First Foundation Inc. Q3 FY2020 Earnings Call

Greetings, and welcome to First Foundation's Third Quarter 2020 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 Chief Executive Officer; Kevin Thompson, Chief Financial Officer; David DePillo, President of First Foundation; and John Hakopian, President of First Foundation Advisors. 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. And now, I would like to turn the call over to Scott Kavanaugh.

Hello and thank you for joining us. We would like to welcome all of you to our third quarter 2020 earnings conference call. We will be providing some prepared comments regarding our activities, and then we will respond to questions. It was another strong quarter for First Foundation. Our business model of providing banking, private wealth management services has performed very well. Lending, deposits, investments, wealth planning and trust services are each contributing in meaningful ways. While many other financial service firms have reduced activities due to the shutdowns, our team has used it as an opportunity to gain ground in the markets we serve, as we continue to find that our clients want to work with a single provider of services, which allows us to build longstanding and meaningful relationships. This really speaks to the value proposition of our firm. As highlighted in the press release this morning, we delivered another quarter of strong financial results. Our earnings for the third quarter were $30.9 million, or $0.69 per share, a 78% increase over the third quarter of 2019. Total revenues were $75.3 million for the quarter, an increase of 32% year-over-year. Our tangible book value increased to $13.05 per share. Our efficiency ratio for the third quarter improved to 40% and 49% year-to-date. As we mentioned on previous calls, our target efficiency ratio is 50% for the full year, so we were well on our way to reaching that important metric. We also declared and will pay our quarterly cash dividend of $0.07 per share and anticipate the continuation of the dividend in future quarters. Over the last nine months, we have experienced strong loan and deposit growth and this quarter, our assets under management increased to pre-pandemic levels. Loan originations for the quarter were $414 million and overall deposits have grown by $573 million year-to-date. We have also decreased our wholesale deposits by 56% and our Federal Home Loan Bank advances 64% year-to-date, which is a part of the successful repositioning of the liability side of our balance sheet that we have spoken about in the past. Loan demand remains strong in our markets and our pipeline in credit underwriting continues to be robust. We successfully completed a securitization of $553 million of multifamily loans, our fifth such deal to date, and we are already starting the process for next year’s securitization. Our digital platforms continue to perform well, allowing us to deliver products and services to our clients in new and efficient ways. As mentioned in the past, we have made important investments in this area and are continuing to see a strong payback. This is highlighted by our year-to-date growth of over 323% in our online savings channel. This has become a valuable complement to our retail offering. Now, our savings clients can engage with us online or in the branch, whatever is most convenient for them. The increase in assets under management for our private wealth management business was thanks in large part to our trust business. Our trust offering, which recently eclipsed $1 billion in assets, continues to differentiate against other wealth managers and financial advisory firms. I also want to say I'm very grateful to our employees who have worked tremendously hard during these challenging circumstances. We know there is much uncertainty in their own lives with school closures, routines being upended and everyday life put on hold, which makes the results we reported today that much more meaningful. It is truly a testament to the great work we have in place here at First Foundation. I would also like to thank all of our clients who entrust us with their financial needs. Now, let me turn the call over to our CFO, Kevin Thompson.

Thank you, Scott. With the successful execution of our securitization and the continued momentum of our customer-centric model, we experienced strong profitability in the quarter with a diluted EPS of $0.69 per share. Efficiency ratio decreased to 40% with a return on assets of 1.79% and a return on tangible common equity of 22%. We completed a securitization of $553 million of multifamily loans in the quarter as is our practice to do annually, achieving a very healthy $15.1 million gain. As part of the transaction, we also recognized the mortgage servicing rights of $3.9 million. Loans held for investment decreased in the quarter due to $513 million of loan balances being transferred to the held-for-sale category in preparation for a securitization next year. Absent this transfer, loan balances increased slightly in the quarter. The cost of deposits decreased from 84 to 57 basis points in the quarter and was 48 basis points in the last month of the quarter. Our broker deposits have decreased to over $670 million or 56% year-to-date. Our strategy of increasing core deposits has gained traction, as our core deposits increased from 76% to 90% of our deposit base year-over-year. Deposits from PPP activity only accounted for $18.5 million of our deposits this quarter as we are seeing that most of our PPP borrowers have already put that money to work to reopen or continue their business. We were also able to pay off $500 million of FHLB advances in the quarter at a rate of 1.77%, which as Scott mentioned, is part of our successful strategy to reposition our liabilities. The net interest margin expanded 7 basis points to 3.03% as a result of the success we have had in lowering deposit pricing. Credit metrics remain strong in all our loan portfolios and the allowance for credit losses for loans decreased by $3.9 million, resulting in an allowance of 52 basis points of loans. This change was largely a result of the decrease in loans held for investment as well as a slight improvement in the economic scenario we utilize for the CECL calculation. With the current interest rate environment and the increase we have experienced in prepayment speeds in our interest-only strip securities, we increased the allowance for credit losses for investments by $5.7 million, which represents the change in expected cash flows on these securities. Also related to prepayment speeds, we recognized a $1.3 million valuation allowance of mortgage servicing rights. With strong expense management and the investments we have made in our infrastructure, we are seeing the benefits from improving operational leverage and efficiencies. We have also begun to take steps to improve our tax profile going forward, including investments in low income housing tax credits, municipal lending and other strategies. I will now turn the call over to David DePillo, President of First Foundation.

Thank you, Kevin. First, I want to reiterate my gratitude to all our employees. Thanks to their efforts we had another great quarter even with the uncertainty in the market. As Scott mentioned, during the quarter, we originated $414 million of loans, which keeps us on track for another strong year of loan originations. Related to our securitization of $553 million of multifamily loans, our total assets decreased for the time being as we opted not to retain lower yielding securities associated with the sale but rather to use the proceeds to pay down balances of borrowings and fund new originations from our strong pipeline. Looking at our pipeline, the current pipeline exceeds $700 million and is at peak levels. We expect to have another record year for loan originations. The composition of our loan originations is as follows; multifamily 53%, C&I 37%, single family 9% and 1% in other. For the third quarter, the weighted average interest rate on our loan originations was 3.6%. I also want to reiterate some items about credit quality in our loan portfolio. As mentioned, our NPA ratio is low at 32 basis points with a slight increase due to a smaller loan portfolio. Also delinquency rates, which are typically a leading indicator for credit quality, have declined significantly from previous quarters. Again, approximately 82% of our portfolio is secured by real estate. Across all segments, the loan to value is low averaging below 55% and our average debt service coverage ratios for multifamily and non-owner occupied commercial real estate remain strong. As we had mentioned in the last quarter, we have low exposure to industries hit hardest by the pandemic, specifically hospitality and restaurants. In addition, we have no exposure to oil and gas, aviation or the cruise industries. Forbearances are down by 58%, representing only about 1% of the total loan portfolio. There are no forbearances in our multifamily, consumer, and land and construction portfolios, and the majority of the forbearances we did approve were three months full payment deferrals. Deposits grew year-to-date by $573 million. We saw growth in both the retail and specialty deposits, and our online deposit activity has contributed to the success of our strategy to increase core deposits. As stated before, core deposits grew to 90% of total deposits in the quarter. Now I'd like to turn the call over to John Hakopian, President of First Foundation Advisors.

Thank you, David, and good morning. Our assets under management closed the quarter at $4.5 billion. Our profit margin for the quarter increased to 14%. And as we finalize the implementation of our new portfolio accounting system, we expect additional cost savings for 2021 and beyond. Although there is still uncertainty in the financial market, our investment strategies have performed well for the year, which is quite remarkable given the broader U.S. economy was in recessionary territory just six months ago. Good performance is a leading indicator for client retention in new business going forward. We are seeing a strong pipeline and we expect to continue to be successful in attracting new clients and servicing our existing clients as we close out the year. As Scott touched on, our trust department continues to be instrumental in our ability to build and maintain relationships with our clients. These client relationships tend to be larger and more complex relationships. We have also seen an uptick in referrals from and to our retail bankers who are often the first point of contact for clients working with First Foundation. We continue to produce valuable content and advice to help our clients better navigate the various aspects of their financial life. And our experienced team of investment and wealth planning professionals provide solutions for some very complex client situations. Through the pandemic, we have found ways to connect with clients using virtual technologies that we already had in place with a significant portion of our team still working remotely. This approach has proven to be very efficient for us and has created more flexibility for our clients. I am very pleased with how our team has been able to operate during this year. At this time, we are ready to take questions and I will hand it back to the operator.

Thank you. Our first question comes from Matthew Clark of Piper Sandler.

Hi. Good morning.

Good morning.

Maybe just starting on the gain on sale this quarter, again, sales a lot higher than I think we previously expected. I guess what drove that related increase? I guess how much was the margin and how much might have been hedging related, if any?

Well, the hedge cost was slightly less than in last year. It was about $13.8 million if I remember correctly.

It is about $12.

Okay. And frankly, our margins proved to be a little better than we had initially thought. Early on when we were modeling, we modeled spreads slightly over 100 on each one of our two APT-1 and APT-2, and I think they came in at like 61 and 71, or 62 and 72, very close to that. So a little bit was margin and a little bit was the hedging cost was slightly less than the year previously.

Also the value of the pilot strip was significantly higher than what we had forecasted.

Okay. And then on the reserve on loans held for investment, down a little bit linked quarter, I see the reasons in the release. But can you give us a sense for what your reserve is on non-commercial real estate and multifamily, maybe just the C&I portfolio just to isolate that?

Kevin, if you can bring that up?

Yes, you bet. It's segregated into various categories, but typically it's anywhere between 1% and 2%.

Yes, and it's about 1.3% on those portfolios.

Okay. And then on the core NIM, up largely in line with expectation, 3.03, or at least reported NIM. I guess what are your thoughts on the new trajectory from here? Can that continue with funding costs coming down? And also do you have the impact of PPP and purchase accounting accretion and any other kind of prepayment fees in the margin this quarter?

It is really not a factor at this point. We're amortizing the fees associated with the PPP over a two-year period. What did we say? 6 basis points.

This quarter is about 4 basis points.

So funding costs, as you said, are continuing to come down. I think we can continue to increase our margin. But there has been pressure on loan origination yields as well. We've obviously been able to save more on the funding costs than we have with loan yields coming down. But I think we can continue to increase, I think as we should be – I think previously we had stated we would maintain a NIM above 3 and we felt confident that that's still the case, and maybe get up as high as 3.10 or 3.15. September was a lot higher than the end of quarter number due in large to the fact that we had a significant portion of borrowings rolling off. And at 3.67, our average yield of new assets going on, that should be kind of a low point for new assets coming on. So you can kind of do the math with funding costs on the margin relatively low. It should be relatively easy to stay there. Yes, 3.67.

Yes. And you had asked about accretion income. That's really immaterial to a point not really impacting.

We don't have much of anything in accretion income.

That's right. And just to correct something I said, it's more around 1% to C&I impact to our credit reserve.

Okay. And then just the uptick in non-accruals, what drove that this quarter? And what's the plan for resolution?

It's really more of a downtick in loans. The loan portfolio overall was the majority of the assets.

So there were loans that had ticked over 90 days; we don't expect any loss from those. One is going to be resolved momentarily; the properties for sale by the owner and that will be completed. There's approximately $7 million of our residential mortgage relationships that our expectations is it may go to sale or being reinstated and that would happen this month, one way or the other. Outside of that, the expectations are as the loan portfolio builds that number, the ratio will come down. But it was primarily residential related with just a handful of properties. But if you look at our delinquency pipeline, you can see that there's not much on the horizon.

Your next question comes from the line of David Feaster of Raymond James.

Hi. Good morning, everybody.

Hi, David.

I just kind of wanted to get a pulse of the market. I'm glad to hear the originations are improving and the pipeline's holding up really well. Just curious what you're seeing out there? It sounds like pricing is pretty tight. Just curious, your thoughts on the market across the board in multifamily and core commercial and what you're seeing?

Multifamily market activity has definitely increased and is nearing the record levels we saw in the first quarter. Our pipeline is performing even better than we expected going into the fourth quarter, and we anticipate reaching capacity in our current production environment by year-end. The market's momentum is promising; it's expected to lead to a slightly higher prepayment rate than initially predicted, resulting in increased prepayment fees in the coming quarters. This has affected our interest-only strip as we've encountered higher prepayment rates than last quarter, but these figures are more consistent with the elevated historical rates seen in the latter half of last year into early this year. The multifamily sector is performing strongly, and competition in pricing has stabilized. We believe our expectations will hold steady in the near future. On the commercial and industrial side, we've made significant gains in certain areas, particularly within our corporate banking and public finance groups. Equipment financing has also rebounded, with pipelines at levels not seen in quite some time. Our core C&I and business banking sectors are recovering as well. Interestingly, the single-family sector, though smaller, is now experiencing substantial demand, a trend reflected across the industry. Overall, when we consider all these factors, we expect that next year's originations will far exceed this year's performance.

Okay, that’s good color. And just you guys always kind of stand on this, this macro topic, you guys always have a really good pulse on the broader landscape. So I just wanted to get your thoughts on some of the pending legislation, specifically like Prop 15 and Prop 22 and implications on CRE and multifamily in California.

Yes, 15 is an interesting situation. It will have some impact, but less than in the multifamily sector because most of the commercial real estate we finance does not have a historically low legacy tax base. Many of the industrial and owner-occupied properties we work with do not have an old Prop 13 basis. Therefore, we don't anticipate a significant effect if it passes. Regarding rent control, it's a mixed bag. There are already some rent control laws at the state level, and the state prefers not to see this passed because it would shift responsibility to local communities. There's a concern that this could lead to dramatic rent increases overall. We feel confident either way. We don’t expect it to pass, but we also don't foresee a substantial impact if it does. If it were to pass, it might add some pressure to rents in markets that are already below market rates. In places with more social impact, like San Francisco, where rents have decreased, we typically do not lend on those types of properties. For example, studio units that were once $4,000 are now $3,000, which appears to be a significant drop. However, when compared to the average rent in the city and surrounding areas, we don't anticipate much effect. We're monitoring the legislation closely, but overall, we do not expect any notable impact in the near future.

Okay, that's good color. And then just you guys have done such a tremendous job managing expenses. As we look forward, do you think you've got opportunities to kind of offset some of these inflationary pressures that kind of keeps costs stable in this $30 million to $31 million level, or are there any upcoming investments maybe on the tech front, just to keep up and new hires or anything that might put pressure, just any thoughts on the expense side?

So, obviously, technology is always an evolving item for us and we probably have 60-some odd projects, some of which don't cost a lot, some of which cost a little bit more. Our technology spend for next year, including capital items, is we're expecting to be slightly less than this year. So we don't really see a huge impact of that and I think a lot of our frontloading in the last five years absorbed the majority of that cost. On the employee side, we've been holding right around 500 employees. There are a few opportunities that come with significant revenue opportunities as well. So again, we don't see the impact. So could it go up marginally? We always plan for it to go up marginally year-over-year somewhere between 5% and 10% is kind of our range.

But that being said, David, last two years I think we've held pretty constant at 500 employees. So we're very cognizant of human capital and expenses and we're really trying to manage to that side of the equation.

That's helpful. Thanks, guys.

Thanks, David.

Your next question comes from the line of Steve Moss of B. Riley Securities.

Hi. Good morning, guys.

Good morning, Steve.

Just to tie up the originations, David, I think you mentioned the pipeline $700 million. You did about $1.7 billion, $1.8 billion so far year-to-date. So can we think about this shaking out in the $2.4 billion to $2.5 billion origination range for this year?

It could be as high as that. We're probably looking around $2.3 billion to $2.4 billion. At $700 million, there is always, I wouldn't say fall out, but delay. So some of that could bleed into the first part of next year anyways. So we typically apply about an 80% rate to that. So you're probably looking – if we hit $2.5 billion, I'd say that's about what we expect to do next year. But some of it is timing of borrowers and just getting it through our system. But as you can see, we're going to be up probably at least, what's that, 15% from prior year.

Yes, right. Okay. And then on interest-bearing liability costs, just kind of curious where costs were at quarter end relative to the average of 90 bps?

They were settling down into the mid-70s at quarter end.

And last question for you on capital here, I’m just kind of curious, capital moved nicely higher here, profitability is stronger. What are your thoughts with regard to maybe a possible buyback?

Yes, it could be put into place. I think it really depends on the reaction to our earnings and banks have struggled recently. And I think if our stock declines and we start trading either below book value or near book value, I would say the chances are pretty strong that we will continue our buyback.

All right. Thank you very much. Good quarter.

Thank you, Steve.

Thank you. Our next question comes from Gary Tenner of D.A. Davidson.

Thanks. Good morning.

Good morning.

A question on balance sheet management. I think the last couple of years when you've done the securitization, you've retained the securities. This year, as you pointed out, you did not. It looks like you may have put a little bit of additional securities on over the course of the third quarter. So I'm just kind of curious how you're thinking about balance sheet mix.

So, we bought – yes, we bought about $58 million of our own securitization, a, just to show that we wanted to participate in our own securitization; and b, frankly, I think these are some of the best yielding mortgage backs out there in the marketplace. We are expected to keep about 12% on balance sheet liquidity, and we were starting to get a little bit low. And I think we felt some need to just buy a little bit to maintain on balance sheet liquidity. That being said, right now we're selling cash. We've been so successful in raising deposits that I think when you combine cash, we're closer to 18% on balance sheet liquidity, which is stronger than we'd necessarily want. But –

If we look at what was the yield – in terms of yield last year, it was about 3%. It was 2.70%. So the yield on those securities was significantly higher and loan opportunities at the time weren't that much greater because of the cost of bonds on the margin was pretty high. What was the yield on these? Less than 1%?

About 1 onwards?

Yes. We believe that if we can secure loans at a rate of 3.5% or higher, which we anticipate will happen, investing in securities that yield 1% is not practical. If we didn't have such a robust pipeline and the capability to quickly replace assets, we might have opted to retain more cash.

Yes, I think we may have leaned towards the securities portfolio more. But the reality is we see more opportunities on the loan side than we do the security side at this moment. Frankly, I've said this in the past and I'll say it again. We have stayed very plain vanilla on our securities portfolio. We deem that to be a liquidity portfolio and not an investment portfolio. So we could have bought some municipal bonds or sub debt or other things that yield way more. But if you look at March 30 of this year, you couldn't find a bid on any of that stuff. And we're using it as a liquidity portfolio.

Okay. Thank you. And then on the origination trends, my recollection was that the trends in the back part, maybe in June of the second quarter, had gotten quite a bit stronger. So was there any, a, am I misremembering that, I guess? But, b, was there anything over the course of the third quarter that kind of drove any headwinds on production?

So if you kind of step back, we had a record first quarter. Interest rates were starting to come down and people were taking advantage of that. In the pandemic and really around the time of the lockdown, it was when the markets kind of retracted. And when I say markets, not only lenders, but also borrowers took a step back to say, we don't know what's going to happen. Well, that was relatively short lived, around 60 days, but that's really when you build your pipeline for the third quarter during the second quarter. So it was probably a couple hundred million below what we thought we would have done in a normal course of business, but because of the low on the market of the pandemic, that kind of impacted us in the third quarter. It's kind of interesting. That pent-up demand is now catching up in the fourth quarter. So I would say the majority of it was pandemic related and there's always a little bit of low in the summertime anyways, just people go away and well now lock themselves in their houses. But there's typically less demand in the summertime, but mostly pandemic related.

Okay, got it. Thanks, guys.

Thank you. That was our final question. I will now turn the call to management for any closing comments.

Thank you everyone for taking the time today. We certainly appreciate it. For additional resources about what we covered on today's call, you can view our investor presentation, which is located on our Investor Relations portion of our corporate website. Overall, we're pleased with our results and we look forward to speaking with you next quarter. Thank you again and have a great remainder of your day.

Thank you for participating in First Foundation's third quarter 2020 earnings conference call. You may now disconnect your lines and have a wonderful day.