the net portfolio value, focusing on a rate shock up or down of 200 basis points.  Net portfolio value is defined as the market value of assets net of the market value of liabilities. The market value of assets and liabilities is determined using a discounted cash flow calculation.  The net portfolio value ratio is the ratio of the net portfolio value to the market value of assets.  All changes in income and value are measured as percentage changes from the projected net interest income and net portfolio value at the base interest rate scenario.  The base interest rate scenario assumes interest rates at June 30, 2014.  Various estimates regarding prepayment assumptions are made at each level of rate shock. However, prepayment penalty income is excluded from this analysis. Actual results could differ significantly from these estimates.  At June 30, 2014, the Company was within the guidelines set forth by the Board of Directors for each interest rate level.
 
The following table presents the Company’s interest rate shock as of June 30, 2014:
 
   
Projected Percentage Change In
       
   
Net Interest
   
Net Portfolio
   
Net Portfolio
 
Change in Interest Rate
 
Income
   
Value
   
Value Ratio
 
-200 Basis points
    -2.20 %     9.23 %     13.66 %
-100 Basis points
    0.95       7.33       13.61  
Base interest rate
    0.00       0.00       12.99  
+100 Basis points
    -5.35       -13.22       11.65  
+200 Basis points
    -11.09       -27.68       10.05  
 
 
-54-

 
PART I – FINANCIAL INFORMATION
FLUSHING FINANCIAL CORPORATION and SUBSIDIARIES
Management’s Discussion and Analysis of
Financial Condition and Results of Operations
 
AVERAGE BALANCES

Net interest income represents the difference between income on interest-earning assets and expense on interest-bearing liabilities. Net interest income depends upon the relative amount of interest-earning assets and interest-bearing liabilities and the interest rate earned or paid on them. The following table sets forth certain information relating to the Company’s Consolidated Statements of Financial Condition and Consolidated Statements of Income for the three months ended June 30, 2014 and 2013, and reflects the average yield on assets and average cost of liabilities for the periods indicated.  Such yields and costs are derived by dividing income or expense by the average balance of assets or liabilities, respectively, for the periods shown. Average balances are derived from average daily balances. The yields include amortizations of fees which are considered adjustments to yields.
 
   
For the three months ended June 30,
 
   
2014
   
2013
 
   
Average
Balance
   
Interest
   
Yield/
Cost
   
Average
Balance
   
Interest
   
Yield/
Cost
 
Assets
 
(Dollars in thousands)
Interest-earning assets:
                                   
  Mortgage loans, net (1)
  $ 3,039,477       38,330       5.04 %   $ 2,883,200       39,816       5.52 %
  Other loans, net (1)
    446,457       4,159       3.73       306,203       3,045       3.98  
      Total loans, net
    3,485,934       42,489       4.88       3,189,403       42,861       5.38  
  Mortgage-backed securities
    769,474       5,320       2.77       794,233       5,868       2.96  
  Other securities
    283,200       1,742       2.46       243,983       1,542       2.53  
      Total securities
    1,052,674       7,062       2.68       1,038,216       7,410       2.85  
  Interest-earning deposits and
                                               
    federal funds sold
    40,156       18       0.18       49,215       24       0.20  
Total interest-earning assets
    4,578,764       49,569       4.33       4,276,834       50,295       4.70  
Other assets
    254,274                       260,411                  
      Total assets
  $ 4,833,038                     $ 4,537,245                  
                                                 
Liabilities and Equity
                                               
Interest-bearing liabilities:
                                               
  Deposits:
                                               
    Savings accounts
  $ 258,659       116       0.18     $ 276,570       128       0.19  
    NOW accounts
    1,458,612       1,586       0.43       1,337,479       1,789       0.54  
    Money market accounts
    216,394       126       0.23       184,422       73       0.16  
    Certificate of deposit accounts
    1,153,010       5,810       2.02       1,143,992       6,095       2.13  
      Total due to depositors
    3,086,675       7,638       0.99       2,942,463       8,085       1.10  
    Mortgagors' escrow accounts
    57,213       32       0.22       55,795       8       0.06  
      Total deposits
    3,143,888       7,670       0.98       2,998,258       8,093       1.08  
  Borrowed funds
    997,174       5,070       2.03       896,025       4,906       2.19  
      Total interest-bearing liabilities
    4,141,062       12,740       1.23       3,894,283       12,999       1.34  
Non interest-bearing deposits
    202,809                       164,327                  
Other liabilities
    37,038                       40,527                  
      Total liabilities
    4,380,909                       4,099,137                  
Equity
    452,129                       438,108                  
      Total liabilities and equity
  $ 4,833,038                     $ 4,537,245                  
                                                 
Net interest income /
                                               
  net interest rate spread
          $ 36,829       3.10 %           $ 37,296       3.36 %
                                                 
Net interest-earning assets /
                                               
  net interest margin
  $ 437,702               3.22 %   $ 382,551               3.49 %
                                                 
                                                 
Ratio of interest-earning assets to interest-bearing liabilities
                    1.11 X                     1.10 X

(1)
Loan interest income includes loan fee income (which includes net amortization of deferred fees and costs, late charges, and prepayment penalties) of approximately $1.1 million for each of the three months ended June 30, 2014 and 2013, respectively.
 
 
-55-

 
PART I – FINANCIAL INFORMATION
FLUSHING FINANCIAL CORPORATION and SUBSIDIARIES
Management’s Discussion and Analysis of
Financial Condition and Results of Operations
 
The following table sets forth certain information relating to the Company’s Consolidated Statements of Financial Condition and Consolidated Statements of Income for the six months ended June 30, 2014 and 2013, and reflects the average yield on assets and average cost of liabilities for the periods indicated. Such yields and costs are derived by dividing income or expense by the average balance of assets or liabilities, respectively, for the periods shown. Average balances are derived from average daily balances. The yields include amortization of fees which are considered adjustments to yields.
 
   
For the six months ended June 30,
   
2014
   
2013
 
   
Average
Balance
   
Interest
   
Yield/
Cost
   
Average
Balance
   
Interest
   
Yield/
Cost
 
Assets
 
(Dollars in thousands)
 
Interest-earning assets:
                                   
  Mortgage loans, net (1)
  $ 3,015,208       76,912       5.10 %   $ 2,882,614       79,563       5.52 %
  Other loans, net (1)
    423,678       7,697       3.63       305,458       6,238       4.08  
      Total loans, net
    3,438,886       84,609       4.92       3,188,072       85,801       5.38  
  Mortgage-backed securities
    769,693       10,710       2.78       751,841       11,589       3.08  
  Other securities
    276,663       3,416       2.47       232,148       2,950       2.54  
      Total securities
    1,046,356       14,126       2.70       983,989       14,539       2.96  
  Interest-earning deposits and
                                               
    federal funds sold
    47,316       45       0.19       44,123       41       0.19  
Total interest-earning assets
    4,532,558       98,780       4.36       4,216,184       100,381       4.76  
Other assets
    253,044                       266,078                  
      Total assets
  $ 4,785,602                     $ 4,482,262                  
                                                 
Liabilities and Equity
                                               
Interest-bearing liabilities:
                                               
  Deposits:
                                               
    Savings accounts
  $ 261,161       235       0.18       280,753       263       0.19  
    NOW accounts
    1,465,276       3,279       0.45       1,261,541       3,371       0.53  
    Money market accounts
    206,976       233       0.23       164,027       127       0.15  
    Certificate of deposit accounts
    1,131,494       11,596       2.05       1,185,284       12,606       2.13  
      Total due to depositors
    3,064,907       15,343       1.00       2,891,605       16,367       1.13  
    Mortgagors' escrow accounts
    50,293       45       0.18       49,005       17       0.07  
      Total deposits
    3,115,200       15,388       0.99       2,940,610       16,384       1.11  
  Borrowed funds
    990,557       10,076       2.03       904,614       12,555       2.78  
      Total interest-bearing liabilities
    4,105,757       25,464       1.24       3,845,224       28,939       1.51  
Non interest-bearing deposits
    196,285                       156,386                  
Other liabilities
    37,250                       40,882                  
      Total liabilities
    4,339,292                       4,042,492                  
Equity
    446,310                       439,770                  
      Total liabilities and equity
  $ 4,785,602                     $ 4,482,262                  
                                                 
Net interest income / net interest rate spread
          $ 73,316       3.12 %           $ 71,442       3.25 %
                                                 
Net interest-earning assets / net interest margin
  $ 426,801               3.24 %   $ 370,960               3.39 %
Ratio of interest-earning assets to interest-bearing liabilities
                    1.10 X                     1.10 X
 
 
(1)
Loan interest income includes loan fee income (which includes net amortization of deferred fees and costs, late charges, and prepayment penalties) of approximately $2.2 million and $1.8 million for the six months ended June 30, 2014 and 2013, respectively.
 
 
-56-

 
PART I – FINANCIAL INFORMATION
FLUSHING FINANCIAL CORPORATION and SUBSIDIARIES
Management’s Discussion and Analysis of
Financial Condition and Results of Operations

LOANS

The following table sets forth the Company’s loan originations (including the net effect of refinancing) and the changes in the Company’s portfolio of loans, including purchases, sales and principal reductions for the periods indicated.
 
   
For the six months ended June 30,
 
(In thousands)
 
2014
   
2013
 
             
Mortgage Loans
 
 
   
 
 
   
 
   
 
 
At beginning of period
  $ 3,028,452     $ 2,906,881  
                 
Mortgage loans originated:
               
    Multi-family residential
    165,009       175,217  
    Commercial real estate
    31,621       38,146  
    One-to-four family – mixed-use property
    18,428       11,734  
    One-to-four family – residential
    15,504       12,890  
    Co-operative apartments
    -       3,762  
    Construction
    997       1,788  
        Total mortgage loans originated
    231,559       243,537  
                 
Mortgage loans purchased:
               
    Commercial real estate
    -       452  
        Total mortgage loans purchased
    -       452  
                 
Less:
               
    Principal and other reductions
    171,029       185,612  
    Sales
    5,943       9,748  
                 
At end of period
  $ 3,083,039     $ 2,955,510  
                 
Commercial Business and Other Loans
               
                 
At beginning of period
  $ 394,556     $ 314,494  
                 
Other loans originated:
               
    Small Business Administration
    578       378  
    Commercial business
    142,170       125,489  
    Taxi medallion
    654       -  
    Other
    1,328       3,212  
        Total other loans originated
    144,730       129,079  
                 
Other loans purchased:
               
    Taxi medallion
    12,884       -  
        Total other loans purchased
    12,884       -  
                 
Less:
               
    Principal and other reductions
    113,483       122,997  
    Sales
    -       -  
                 
At end of period
  $ 438,687     $ 320,576  

 
-57-

 
PART I – FINANCIAL INFORMATION
FLUSHING FINANCIAL CORPORATION and SUBSIDIARIES
Management’s Discussion and Analysis of
Financial Condition and Results of Operations
 
TROUBLED DEBT RESTRUCUTURED (“TDR”) AND NON-PERFORMING ASSETS

Management continues to adhere to the Bank’s conservative underwriting standards. The majority of the Bank’s non-performing loans are collateralized by residential income producing properties that are occupied, thereby retaining more of their value and reducing the potential loss. The Bank takes a proactive approach to managing delinquent loans, including conducting site examinations and encouraging borrowers to meet with a Bank representative. The Bank has been developing short-term payment plans that enable certain borrowers to bring their loans current. The Bank reviews its delinquencies on a loan by loan basis and continually explores ways to help borrowers meet their obligations and return them back to current status. At times, the Bank may restructure a loan to enable a borrower to continue making payments when it is deemed to be in the best long-term interest of the Bank. This restructure may include making concessions to the borrower that the Bank would not make in the normal course of business, such as reducing the interest rate until the next reset date, extending the amortization period thereby lowering the monthly payments, or changing the loan to interest only payments for a limited time period. At times, certain problem loans have been restructured by combining more than one of these options. The Bank believes that restructuring these loans in this manner will allow certain borrowers to become and remain current on their loans. The Bank classifies these loans as TDR. Loans which have been current for six consecutive months at the time they are restructured as TDR remain on accrual status. Loans which were delinquent at the time they are restructured as a TDR are placed on non-accrual status until they have made timely payments for six consecutive months. Loans that are restructured as TDR but are not performing in accordance with the restructured terms are excluded from the TDR table below, as they are placed on non-accrual status and reported as non-performing loans.
 
The following table shows loans classified as TDR that are performing according to their restructured terms at the periods indicated:
 
(In thousands)
 
June 30,
2014
   
March 31,
2014
   
December 31,
2013
 
Accrual Status:
                 
Multi-family residential
  $ 3,061     $ 3,074     $ 3,087  
Commercial real estate
    2,389       2,398       2,407  
One-to-four family - mixed-use property
    2,022       2,288       2,297  
One-to-four family - residential
    359       362       364  
Construction
    -       -       442  
Commercial business and other
    2,329       2,367       4,406  
                         
Total
    10,160       10,489       13,003  
                         
Non-accrual status:
                       
One-to-four family - mixed-use property
    380       382       383  
Total
    380       382       383  
                         
Total performing troubled debt restructured
  $ 10,540     $ 10,871     $ 13,386  
 
During the six months ended June 30, 2014, two TDR loans totaling $2.4 million were transferred to non-performing status when they became over 90 days past maturity, which resulted in these loans being included in non-performing loans. These loans were paid in full during the quarter ended June 30, 2014. During the six months ended June 30, 2014, one additional TDR loan for $0.2 million was transferred to non-performing status when it became 90 days past due as to payments.
 
Interest income on loans is recognized on the accrual basis. The accrual of income on loans is discontinued when certain factors, such as contractual delinquency of 90 days or more, indicate reasonable doubt as to the timely collectability of such income. Additionally, uncollected interest previously recognized on non-accrual loans is reversed from interest income at the time the loan is placed on non-accrual status. Loans in default 90 days or more, as to their maturity date but not their payments, continue to accrue interest as long as the borrower continues to remit monthly payments.
 
 
-58-

 
PART I – FINANCIAL INFORMATION
FLUSHING FINANCIAL CORPORATION and SUBSIDIARIES
Management’s Discussion and Analysis of
Financial Condition and Results of Operations
 
The following table shows non-performing assets, including Loans held for sale, at the periods indicated:
 
(In thousands)
 
June 30,
2014
   
March 31,
2014
   
December 31,
2013
 
Loans 90 days or more past due and still accruing:
                 
Multi-family residential
  $ 987     $ 188     $ 52  
Commercial real estate
    266       793       -  
One-to-four family - mixed-use property
    1,303       874       -  
One-to-four family - residential
    14       15       15  
Construction
    -       1,012       -  
Commercial business and other
    410       2,490       539  
Total
    2,980       5,372       606  
                         
Non-accrual loans:
                       
Multi-family residential
    10,861       12,062       13,682  
Commercial real estate
    9,761       8,769       9,962  
One-to-four family - mixed-use property
    8,713       7,977       9,063  
One-to-four family - residential
    11,346       12,208       13,250  
Co-operative apartments
    -       -       57  
Commercial business and other
    2,130       2,165       2,348  
Total
    42,811       43,181       48,362  
                         
Total non-performing loans
    45,791       48,553       48,968  
                         
Other non-performing assets:
                       
Real estate acquired through foreclosure
    1,346       1,700       2,985  
Investment securities
    -       -       1,871  
Total
    1,346       1,700       4,856  
                         
Total non-performing assets
  $ 47,137     $ 50,253     $ 53,824  
 
Included in loans over 90 days past due and still accruing were 11 loans totaling $3.0 million, 13 loans totaling $5.4 million and six loans totaling $0.6 million at June 30, 2014, March 31, 2014 and December 31, 2013, respectively. These loans are all past their respective maturity dates and are still remitting payments.  The Bank is actively working with these borrowers to extend the maturity of or repay these loans.
 
Included in non-performing loans were two loans totaling $2.4 million, three loans totaling $4.7 million and one loan for $2.3 million which were restructured as TDR and not performing in accordance with their restructured terms at June 30, 2014, March 31, 2014 and December 31, 2013, respectively.
 
Hurricane Sandy caused significant damage to numerous homes and businesses throughout the New York Metropolitan area. In working with its borrowers and depositors affected by this hurricane, the Bank had entered into payment agreements on 30 loans totaling $18.9 million. These agreements originally provided for partial payment deferrals, generally for 90 days, but some agreements provide for longer deferral periods. These agreements were intended to provide the borrowers the opportunity to fully assess any damage to the properties, apply for and receive insurance proceeds, and repair damages to the properties. At June 30, 2014, eight loans totaling $4.9 million remain under these agreements, of which seven loans totaling $4.6 million are considered non-performing and we have placed them on non-accrual status until they reestablish a payment history and bring the loans current. Eight loans are current under their repayment plans and have had their agreements extended into 2014 to give the borrowers additional time to recover. Each borrower was required, commencing at the end of the deferral period, to make their regularly scheduled loan payments plus a portion of the deferred amounts. As of June 30, 2014, the Bank has not incurred, and does not expect to incur, any losses related to these agreements.
 
The Bank’s non-performing assets totaled $47.1 million at June 30, 2014, a decrease of $3.1 million from $50.3 million at March 31, 2014 and a decrease of $6.7 million from $53.8 million at December 31, 2013. Total non-performing assets as a percentage of total assets were 0.97% at June 30, 2014, 1.04% at March 31, 2014 and 1.14% at December 31, 2013. The ratio of allowance for loan losses to total non-performing loans was 63.8% at June 30, 2014, 62.3% at March 31, 2014 and 64.9% at December 31, 2013.
 
 
-59-

 
PART I – FINANCIAL INFORMATION
FLUSHING FINANCIAL CORPORATION and SUBSIDIARIES
Management’s Discussion and Analysis of
Financial Condition and Results of Operations
 
During the three months ended June 30, 2014, 18 loans totaling $5.3 million were added to non-accrual loans, 12 loans totaling $2.5 million were returned to performing status, seven loans totaling $1.3 million were paid in full, three loans totaling $0.9 million were sold, two loans totaling $0.4 million was transferred to other real estate owned, and charge-offs of $0.3 million were recorded on non-accrual loans that were non-accrual at the beginning of the second quarter of 2014.
 
At December 31, 2013, non-accrual investment securities included one pooled trust preferred security with a carrying amount of $1.9 million for which we were not receiving payments. During the six months ended June 30, 2014, the Company sold the one non-accrual trust preferred security for total proceeds of $2.1 million.
 
The following table shows our delinquent loans that are less than 90 days past due still accruing interest and considered performing at the periods indicated:
 
   
June 30, 2014
   
December 31, 2013
 
   
60 - 89
days
   
30 - 59
days
   
60 - 89
days
   
30 - 59
days
 
   
(In thousands)
 
                                 
Multi-family residential
  $ 1,325     $ 12,222     $ 2,555     $ 14,102  
Commercial real estate
    -       8,615       523       5,029  
One-to-four family - mixed-use property
    718       13,022       1,099       14,017  
One-to-four family - residential
    472       2,363       517       3,927  
Co-operative apartments
    -       -       -       -  
Construction loans
    -       -       -       -  
Small Business Administration
    -       108       -       105  
Taxi medallion
    -       -       -       -  
Commercial business and other
    -       51       2       187  
  Total delinquent loans
  $ 2,515     $ 36,381     $ 4,696     $ 37,367  
 
CRITICIZED AND CLASSIFIED ASSETS

 Our policy is to review our assets, focusing primarily on the loan portfolio, OREO and the investment portfolios, to ensure that the credit quality is maintained at the highest levels.  When weaknesses are identified, immediate action is taken to correct the problem through direct contact with the borrower or issuer. We then monitor these assets, and, in accordance with our policy and current regulatory guidelines, we designate them as “Special Mention,” which is considered a “Criticized Asset,” and “Substandard,” “Doubtful,” or “Loss” which are considered “Classified Assets,” as deemed necessary.  These asset designations are updated quarterly. We designate an asset as Substandard when a well-defined weakness is identified that jeopardizes the orderly liquidation of the debt. We designate an asset as Doubtful when it displays the inherent weakness of a Substandard asset with the added provision that collection of the debt in full, on the basis of existing facts, is highly improbable. We designate an asset as Loss if it is deemed the debtor is incapable of repayment.  We do not hold any loans designated as loss, as loans that are designated as Loss are charged to the Allowance for Loan Losses.  Assets that are non-accrual are designated as Substandard or Doubtful. We designate an asset as Special Mention if the asset does not warrant designation within one of the other categories, but does contain a potential weakness that deserves closer attention. Our total Criticized and Classified assets were $110.2 million at June 30, 2014, a decrease of $20.0 million from $130.2 million at December 31, 2013.
 
 
-60-

 
PART I – FINANCIAL INFORMATION
FLUSHING FINANCIAL CORPORATION and SUBSIDIARIES
Management’s Discussion and Analysis of
Financial Condition and Results of Operations
 
The following table sets forth the Bank’s assets designated as Criticized and Classified at June 30, 2014:
 
(In thousands)
 
Special Mention
   
Substandard
   
Doubtful
   
Loss
   
Total
 
                               
Loans:
                             
Multi-family residential
  $ 9,622     $ 15,905     $ 1,647     $ -     $ 27,174  
Commercial real estate
    10,626       14,339       -       -       24,965  
One-to-four family - mixed-use property
    4,438       14,682       -       -       19,120  
One-to-four family - residential
    2,869       13,146       -       -       16,015  
Co-operative apartments
    -       -       -       -       -  
Construction loans
    -       570       -       -       570  
Small Business Administration
    301       -       -       -       301  
Commercial business and other
    5,262       6,145       50       -       11,457  
Total loans
    33,118       64,787       1,697       -       99,602  
                                         
Investment Securities: (1)
                                       
Pooled trust preferred securities
    -       9,262       -       -       9,262  
Total investment securities
    -       9,262       -       -       9,262  
                                         
Other Real Estate Owned
    -       1,346       -       -       1,346  
Total
  $ 33,118     $ 75,395     $ 1,697     $ -     $ 110,210  
 
The following table sets forth the Bank’s assets designated as Criticized and Classified at December 31, 2013:
 
(In thousands)
 
Special Mention
   
Substandard
   
Doubtful
   
Loss
   
Total
 
                               
Loans:
                             
Multi-family residential
  $ 9,940     $ 19,089     $ -     $ -     $ 29,029  
Commercial real estate
    13,503       16,820       -       -       30,323  
One-to-four family - mixed-use property
    7,992       14,898       -       -       22,890  
One-to-four family - residential
    2,848       14,026       -       -       16,874  
Co-operative apartments
    -       59       -       -       59  
Construction loans
    746       -       -       -       746  
Small Business Administration
    310       -       -       -       310  
Commercial business and other
    7,314       8,450       50       -       15,814  
Total loans
    42,653       73,342       50       -       116,045  
                                         
Investment Securities: (1)
                                       
Pooled trust preferred securities
    -       11,134       -       -       11,134  
Total investment securities
    -       11,134       -       -       11,134  
                                         
Other Real Estate Owned
    -       2,985       -       -       2,985  
Total
  $ 42,653     $ 87,461     $ 50     $ -     $ 130,164  
 
(1)   Our investment securities are classified as securities available for sale and as such are carried at their fair value in our Consolidated Financial Statements. The securities above had a fair value of $6.3 million and $7.9 million at June 30, 2014 and December 31, 2013, respectively. Under current applicable regulatory guidelines, we are required to disclose the classified investment securities, as shown in the tables above, at their book values (amortized cost, or fair value for securities that are under the fair value option). Additionally, the requirement is only for the Bank’s securities. Flushing Financial Corporation did not have any securities classified or criticized at June 30, 2014 and December 31, 2013.
 
On a quarterly basis all collateral dependent loans that are classified as Substandard or Doubtful are internally reviewed for impairment, based on updated cash flows for income producing properties, or updated independent appraisals.  The loan balances of collateral dependent loans reviewed for impairment are then compared to the loans updated fair value. We consider fair value of collateral dependent loans to be 85% of the appraised or internally estimated value of the property.  The balance which exceeds fair value is generally charged-off against the allowance for loan losses. At June 30, 2014, the current loan-to-value ratio on our collateral dependent loans reviewed for impairment was 46.1%.

 
-61-

 
PART I – FINANCIAL INFORMATION
FLUSHING FINANCIAL CORPORATION and SUBSIDIARIES
Management’s Discussion and Analysis of
Financial Condition and Results of Operations
 
We classify investment securities as Substandard when, based on an internal review, we concluded the securities are below investment grade. We have designated a total of two investment securities that are held at the Bank as Substandard at June 30, 2014. Our classified investment securities at June 30, 2014 held by the Bank include two issues of pooled trust preferred securities. The Investment Securities which are classified as Substandard at June 30, 2014 are securities that were rated investment grade when we purchased them. These securities have each been subsequently downgraded by at least one rating agency to below investment grade. We test each of these securities quarterly for impairment, through an independent third party.

ALLOWANCE FOR LOAN LOSSES
 
We have established and maintain on our books an allowance for loan losses that is designed to provide a reserve against estimated losses inherent in our overall loan portfolio. The allowance is established through a provision for loan losses based on management’s evaluation of the risk inherent in the various components of the loan portfolio and other factors, including historical loan loss experience (which is updated quarterly), current economic conditions, delinquency and non-accrual trends, classified loan levels, risk in the portfolio and volumes and trends in loan types, recent trends in charge-offs, changes in underwriting standards, experience, ability and depth of our lenders, collection policies and experience, internal loan review function and other external factors.  Additionally, we segregated our loans into two portfolios based on year of origination. One portfolio was reviewed for loans originated after December 31, 2009 and a second portfolio for loans originated prior to January 1, 2010. Our decision to segregate the portfolio based upon origination dates was based on changes made in our underwriting standards during 2009. By the end of 2009, all loans were being underwritten based on revised and tightened underwriting standards.  Loans originated prior to 2010 have a higher delinquency rate and loss history. Each of the years in the portfolio for loans originated prior to 2010 have a similar delinquency rate. The determination of the amount of the allowance for loan losses includes estimates that are susceptible to significant changes due to changes in appraisal values of collateral, national and local economic conditions and other factors. We review our loan portfolio by separate categories with similar risk and collateral characteristics. Impaired loans are segregated and reviewed separately. All non-accrual loans are classified as impaired. Impaired loans secured by collateral are reviewed based on the fair value of their collateral. For non-collateralized impaired loans, management estimates any recoveries that are anticipated for each loan. In connection with the determination of the allowance, the market value of collateral is generally evaluated by our staff appraiser. On a quarterly basis, the estimated values of impaired collateral dependent loans are internally reviewed, based on updated cash flows for income producing properties, and at times an updated independent appraisal is obtained.  The loan balances of collateral dependent impaired loans are then compared to the property’s updated fair value. We consider fair value of collateral dependent loans to be 85% of the appraised or internally estimated value of the property. The balance which exceeds fair value is generally charged-off. When evaluating a loan for impairment, we do not rely on guarantees, and the amount of impairment, if any, is based on the fair value of the collateral. We do not carry loans at a value in excess of the fair value due to a guarantee from the borrower. Impaired collateral dependent loans that were written down resulted from quarterly reviews or updated appraisals that indicated the properties’ estimated value had declined from when the loan was originated.  The Board of Directors reviews and approves the adequacy of the allowance for loan losses on a quarterly basis.

In assessing the adequacy of the allowance for loan losses, we review our loan portfolio by separate categories which have similar risk and collateral characteristics, e.g., multi-family residential, commercial real estate, one-to-four family mixed-use property, one-to-four family residential, co-operative apartment, construction, SBA, commercial business, taxi medallion and consumer loans. General provisions are established against performing loans in our portfolio in amounts deemed prudent based on our qualitative analysis of the factors, including the historical loss experience, delinquency trends and local economic conditions. We experienced total net recoveries of $0.1 million during the three months ended June 30, 2014, compared to total net charge-offs of $2.2 million during the three months ended June 30, 2013. Non-performing loans totaled $45.8 million and $73.9 million at June 30, 2014 and 2013, respectively.   The Bank’s underwriting standards generally require a loan-to-value ratio of no more than 75% at the time the loan is originated. At June 30, 2014, the average loan-to-value ratio for our non-performing loans collateralized by real estate was 46.1%. A provision (benefit) for loan losses of ($1.1 million) and $3.5 million was recorded for the three months ended June 30, 2014 and 2013, respectively.  Management has concluded, and the Board of Directors has concurred, that at June 30, 2014, the allowance for loan losses was sufficient to absorb losses inherent in our loan portfolio.
 
 
-62-

 
PART I – FINANCIAL INFORMATION
FLUSHING FINANCIAL CORPORATION and SUBSIDIARIES
Management’s Discussion and Analysis of
Financial Condition and Results of Operations
 
The following table sets forth the activity in the Company's allowance for loan losses for the periods indicated:
 
   
For the six months ended June 30,
 
(Dollars in thousands)
 
2014
   
2013
 
             
Balance at beginning of period
  $ 31,776     $ 31,104  
                 
Provision (benefit) for loan losses
    (2,211 )     9,500  
                 
Loans charged-off:
               
    Multi-family residential
    (674 )     (2,749 )
    Commercial real estate
    (86 )     (734 )
    One-to-four family – mixed-use property
    (258 )     (3,135 )
    One-to-four family – residential
    (79 )     (691 )
    Co-operative apartments
    -       (74 )
    Construction
    -       (304 )
    Small Business Administration
    (49 )     (337 )
    Commercial business and other
    (125 )     (864 )
        Total loans charged-off
    (1,271 )     (8,888 )
                 
Recoveries:
               
    Multi-family residential
    141       65  
    Commercial real estate
    382       293  
    One-to-four family – mixed-use property
    135       111  
    One-to-four family – residential
    165       106  
    Co-operative apartments
    7       4  
    Small Business Administration
    61       60  
    Commercial business and other
    50       -  
        Total recoveries
    941       639  
                 
Net charge-offs
    (330 )     (8,249 )
                 
Balance at end of period
  $ 29,235     $ 32,355  
                 
Ratio of net charge-offs during the period to
               
   average loans outstanding during the period
    0.02 %     0.52 %
Ratio of allowance for loan losses to gross loans at end of period
    0.83 %     0.99 %
Ratio of allowance for loan losses to non-performing
               
   assets at end of period
    62.02 %     40.06 %
Ratio of allowance for loan losses to non-performing
               
   loans at end of period
    63.84 %     43.79 %
 
 
-63-

 
PART I – FINANCIAL INFORMATION
FLUSHING FINANCIAL CORPORATION and SUBSIDIARIES
Management’s Discussion and Analysis of
Financial Condition and Results of Operations

Basel III
 
In the summer of 2012, our primary federal regulators published two Notices of Proposed Rulemaking (“NPRs”) that would have substantially revised the risk-based capital requirements applicable to bank holding companies and depository institutions, including the Company and the Bank, compared to the then current U.S. risk-based capital rules, which are based on the international capital accords of the Basel Committee on Banking Supervision, which are generally referred to as “Basel I.”
 
During July 2013, our primary federal regulators issued revised NPRs that will revise and replace the agencies' current capital rules. The NPRs include numerous revisions to the existing capital regulations, including, but not limited to, the following:
 
 
·
Revises the definition of regulatory capital components and related calculations.
 
 
·
Adds a new common equity tier 1 capital ratio.
 
 
·
Increases the minimum tier 1 capital ratio requirement from four percent to six percent.
 
 
·
Incorporates the revised regulatory capital requirements into the Prompt Corrective Action framework.
 
 
·
Implements a new capital conservation buffer that would limit payment of capital distributions and certain discretionary bonus payments to executive officers and key risk takers if the banking organization does not hold certain amounts of common equity tier 1 capital in addition to those needed to meet its minimum risk-based capital requirements.
 
 
·
Provides a transition period for several aspects of the proposed rule: the new minimum capital ratio requirements, the capital conservation buffer, and the regulatory capital adjustments and deductions.
 
 
·
Increases capital requirements for past-due loans, high volatility commercial real estate exposures, and certain short-term loan commitments.
 
 
·
Removes references to credit ratings consistent with Section 939A of the Dodd-Frank Act.
 
 
·
Establishes due diligence requirements for securitization exposures.
 
The capital regulations would be effective January 1, 2015 for bank holding companies and banks with less than $15 billion in total assets, such as our Company and Bank. Based on our preliminary assessment of the NPRs, we believe we will see an increase in our total risk-weighted assets. However, the Company and the Bank, based on our preliminary assessment, would meet the requirements of the NPRs and will continue to be considered well-capitalized.

Volcker Rule
 
On December 10, 2013, our primary federal regulators adopted Section 619 of the Dodd-Frank Act, commonly referred to as the “Volcker Rule,” which prohibits insured depository institutions from engaging in short-term proprietary trading of certain securities, derivatives and other financial instruments for the firm’s own account, subject to certain exemptions, including market making and risk-mitigating hedging. The Volcker Rule also imposes limits on banking entities’ investments in, and other relationships with, hedge funds and private equity funds.
 
The rule as adopted prohibited banking entities from owning collateralized debt obligations backed primarily by trust preferred securities (“TruPS CDOs”) after July 21, 2015. At June 30, 2014, the Company held TruPs CDOs with an amortized cost and market value totaling $9.3 million and $6.3 million, respectively.
 
On January 14, 2014, our primary federal regulators approved an interim final rule to permit banking entities to retain interests in certain TruPS CDOs from the investment prohibitions of Section 619 of the Dodd-Frank Act.
 
 
-64-

 
PART I – FINANCIAL INFORMATION
FLUSHING FINANCIAL CORPORATION and SUBSIDIARIES
Management’s Discussion and Analysis of
Financial Condition and Results of Operations
 
Under the interim final rule, the agencies permit the retention of an interest in or sponsorship of covered funds by banking entities if the following qualifications are met:
 
 
·
the TruPS CDO was established, and the interest was issued, before May 19, 2010;
 
 
·
the banking entity reasonably believes that the offering proceeds received by the TruPS CDO were invested primarily in Qualifying TruPS Collateral; and
 
 
·
the banking entity's interest in the TruPS CDO was acquired on or before December 10, 2013.
 
The interim final rule defines Qualifying TruPS Collateral as any trust preferred security or subordinated debt instrument that was:
 
 
·
issued prior to May 19, 2010, by a depository institution holding company that as of the end of any reporting period within 12 months immediately preceding the issuance of such trust preferred security or subordinated debt instrument had total consolidated assets of less than $15 billion; or
 
 
·
issued prior to May 19, 2010, by a mutual holding company.
 
As a result of the interim final rule, the Company determined that the TruPS CDOs it owns at June 30, 2014 are not prohibited by the Volcker Rule.

 
-65-

 
PART I – FINANCIAL INFORMATIOMTION
FLUSHING FINANCIAL CORPORATION and SUBSIDIARIES
ITEM 3.     QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

For a discussion of the qualitative and quantitative disclosures about market risk, see the information under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations - Interest Rate Risk."

ITEM 4.     CONTROLS AND PROCEDURES

The Company carried out, under the supervision and with the participation of the Company’s management, including its Chief Executive Officer and Chief Financial Officer, an evaluation of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934) as of the end of the period covered by this Quarterly Report.  Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as of June 30, 2014, the design and operation of these disclosure controls and procedures were effective.  During the period covered by this Quarterly Report, there have been no changes in the Company’s internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 
-66-

 
PART II – OTHER INFORMATIOMTION
FLUSHING FINANCIAL CORPORATION and SUBSIDIARIES
  
ITEM 1.     LEGAL PROCEEDINGS

The Company is a defendant in various lawsuits.  Management of the Company, after consultation with outside legal counsel, believes that the resolution of these various matters will not result in any material adverse effect on the Company's consolidated financial condition, results of operations and cash flows.

ITEM 1A.  RISK FACTORS

There have been no material changes from the risk factors disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013.
 
ITEM 2.     UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

The following table sets forth information regarding the shares of common stock repurchased by the Company during the three months ended June 30, 2014:

Period
 
Total
Number
of Shares
Purchased
   
Average Price
Paid per Share
   
Total Number of
Shares Purchased
as Part of Publicly
Announced Plans
or Programs
   
Maximum
Number of
Shares That May
Yet Be Purchased
Under the Plans
or Programs
 
April 1 to April 30, 2014
    -     $ -       -       521,750  
May 1 to May 31, 2014
    50,000       19.85       50,000       471,750  
June 1 to June 30, 2014
    30,000       19.85       30,000       441,750  
     Total
    80,000     $ 19.85       80,000          
 
During the year ended December 31, 2013, the Company completed the common stock repurchase program that was approved by the Company’s Board of Directors on September 20, 2011.  On May 22, 2013, the Company announced the authorization by the Board of Directors of a new common stock repurchase program, which authorizes the purchase of up to 1,000,000 shares of its common stock.  During the three months ended June 30, 2014, the Company repurchased 80,000 shares of the Company’s common stock at an average cost of $19.85 per share.  At June 30, 2014, 441,750 shares remain to be repurchased under the current stock repurchase program. Stock will be purchased under the current stock repurchase program from time to time, in the open market or through private transactions subject to market conditions and at the discretion of the management of the Company. There is no expiration or maximum dollar amount under this authorization.
 
ITEM 3.     DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4.     MINE SAFETY DISCLOSURES

Not applicable.

ITEM 5.     OTHER INFORMATION

On August 7, 2014, the Board of Directors amended the Company's Bylaws to add a new section 5.04 adding an exclusive forum provision.
 
 
-67-

 
PART II – OTHER INFORMATIOMTION
FLUSHING FINANCIAL CORPORATION and SUBSIDIARIES
 
ITEM 6. EXHIBITS
 
Exhibit  No.
Description
   
2.1
Agreement and Plan of Merger dated as of December 20, 2005 by and between Flushing Financial Corporation and Atlantic Liberty Financial Corp. (7)
3.1
Certificate of Incorporation of Flushing Financial Corporation (1)
3.2
Certificate of Amendment to Certificate of Incorporation of Flushing Financial Corporation (3)
3.3
Certificate of Amendment to Certificate of Incorporation of Flushing Financial Corporation (6)
3.4
Certificate of Designations of Series A Junior Participating Preferred Stock of Flushing Financial Corporation (4)
3.5
Certificate of Increase of Shares Designated as Series A Junior Participating Preferred Stock of Flushing Financial Corporation (2)
3.6
Amended and Restated By-Laws of Flushing Financial Corporation as of August 7, 2014 (filed herewith).
4.1
Rights Agreement, dated as of September 8, 2006, between Flushing Financial Corporation and Computershare Trust Company N.A., as Rights Agent, which includes the form of Certificate of Increase of Shares Designated as Series A Junior Participating Preferred Stock as Exhibit A, form of Right Certificate as Exhibit B and the Summary of Rights to Purchase Preferred Stock as Exhibit C (5)
4.2
Flushing Financial Corporation has outstanding certain long-term debt. None of such debt exceeds ten percent of Flushing Financial Corporation's total assets; therefore, copies of constituent instruments defining the rights of the holders of such debt are not included as exhibits. Copies of instruments with respect to such long-term debt will be furnished to the Securities and Exchange Commission upon request.
10.1
Lease agreement between Flushing Bank and Rexcorp Plaza SPE LLC (filed herewith)
10.2 2014 Omnibus Incentive Plan (filed herewith)
31.1
Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 by the Chief Executive Officer (filed herewith)
31.2
Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 by the Chief Financial Officer (filed herewith)
32.1
Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes Oxley Act of 2002 by the Chief Executive Officer (furnished herewith)
32.2
Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes Oxley Act of 2002 by the Chief Financial Officer (furnished herewith)
101.INS
XBRL Instance Document (filed herewith)
101.SCH
XBRL Taxonomy Extension Schema Document (filed herewith)
101.CAL
XBRL Taxonomy Extension Calculation Linkbase Document (filed herewith)
101.DEF
XBRL Taxonomy Extension Definition Linkbase Document (filed herewith)
101.LAB
XBRL Taxonomy Extension Label Linkbase Document (filed herewith)
101.PRE
XBRL Taxonomy Extension Presentation Linkbase Document (filed herewith)
(1) Incorporated by reference to Exhibits filed with the Registration Statement on Form S-1 filed September 1, 1995, Registration No. 33-96488.
(2) Incorporated by reference to Exhibits filed with Form 8-K filed September 26, 2006.
(3) Incorporated by reference to Exhibits filed with Form S-8 filed May 31, 2002.
(4) Incorporated by reference to Exhibits filed with Form 10-Q for the quarter ended September 30, 2002.
(5) Incorporated by reference to Exhibit filed with Form 8-K filed September 11, 2006.
(6) Incorporated by reference to Exhibit filed with Form 10-K filed December 31, 2011.
(7) Incorporated by reference to Exhibit filed with Form 8-K filed December 23, 2005.
 
 
-68-

 
FLUSHING FINANCIAL CORPORATION and SUBSIDIARIES
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
Flushing Financial Corporation,
 
 
 
Dated: August 11, 2014
By: /s/John R. Buran
John R. Buran
President and Chief Executive Officer
 
 
 
 
Dated: August 11, 2014
 
 
 
By: /s/David Fry
David Fry
Senior Executive Vice President, Treasurer and
Chief Financial Officer
 
 
                                                                                                                                                                                                                  
 
 
-69-

 
FLUSHING FINANCIAL CORPORATION and SUBSIDIARIES
EXHIBIT INDEX

Exhibit  No.
Description
   
2.1
Agreement and Plan of Merger dated as of December 20, 2005 by and between Flushing Financial Corporation and Atlantic Liberty Financial Corp. (7)
3.1
Certificate of Incorporation of Flushing Financial Corporation (1)
3.2
Certificate of Amendment to Certificate of Incorporation of Flushing Financial Corporation (3)
3.3
Certificate of Amendment to Certificate of Incorporation of Flushing Financial Corporation (6)
3.4
Certificate of Designations of Series A Junior Participating Preferred Stock of Flushing Financial Corporation (4)
3.5
Certificate of Increase of Shares Designated as Series A Junior Participating Preferred Stock of Flushing Financial Corporation (2)
3.6
Amended and Restated By-Laws of Flushing Financial Corporation as of August 7, 2014 (filed herewith).
4.1
Rights Agreement, dated as of September 8, 2006, between Flushing Financial Corporation and Computershare Trust Company N.A., as Rights Agent, which includes the form of Certificate of Increase of Shares Designated as Series A Junior Participating Preferred Stock as Exhibit A, form of Right Certificate as Exhibit B and the Summary of Rights to Purchase Preferred Stock as Exhibit C (5)
4.2
Flushing Financial Corporation has outstanding certain long-term debt. None of such debt exceeds ten percent of Flushing Financial Corporation's total assets; therefore, copies of constituent instruments defining the rights of the holders of such debt are not included as exhibits. Copies of instruments with respect to such long-term debt will be furnished to the Securities and Exchange Commission upon request.
10.1
Lease agreement between Flushing Bank and Rexcorp Plaza SPE LLC (filed herewith)
10.2 2014 Omnibus Incentive Plan (filed herewith)
31.1
Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 by the Chief Executive Officer (filed herewith)
31.2
Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 by the Chief Financial Officer (filed herewith)
32.1
Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes Oxley Act of 2002 by the Chief Executive Officer (furnished herewith)
32.2
Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes Oxley Act of 2002 by the Chief Financial Officer (furnished herewith)
101.INS
XBRL Instance Document (filed herewith)
101.SCH
XBRL Taxonomy Extension Schema Document (filed herewith)
101.CAL
XBRL Taxonomy Extension Calculation Linkbase Document (filed herewith)
101.DEF
XBRL Taxonomy Extension Definition Linkbase Document (filed herewith)
101.LAB
XBRL Taxonomy Extension Label Linkbase Document (filed herewith)
101.PRE
XBRL Taxonomy Extension Presentation Linkbase Document (filed herewith)
(1) Incorporated by reference to Exhibits filed with the Registration Statement on Form S-1 filed September 1, 1995, Registration No. 33-96488.
(2) Incorporated by reference to Exhibits filed with Form 8-K filed September 26, 2006.
(3) Incorporated by reference to Exhibits filed with Form S-8 filed May 31, 2002.
(4) Incorporated by reference to Exhibits filed with Form 10-Q for the quarter ended September 30, 2002.
(5) Incorporated by reference to Exhibit filed with Form 8-K filed September 11, 2006.
(6) Incorporated by reference to Exhibit filed with Form 10-K filed December 31, 2011.
(7) Incorporated by reference to Exhibit filed with Form 8-K filed December 23, 2005.