First Foundation Inc. Q2 FY2024 Earnings Call

Greetings, and welcome to First Foundation's Second Quarter 2024 Earnings Conference Call. Today's call is being recorded. Speaking today will be Scott Kavanaugh, First Foundation's Chief Executive Officer; Jamie Britton, First Foundation's Chief Financial Officer; and Chris Naghibi, First Foundation's Chief Operating Officer. Also joining the call is Simone Lagomarsino, First Foundation Bank's President. 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, please see the company's filings with the Securities and Exchange Commission. And now I would like to turn the call over to CEO, Scott Kavanaugh.

Hey, good morning, and welcome. Thank you for joining us for today's second quarter 2024 earnings call. Once again, First Foundation was able to generate earnings that were above consensus and exit the quarter with positive momentum. As I mentioned in previous calls, I believe our earnings troughed in the first quarter of 2024. This is significant when coupled with the backdrop of strengthening our balance sheet with the recently announced $228 million capital raise. I want to be clear, the Board sought the additional capital to support the growth of the company, not to satisfy any regulatory concerns. This raise allows us to accomplish that goal. I also want to emphasize First Foundation has never had a credit problem. Our NPAs remained at remarkably low levels, unchanged from last quarter. Charge-offs were almost nonexistent at 0.01%. Our recent performance issues stemmed from the interest rate risk positioning of our balance sheet, which surfaced in 2022 when fixed-rate lending surpassed historical levels while the Federal Reserve began aggressively raising rates. As you know, this put tremendous stress on our net income and reduced the flexibility we had to navigate the turbulent economic environment. With this capital raise, we will take actions to solve this issue and begin to expand into the desirable geographic markets we are already in and have a presence. This will be outlined in our discussion by both Jamie and Chris. I noted in the first quarter that we had taken great strides to increase recurring revenue and reduce core expenses to benefit future profitability. And those efforts continued in the second quarter. Once again, we were able to improve our loans-to-deposit ratio, increase our overall loan yield and continue the process of improving the sensitivity of our balance sheet to changing rates. Capital ratios were improved as well. First Foundation Advisors once again closed the quarter at near record assets under management with profitability at FFA remaining strong. The trust department posted another solid quarter as well. For the second quarter, we reported net income attributable to common shareholders of $3.1 million or $0.05 per share for both basic and diluted shares. Tangible book value, which is a non-GAAP measure, ended the quarter up $0.08 from the first quarter of 2024 to $16.43. Pretax pre-provision revenue totaled $1.9 million compared to $460,000 in the prior quarter. Interest income totaled $150.9 million for the quarter, relatively unchanged from the $150.4 million in the first quarter and up from the $145.3 million in the second quarter of 2023. Noninterest income as a percentage of total revenue was 23% for the quarter compared to 25% for the first quarter. Our net interest margin was 1.36% compared to 1.17% for the first quarter of 2024. This was largely driven by the return of MSR deposits. Noninterest expense was $55.6 million in the quarter compared to $50.6 million in the prior quarter. Again, largely driven by an increase in customer service expense related to the seasonally returning MSR deposits. Despite the increase in noninterest expense, our efficiency ratio improved to 96.1% compared to 98.4% for the first quarter of 2024. Adjusted return on assets, a non-GAAP measure increased to 0.10% compared to 0.03% as of March 31, 2024. Our loan-to-deposit ratio improved to 93.8% in the quarter compared to 94.8% as of March 31, 2024. This was largely driven by an increase in core deposits late in the quarter. We remain committed to continuing to improve this ratio through a combination of strategically reducing lower-yielding loan balances and continuing to grow core relationship deposits. Total deposits were $10.8 billion in the quarter compared to $10.6 billion in the first quarter. Core non-brokered deposits totaled 62% during the quarter, compared to 64% in the first quarter of 2024. Noninterest-bearing demand deposits increased to 20% for the quarter compared to 17% of total deposits as of March 31, 2024. Our insured and collateralized deposits remained relatively unchanged compared to the first quarter at 85% of total deposits. We maintained a strong liquidity position of $4.4 billion. At these levels, our available liquidity to uninsured and uncollateralized deposits ratio slightly increased to 2.8 times. Borrowings remained flat quarter-over-quarter at $1.7 billion as of June 30. Average borrowings outstanding were down to $1.4 billion or 10.4% of total average assets for the quarter compared to $1.6 billion or 11.8% of total average assets for the quarter. As I stated earlier, credit quality remains incredibly strong for our bank. Our nonperforming assets to total assets remained at 0.18% quarter-over-quarter. Loan balances ended the quarter at $10.1 billion, flat from the first quarter. C&I loans totaled 83% of loan fundings during the quarter and 86% of total fundings year-to-date. Loan yields increased nicely to 4.77% in the second quarter from 4.70% in the first quarter. First Foundation Advisors assets under management was $5.5 billion, unchanged from the end of the first quarter. Our pipeline of new relationships remains strong. Assets under advisement at FFB's trust department was $1.1 billion for the quarter compared to $1.2 billion at the end of March 31, 2023. Once again, I would like to close by reiterating my appreciation for the incredible efforts and unwavering dedication of our entire team. I remain incredibly thankful to each of the company's wonderful employees. I will now turn the call over to Jamie to cover the financials in greater detail.

Thank you, Scott. Before diving into the capital raise and our strategic objectives, Chris and I will start with a brief review of the quarter. I'll begin with the balance sheet and the improvement in our net interest margin, which, as Scott mentioned, expanded 19 basis points during the quarter from 1.17% in the first to 1.36% in the second. Our earning asset yield continues to improve, increasing to 4.71% in Q2, which is 7 basis points above the 4.64% reported in Q1 and 20 basis points above the year-ago period of 4.51%. After remaining relatively stable for the past several periods, loan yields made a larger contribution this quarter, increasing from 4.7% in Q1 to 4.77% in Q2. Though the available-for-sale portfolios yield improved modestly this quarter by 2 basis points due in part to new investment yields of approximately 5.8% and a mix shift toward health maturity led to a slight reduction in the overall investment portfolio yield, which was down this quarter from 4.06% in the first to 4% in the second. As we have noted in past calls, we are comfortable using safe, high-quality securities in the investment portfolio to support our liquidity position, improve the balance sheet rate profile and more efficiently enhance recurring revenue. In this vein, I'd note, our ending balance for the quarter was higher than the quarter's average balance. Turning to funding costs. Like last quarter, I'd like to start by highlighting the seasonal nature of our noninterest-bearing deposit portfolio and its MSR escrow balances, which, as expected, continued their return to the balance sheet this quarter following their normal annual outflows late in the fourth before beginning to rebuild late in the first. Whereas the first quarter's mix towards interest-bearing liabilities, which, as a reminder, are temporarily ramped each year to replace the seasonal decline in noninterest MSR escrow balances weighed on our net interest margin in Q1, the opposite was true in the second. Coupled with the improvement in loan yields, the shift back to noninterest-bearing MSR deposits helped return the net interest margin to its Q4 level of 1.36%. These shifts led to an improvement in net interest income for the quarter, which increased from $38.4 million in the first to $43.8 million in the second. The shift led to a commensurate increase in customer service costs as well, which also increased by $5.4 million in the quarter. Net-net, the balance sheet's contribution to earnings remains stable. Before leaving this topic, as I mentioned last quarter, though these seasonal fluctuations caused shifts in our net interest margin and noninterest expense each year, we appreciate the holistic nature of these relationships and are comfortable continuing to manage around their predictable seasonal inflows and outflows. I'd also note that given the continued growth in these balances through the quarter, we would expect the third quarter's average balance and related customer service costs to be higher than the second quarter's by approximately 15%. As is typical in an elongated plateau during a rate cycle, we continue to experience modest pressure on interest-bearing liability costs, which are up 3 basis points this quarter from 4.24% in the first to 4.27% in the second. Both borrowing costs and interest-bearing deposit costs were slightly higher, though we reduced some of our higher-cost deposits to account for the returning noninterest-bearing MSR escrow balances, which on its own helps costs; we also took advantage of relatively attractive broker deposit costs and shifted the $350 million of balances underlying our recently initiated cash flow hedge from short-term FHLB advances to short-term broker deposits. The result of this move benefited net interest income, but it did cause a shift in cost towards deposits as well as a modest quarter-over-quarter increase in our brokered deposit concentration, which, as Scott alluded to, slightly increased this quarter. As noted on last quarter’s call, by taking advantage of the market's early year optimism for declining rates via the swap and additional securities balances, we were able to add new rate-insensitive recurring revenue, and we will continue to look for similar opportunities to both enhance revenue and stabilize our rate profile going forward. Finally, I'd note that monthly trends in deposit costs exited the quarter consistent with quarterly averages with total interest-bearing deposit costs ending the month of June at 4.28%. We appreciate the work our teams are doing in each deposit channel to remain responsive to our clients' needs while holding the line on costs. Shifting to the income statement. Interest income grew again this quarter. On a slightly smaller average earning asset base, we reported $150.9 million for the second quarter versus $150.5 million in the first. Interest expense saw a decline, which, as discussed, was due to lower balances resulting from the return of average noninterest-bearing MSR escrow deposits. Combined with a slight improvement in net interest income, the $5 million decrease in interest expense benefited net interest income by $5.4 million. We reported a negative provision expense for the quarter, driven by reductions in both the reserve on our investment portfolio and the reserve on unused commitments. The balance for our ACL on loans, however, was stable again this quarter at 29 basis points. And as Scott mentioned, asset quality remains stable. Wealth and trust-related fees were higher in the quarter, up from $8.6 million in the first to $9.2 million in the second. As Scott mentioned, AUM ended the quarter at $5.5 billion, consistent with the first quarter's ending balance, and we are pleased with the pipelines we see in the business. As we'll discuss in a moment, we are excited about the opportunity to accelerate growth in First Foundation Advisors and the trust department following the capital raise. Moving to noninterest expense. Outside of customer service costs, remaining noninterest expense categories totaled $39.5 million for the quarter, slightly lower than the first quarter's $39.9 million. Compensation and benefits expense was lower by $0.3 million in the quarter as the impacts of the annual tax reset that elevate the expenses in the first quarter each year were not as much of a factor in the second. In addition, we recognized the full quarter benefit of our decision late in the first to exit our equipment finance business. As shown again this quarter, we are maintaining our disciplined approach to core expenses, and we continue to do so. We plan to continue to do so even as we make strategic investments for future growth following the capital raise. We are committed to controlling our discretionary investments and ensuring that any plans for measured investments going forward across our markets are both in line with our strategic objectives and supported by commensurate growth in revenue and profitability. Moving finally to capital and liquidity. We are pleased to highlight another quarter's improvement in First Foundation's capital ratios. Our total risk-based capital ratio, which we estimate will be 12.6%, increased by 11 basis points in the quarter and by 84 basis points since Q2 of 2023. Our liquidity and funding positions also remained strong this quarter as uninsured and uncollateralized deposits remain low, available liquidity remains high. Our loan-to-deposit ratio declined and our core deposit concentration remained relatively stable. Our capital ratios and liquidity position were strengthened further since quarter-end by the announced capital raise, providing significant flexibility to further strengthen our balance sheet, capitalize on the opportunities ahead and improve our earnings profile going forward. Before jumping into more detail in our plans here, I'll turn it over to Chris to provide our final thoughts on the quarter.

Thank you, Jamie. Good morning. Today, I will quickly touch on our second quarter 2024 lending operations, deposits, and the strength of our assets. As Jamie mentioned, before concluding the call, the management team and I want to provide further detail and insight into our newly announced capital raise initiative and discuss both near-term strategic implications for the forthcoming third quarter as well as our longer-term vision. Let's first focus on the institution's lending operations. First Foundation continues to maintain a sharp focus on remediating our fixed-rate lending portfolio's position in the current interest rate environment. Our goal has been and continues to be to reduce that exposure and diversify into index-plus-margin-based pricing, focusing on conservatively underwritten C&I lending where we prioritize relationships. I want to be clear that while historically, multifamily originations outpaced C&I lending, First Foundation has been deeply steeped in C&I lending dating back to the bank's inception. A more robust C&I team was built out nearly 10 years ago in order to help balance out the concentration risk in the underlying loan portfolio. First Foundation is not a real estate lender growing into the C&I business. C&I lending has been a long-standing and important part of the underlying franchise value. To that effect, I would be remiss if we did not highlight how amazing this team has been. Over 85% of our loan origination volume this year has been from the maturation of a prolonged strategy building on C&I relationships. From our former C&I Chief Credit Officer, who is now our Chief Lending Officer, David Masucci; to Eric Graham, our Corporate Banking Director; to Riya Kumari, our Chief Commercial Credit Officer; to Lillian Gavin, our Chief Credit Officer, our C&I team has done incredible work. Our middle market-focused teams are exceptional as well. From Scott Noren, our Commercial Banking Manager to Tobias Halbmaier, our Director of Guaranteed Lending, our teams have put in the work and have really helped drive relationship-focused C&I growth when we needed it most. As I've stated on previous calls, C&I lending growth in the future, outpacing that in commercial real estate lending will provide justification for a continued increase in our CECL reserves as a byproduct of the asset class and historical data that supports it. This will be notable in both the growth of the reserve as a percentage of the portfolio as well as the total dollar amount of the reserve. One of the many complexities the market is still adapting to is navigating CECL's future forecast of the life of loan losses at origination or acquisition of loans in the wake of 14 years of artificial interest rate deflation and a lack of meaningful historical loss data in some asset classes to support additional reserves. We continue to believe this increase in loan loss reserves will be a strong step in positioning the company in line with the risk profile of peers. As a reminder, given the relatively short duration of the multifamily asset class and the cash flow focus of most investors, we anticipate future benefit from anticipated repricing activity. Long term, we aim to diversify our asset base, which will gradually increase our CECL reserves as a more balanced portfolio will naturally require higher reserves. To help facilitate this transformation in the near term, First Foundation's strategic plan does include the thoughtful and strategic sale and/or securitization of loans into the market. This systematic and careful reduction in our multifamily concentration will provide some noteworthy and meaningful benefits. First, it will allow the bank to blunt its interest rate risk exposure to the looming maturities in the portfolio. Specifically, reducing lower-yielding assets that mature during 2025, 2026, and potentially 2027 maturities that came from unprecedented growth in the bank's multifamily balance sheet over the last three years. Second, it will allow the bank to redeploy this capital into higher-yielding loans much sooner than waiting for the organic maturity of the underlying assets. The management team and I will further elaborate on this nuance in addition to identifying how we plan on leveraging our new capital to highlight our commitment to aligning our reserves with peers prior to the conclusion of this call. Our loan portfolio as of June 30, 2024 can be summarized with the following composition: 51% multifamily loans, down from its height of approximately 54% as of Q3 of 2022; 32% commercial business loans, including owner-occupied commercial real estate and equipment finance compared to approximately 28% as of Q4 of 2022. 9% consumer and single-family residence loans; 6% non-owner-occupied commercial real estate; and approximately 1% of land and construction loans. From an operational perspective, we continue to challenge our lending departments and adapt to a heavy focus on asset quality. We want to ensure the assets we do have on the books continue to remain as strong and are as reflective of the same credit culture today as they were at origination. If there are cracks coming in the economy, we want to spot them proactively. We continue to maintain our steadfast, cautious yet proactive approach to growing with best-in-class asset quality as indicated by our historical performance. As you would expect, loan fundings continue to be comprised primarily of high-quality adjustable-rate C&I, SBA, and mortgage lending, totaling $516 million for the second quarter offset by loan paydowns and payoffs of $515 million for this quarter. Moving quickly to deposit operations. The bank continues to focus on deeper relationships with our clients which we believe, combined with our value proposition of service, distinguishes us in the marketplace. This ethos will be pivotal to the execution of deposit growth, as we focus on greater organic growth and lessening the interest rate impacts from higher-cost deposits and noncore funding. This will also be aided by the aforementioned multifamily concentration reductions and will assist in limiting exposure to changes in the deposit franchise. As you have heard on previous calls, we are still keeping a close eye on liquidity and funding in the near term but have already begun to refocus on our core funding growth efforts and have made sizable changes to reflect that in the quarter. Continued improvement in funding and the additional capital will allow us to allocate more attention to driving down any overdependence on broker deposits and wholesale borrowings. The breakdown of our current deposits is as follows: money market and savings at 30%; certificates of deposit, 29%; interest-bearing demand deposits, 27%; and noninterest-bearing demand deposits at 14%. Our core deposits are geographically largely unchanged with California accounting for 36% of total deposits; Florida at 36%; and Texas at 10%. Outside of this majority, Nevada, Hawaii, and other states make up the remaining 18% of the total. The internal culture has seen a galvanized pivot from a defensive focused stance to an offensive leaning one where our teams in the digital branch and our physical branches can focus on delivering service and organically growing our business, the timing of which could not be better. While we operate with a rate-neutral mindset, we have begun preparing for a changing landscape ahead of potential rate cuts during the 2024 calendar year by strategically deprioritizing marketing based on rates and instead highlighting relationships, community, and service. If we are fortunate enough to see a rate cut in 2024, the benefits to First Foundation's earnings will be felt quickly given the company's liability sensitivity. A lot is changing about the way we do business. And I would like to thank every single contributor at First Foundation for their support and commitment to improving what we do. I continue to be grateful for so many wonderful colleagues who genuinely care about the long-term viability of the company. We have endured a lot the last two years, but now it is time to shift our focus to offense. If adversity builds character, this team has developed a tremendous amount of character, and I can proudly tell you they are ready to prove what they can do next.

Okay. Well, a terrific way to wrap up the quarter. As we continue to say, First Foundation's success is certainly a result of its people, and Chris' sentiment couldn't be a better way to kick off a discussion of the capital raise and where we see the company going from here because importantly, we value the culture our team has built and nurtured over the years. We believe our focus on customer experience, providing a holistic set of banking options, and leaning into our expertise to help build our bank and support our communities have been foundational to our success. Rather than using the capital raise as an inflection point to focus on new businesses or materially change our old, we hope to use it as an opportunity to get back to what we do best, leading with our people and sharing with our markets the hallmarks that have made First Foundation such a valued partner to our clients and a trusted steward of our shareholders' capital. Before we can pivot entirely to offense, however, there are some near-term actions we would like to take to further strengthen the balance sheet and stabilize our earnings profile. In this first phase, which we expect to complete this quarter, we set out to successfully complete our capital raise, which we've done, move a portion of our lower-yielding multifamily loans to held for sale, initiate a detailed review of our ACL methodology to address once and for all various stakeholder concerns, and begin ensuring that once we fully pivot back to offense, we will be ready with cascading organizational goals and incentive alignment necessary to ensure our measured investments achieve their goals. Together, we believe these actions set us up for success, leaving us with a strengthened capital and liquidity position, a reduction to our multifamily concentration and ACL within range of similarly situated peers, greater flexibility to decrease our reliance on wholesale funding going forward, and, of course, improvements to our net interest margin and core profitability that are necessary to make the investments available across our footprint which we believe will lead to further geographic and product diversification, growth in core funding and improved revenue mix based even larger part on stable recurring fee income and most of all, reduced through-cycle earnings variability that will lower our cost of equity and enhance long-term shareholder value. Now the near-term actions are not without hard work; we have already initiated our detailed ACL methodology review, and we are confident it will be completed this quarter. But simply moving some of our lower-yielding multifamily loans to held for sale this quarter does not mean we are done. As we did with our new investors during the capital raise, we believe it is important to engage with those willing to dig into our portfolio, understand why we hold such conviction in its credit quality, model through the loans' repricing characteristics, and arrive at a fair execution price that we would be comfortable ultimately sharing on these calls with you. That takes time, but we are committed to best execution, and our team is willing to do the hard work to ensure we get it. As an organization, I can assure you we are excited to pivot again to offense. We are thrilled for the growth opportunities this will provide to our teammates who have already invested so much. We are honored for the opportunities to grow our existing relationships and build new ones across our markets and we look forward to the opportunity to return our financial performance to levels our shareholders deserve. By investing our resources and these strategic objectives, success will not occur overnight, but by the end of 2026, we are confident we can get First Foundation's ROA back to 90 basis points to 100 basis points, ROTCE back to 10% to 12%, and our CRE concentration below 400%. Coupled with the improvements we expect in our liquidity, interest rate, and credit risk profiles, a long-term Tier 1 risk-based capital ratio in the 12% to 13% range will ready First Foundation with a strong risk capital balance poised for further growth in 2027 and beyond. With that, I'd like to turn it to Chris to provide further detail.

Thank you again, Jamie. As Jamie noted, and as you can see on Page 3 of the provided investor deck, the near-term actions in the third quarter of 2024 will be about repositioning the balance sheet and stabilizing earnings. A big part of the mechanics around achieving this goal will come from moving loans to held for sale as well as a thorough review of the bank's current ACL methodology. First Foundation intends to move approximately 20% of its existing multifamily loans to a held-for-sale designation. I would caution against looking at recent market transactions as the sole indicator of the potential marks we could see on the move. And I would certainly emphasize this point when considering final execution prices. As Jamie mentioned a moment ago, we are willing to put in the time and work here. First Foundation intends to explore every avenue to ensure best execution, including options through its relationship with Freddie Mac, as well as potential private party sales. First Foundation is a Freddie Mac seller servicer and has successfully completed numerous securitizations with Freddie in the past. While this is no longer a part of our normal business, we still have the expertise to invest, and we have historically found that upon doing so, execution and settlement can contrast market pricing based on the desirability of the bank's underlying affordable housing multifamily loan characteristics. The characteristics I detailed on last quarter's earnings call that support our credit quality, such as low-income housing components, rent-controlled properties and others assist in Freddie's duty-to-serve requirements as well. Our asset quality remains strong. So given there is an increasing likelihood of rate cuts to end 2024 and through 2025, we anticipate that the environment for execution will only improve through this process. Management is currently in the process of working with an outside third party to determine the potential mark as a result of a fair market value analysis, but I will reiterate again that we are committed to best execution as we work to ultimately disposition the assets and reduce our multifamily real estate and fixed-rate asset exposures. Despite the noteworthy strength of the loan portfolio and the historical lack of loan losses since the bank's inception, management recognizes the bank is a statistical outlier when compared to similarly situated peers. Because First Foundation's concentration in commercial real estate is narrowly tailored in the historically lower loss end of the multifamily asset class, the historical loss factor has not led to the bank setting aside large reserves under the current expected credit loss model. We do believe, however, that there is an element of interest rate risk in the market, which is truly unprecedented, and that First Foundation needs to initiate a detailed review of its ACL methodology as a result. I want to be clear; we do not believe we have credit losses on the horizon. As part of the months-long due diligence, Fortress not only conducted a thorough internal due diligence of the bank's underlying loan portfolio, but they also engaged a nationally recognized independent third-party due diligence and credit review. If there is one thing I can assure the market, it is that the confidence in our underlying credit quality relative to our peers is shared by management and our new investors. It helps that almost 70% of our portfolio is focused on relatively safe, multifamily, 1 to 4 single-family, and municipal loans, but our success is another testament to the incredible team we have built and the seriousness with which our culture approaches credit. As we have always done, we intend on providing confidence that our reserves are adequate to address any changes in credit quality or interest rate risk that may be present in the market, and we believe that to do so, a holistic review of our methodology is appropriate. A result of this review will likely conclude in an increase to the bank's reserve to be more in line with similarly sized and concentrated peers. Regarding the loans we are moving to held for sale, the move will focus on loans with balances approximately between $1.5 million and $4.5 million and which are set to reprice in the next 18 to 36 months. Reducing these balances will mute the impacts of the historical loan growth we saw in 2022 and the repricing uncertainty they could introduce on the horizon. The market needs to be able to model this pivot, and we, as management, will provide additional detail of our findings during our Q3 earnings call. The second phase of our strategic plan is the most exciting, and we hope that it gives the market, our employees and our shareholders that confidence in the strategic vision for the medium and the long-term strength of First Foundation. Frankly put, we are going to go on the offensive with measured investments to capitalize on what will surely be market opportunities ahead. Before going into detail, it is important to note that the prolonged due diligence in capital raise discussions led by Fortress and Canyon also allowed for a thoughtful and strategic collaboration in which management, the legacy Board and our investors were all steeped. It is a proud result of active and ongoing planning that began as far back as the beginning of the second quarter of 2024. As you know, First Foundation currently has a wide geographical presence, spanning from Florida to Texas to Nevada and California and all the way to Hawaii. Collectively, we believe there is tremendous untapped potential in these geographies we currently serve. Given that we have a physical presence in these locations and the mature infrastructure in our C&I lending business, the strategic vision anticipates the further diversification of the underlying loan portfolio. This diversification into C&I lending, which leverages the existing C&I infrastructure and enterprise will improve core funding, further reduce multifamily commercial real estate concentrations, increase loan yields, and bolster deposit growth with a heavy focus on offering our platform to relationships and not transactions. New bankers in these markets will have loan goals and deposit goals, so they will be properly incentivized to focus on relationships, which are at least partially self-funding. As core deposits grow, we will, of course, want to focus on the concentrations in the underlying deposit portfolio as much as we do the loan portfolio. This will mean a reduced reliance on noncore funding and wholesale funding as well as a reduction in high-cost deposits. Goals, you have heard us speak about strategically for several quarters now. While we have made strides towards these objectives, we are far from satisfied that we have maximized these improvements. The proposed balance sheet changes should limit exposure to high-cost deposits, and the enhancement to profitability will only be further bolstered by the tailwinds of rate cuts whenever they do come.

Thanks, Chris. First, sorry that the script is taking longer than normal, but we frankly believe that the emphasis of this call needs to be on the capital raise. So sorry, please bear with us. We hope that all the strategic direction detail provided by Jamie and Chris and summarized in the provided investor presentation gives everyone some insight into how transformative we believe this capital has already been and is going to be. The benefits will also extend to the wealth advisory platform, First Foundation Advisors. As a logical natural byproduct of the steps we have detailed for the bank, you can anticipate accelerated FFA growth and further increases in fee income. While FFA has continued to hit its growth milestones over the course of the last two years, management believes that First Foundation's expansion deeper into the existing markets will only benefit FFA as these markets have significant high net worth household concentrations and attractive in-migration demographics. It should also be noted that having a wealth advisory arm is a very valuable thing for the bank and serves to make relationships stickier and longer lasting across the First Foundation platform. Speaking of which, the bank's trust division will continue to grow and season in these markets as bankers and wealth advisers identify the need for their services and the growth of the client-base compounds. I am proud that the enterprise value of this franchise has been and will continue to be our ability to provide an unparalleled value proposition of service, service that comes from the talent and abilities of our team so that we can capture and grow with our target demographic as they age and even as they relocate through chapters of their lives. I am incredibly proud of what we built at First Foundation over the course of the last 17 years. Much like our clients, we have evolved and have grown into the next chapter of the company's life. With growth comes change, and it is with a heavy heart and a tremendous amount of gratitude that I think some of our departing legacy Board members for their tenure and commitment to helping us build First Foundation into what it is today. At the same time, I'm grateful for the gift of fresh eyes and perspectives from our incoming cohort of directors, who I can tell you are already aligned with our culture. Together, management and I know that we have found the right partners with this capital raise, and we are thankful for their commitment to preserving our enterprise value and honoring the legacy of First Foundation. Lastly, I cannot thank our team of employees enough. The tellers on the front lines of challenging discussions during volatile times in the stock market, the managers who concerned customers calling to hear the First Foundation was strong. The management team and I want you to know that this capital raise and the resulting strategic plan will position us all to be on the offense again. And I want you all to know that we appreciate your commitment. Thank you for being a part of our team. Thank you for trusting us to execute and deliver a stronger bank. And now I will turn the call back to the operator for questions.

Your first question comes from David Feaster from Raymond James. Your line is open.

I wanted to highlight the potential for optimizing the balance sheet. It seems that securitization could be a near-term opportunity, especially considering your experience and track record. Could you share your thoughts on this? Given the previous securitizations in the $400 million to $500 million range, do you anticipate doing a couple of tranches, or is a larger transaction feasible? Also, I'm curious about the market testing you've conducted and your insights on the current appetite and conditions in the secondary markets.

It's always a pleasure. It's Chris. I think the maximum they usually allow at Freddie is typically up to $500 million. Historically, we've done a bit more, but I would expect us to aim for that size. This is somewhat speculative because there would need to be pricing and some initial discussions and work involved. Generally, we will always strive for the maximum. The reason for this is due to the efficiencies of time and usage. We want to maximize our efforts as GPs related to the transaction. So my target would be around $0.5 billion. We would also consider private party sales and explore other opportunities as they arise.

Yes. I had some pretty good inquiries out to other financial institutions as well as possibly the Freddie Mac outlet. We've also had some recent reverse inquiries. So I'm pretty confident amongst everything that we will really test the marketplace and determine the best execution route.

I'm curious about your thoughts on the size of the balance sheet. We used some excess liquidity this quarter to buy securities and have the potential for securitization to free up more liquidity. With some loan growth on the horizon, would your priorities focus on de-levering the balance sheet and reducing wholesale funding, or would you look to accelerate the C&I remix?

David, this is Jamie. The first step we would take with any multifamily transactions would be to concentrate on wholesale funding on the right side of the balance sheet, potentially along with some higher-cost core deposits. However, we would prioritize wholesale funding, as we believe we have an excess there. Although a significant portion of our deposits is in brokered CDs with various maturity links, our initial focus would be on exiting the wholesale funding. Moving forward, we aim to ensure that our earning asset base consistently supports the investments we intend to make. We are looking to avoid low earnings, and instead, we wish to see growth from this point onward. Therefore, we plan to keep earning assets in cash or high-quality liquid securities to back our investments. As we delve deeper into this, we will gain a clearer picture of the timing when we start discussions with various lenders and teams in the markets, helping us determine when we can bring in new partners. We will balance our expenses and investments with our decisions on the balance sheet size and assess if we need anything beyond loans to support our desired investments.

It seems that a lot of the focus is on Florida and Texas. Chris mentioned the untapped potential in some of the newer areas. Could you elaborate on what your expectations are? It sounds like you're planning to make some new hires. Are there any specific new markets you are concentrating on? I'm curious if you could share more about the strategy and what considerations you have regarding this.

Yes. So obviously, we have our corporate headquarters located in Texas, and we have unlimited top potential in the market. There's a lot of business there that we need to really capture. Our plan as it is right now would entail growth there. It would also consider really tapping in heavily into Southwestern Florida markets where we have geographic presence. But one of the things I can tell you that we haven't done is allocated people on the front lines to originate business. Obviously, the last two years were really a defensive focus as the narrative really alluded to. So getting people there that can originate relationships and focus on those franchises, I think, will help bolster significantly. But there's still potential in California as well. I don't want to minimize where we are here. Northern California, Southern California, in particular, have a pretty growing expansion. The interesting thing from a dynamic perspective is we see a lot of people from a relationship position leave the state of California and go into the states that are typically tax shelters like Texas and Florida. And because of that, we've been able to follow them there; that's a great entry point into introductions and additional business there. So we have a very warm handoff in those two states, and it makes the most logical sense for growth in the immediate future.

The only thing I would add is that we expanded into Texas and Florida, and then COVID and the challenging economic times hit. We haven't really had much opportunity to expand further into those markets. We found ourselves needing to adopt a defensive strategy. As Chris mentioned, we still see tremendous opportunities in the California marketplace, but we genuinely believe that the potential for growth in Texas and Florida is vast. Regarding your question about other markets, we have plenty to focus on just in those two states, so I don't foresee us expanding into any new markets beyond those we currently serve.

I appreciate the profitability targets. I was curious if you have a timeline for achieving those or getting closer to them. Obviously, this is somewhat dependent on the ability to execute on the securitization and selling some of the multifamily properties, but I don't know if you had a...

I think we were targeting towards the end of 2026.

That's correct. I appreciate your question. As the finance chief, I'm looking forward to the upcoming months of planning and budget season. We'll be engaging with the market and having more discussions about hiring. We're aiming to take our high-level plans and implement a detailed budgeting process, which should help clarify the timing for our profitability improvements. However, as you mentioned, much of the restructuring related to our balance sheet and the enhancements from that will rely on our efforts with the multifamily loans we classified as held for sale and how quickly we can achieve the best execution and acceptable prices. Therefore, it might be a bit early to discuss specific trajectories regarding profitability. That said, we are confident in the goals we established for the end of 2026 and our long-term objectives concerning our multifamily and commercial real estate focus overall.

Your next question comes from the line of Gary Tenner from D.A. Davidson. Your line is open.

I'll just follow up on that profitability question. As you've laid it out in the deck towards the end of 2026, what would be the contemplated kind of asset size would you think at that period of time? And it seems like $12.5 billion to $13 billion doesn't seem unreasonable, but I just wanted to sanity check that.

Yes. I think you're in the ballpark there, Gary. We've gone through the initial planning process, and we came up with targets for growth and what we think is available in new markets, for instance. But we do think that there is a lot of opportunity, as Chris and as Scott mentioned before. And I think as we get into it, we could find that there's more than expected and perhaps the balance sheet is a little larger than what you mentioned. But I think the target that you laid out in that $12.5 billion to $13 billion is probably a good place to start at this point anyway.

And then as you talk about doing your review of your allowance methodology in the third quarter, is that something that would be more of a kind of longer-term guidepost for you? Or would you anticipate it would be sort of an immediate adjustment in the third or maybe that softens in the fourth quarter on the ACI level?

Well, on the auspice of full disclosure, that's one of those things that there are more ramifications. There's several different people and concern to think about. Obviously, you have the regulators' perspective on it; you have outside accountants and auditors' perspective on it. We think the risk in the market right now exists, and we want to address it, and we want to address it in a timely manner, but the proper methodology will take part as part of the review. So I'm not being dodgy just to say that we're committed to getting it there, we'd like to do it as soon as reasonable and feasible, but we want to make sure we do it the right way.

We expect it to be way that this quarter, though, Gary, to be firm on that.

Okay. Jamie, in terms of your comments on the MSR deposits and the customer service costs, could you give us the average of those deposits that impacted the customer service line in the second quarter?

The total for customer service deposits, including MSR escrow balances and others like 1031 exchanges, was an average of close to 1.2 for the second quarter.

And then if I could, just one last question. Simone, you kind of having a couple of weeks under your belt at First Foundation. Just kind of would love to hear your updated thoughts perhaps in terms of the opportunities and kind of how you see the bank situated here.

Thank you, Gary. Yes, I am on. And so thank you for the question. Yes, this is end of my third week or coming close to the end of my third week and it is really a privilege to work with Scott. I've known him for many years and also with Jamie and Chris and to work with them and our legacy Board and the new investors in developing a plan and focusing on how we reposition the organization. A lot of the details of which were discussed earlier. So I'm excited about the future. And thank you for the question. That's about as much as I'll go into because I think a lot of detail was covered earlier in the call about how our focus on repositioning and moving forward.

Your next question comes from the line of Andrew Terrell from Stephens. Your line is open.

I wanted to ask about the profitability targets, specifically the 90 to 100 basis points for the fourth quarter of '26 return on assets. How does that compare pre and post capital raise, and what could have been achieved organically without the capital raise by the fourth quarter of '26?

It would likely be much less. I'm not sure, we would need to review our previous forecasts to determine the specifics. However, I would estimate that it would be reduced by about half.

Yes. Okay. And then my only other one, I've gotten a lot of questions from investors this morning around under Phase 1 of the near-term actions, the piece setting goals and aligning incentives through the organization, could you maybe expand a little bit on what you mean by this? And the specific question would be, what are the kind of set management payouts as you hit certain parts of the Phase 2 actions?

So this is Chris. We were thinking really with the context that it would be more driven down to the bottom line. One of the things incentive-wise, in financial, frankly, compensation-wise, is you want to have people who are equally motivated to bring in deposits as well as loans. And you want to have them driven in line with the bank's ultimate success and profitability according to its strategic plan. That being said, with the very clear strategic plan that we are putting in place, obviously, with the new incoming cohort of Board members and a very clear vision of where we want to be, we want to make sure that the compensation down to the front line is equally as clear and drives those results. Frankly, people will do what you compensate them appropriately to do, and that's what we want to maintain, if that makes sense.

Your next question comes from the line of Matthew Clark from Piper Sandler. Your line is open.

Just wanted to ask about the kind of share count going forward, should we assume the share count is fully loaded with the warrants now that they're in the money and knowing that your GAAP numbers are likely going to differ from non-GAAP, assuming you show growth ahead of the shareholder vote. But is that a fair assumption, assuming you'll show both going forward?

Matthew, this is Jamie. We definitely will provide clarity on share counts as we finalize our financials. There is a net settlement on the warrants that will be influenced by stock price fluctuations. We aim to clearly outline the trajectories for EPS and ROTCE, both on an actual and fully diluted basis. The timing will change when different types of preferred shares and nonvoting common equivalents transition from current investors to new ones. This will be a priority for us, and we welcome any feedback you can provide to ensure that our communication is clear for both the investment community and your team.

And then do you have a date set for the shareholder vote?

It's in August. I believe it's September, sorry. I think the proxy statement we were finalizing yesterday should be going out fairly soon. But I expect you will see something pretty soon from our attorneys, and it will be held in September.

Yes. I can't say enough about how much support we've gotten from our team on the legal side. They're still working around the clock to get everything buttoned up and ready. As Scott mentioned, the proxy's draft is getting ready to go out. There is a period where the SEC has to review, but we'd hope to get that out to shareholders in August and then the vote and the special meeting in September.

A shout out to Josh Dean at Sheppard Mullin.

Great. Can you share your outlook for customer service costs in the fourth quarter, considering the seasonal trends and the potential impact of rate cuts?

Yes, just a second. For the margin, we were at 1.42 in June and the spot rate for total deposits was 4.28.

That concludes our question-and-answer session. I will now turn the call back over to CEO, Scott Kavanaugh, for some final closing remarks.

We thank you for attending today's conference call. We hope it was informative. So as I said previously, we are super excited to have our new partners with the investment of $228 million of capital. We're going to continue to work with them and our newly reconstituted Board to continue to build upon the foundation of what we put in place. So with that, we thank you again and hope you have a great remainder of the day.

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