First Foundation Inc.
Q2 2021 Earnings Call Transcript

Published: 27 Jul 2021

[Operator:]

Greetings, and welcome to First Foundation’s Second Quarter 2021 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 would be opened for your questions following the presentation Speaking today will be Scott Kavanaugh, First Foundation’s Chief Executive Officer; Kevin Thompson, Chief Financial Officer; and David DePillo, the 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.

[Scott Kavanaugh:]

Hello and thank you for joining us. We would like to welcome all of you to our second quarter 2021 earnings conference call. We will be providing some prepared comments regarding our activities, and then we will respond to questions. We delivered another strong quarter of results as our business model is performing well across the entire represents a 17% increase over the first quarter of 2021 and a 46% increase year-over-year. Total revenues were 71.9 million for the quarter, a 9% increase for the first quarter of 2021 and a 25% increase year-over-year. Our tangible book value per share ended the quarter higher at $14.27. We declared and paid our second quarter cash dividend of $0.09 per share. The transformation of our business model has really taken shape. As I have mentioned on these calls before, we have been focused on transforming our balance sheet and diversifying our offering. This has only strengthened our position as a regional commercial bank. As we look at our business today, we are a much safer bank than what we were just three short years ago when many of you on the call first invested in it. Let me elaborate on a few points related to this. Business and commercial loans now account for 28% of our loan portfolio, and no one sector accounts for more than 20% of our business lending portfolio showcasing the diversity of the businesses we serve. We still do an amazing job with originating and funding multifamily loans, but our C&I division has been responsible for a significant uptick in originations, including 30% of the 1.1 billion we originated this quarter. We continue to add to our commercial lending capability with the addition of new lending teams in Las Vegas and the Los Angeles area. And we brought on a new dedicated builder finance team that is focused on the construction lending. Another way we are diversifying our loan offering. We also established our municipal finance team last year and equipment finance continues to be a strong source of loan originations. And our single-family team is consistently adding high credit quality, low LTV loans to our portfolio.

[Kevin Thompson:]

Thank you, Scott. Earnings per diluted share of $0.58 in the second quarter included 1.2 million of expenses related to our acquisition of TGR Financial. The return on assets was strong at 1.4% with a return on tangible common equity of 16.7%. Adjusting for the merger-related expenses, our return on assets would have been 1.45% and our adjusted return on tangible common equity would have been 17.3%. The net interest margin expanded four basis points to 3.2% in the quarter as a result of strong loan growth and the continued success we have had in lowering deposit pricing. We maintain discipline in loan production with the average yield on loans dropping slightly by 11 basis points to 3.88%. Our cost of deposits decreased from 31 to 20 basis points in the quarter and continued the downward trend to 18 basis points in June.

[David DePillo:]

Thank you, Kevin. As Scott mentioned, the transformation of our balance sheet continues to develop nicely and today, we are well positioned as a regional commercial bank servicing diverse client base. Adding some more detail to that, I would like to highlight our commercial business lending accounted for 39% of our originations for the first six months of the year. In the quarter, we funded 336 million of C&I loans, which contributed to our third straight record quarter of originations of 1.1 billion for this quarter. 57% of our C&I loans in the quarter were adjustable commercial revolving lines of credit, which is a strategic move for us as we continue to shift the balance sheet to more rate neutral from liability sensitive. The remaining C&I originations were comprised of 73 million of commercial term loans, 34 million of public finance loans, 27 million of equipment finance loans and 10 million of owner-occupied commercial real estate loans. They are all high-quality business loans that generate strong yields and continue to diversify our loan portfolio.

[Operator:]

Thank you the floor is now open for questions. And your first question comes from Matthew Clark of Piper Sandler.

[Matthew Clark:]

Hey good morning guys. Just wanted to hone in on the non-interest-bearing deposit growth a little more. Can you give us a better sense of how much of that came from your Dallas initiative, how much of it might have come from cannabis efforts and then just speak to kind of the more traditional types of sources of growth. It is a pretty meaningful increase, It is almost - could be considering the size of a bank in one quarter.

[Scott Kavanaugh:]

So Dallas has not really kicked in yet. The reality is we are just signing our first branch opportunity and that probably won’t even be online until the first quarter of next year. Cannabis has slowly increased, but it is still a very minor portion. I would say that the increase is really attributable more to the traditional means and the people that we have had in staff for a while.

[Kevin Thompson:]

Yes. I would just add that some of that is growth from existing clients. A lot of it is new client acquisition. But we would mention that we do have existing clients in the Dallas market that contributed a pretty significant growth during the second quarter one particular plan added several hundred millions. So we are seeing growth out of that market, we still happen to start banking that client prior to our move of the headquarters. But yes, it is organic through our distribution channel and clearly, demand is outstripping our ability to deploy deposits at this point.

[Matthew Clark:]

Okay. And do you feel like those balances are sticky or do you feel like there is some portion of that growth this quarter that was more of a timing issue that might move in the upcoming -.

[Scott Kavanaugh:]

So I think they are very sticky, but the reality is there are high points and low points with some of those clients. And right now, the balances are starting to build back, and they will fall - what, Dave, in the fourth quarter slightly and then build -.

[David DePillo:]

Yes, I would say we probably see a lot of the traditional balance growth of existing customers as Scott just stated, typically hits during the third quarter and then the cyclicality nature of some of those will we - they were way down during the fourth quarter and then start building up. However, we have made a conservative effort to diversify those business deposits away from some of the cyclicality that we see in some of the clients. So we probably won’t see the level of movement. But again, Matthew, the demand out there from even new customers is so high and they are pretty much - yes, we are turning away deposits at record levels.

[Matthew Clark:]

Okay. And then just shifting gears to the loan pipeline and kind of growth outlook a lot stronger this quarter. It sounds like you expect some seasonality in the third quarter, but what are your overall thoughts on production in the back half and kind of net growth in general?

[David DePillo:]

So we still expect the first quarter to be the low point. Third quarter will be obviously down from the second quarter just because of the summer months. And actually knock on wood, post COVID, people are actually traveling. So we are seeing more of a - unlike last year, we had record lows in production, mostly related to COVID during the third quarter. This will be a traditional cyclicality, but it still should be greater than what we experienced in the first quarter. But I would say that we have traditionally hit and run anywhere from 2.5 billion to 2.8 billion. Our current run rate is 3.5 billion to four billion. Our expectation is we are going to continue at that run rate, and we don’t see demand at this point falling off. So as we stated previously, we have kind of built infrastructure and teams to support a much greater funding level than we have historically achieved in the past, and we are starting to see the fruits of those labor pay off.

[Matthew Clark:]

Okay. And is it fair to assume with the acquisition that you will probably be at five billion next year, roughly?

[David DePillo:]

It all depends on how quickly we expand in that market. Their historical run rate - Kevin, correct me if I’m wrong, I think it is 200 million to 300 million a year ex-PPP. We think that is going to be a gradual increase as we expand in that market. So I’m not sure it is going to be one billion by next year, but it will certainly be scaling up from what they historically have done. But again -.

[Kevin Thompson:]

I think it depends on what Florida can chip in. Texas is already gearing up pretty substantially on the loan side. They are approaching 100 million in a pipeline, which is pretty healthy considering the team has only been here for a couple of months. So that may be a little bit ambitious on the five billion, but -.

[David DePillo:]

Yes, I would say we have not modeled that. However, we have not completely integrated all of the modeling around post acquisition, at least from our expectations outside of what we put a redeployment of cash in the model. But I would say our plan is to step up their historical run rate and in our engine new markets relatively rapidly as they were planning to do that on their own. But that tended to be a little more capital constrained in the past.

[Matthew Clark:]

Okay. And then just on the reserve, down a little bit ex-PPP, I think, roughly 41 basis points. I think some of that is macro factors. And I would assume some of it is also just less C&I contributing to the overall production this quarter relative to last. But what are your thoughts on the reserves. So should we expect that to kind of reset back to 50 basis points with the acquisition in the fourth quarter?

[David DePillo:]

We haven’t fully modeled that yet. Other than you can see our - when we announced the deal, that’s our latest modeling and you saw in our S4, we did some estimates as well. So more to come, we have a lot of work to do before we close to understand their loan portfolio better and to implement CECL as a smaller bank. They weren’t subject to CECL requirements. So we will run their loans through our model. And to your point, there are more commercial loans. So we do anticipate a higher reserve rate I wouldn’t say it would be that significant, even the credit quality of the portfolios and the historical performance and the seasoning of it. They are a very, very conservative bank and their reserve levels are at a little over -.

[Scott Kavanaugh:]

They are 1.5%.

[David DePillo:]

Yes. 1.5%.

[Kevin Thompson:]

Yes, but on commercial real estate.

[David DePillo:]

At commercials, they are probably up there in the -.

[Kevin Thompson:]

Yes. So it may drive us up a little, Matthew, but given their portfolio compared to ours in size, the primary driver is, obviously multifamily and residential mortgage tend to drive our ratio down since we do tend to reserve higher levels on C&I.

[Matthew Clark:]

Yes, understood. Thank you.

[Operator:]

Thank you. Your next question is from Steve Moss of B. Riley Securities.

[Stephen Moss:]

Hi good morning. -- next quarter here. Maybe just tying up loan growth a little bit further. Obviously, it sounds good on the pipeline and originations are impressed. You do have a pickup in pay downs. As you think about the pace of growth, maybe even with TGRF, are you guys comfortable with kind of like a mid-teens type growth rate heading into next year?

[Kevin Thompson:]

Yes, I think so. Like you say, it all really depends on where the market is as far as rates from a CPR standpoint. We have tended to step those up in our modeling recently to reflect current pay down rates. But if the CPRs stay where they are at, I would say mid-teens is probably where we expect to be.

[Stephen Moss:]

Perfect. That is helpful. And then just in terms of the teams you guys added in Vegas and Los Angeles, I think it was this quarter. Can you give a little more color as to what you are expecting from them and their business focus?

[David DePillo:]

Sure. So L.A. is more mid-market and below traditional team that has been in the market for, I would say, several years now. So that would be kind of LA Metro mid-market and below. Pace is a little different animal. It is part of our corporate banking team. It is a team that originally came out of U.S. Bank and eventually made their way over to us, which have a strong hold in the Western region on the corporate. So we would say that is mid-market and above. And they are hitting stride and have been very successful. The management team there is also helping in leveraging our overall corporate initiatives nationwide. So it was really to add - it is really additive not only from just a pure production standpoint, but just the depth and breadth to our corporate banking group.

[Scott Kavanaugh:]

Dave, you may also talk about the new builder finance team and their pipeline.

[David DePillo:]

Yes. We added a builder finance team that actually - the individual that runs that worked with us at a bank several years ago and it has been very successful. This is what we would consider more of an infill spec and owner builder program they do infill as well as some multifamily construction as well. So this isn’t large track or a large builder finance, and it is primarily in California as a majority of their production. They are actually doing extremely well so far, building their pipeline and we are adding the additional expertise. We always had a very, very strong funds control and infrastructure, but we lacked a team to focus on really driving more scale in that production side. So we are very pleased they have been here for a few months now and already have a nice pipeline building.

[Stephen Moss:]

Got it. And maybe on the Texas LPO as well, I think Scott, you mentioned $100 million, close to $100 million pipeline just kind of curious what the type of loans you are seeing and Texas activity.

[David DePillo:]

So that traditional commercial real estate, mostly multifamily focused throughout. As you know, Texas is a very large market for that and these are individuals that have been servicing the market. We are doing some bridge financing around that as well because of the repositioning of some complexes within the market as that market continues to grow and prosper. So I would say majority of it is multifamily, multifamily bridge and a little bit of CRE. We have plans to add additional C&I bankers in the market, but have been very, very selective in our approach to that market as it relates to C&I.

[Stephen Moss:]

Okay. Great. And then just with all the investments ongoing, just excluding TGRF, kind of curious as to how you guys are thinking about expenses and expense growth rate here.

[David DePillo:]

So because you know we have always not been shy about adding infrastructure as needed in order to continue to expand our profitability and we kind of manage to an overall expense ratio. So we want to try to maintain that kind of 50% or below from an efficiency standpoint. And I think you saw in the second quarter, some of the investments we made in previous quarters are now starting to pay off. We still are going to add additional production and infrastructure, but our expectations are we kind of target 50% efficiency.

[David DePillo:]

Yes. The only thing I would add on that Steve is we were stuck at like 500 employees for a while until we decided to kind of ramp up the production side. And with that we had to ramp up underwriters, processors, funders, compliance people. You really have to have that same infrastructure build. And so we have gone just this year alone from 500 employees around the start of this year to think it is about 540 or 550. If not, we are leaning that way towards getting very close to it. But Dave’s right, we are trying to do at lockstep with making sure that our efficiency ratio maintains around that 50-ish level until we can taper off and then hopefully get some efficiencies to scale.

[Scott Kavanaugh:]

And I will just add that with the acquisition of TGR Financial, we anticipate getting to the 9.4 billion level by year-end and sometime next year dipping into 10 billion area, which, as you know, brings a new regulatory regime and additional requirements for a bank. And we are well on the way of preparing for that and investing as we need to in talent. One of the nice things about TGR Financials, they come with a very talented team and a great addition to both our culture, but as well as the infrastructure we need to add in order to have a really high functioning team. So where normally, you would see higher cost saves. We have opted to retain many really talented employees from TGR at close, so that we can be prepared for this 10 billion mark. So there will be expenses related to that. But to Dave’s point, we anticipate seeing at or below the 50% efficiency ratio, Mark.

[Stephen Moss:]

Okay, great. well thanks very much guys.

[David DePillo:]

Thank you.

[Scott Kavanaugh:]

Thanks you Steve.

[Operator:]

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

[Gary Tenner:]

Thanks good morning. Just touch on the margin for a second. Last couple of quarters or three quarters, you have been able to kind of offset the decline in headwinds on earning asset yield side by lowering deposit costs. Given where those deposit costs are right now, is there enough room to kind of sustain the margin at the current level or given kind of the new loan production rate in the low threes and drag on loan yields, are we likely to see a little bit of pressure.

[Scott Kavanaugh:]

I will start with the deposit side. We have squeezed a fair amount out and I would say that for the most part, we are probably drawing to a close on what we think we can really squeeze out of the marketplace. So I mean, I think we have done an exceptional job of lowering the cost of deposits. But I don’t think that you are going to see much more in the way of our cost of funds shrinking much more than the 18 basis points that was experienced in June.

[David DePillo:]

So I would say on the loan side, it is interesting, Gary, it is a little less to do whether or not we are adding a lower loan yields on our portfolio and really getting cash returning close to zero deployed into some earning asset above zero. So whether we fund that 335 million or 325 or even 300, on new loans is getting that $1 billion of excess cash that is earning 20 basis points or less into an earning asset - about earning 3% or more, and that will probably have a much more material impact to maintain our margin than slightly lower loan yields. But as you can see, we have been funding in this range for quite some time. And whatever the yield curve does day-in and day-out, week-in, week-out. We pretty much have been funding at a floor rate for I would say well over a year. So our rate may vary 10 basis points up or down, but that certainly has some impact, but it is really getting cash earning almost zero into something more than that is going to have the biggest impact.

[Gary Tenner:]

Yes. That makes sense. So with the backdrop of obviously the liquidity build being a headwind in terms of asset yields, can you talk about the decision to sell loans this quarter in advance of the serialization?

[David DePillo:]

So that was interesting. Dealing with the agencies when we originally were talking to them, there was a focus on them securitizing assets that met a national (Ph) calculator very little of what we originate meets the national BLI scenario. So we said, well, if we may move away from a single securitization and selling to private institutions and smaller blocks. We completed one of those and then went back into the agency said well we can actually complete a transaction, which also benefited us. So net-net, at the end of the day, we are probably doing a slightly smaller transaction in a both scenario versus what we sold in the second quarter. So that was really the primary reason why you have a little bit of sale in this quarter, and then we will have a larger sale in the third quarter. Again, the majority of the reason we are selling these assets are to make room with existing customers in order to maintain our one-to-one borrower ratio. It is just our ability to service those customers year-in and year-out, and it is strategic for us to maintain the relationship also the servicing through multi securitization. But that is the reason why we had that split.

[Gary Tenner:]

Okay, I appreciate the color.

[Operator:]

Thank you. And your next question is from David Chiaverini of Wedbush Securities.

[David Chiaverini:]

Hi thanks. A couple of questions for you. A follow-up on deposits. You mentioned about how the commercial deposit services channel serving complex treasury management, commercial customers. I was curious, is there anything new with the product offering as you approach clients or was it this Las Vegas corporate banking team that was a big contributor there. I’m just curious if there is any change or anything new that helped drive the strong growth.

[Scott Kavanaugh:]

I would say that the main reason for - or the main changes that came about, historically, most of our clients have done more batch operations. And some of our clients have now gone to more of an online type banking situation, which has required some changes. So I would say we are much more dynamic than we previously were in how we handle those clients, which overall has made our systems better. But frankly, there really hasn’t been any product offerings or anything that has really changed other than meeting the demands of clients to upgrade to handle those types of online versus a batch.

[David DePillo:]

Yes. I would say, in particular, we did a conversion of our commercial system this year in order to service those clients. As Scott mentioned, there is several complexities as far as open API environment and our ability to service those clients that have I would say, more real-time needs versus nightly batch, which is a segment of the clientele. So yes, strategically, we made an investment in our transformation of our C&I platform to what we consider a best-in-class delivery mechanism. And it can service clients from one million to one billion. It really doesn’t matter. And our ability to handle large volumes of transactions significantly increase during that conversion process and post conversion process And as Scott mentioned, just outsized demand from our client base. Not necessarily that much is driven by the Vegas Group. They are particularly focused more on the loan side of the business, but they do provide us additional deposits through those relationships.

[David Chiaverini:]

Got it, that is helpful. And then shifting gears. This is more of a housekeeping question, but I saw the professional services and marketing line item and expenses jumped up a little bit. Is that a function of the merger charge, is that where that was?

[Kevin Thompson:]

Yes. All the merger charges are in that line That is correct.

[David DePillo:]

It is legal.

[Kevin Thompson:]

Yes. Legal and professional.

[David DePillo:]

Legal and professional.

[David Chiaverini:]

Got it. Thanks very much.

[Operator:]

We have no further questions at this time. I will turn the call back over to Mr. Scott Kavanaugh for closing remarks.

[Scott Kavanaugh:]

Thank you again for participating in today’s call. Very proud of the results we reported. All of our business lines are doing exceptionally well, and I’m very pleased that the path we are on. There are great opportunities related to our geographic expansion in the Dallas-Fort Worth Metroplex and in Florida, and we continue to invest in serving our existing markets in California, Nevada and Hawaii. 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.

[Operator:]

Thank you, everyone. This does conclude today’s conference call. You may now disconnect.