First Foundation Inc.

Greetings and welcome to FIRST Foundation's fourth quarter 2024 earnings conference call. Today's call is being recorded. Speaking today will be Thelma C. Schaefer, FIRST Foundation's Chief Executive Officer, and Jamie Britton, FIRST Foundation's Chief Financial Officer. Before I hand the call over to Mr. Schaefer, please note that management will make certain productive statements during today's call that reflects 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 Thomas C. Schaefer.

Thanks, Kate. Good morning and welcome. Thank you for joining us today for our fourth quarter 2024 earnings call. Before we begin, I'd like to provide a few remarks on the fires that have devastated so many communities in Southern California. We have been fortunate. Though we closed several branches for brief periods, none of our locations have been damaged, and none of our team members have lost their homes. At this point, we have been in close contact with four customers whose properties have been impacted and all had replacement cost insurance. I want you to know our team is continuing to monitor the situation, and we're all committed to supporting our communities and customers. I was appointed CEO of our company in late November of last year and have used the last two months to learn more about our current operations, our skills, and the standards employed throughout our organization. In the fourth quarter, we also added another distinguished director, Alan Parker, who brings a wealth of corporate governance and regulatory knowledge to our company. I'm delighted to be working with Alan, the rest of our board, and our team to help build First Foundation's next chapter for the success of all constituents. We have previously articulated our goals to diversify our loan portfolio and reduce our commercial real estate concentration. During the quarter, we sold $489 million of the multifamily loans reclassified to loans held for sale in the third quarter. We continue to have approximately $1.4 billion of multifamily loans held for sale in our balance sheet, and we are actively reviewing opportunities to continue selling the portfolio. Reducing our CRE concentration and lessening our dependence on high-cost and wholesale funding is among our highest priorities. It will not only improve our risk profile, but also contribute to stronger financial performance going forward. Proceeds of our first sale went to paying down high-cost broker deposits. As sales continue, each of our high-cost deposit portfolios will be reviewed for reductions in 2025. As you know, another area of focus has been our ACL methodology. We exited the year with another quarterly increase in our reserves to 41 basis points, up from 36 basis points reported in the prior quarter. In addition to the reserve build, we also recorded $17.1 million in net charge-offs. $13.4 million was attributable to three longstanding commercial relationships, and of the total, only $657,000 was associated with one multifamily loan. I'm still early in my tenure with First Foundation, but I'm making meaningful strides in reviewing our historical practices, and I'm already working with our team to establish standards appropriate for a $13 billion bank. As we transition our business mix and improve our risk profile, it will be important for us to also develop an operating framework that will support our sustainability in future periods, regardless of the interest rate environment. A couple of examples I'd like to share are in the areas of credit risk and interest rate risk. The team had already initiated a review of our CECL methodology, but we must also ensure we have standards in place to match our size and complexity. Strengthening our credit processes, controls, and analytics will drive more consistent credit decisions and is fundamental to mitigating future risks as we reposition our credit portfolios. The same is true for how we manage interest rate risk. Over the past year, the company has invested in resources to meaningfully enhance our treasury capabilities and perform a bottom-up review of the assumptions and methodologies driving our modeling. Moving into 2025, we are more confident in our abilities to understand the risk we are taking, and we will be working to develop an operating model, processes, and tools needed to leverage this information in all of our pricing and investment decisions. Migrating our model and establishing the standards necessary for success will take time, but as I continue to learn, I am pleased with the progress we have been able to make together in my first 60 days at First Foundation. This is such a critical area for our company, and I look forward to sharing with you our success as we move forward. I'll let Jamie go into more detail on the financials, but I'm happy to note another modest improvement in our net interest margin, which moved from 1.5% in the third quarter to 1.58% in the fourth. We've spoken previously of our optimism on the rate environment, but that unfortunately subsided at the end of the year. We do expect continued margin improvement in 2025. The first few rate reductions are a supportive tailwind, and continued actions to exit the relatively low-yielding loans moved to held for sale will continue to chip away at these headwinds. I'd also like to take a moment to note the continued success of our wealth and trust business. Both have been stable sources of fee income for our company, and their performance in the fourth quarter was no different. I'm excited about the opportunities we see for the future here. Not only are we investing in strengthening our platforms, but we're also recommitting to a culture of integrated support for our clients. Looking back on 2024, we have a lot to be proud of. It was an important year, but also a challenging one. And I would like to take a moment to thank our team for their commitment to First Foundation, welcome our new stakeholders, including our new audit partner, Crow, and thank you again for your continued interest in our company. Now I'll hand it to Jamie to walk through the financials. Jamie?

Thanks, Tom, and good morning. Starting with the balance sheet, as Tom noted, we continue to make progress on our strategic initiatives, successfully executing a $489 million multifamily loan securitization in early December. We remain confident in the economics of our multifamily portfolio and we're pleased to execute at a price above 95, which was a premium to where the overall health for sale portfolio was marked at the end of both the third and fourth quarters, 93.8 and 93.4 respectively. I would also note that following the quarter, we entered into a swap that will help mitigate fair value-related earnings volatility as we work to disposition the remaining help-for-sale loans. As expected, the reduction in loan balances was a factor contributing to lower loan interest income in the quarter, but our team moved quickly in deploying the proceeds and exited a similar level of high-cost broker deposits shortly after the close. The transaction overall provided a net benefit to net interest income, and we remain laser-focused on continuing to drive similar benefits through additional transactions in the first half of 2025. Broker deposits and other high-cost deposits, such as those contributing to our monthly customer service costs, are all candidates for reductions, and we will consider each as we work to balance the transition of our balance sheet and minimize impacts to our clients. Whether it's through increased net interest income alone or a combination of higher net interest income and lower customer service costs, we expect each loan disposition to contribute to improved financial performance going forward. Though improvements from the December securitization were minimal in the fourth quarter, our net interest margin benefited from the first three moves in the Fed's rate-cutting cycle, improving to 1.58% in Q4. The eight basis points quarter-over-quarter increase left NIM 41 basis points above the 1.17% we reported in the first quarter of 2024, the year's low point, and 22 basis points above the year-ago period of Q4 2023. While the margin expanded and we realized a 19 basis point improvement in our interest-bearing liability cost, our earning asset yield declined in the quarter. decreasing to 4.68%, which is seven basis points below the 4.75% reported in Q3 and in line with the 4.69% reported for the full year. Driven primarily by balance and yield declines in our commercial portfolio, overall total loan yields decreased in the fourth quarter, down six basis points to 4.71%. The anticipated decline in our cash positions yield following the Fed's initial rate reductions 5.47% in the third to 4.82% in the fourth, also contributed to the earning asset yields decline. The average balance in that portfolio remains elevated but is expected to be managed modestly lower over time as we work through our loan sale initiative, reduce our reliance on high-cost and wholesale funding, and migrate our balance sheet to the desired long-term, more sustainable business mix. Partially offsetting the lower yields in loans and cash, the quarter's newly purchased investment security yield of 5.36%, coupled with those on investments in the third quarter, to support the nine basis point yield improvements seen in the available for sale portfolio. Unlike the prior couple of quarters, the available sale portfolio's balance ended the quarter lower than its average. As demonstrated, however, by the investment portfolio's year-over-year growth, we remain comfortable using safe, high-quality securities to support our liquidity position, improve the balance sheet's rate profile, grow recurring revenue, and support investments in new relationship bankers for our markets and a more holistic product suite for our clients. Turning to funding costs, our MSR escrow deposit portfolio's average balance unexpectedly grew this quarter. We have described in the past that annual seasonal inflows and outflows will drive changes in our net interest margin through the year. Whereas in most years, we would expect to see some pressure on the margin this time of year due to our needing to match non-interest-bearing MSR deposit outflows with higher cost interest-bearing funding, that was not the case in the fourth quarter. Entering the first quarter with elevated MSR deposits, we expect the normal first quarter trough to be somewhat muted as well. As expected, the Fed's 50 basis point rate cut in September and the two 25 basis point cuts that followed in the fourth quarter benefited the quarter's interest-bearing liability costs, which declined to 4.05%, 19 basis points below the third quarter's 4.24%, and 14 basis points below the year-ago period's 4.19%. Since the cost on our $1.4 billion in FHLB advances remained effectively fixed at 4.08%, the benefit was driven by improvements in deposit costs. The full benefit of the reductions in our interest-bearing deposit costs will be reflected in the first quarter of 2025, but for the fourth quarter of 2024, costs declined by 25 basis points to 4.04%. Importantly, Monthly trends were such that rates exited the quarter below quarterly average rates in all categories except brokered CDs, which remained stable at approximately 5%. As mentioned, the proceeds of our December securitization were focused on high-cost broker deposits, which helped drive December's monthly interest-bearing deposit costs to 3.92%, or 43 basis points below the monthly cost of 4.35% in August before the first before the Fed's first rate cut. Excluding traditional brokered CDs, monthly interest-bearing deposit costs exited the year at 3.58%, or 53 basis points below the monthly August rate of 4.11%. We are pleased with these trends and look forward to the full quarter benefits they will provide in Q1 2025. As we proceed through the year and make progress on exiting the loans held for sale portfolio, we expect to be able to allow the brokered CD portfolio to mature without replacement. Approximately 47% of the $1.9 billion year-end balance, which is being carried at a weighted average rate above 5%, is maturing in 2025. Given the loans held for sale portfolio's sub-4% yield, exiting a portion of the loans held for sale balances alongside 2025's Brokered CDs maturities will eliminate meaningful drags on both net interest margin and net interest income. We appreciate our team's proactive approach in serving our clients' needs. The initial rate cuts this cycle have offered some flexibility in how we do that on deposit costs, and we are encouraged by the balanced growth we have been able to achieve with our core clients since the Fed's first move in September. balances in the retail and digital channels have increased over $75 million from the end of August to the end of the year. Before moving to the income statement, I would note again that following the end of the quarter, we entered into our second swap focused on hedging the balance sheet. The hedge will help reduce any earnings volatility related to our remaining loan sell-for-sale portfolio while also improving our overall interest rate risk position. We did not add any new swaps in the fourth quarter, but we fully expect this to be a valuable risk management tool for us, and we will continue monitoring for opportunities to further stabilize our rate profile and earnings going forward. Turning to income, with only the securities portfolio showing quarter-over-quarter interest income growth, total interest income declined from $157.2 million in the third quarter to $152.5 million in the fourth quarter. a $6.9 million decrease in interest expense more than offset the decline, leading to a $2.2 million increase in net interest income. Deposit expense was the largest driver of the improvement, but interest expense on borrowings also contributed following the repaying of our $260 million bank term funding program borrowings, which were being carried at a rate of 4.76%. In addition to net interest income, overall balance sheet contribution remains a focus. Despite higher average MSR-related deposit balances in the quarter, customer service costs declined modestly by $1.2 million from $19 million in the third to $17.8 million in the second. Combined with the improvement in net interest income, balance sheet contribution increased by $3.4 million. All else being equal, we expect further benefits in the first quarter as we see the full quarter benefits of declining non-brokered CD deposit rates and the removal of $480 million of relatively low-yielding multifamily loans. Provision for credit losses was significantly higher this quarter, with the largest factor being $17.1 million in net charge-offs. Comprising $13.4 million of the total was the full write-off of three commercial relationships with inadequate pay performance, sustained operating losses, and insufficient collateral protection. As Tom described, an important part of our pivot to a more sustainable business will be the implementation of important standards to guide our execution. We remain competent in the loan portfolio's credit quality, but we will continue to strengthen our risk management practices and and assess the portfolio accordingly. Also contributing to the quarter's net charge-offs were additional delinquent equipment finance loans with little to no collateral and the first loss in the history of our multifamily portfolio for $657,000. While our delinquencies remain relatively low today, we will continue to enhance our stress testing and adjust loan grading across the portfolio as appropriate. As a result of the moves in credit, our ACL balance increased from $29.3 million or 0.36% of total loans in the third quarter to $32.3 million or 0.41% of total loans in the fourth quarter. As our balance sheet mixes towards commercial loans and as we continue ensuring our credit risk management practices are appropriate for an institution of our size and complexity, further increases in the ACL coverage ratio are expected going forward. As a reminder, credit risk on the loan sell-for-sale portfolio is considered in its fair value adjustment instead of in the allowance for credit losses. Next, wealth and trust-related fees were $9.3 million during the quarter, in line with last quarter's $9.2 million. Assets under management were modestly lower for the quarter, ending at $5.4 billion. We remain pleased with the pipelines we see in businesses, and as mentioned previously, Investments in First Foundation Advisors and our Trust Department remain a strategic priority going forward. New investments will occur alongside our continued efforts to better serve clients by strengthening the integration between our banking and wealth offerings. Following the increase in market rates since the end of the third quarter, we recorded a $3.3 million fair value charge on the remaining multifamily loans reclassified to help for sale. This was more than offset, however, by the $4.4 million gain on sale recorded following the securitization. Given the continued interest we see in these loans, we remain confident we will be able to secure final pricing execution at strong levels. We expect to complete additional sales in the first half of 2025, but we expect to also recover some of our fair value mark as our clients make regular principal payments and and take advantage of opportunities to make prepayments or refinance their loans at par. Moving to non-interest expense, outside of customer service costs, remaining non-interest expense categories totaled $49.2 million for the quarter, up from $41.3 million in the third. The largest contributor to the $7.9 million increase was compensation and benefits expense, which finished $5.4 million higher than in the third. Tire production-related incentives were a factor, but the primary driver was year-end awards for our internally-focused, non-executive officer team members. Accruals for year-end awards were concentrated in the fourth quarter, but we felt it important to recognize our teammates for their continued efforts and dedication to our company. Occupancy and depreciation expense was impacted by a write-off of software development costs. And the remaining quarter-over-quarter increase was related to year-end property taxes and charges related to terminating the lease on a previously exited loan production facility. Increases in professional services and marketing fees were primarily driven by normal year-end activity and the resolution of a one-off legal dispute. As we move forward, we will continue making strategic investments for future growth, but we are committed to controlling our discretionary costs. And as we mentioned on last quarter's call, we'll ensure any plans for measured investments across our markets are both in line with our strategic objectives and ultimately supported by commensurate growth in revenue and profitability. Closing with capital, though we expect to report modest declines in regulatory capital this quarter, First Foundation Inc.' 's Common Equity Tier 1 capital benefited as part of our preferred shares, the Series B preferred, converted to common equity following our recent shareholder vote. The shift, however, reduced tangible book value for common share, which ended the quarter at $11.68 per share, or $2.11 per share lower than reported at the end of the third. As noted in our release, were all our remaining preferred shares, the Series A preferred, to convert to common equity, Our tangible book value per share for the fourth quarter would have been $9.36 per share. As Tom has noted, 2024 was a really challenging year for First Foundation, but an important one. And as always, I'd like to send a tremendous thank you to our team for the hard work you put in to make it a success. And with that, I'll turn it over to the operator to begin the Q&A session.