First Foundation Inc. (NASDAQ:FFWM) Q4 2022 Earnings Call Transcript

First Foundation Inc. (NASDAQ:FFWM) Q4 2022 Earnings Call Transcript January 26, 2023

Operator: Greetings, and welcome to First Foundation’s Fourth Quarter and Full Year 2022 Earnings Conference Call. Today’s call is being recorded. At this time, all participants have been placed in a listen-only mode and the floor will be open for your questions following the presentation. Speaking today will be Scott Kavanaugh, First Foundation’s President and Chief Executive Officer and Chris Naghibi, Chief Operating Officer. Before I hand the call over to Scott, please note that management will make certain predictive statements during today’s call that reflect their current views and expectations about the company’s performance and financial results. These forward-looking statements are made subject to the safe harbor statement included in today’s earnings release.

In addition, some of the discussion may include non-GAAP financial measures. For a more complete discussion of the risks and uncertainties that could cause actual results to differ materially from any forward-looking statements and reconciliations of non-GAAP financial measures. See the company’s filings with the Securities and Exchange Commission. Additionally, I’d like to inform you that the First Foundation in terms of the filing a proxy statement and related proxy materials with the Securities and Exchange in connection with the company’s 2023 annual meeting of stockholders and in connection there within extracted in terms of its executive officers are participants in the solicitation are proxies from our stockholders in connection with the annual meeting.

Stockholders are First Foundation strongly encourage to read such proxy statement and all other related materials filed with the Securities and Exchange Commission. Carefully and in their entirety, when they become available as they will contain important information about the 2023 annual meeting and we’ll not be making any comment on this call about the recent nominations made. And now, I’d like to turn the call over to Scott Kavanaugh.

Scott Kavanaugh: Good morning, and welcome. Thank you for joining today’s earnings conference call. First, I’ll discuss the highlights of our fourth quarter and full year 2022 results, followed by Chris Naghibi, our newly appointed Chief Operating Officer, who will discuss our loan and deposit business. Then we’ll open it up for questions. The earnings that we reported this morning reflect the resilience of our core businesses and our commitment to managing expenses strategically slowing loan growth, identifying greater operational efficiencies while growing the meaningful relationships we have built with our new and existing clients. As you know, we also made some key management changes in organizational realignment over the last quarter that are reflective of our commitment to optimize our workforce, identify the right talent for critical positions and realign First Foundation to best execute on behalf of our clients and shareholders.

I can truly say that everyone has done a tremendous job and I am so proud of how our deep bench of talent has stepped up. Our diverse business model and service focus culture, continue to perform well and this is particularly true during this market cycle. There is no question we continue to face the pressures placed on the banking industry due to the Fed’s actions over the last nine months. In the last quarter, the Fed raised rates an additional 125 basis points. This has occurred while the tenure year also has decreased by 50 basis points. This interest rate inversion has put pressure on both margin and income for the entire banking sector, and we fully realize those factors remain a challenge for 2023 and beyond. It is against that backdrop that I am pleased to report our earnings per share was $0.31 or $0.35 when accounting for the valuation adjustment on the NYDIG equity investment, recent executive departures and professional service fees.

We generated $81.9 million in revenue and $17.4 million in earnings for the quarter and $366.9 million in revenue and $110.5 million in earnings for the full year, while our adjusted return on average assets ended the quarter at 0.63% and 1% for the full year. We continue to actively position ourselves for long-term success. We are focused on optimizing our operation to reflect the current environment and we have taken steps to create additional operational efficiencies. We have always run a lean operation compared to our peers and we continue to manage with this in mind. That said, we will prioritize our spending on client service, risk management and security. We will not sacrifice our strong reputation in these key areas. This means that projects such as optimizing our data warehouse in cross-promoting our services will be a priority.

Our Bitcoin project to our banking clients will be on hold indefinitely as we continue to seek regulatory guidance. Our tangible book value per share ended the quarter at $16.20, which represents a $0.24 increase for the quarter and a $1.28 increase for the full year. We also declared and paid our fourth quarter cash dividend of $0.11 per share. We experienced an 11.5% year-over-year growth in tangible book value per share, including cash dividends paid. We believe this will continue as we deliver strong returns to our shareholders. As we mentioned in the last quarter, we began strategically managing our loan growth while focusing on keeping and adding deposits and our fundamentals remained strong with excellent credit quality. Notably, our credit quality remains pristine and our NPA ratio declined to 13 basis points, which is even low for us, considering we started the quarter at 14 basis points.

This reflects our continued underwriting discipline and standards. Our loan-to-deposit ratio decreased to 103.5% as of December 31, 2022 down from the 108.4% at the end of the quarter. This is a testament to the incredible strides we have made and this important metric continues to already improve as we head into 2023. Although it is still early in the quarter of 2023, we have seen further improvements on our loan-to-deposit ratio. Our plan to slow funding while actively raising deposits is working. Given the successful strategic management of our balance sheet that has resulted in bringing the loan origination numbers down, we do not see the need for utilizing a loan sale as we have done in the past. Our bank is defined by maintaining exceptional credit quality standards while delivering growth in value for stakeholders.

And while this is a challenging macroeconomic cycle, we were executing on a very solid business plan and expect the results to follow once we experience a more normalized rate environment. Our NIM for the quarter was 2.45%, which obviously is a reflection of the interest rate environment and the continued pressure by the fed’s action. And we expect this to normalize to historic levels as soon as the fed eases and the market conditions settle. We are focused on making more adjustable rate loans, which should offset some of those pressures of the current rate environment, but we are limited by a variety of factors including funding constraints as the deposit market remains extremely competitive and liquidity continues to drain from the financial system along with limiting our exposure to higher cost wholesale funding.

Looking at our wealth management and trust business, we continue to experience meaningful contributions to the firm as evidenced by combined business unit revenue of $40 million for the year. 2022, this diversified revenue source in the form of recurring non-interest income accounted for 14% of the company’s total revenue. We have also been successful in retaining existing clients and attracting new loans. Assets under management increase by $359 million in the quarter and ended the year at $5 billion and trust under advisement ended the year at $1.3 billion. The increases in ARM and AUA were the result of both new client inflows and positive market performance. When there is a market volatility and uncertainty, we typically experience an inflow of assets from existing clients and new clients.

New clients are attracted to the independent RIAA model where they know they’re working with a fiduciary, which is even more important than ever during market conditions like these. We have been proactively communicating with existing clients and strategically managing their portfolios as needed. We have been successful in engaging with them from an educational standpoint through our written market commentaries, our blog, our webinars, and our in-person events, as well as through our robust suite, our products and services such as an advanced wealth planning and tax aware investing. As a result, we are seeing strong client retention across the entire wealth management platform. Our investment performance has also been another bright spot. While the S&P 500 and another major indices were down more than 19% for the year, our moderate balanced portfolios were only down 14% on average and our total return fund received a three year and five year, five star rating from Morningstar.

As we reflect in the quarter, I confidently say that we have an incredible client base and extremely attractive markets. I also want to say how proud I am of our entire management team. They are more aligned than ever and we have been working hard to accomplish our strategic objectives. Our entire team is working towards a common goal and I am so pleased that our executive management and the board have responded to all the events that have unfolded last quarter. We have a board that is well positioned, well represented across various industries with deep domain experience in financial services and banking, and I am pleased with their support of our go-forward approach. Let me touch on a few final data points. As a financial institution, we remain well capitalized with a tier one risk-based capital ratio at 9.18% at quarter end.

Our tangible book value ended higher at $16.20 a $1.28 increase for the full year. Liquidity remained strong with no net charge offs and our provision for credit losses reflects the strength of our multi-family lending portfolio, which continues to be the strongest performing asset class across all real estate loans. We believe it is worth noting that we have never taken a charge off or a loss in multi-family in the history of this firm. As mentioned in previous calls, we are focused on managing our tax rate. We have tax rate substantially downward, and we have successfully gotten it to a run rate of 26%, which is largely attributable to our municipal loans and LIHTC deals and an increase of loans in Florida and Texas. We believe we can continue to experience favorable tax treatment as part of our growth strategy.

Heading into 2023, our balance sheet remained strong with total assets of $13 billion. Between the strength of our existing management team and board, our relentless focus on client service and our ability to offer solutions to clients wherever they are in their financial lives, I continue to be very excited about our future. Once again, I want to thank everyone at First Foundation for the contributions through a difficult year and the continued support I have received. Now, before I hand the call over to Chris, let me first introduce him to you all. Chris Naghibi was appointed as our Chief Operating Officer in November and has seamlessly stepped into the role and has already started making a very positive impact. Chris sits in Irvine where our banking operations are headquartered.

As some of you know, Chris was one of the original members of the First Foundation Bank team when we started the bank 15 years ago. He has continued to progress through various departments of the bank, most recently having served as our Chief Credit Officer. Among the many areas of focus and his role as the Chief Operating Officer, he has dedicated his first 90 days to building a stronger alignment among our business units, including the bank, wealth management interest department. These are the cornerstones of our business model and I am so thrilled to have Chris working to help optimize them. With that, I’ll turn it over to our newly appointed Chief Operating Officer, Chris Naghibi.

Chris Naghibi: Thank you for the kind words, Scott, and let me be the first say that I’m honored to have been appointed Chief Operating Officer Loan originations were $849 million for the quarter and $5.8 billion for the full year. Looking at the breakdown of loans that we originated in the quarter, the percentages are as follows. Commercial, including owner-occupied commercial real estate, 51%; multi-family, 35%; single family 7%; land and construction is now at 3% and CRE investment at 4%. It is always important to note that we accomplish this without changing our high underwriting standards and our MPAs fell to a low of 13 basis points for the quarter, which as Scott mentioned, is low even for First Foundation Bank. This is also reflected is low even for First Foundation Bank.

This is also reflected in our conservative underwriting standards as evidenced by our LTVs of 54% for multifamily loans and 49% for single-family loans. While it is true that we have followed the plan to slow our growth, we still reached peak levels of loan originations in 2022. As we look ahead, we anticipate that growth will continue to be strategically slowed in 2023 as we wait for the market to catch up to the actions of the Fed. Speaking more specifically about our loan yields, we achieved a weighted average rate of 5.72% on originations, which increased substantially from the third quarter. This quarter, we continue to see the impact of higher origination rates due to increases in the long end of the yield curve and as prior lower yielding rate lock loans have largely funded out our pipelines.

As of December 31, 2022, our loan portfolio is comprised of: 50% multifamily loans; 32% commercial business loans; 7% nonowner-occupied commercial real estate; 9% consumer and single-family residence loans; and 2% of land and construction loans, which are selectively and carefully considered for our most valued clients. Before we look at our deposit business, I want to touch on our multifamily portfolio. As you may have seen, we added a few slides to our investor presentation about our multifamily lending business. The updated section in the presentation highlighted three things that I will speak to here: First, the markets we serve; second, the profile of our borrowers; and third, the assets that we lend on. Let me try to help paint a picture of the markets we serve.

90% plus of where we lend is in the State of California. In many of these areas within the state, rent control applies, which serves as both a ceiling when prices go up, but also as a floor when prices go down. In addition to this in almost all of our regions, the cost to buy is far greater than the cost to rent. There’s a limited supply of units in land, which serves to keep the barrier for entry into the markets quite high. And even though we have referenced it on these calls, we have limited exposure to the Sunbelt region having never actively pursued lending there. The second point is our borrowers. We largely lend to what we consider real estate professionals, typically too big to take standard terms from a bank, typically too small to be part of a fund or large syndicate, although we do some syndicated deals.

This all boils down to the fact we are working with knowledgeable and oftentimes repeat clients. And finally, let me touch on the properties or assets we lend on. These are what we consider essential or workforce housing in prize of 15 units to 20 units on average. A large portion were built between 1950 and 1980. And so these are classified as C&B grade buildings with higher quality, generally newer construction A-grade buildings mixed in. It has been our experience that Class A properties like this have greater downside risk given they are often leased up at top of market rents in our markets. It is this profile, which gives us confidence that the multifamily asset class will hold up like it historically has, as being one of the top-performing real estate loan products that banks can offer.

This data goes back to before the financial crisis. Okay. Shifting gears and looking at our deposit business. Deposits increased by $802 million for the quarter and $1.6 billion for the year to end the year at $10.4 billion. As Scott referenced last quarter, it is a dogfight out there, and there is increased competition across all deposit channels. Our deposit costs came in at 1.47%, which is on par with our expectations. Before I wrap up, I just want to recap some of the successful projects we completed last year. During 2022, we successfully opened a retail banking location in Plano, Texas. We also completed the integration of our Florida acquisition. While we still maintain our banking headquarters in California, we have successfully expanded into new growth markets.

To assist in that endeavor, we also launched our redesigned mobile app. This has allowed us to virtually connect with thousands of clients nationwide as they now can conduct banking via any mobile device. The app is very valuable as we continue to see client base expand into markets where we do not have a physical retail presence. Before I hand it back over to the operator for Q&A, I want to reiterate Scott’s comments. I am very grateful for our team’s dedication to delivering excellent client service when it matters most. This is a challenging time in banking, but I am confident we have the right team in place. At this time, we are ready to take questions, and I will hand it back to the operator.

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Q&A Session

Operator: Our first question is coming from David Feaster from Raymond James.

Scott Kavanaugh: Hey David, before you begin, I’d just like to say that I have two other people here with us — with Chris and I that are here to assist answering questions. So Amy Djou is here our Interim CFO and also Dave DePillo, our Deputy CFO, is here. So I just wanted to kind of formally say they’re here as well to help assist with questions.

David Feaster: And Chris, congrats on the promotion, very well deserved. I guess maybe at a high level, could we just talk about the organic growth trajectory going forward? We’ve strategically decelerated. Maybe just how do you think about the composition of production going forward? Would you expect to see more commercial business? Maybe that becomes a larger proportion of production? Or just curious kind of how you think about the growth trajectory as we head into 2023?

Scott Kavanaugh: So first and foremost, we have to get our loan-to-deposit ratio under control. We made significant improvements, lowering it from 108.4 down to 103.5. And we’ve made additional improvements since that time, and we’re not even at the end of January. But we’re hyper focused right now I think I said at the end of the third quarter, deposits just evaporated. And I think we made an amazing turnaround to be able to get our loan-to-deposit ratio down to that 103.5 and continue to improve. But that being said, David, and I appreciate your question because we’re not looking to shrink the balance sheet. We really do hope to continue to modestly grow the loan portfolio throughout the year. Joe can touch on the modeling in terms of loan activity that we are projecting this year.

But I will tell you, just to start with, multifamily is in a very weird spot right now. That’s a technical term. The John Ecopia and FFA, our advisor, told us that some of his clients are funding stuff through Freddie and Fannie right now in the 4.60, 4.70 range, which, clearly we can’t follow. I know that there are a few banks that are still modestly doing apartment lending, especially in the state of California, and those rates seem to be in the 5.50 range, which again, given where funding costs are, don’t seem to make a lot of sense to me. And so there’s not a lot of activity in the multifamily space. And I think I believe it to be prudent that we should not be lending on more fixed rate assets until we get greater clarity from the Fed on what their intentions are.

So to answer, this is long ended way of saying, yes, we’re going to focus more on C&I, it will help us more from an asset liability perspective on a go-forward basis. The great thing is that I want to mention before Joe and Chris step in here the duration of multifamily is pretty short. And it’s like 2.3 years, 2.4 years. And part of that is the seasoning of some of our older years of books, the newer stuff is probably more like 2.8 years. But you’re going to start to see a real turnover of some of those low coupons. Right now, it’s not real advantageous for a borrower to want to pay those off. But this year, we’ve got quite a few that roll into the adjustable rate phase, which obviously will help our NIM, and bring the average coupon of our portfolio higher.

But Joe, you want to talk about what you think are projections for this year.

Chris Naghibi: Yes. Just at a high level in terms of loan production, we’re forecasting in a range of, call it, $1.5 billion to $2 billion, excluding draws, potentially higher. We normally report with drugs. So it could be a $500 million on that. Multifamily, as Scott alluded to, is certainly less as a percent. So of what we have modeled in C&I is definitely over 50% of the forecasted growth on the production side.

Amy Djou: So I think that covers essentially what the market looks like, but I’ll also add one other — a little bit of color, much like the single-family market, which was a bit of a stalemate towards the end of the year. the life cycle of the multifamily market has been a bit of a stalemate as well. Some of the seasoned investors are choosing not to sell and to hold off and see what the actions by the Fed are taking. So some of it is market di in and of itself in addition to the pricing that we’re seeing out there. So the renewed focus on relationships and the additional detail as it relates to the C&I book, I think, is important for where we’re going and what we’re doing, and it really dovetails into the value proposition of the brand. So historically, we’ve grown those channels prior to the Fed’s decision-making in the last year. And I think that growth has served us well, and we’ll continue to see the benefits of that moving forward.

David Feaster: Okay. That’s great color. And maybe along the same lines, I mean, you talked about some of the repricing dynamics. Could you help us think about the yield pickup that you would expect from that just — and given the shorter duration of those assets? And ultimately, like how should we think about the margin trajectory going forward once the Fed does stop and funding pressures start subsiding a bit and assets continue to reprice higher?

Scott Kavanaugh: Well, I believe the books of business this year that are to reprice is around $1 billion. Is that right, Djou?

Amy Djou: Yes. And in terms of the over forecasting for across, I’d say, all at costs. And of course, we actually have about $1.5 billion of adjustable C&I between both the term and the revolver as well. So a combination of those. What we’re forecasting for loan yields going forward is kind of hitting a height somewhere in the high I’d say, high 4s for 2023 as those books continue to reprice.

Scott Kavanaugh: So I think as I indicated on the call, NIM is definitely going to continue to shrink a little bit until the Fed stops their actions. But I truly believe that the trough that we are experiencing is — we’re about to be at the trough. And I believe by the time we get to the second quarter, that will be the trough of NIM, and we will start to see an improvement of NIM shortly thereafter. So I think — and that’s going to be a combination of repricing of some of the multifamily and largely an increase in C&I.

David Feaster: Okay. All right. That makes sense. And I wanted to maybe shift gears. You talked about some of the focus of Chris and better aligning the business units. I mean, the trust business has been phenomenal. And you talked about some of the strength there. Just curious if you could talk about some of the initiatives that you’re working on? And just give us maybe some more details on the outlook for trust and some of the integration that you’re talking about.