First Foundation Inc. Q1 FY2021 Earnings Call

Greetings, and welcome to First Foundation's First Quarter 2021 Earnings Conference Call. Today's call is being recorded. Speaking today will be Scott Kavanaugh, First Foundation's Chief Executive Officer; Kevin Thompson, Chief Financial Officer; and David DePillo, President of First Foundation. 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 will turn the call over to Scott Kavanaugh.

Hi. Good morning, and thank you for joining us. We would like to welcome all of you to our first quarter 2021 earnings conference call. We will be providing some prepared comments regarding our activities, and then we will respond to questions. Our earnings for the first quarter were $22.4 million or $0.50 per share. This represents a 69% increase over the first quarter of 2020. Total revenues were $66.1 million for the quarter, a 19% increase from the first quarter of 2020. Our tangible book value per share ended the quarter higher at $13.84. We declared and paid our first quarter cash dividend of $0.09 per share. As many of you have heard me say, our business model is designed to help clients wherever they are in their financial lives. And today's results indicate that our model is working very well across the diverse and dynamic markets we serve. During the quarter, as we previously announced, we expanded into Texas, which included the move of our principal executive office as well as the addition of new employees to our team in the Dallas-Fort Worth Metroplex. We believe this move solidifies our positioning as a regional commercial bank. We are seeking further expansion in the area, including building out our team, having a retail branch presence, and eventually adding trust powers in the state. There is an enormous opportunity for growth in Texas, and we are excited to be here. Our operations in California, Nevada, and Hawaii will remain unchanged. We think our regional presence across all four states that we operate in is a great fit for the products and services we offer. We are in areas that have great opportunities for everything from wealth management to lending, to business and personal banking. Related specifically to the profile of our bank, we had record loan originations of $765 million for the quarter, with 53% of those originations coming from C&I. NPAs remained low at 24 basis points for the quarter. We continue to have a well-balanced loan portfolio that Dave will touch on in more detail later on in the call. Deposits increased by $322 million for the quarter, and our loan-to-deposit ratio was 90.1% at the end of the quarter, driven in part by our ability to continue to attract high-quality commercial clients. All of this speaks to the strength of our deposit team. Over the last year, our core funding has increased from 73% to 98%. We continue to reduce our broker deposits, and we will not have a need for our home loan bank borrowings for the foreseeable future. Our Wealth Management and Trust business continue to provide meaningful contributions to the success of the firm. The Wealth Management business is continuing to gain scale. And the combined pretax profit margin for Trust and Wealth Management was 16% for the quarter. We generated $101 million in new assets under management for the quarter, and AUM ended at record levels eclipsing $5 billion. Our private wealth management business serves our clients with high-touch and sophisticated investment planning solutions. They, along with our Trust department, were very instrumental in retaining and attracting new clients during some volatile times last year and have experienced a great start to this year. Our new business pipelines across our entire platform remain remarkably strong as we continue to attract new clients to all facets of our offering. And with our recently announced strategic investment in the institutional Bitcoin provider, NYDIG, we are seeking ways to add Bitcoin-related solutions to our platform. In a first such partnership of its kind, this strategic investment helps lay the foundation for building the infrastructure required to offer safe and reliable access to digital assets. We believe cryptocurrencies and blockchain technology will play a critical role in the future refinance. And we are pleased to be the catalyst to bring digital assets into traditional financial services. There are many ways we can participate in this important asset class, and we are very excited about what we will be able to offer our clients. With the support of our partners NYDIG and our processing provider Fiserv, we are looking to bring digital assets to the forefront. Before I hand the call over, I want to take a moment to thank all of our employees for their extraordinary efforts over the past quarter. We have some of the best employees in the business. And I am also very grateful to our clients who entrust us with their financial needs. Now let me turn the call over to our CFO, Kevin Thompson.

Thank you, Scott. Earnings per diluted share of $0.50 in the first quarter is flat to last quarter and a 47% increase over the first quarter 2020. As a result of this momentum, our tangible book value per share increased 3% to $13.84 in the quarter. The return on assets was strong at 1.25%, with a return on tangible equity of 14.9%. The net interest margin contracted 3 basis points to 3.16% in the quarter as a result of high average cash balances from the success we have had in increasing core deposits. For the month of March, our NIM increased to 3.24%, following the deployment of excess cash through our pay down of higher cost funding sources and growth in loans in the second half of the quarter. We maintained discipline in loan production, with the average yield on loans dropping just 2 basis points to 3.99%. And we continued our efforts to lower deposit pricing, bringing the cost of deposits down from 41 to 31 basis points. With the strong C&I loan production and increasing core deposits over the past several quarters, our balance sheet is trending less liability sensitive. We recognized $1.2 million of PPP fee income or 20% of the total net PPP fees, bringing the total fees realized to 76% from the $171 million of their first round of PPP loans funded. Excluding the effects of PPP, the NIM would have been 3.13% for the quarter. Credit metrics remain strong in all our loan portfolios, and the allowance for credit losses for loans decreased to 45 basis points of total loans. This was primarily a result of improvement in the economic scenario we utilize for the CECL calculation. We had net recoveries of 1 basis point, and nonperforming assets remained low at 24 basis points to total assets. The allowance for credit losses for investments increased by $1.6 million as a result of the lower interest rate environment and faster-than-expected prepayments that negatively impacted the projected cash flows on our interest-only securities. Asset management fees were strong with revenues of $8.3 million. And our Advisory and Trust divisions achieved a combined pretax profit margin of 16% in the quarter. Assets under management at FFA increased to $5 billion, while Trust assets under advisement at FFB increased to $1.2 billion. Our noninterest expense increased due to merit increases that were effective at the beginning of the year and annual bonus and commission payouts in the first quarter. The efficiency ratio for the quarter was 51.5%. With strong expense management and the investments we have made in our infrastructure, we are seeing growing benefits from operational leverage and efficiencies. I will now turn the call over to David DePillo.

Thank you, Kevin. It was indeed a very successful start of the year for First Foundation. As Scott mentioned, we originated $765 million of loans in the first quarter, a record for us. Our commercial business lending accounted for over half of our originations in the first three months of the year. We funded $406 million of C&I loans, which was also a record for us. 48% of our C&I loans in the quarter were adjustable revolving lines of credit, which is a strategic move for us as we look to shift the balance sheet to more rate neutral from liability sensitive. The remaining C&I originations were comprised of $108 million of commercial term loans, $69 million of public finance loans, $24 million of equipment finance loans, and $9 million of owner-occupied commercial real estate loans. Included in commercial term loan originations is $45.8 million of the second round of PPP fundings. We continue to focus on high-quality loans with solid borrowers. As a percentage breakdown, the composition of our loan originations during the quarter was as follows: C&I, 53%; multifamily, 42%; single-family, 5%; and 1% in other. We accomplished this without changing our high underwriting standards and the loan pipeline remains strong heading into the second quarter. In addition, it is worth mentioning that even with record loan originations in the first quarter of $765 million, we achieved a weighted average rate of 3.55% on originations excluding PPP compared to 3.61% in the fourth quarter or only a 6 basis points drop. This continues to demonstrate our ability to achieve record volumes while still defending the yield on our portfolio. As of March 31, our loan portfolio balances consist of 43% multifamily loans, 26% commercial business loans, 5% non-owner occupied CRE, 15% consumer and single-family loans, and 1% land and construction. Of note, our commercial business loan balances increased approximately 25% year-over-year, which reflects our continued focus on commercial banking. As mentioned, our deposit business also experienced a strong quarter, with an increase of $332 million during the first quarter of 2021 to end the quarter at $6.2 billion, which reflects a 14% increase compared to the first quarter of 2020. Deposit growth during the quarter of 2021 was primarily driven by an increase of $527 million or 32% in noninterest-bearing demand deposits, largely attributed to our commercial deposit services division, an increase of $141 million or 16% in interest-bearing demand deposits, primarily driven by our retail branches. Our noninterest-bearing deposits now account for 35% of our total deposit balances. The $332 million growth in deposits during the first quarter of 2021 included an increase in our commercial deposit service group of $419 million and retail branch deposits of $45 million. Of the $500 million or 11% increase in core deposits, $491 million or 96% were attributed to commercial business deposits from both our commercial deposit channel, serving complex treasury management, commercial customers, and from our business banking customers served by our retail branches. Commercial deposits were 70% of total core deposits as of March 31. And as Scott mentioned, our core deposits now sit at 98% of total deposits. All of the success in this quarter could not have been achieved without the great team we have in place. I am so grateful for their dedication and hard work. At this time, we're ready to take questions. I'll turn it back to the operator.

Our first question is coming from Steve Moss with B. Riley Securities.

Hope everybody is well. Nice quarter here in terms of loan originations, and you guys indicated in the release that the pipeline remains strong. Just kind of wondering if you could give us an update in terms of your expectations for the full year and kind of the underlying mix within the pipeline?

Dave?

So I would say the first quarter will probably be a low point for originations based on current pipelines. So I would expect growth from here. That depends certainly on how the year develops as we go forward. But current pipelines indicate that we'd have a stronger second quarter than first. And I would say it's across, again, all books of business. We'll probably have a little more disproportionate in multifamily in the second quarter compared to the first. So I would expect that to probably be over 50%, as it traditionally has been. But C&I and multifamily are kind of neck and neck. But again, from just a general trajectory, every aspect of our business pipelines are at levels we haven't seen historically. Part of that, Steve, is we continue to make investments in our sales teams and support for a higher growth level. As we've mentioned in the past, we're trying to step up to a new level going forward. So long story short, I would say first quarter probably would be the low point for the year.

Got you. That's helpful. Then as we just think about full year originations, I think the previous guidance called $2.9 billion. Just kind of curious, it sounds like it's going to be north of $3 billion meaningfully.

Yes. I think you could just take the current quarter run rate and extrapolate, and you should get a higher number than we previously indicated. But we would be comfortable with that range and $3 billion plus.

Okay. And then in terms of just loan yields here, an update on loan pricing and how you're seeing things in the market these days?

It's interesting that much of the funding from the first quarter was related to previously quoted loans, which take time to process and typically have rate locks. We're noticing that market rates are stabilizing, leading us to expect our average loan yield to remain similar going into the next quarter. This is partly due to our increasing focus on adjustable-rate lending in the commercial and industrial sector, as we aim to better position ourselves for potential increases in short-term rates. The average yield largely depends on the composition of our loans, but pricing appears stable since most loans are being priced at floor levels. The longer end of the rate curve has seen more fluctuations, although we usually do not lend in that area. Overall, we anticipate consistency in our loan yields relative to current levels.

Okay. That's helpful. And then just in terms of funding costs here. We continue to see a good leg down in terms of deposit costs. And since you basically have no borrowings at quarter end, kind of curious as to where deposit pricing is today and how we should think about that? And maybe any trends you're seeing in April for deposits?

The pipeline remains very strong, and we need to manage it carefully. As you noticed, our net interest margin experienced some drag due to the excess cash we held, which was largely deployed in March. Most of the cost savings we've observed are accounted for at this stage, with only minor adjustments expected. However, if deposit strength continues at its current rapid pace, we may need to lower rates a bit more.

Scott, I agree. And I'll just add. You saw that our cost of deposits was 31 basis points in the quarter. At the end of the quarter, the last month in March, it dipped down to about 26 basis points. So to Scott's point, there is still some room as they're going down now and probably that trajectory will continue slightly. But at a certain point, I think those will stabilize throughout the year until we start seeing eventually the yield curve change and some deposit beta down the road.

Our next question is coming from David Feaster with Raymond James.

I wanted to start on the crypto partnership. I think this is pretty unique. Just hoping you could maybe give us some details on the investment, the timing maybe of when you think it could be up and running? And ultimately, what do you expect to see in terms of the benefits from this partnership, whether it be AUM growth, and wealth management deposit growth that can help fund the growth engine, fee income opportunities. Just curious what you expect to see from that partnership?

Kevin, do you want to start with that?

We would say all of the above.

We haven't revealed the exact amount of our investment, but we have partnered with NYDIG, a leading player in the Bitcoin market. They are at the forefront in terms of regulatory and security aspects in the Bitcoin space. As a Bitcoin investor myself, I've always been very impressed with this company. We're excited to collaborate with them to integrate Bitcoin into traditional banking. We are exploring various opportunities, which could lead to increased fee-based income. There is a complex interaction between traditional banking and Bitcoin providers, but it is improving. Many people want to engage with their trusted banks while having easier access to invest in both fiat and Bitcoin currencies, across banking and wealth management sectors. Regarding the timing, we are still determining how long it will take to establish the necessary infrastructure with NYDIG and Fiserv to ensure this is done securely for our clients.

To be quite honest, we couldn't have two better partners. I'm truly excited.

That's great. That's pretty exciting. And then maybe could you just give us an update on the Dallas expansion? How hiring has trended? It sounds like you've already picked up some folks there. And just how the pipeline has been? Have you started to see any contribution from the region yet? And where you have an early success and how has reception been in the region? Are you seeing more opportunities on the multifamily or the core commercial business banking? Just curious, any updates there.

Well, initially, the hire was in the commercial real estate side of things. It's a bit early yet. I've only been here for about a month or five weeks. But I would say, we've been fortunate in that some of the local periodicals, the Dallas Business Journal, the Dallas Morning News, and the Houston Business Journal have carried articles. And we've gotten a very warm reception from a lot of people, a lot of curiosity about our expansion plans. So I'm very optimistic about the opportunities here. I would say that you should probably expect expenses more than a lot of production this quarter. But I think in the outer quarters, you'll start to see some loan production ramping up. Frankly, some of our staff here is just getting their feet grounded and starting to get out there. But in talking to them, we've gotten a very warm reception from some of the borrowers as well.

The only thing I would add, Scott, is we have had some traction on the C&I side, and we will have fundings in the second quarter related to C&I. But from getting our production people in place, we're adding underwriting staff around them. We want to make sure that we don't have any false starts. So to Scott's point, we're building the infrastructure first, taking a very methodical patient approach and making sure that we can meet the needs of clients out there. But we already do have some C&I business that should fund out in this quarter.

Yes.

That's perfect. Please continue.

No, I was going to just say, I still believe on the M&A front, there are opportunities here. Obviously, it depends on how our stock trades relative to other folks. But we continue to have discussions out there, and I'm sure something will come up at some point in time. So I'm still very optimistic about that as well.

That's great. Just maybe following up on the C&I commentary. It was great to see the growth that you guys put up in the quarter. Just curious if you could give us some commentary on the trends you're seeing and where you're seeing demand on the commercial term loan side? And kind of what's driving the growth that you're seeing?

It's interesting to note the current dynamics in the commercial and industrial sector, where there's a clear distinction between companies that are thriving and those that are struggling. We've observed that smaller companies, particularly those impacted by regional COVID challenges or other operational issues, have had a greater effect on smaller community banks. In contrast, we've focused on mid-market companies and above, as well as those with strong balance sheets and diverse business strategies, who entered the crisis with significant liquidity and have performed well. This includes various industries, from food manufacturing to heavy equipment. We're noticing a surge of strong companies entering the market to capitalize on the current environment of lower interest rates and tighter credit spreads in the C&I sector, which makes it advantageous for them to expand their businesses. Our focus has been on larger, well-diversified credits, many of which are regional. We've also engaged with quality companies in Texas. Additionally, we aim to support local communities through SBA loans and small balances, particularly as there's significant interest in municipal lending, especially for smaller funding needs of around $5 million to $10 million. This sector presents a large market opportunity. While we do handle larger transactions, the demand for smaller municipal loans has been particularly pronounced. Our equipment finance group is also achieving record levels. Over the past six years, we've dedicated ourselves to diversifying our lending focus, and our strategy has proven successful, particularly reflected in our performance metrics during the pandemic in C&I. All areas of our business have shown growth, though we've pulled back somewhat on smaller business banking due to the demand skewing towards distressed companies. We're taking a measured approach in this space moving forward.

Well, quite honestly, most people elect to go through the PPP route than through a traditional bank route.

Our next question is coming from Gary Tenner with D.A. Davidson.

Just wanted to ask a little bit more on the kind of expense outlook. The last couple of years really since 2018, you all have done a great job of kind of holding expenses flat, if not lowering them and kind of generating positive operating leverage. Obviously, a bit of a step-up this quarter. I'm sure there's obviously a seasonal component there. But as you talk about investing in people and sales teams plus the Texas expansion, can you talk about maybe just some guideposts in terms of operating expenses for the year or for the next quarter or two?

I'll begin, and then Kevin and Dave can add their insights. When we were planning for this year, we decided it was time to increase our efforts. Toward the end of last year and the start of this year, loan demand was quite high, leading us to believe it was the right moment to boost our loan offerings. We have been fortunate that some recent acquisitions and actions by other institutions have created valuable opportunities for us. We are currently engaged with a couple of teams or have already onboarded some that may not have been fully announced yet. Our intention is to keep growing, with a focus on expanding in the commercial and industrial sector. Additionally, there were some large bonuses and other seasonal expenses recently, so I'll stop there and let Kevin continue.

Well, the way I would probably characterize it, Gary, is this year, as Scott mentioned, we are making some strategic investments, not only on the sales side but also on the support side to make sure that we've got continued good customer experience through the entire process on all aspects. What I would expect is, even with a little bit of higher first quarter because of the seasonality, this year looks like about 50% efficiency overall with those investments. But really looking into next year, you'll see that operating leverage really kick in. So it's a little bit again as a print loading for growth. But at 50%, we really feel that's still fairly optimal. But I would expect next year to drop well below.

Yes. Our employee count has remained roughly around 500 people for the last several years. I would expect that we’ll be closer to 550 or possibly even a bit more, considering the operational side that Dave just discussed and the other teams. Hopefully, that provides some guidance on the employee count.

And we're experiencing strong organic growth. We expect to continue that. We'll have to add resources to match that over time. But we'll still be able to add resources at a lesser rate than we're able to take advantage of operational leverage over time.

Okay. I appreciate the color. And then just on PPP, I think you gave pretty much all the numbers needed there other than just was wondering, Kevin, if you could confirm the average PPP loans outstanding for the quarter. I don't think I have that number.

We started the quarter with $145 million and ended at $136 million. We added new PPP and had some payoffs during the quarter as well.

Okay. I mean for average purposes, I assume the adds were mostly March and the payoffs were February and March. Is that a reasonable essential?

Adds came in February time frame. So I'd kind of just take an average of those two. It was around $140 million for the quarter, the average.

Our next question is coming from David Chiaverini with Wedbush Securities.

A couple of questions for you. Starting with deposits, can you talk about the deposit outlook? Should we assume that deposit flow should be similar to the strong pipelines that you've talked about on the loan side?

Yes. As I mentioned earlier, I almost feel like we're having to bridle discussions of bringing deposits on too quickly. So we do have a fairly significant round of deposits coming in around May 1. We've got several relationships that are requesting, either new relationships or existing relationships to bring on more. So I'm pretty convinced that we can stay somewhere under a 100% loan-to-deposit ratio even with our strong funding or loan base.

Great. Regarding securities, I noticed that while the loans performed strongly this quarter, the securities portfolio has decreased slightly compared to the previous quarter. Could you explain how we should view the securities portfolio moving forward, especially considering the strong pipelines in loans?

Yes. We try to average, and this is always a discussion with our primary regulators. We try to stay somewhere around 12% on balance sheet liquidity. As you suggested, the prepayments on our securities have been a little brisk; they're slowing down. But we are going to have to add some securities over the next several quarters. And quite honestly, depending on what we tend to put it into, that might put a little drag on NIM overall. But I would still say our loan fundings are going to be high enough that it won't be that significant. But we are going to have to add to the portfolio. If you just look at the composition of the securities portfolio, we've always been very conservative. So we have relatively few municipal bonds; most are mortgage-backed securities, either our own deals or pass-throughs that we've purchased in the past. And so we're going to have to continue to add to that in some form or fashion. We have very little sub-debt. We might buy a little bit of that, but probably not inclined to do much of it.

Got it. That's helpful. You mentioned that the securities purchases might slightly negatively impact the net interest margin. Looking ahead, how should we consider the net interest margin moving forward?

I believe net interest margin should stabilize as long as we manage the excess liquidity effectively. Dave mentioned that our loan fundings are currently quite stable, and I expect the loan yields to also remain stable. Reading between the lines of Dave's comments, our loan fundings for the quarter should exceed those of the previous quarter. If we add approximately $100 million in securities over the next few quarters, the impact on net interest margin won’t be significant; it may have a modest effect, but not much. With our funding costs expected to continue decreasing slightly and our yields remaining constant while we fund more loans on the balance sheet, we anticipate that net interest margin will stay relatively stable.

Yes. The yield on securities is likely to be the most significant factor over time as we grow and hold more securities. In this current environment, it will have an impact. However, I would say that where we stand at the end of the quarter reflects a good average for the quarter, which indicates the potential effect of a liquidity drag over time compared to...

I mean, what was shown or demonstrated in the press release, NIM was 3.16%, but in March, it was 3.24%. This indicates that carrying cash is likely the biggest detriment to NIM. Otherwise, it would have been much stronger than it actually was.

Our next question is coming from Bob Shone with Piper Sandler.

I wanted to discuss future provisioning and the reserve moving forward. I believe you made about $1 million in releases to improve the economic forecast. Should we expect the level of provisioning to remain stable as you aim for growth and anticipate a relatively stable reserve? Or is there potential for this to decrease if we see further improvements in the economic forecast?

We're estimating the former as taking our general reserve levels at 45 basis points and adding growth to it, which reflects what we would consider as additional reserve requirements. Is there room for improvement? Yes, likely, but it's difficult to predict due to the CECL modeling. It could fluctuate depending on the funding mix; more commercial and industrial lending requires higher reserves in multifamily. Therefore, we project 45 basis points against the growth.

As you know, CECL is a very sophisticated calculation involving economic scenarios and is mixed with a historical view. And so it's hard to know at this point. At this point, we see the economy kind of continuing as is. So the 45 basis point would probably be sufficient over time, but we'll advise as that changes.

Okay. And then last one for me. In your prepared remarks, you mentioned about seeking further organic expansion in the Dallas area. Could you maybe give us an update on your appetite for M&A in the area? And maybe any color on how those conversations with potential partners have been going?

In terms of updates with other people, the answer is, I probably can't really speak to that. But I would say that very much so we would like to have an M&A deal in the Texas marketplace. Specifically, the Dallas-Fort Worth Metroplex is where I'm hyper-focused right now. As you know, there's more banks in Texas with the exception of Illinois. And so I remain optimistic, and especially if our stock can continue to trade at premium levels, then I feel fairly strongly that something will come up at some point in time.

This concludes our allotted time for the question-and-answer session. I will now turn the call back over to Mr. Scott Kavanaugh for closing remarks.

Thank you again for participating in today's call. I'm very proud of how we have started the year. All of our business lines are doing exceptionally well as evidenced by the results we reported. There are great opportunities related to our geographic expansion to the Dallas-Fort Worth Metroplex, and I am very excited about our efforts related to Bitcoin and digital assets. As a reminder, our earnings report and investor presentation can be found on the Investor Relations section of our website. Thank you, and have a great remainder of your day.

This concludes today's conference call. Thank you for participating. You may now disconnect.