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First Foundation Inc. (NASDAQ:FFWM)
Q3 2018 Earnings Conference Call
Oct. 23, 2018 11:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Greetings, and welcome to First Foundation's third-quarter 2018 earnings conference call. Today's call is being recorded. [Operator instructions] Speaking today will be Scott Kavanaugh, First Foundation's chief executive officer; John Michel, chief financial officer; David DePillo, president of First Foundation Bank; and John Hakopian, president of First Foundation Advisors. Before I hand the call over to Scott, please note that management will make certain predictive statements during today's call that reflect their current views and expectations about the company's performance and financial results.

These forward-looking statements are made subject to the safe harbor statement included in today's earnings release. In addition, some of the discussion may include non-GAAP financial measures. For a more complete discussion of the risks and uncertainties that could cause actual results to differ materially from any forward-looking statements and reconciliations of non-GAAP financial measures, see the company's filings with the Securities and Exchange Commission. And now, I would like to turn the call over to Scott Kavanaugh.

Scott Kavanaugh -- Chief Executive Officer

Hey, good morning, and thank you for joining us. We would like to welcome all of you to our third-quarter 2018 earnings conference call. We will be providing some prepared comments regarding our activities and then we will respond to questions. As highlighted in the press release this morning, we delivered a quarter of strong financial results across key metrics of our business.

Our earnings for the third quarter were $14.7 million, or $0.33 per share. Total revenues were $55 million for the quarter and $141 million year to date. For the quarter, this represents an increase of 43% from the prior year. Our net interest margin expanded 29 basis points from the second quarter of 2018 to 3.12%.

And at the close of the third quarter, our loan to deposit ratio was 95.3%, as compared to 106.5% at June 30, 2018. Our efficiency ratio came in at 61.9% for the quarter. And as of September 30, our tangible book value was $9.71. As many of you know, we announced the remixing of our balance sheet last quarter, which included the sale and securitization of $622 million of our multifamily loans in a Q-Deal with Freddie Mac.

We are beginning to see the early benefits of this remix, and we anticipate additional benefits in the fourth quarter and beyond as we bring on new loans at current market rates. One of the good things about our business is that our balance sheet is more fungible than many other banks, and we anticipate doing another securitization at approximately the same time next year. On the credit front, we continue to maintain our credit standards as evidenced by our low levels of nonperforming assets and a minimal charge-off in the quarter. With regards to our noninterest income, we continue to increase our revenues from other lines of business.

Year to date, revenues for wealth management and trust increased by $1.6 million and $300,000, respectively. Our wealth management arm increased by $93 million in the quarter and ended the quarter at $4.3 billion. Related to our previously announced merger with Premier Business Bank, full integration is planned to be completed in the fourth quarter. We are very excited about the people who have joined our company and the opportunity that this presents.

Overall, it has been a strong quarter and we look forward to and are excited about the opportunities in 2019. At this point, I'd like to turn the call over to our CFO, John Michel.

John Michel -- Chief Financial Officer

Thank you, Scott. I will provide a brief summary of our financial results for the quarter. Diluted earnings per share for the quarter and year to date were $0.33 and $0.69, respectively. The results for the quarter were positively impacted by the $1.4 million gain on sale of loans and the recognition of $1.5 million of credit and yield discounts on the payoff on acquired loans, which combined added approximately $0.05 per share to our earnings for the quarter.

Net income for the third quarter in the first nine months of 2018 was 54% and 14% higher, respectively, than the corresponding periods in 2017. Total revenues for the third quarter and the first nine months of 2018 were 43% and 29% higher, respectively, than the corresponding periods in 2017. Loan originations during the first nine months of 2018 were $1.3 billion. As a result of our continuing loan production and the acquisition of Premier Business Bank in June, during the last six months, we have added over $1.4 billion of loans to our portfolio with the weighted average yields in excess of 4.5%.

During the first nine months of 2017, deposits have increased by $1.2 billion. As a result of our remix, which includes the sale of $622 million of loans, total assets, and total loans decreased during the quarter while we replaced cash held for liquidity purpose with higher-yielding securities. In addition, our FHLB borrowings decreased $431 million during the quarter and stand at $187 million at September 30, 2018. For the quarter and year to date, interest-earning assets increased 43% and 36%, respectively.

For the quarter, our net yield on interest-earning assets increased as the addition of higher-yielding loans and the recovery of credit yield discounts on the payoff of -- on acquired loans were only partially offset by higher rates on our deposits and borrowings. The recovery of $1.5 million of credit in yield discounts on the payoff on acquired loans added 11 basis points to our net yield. Our efficiency ratio for the third quarter of 2018 was 61.9%, as compared to 61.1% in the third quarter in 2017, as increases in revenues was offset by higher noninterest expenses. Increases in our noninterest expenses are related to our growth in loans and deposits, including increased staffing, the acquisition of Premier Business Bank in June of 2018, the implementation of upgrades to IT equipment and processing services and higher customer services -- higher customer service cost.

I will now turn the call over to Dave DePillo, president of First Foundation Bank.

David DePillo -- President, First Foundation Bank

Thank you, John. We had another strong quarter at the bank. As we continue to grow our loans and deposits, we are not compromising our credit standards and our originating loans at higher rates today than our existing portfolio, while we are focusing on growing lower cost deposits. During the third quarter in the first nine months of 2018, we originated $368 million and $1.3 billion in loans, respectively.

In addition, we added $523 million of loans from the acquisition of Premier Business Bank in June of 2018; and in the third quarter sold $622 million of lower-yielding multifamily loans as part of our remix strategy. The composition of our loan originations for the quarter were as follows: multifamily, 53%; C&I, 30%; single family, 14%; land and construction, 2%. Our pipelines remain strong and consistent with prior periods. The credit quality of our loan portfolio is strong as evidenced by our long level of delinquencies and our NPA ratio at 0.24%.

As of September 30th, our loan portfolio consists of 49% multifamily loans, 18% business loans, 10% nonowner-occupied commercial real estate, 21% consumer and single-family loans, and 2% of land and construction. Deposit growth remains strong at $1.2 billion increase in balances for the first nine months of 2018, $478 million of which came from the acquisition of Premier Business Bank. The remaining increase of $748 million was due to increases across our entire platform, including branches, specialty deposits and our wholesale channel. As of September 30, 2018, our 20 branch locations account for 46% of our total deposits.

We anticipate to continue to improve our efficiencies over time due to our increased scale and as we complete the remaining system integration of Premier Business Bank in the fourth quarter of 2018. I would now like to turn the call over to John Hakopian, president of First Foundation Advisors.

John Hakopian -- President, First Foundation Advisors

Thank you, David, and good morning. As Scott mentioned, our assets under management increased $93 million and ended the quarter at $4.3 billion. Year to date, we have added $195 million in assets under management from new clients as we continue to be successful in our business development efforts. Year to date, due to increases in our total revenue, our gross margin increased to 14%.

As we look at the current financial market, we have seen an uptick in volatility, which further demonstrates the merits of our investment philosophy and supports our strategy to invest for the long term. We maintain a strong pipeline and expect to continue to be successful in attracting new clients while maintaining our focus on servicing existing clients. At this time, we are ready to take questions, and I'll hand it back to the operator.

Questions and Answers:

Operator

[Operator instructions] Thank you. Your first question is coming from the line of Matthew Clark with Piper Jaffray.

Matthew Clark -- Piper Jaffray -- Analyst

Hey, good morning.

John Michel -- Chief Financial Officer

Good morning.

Matthew Clark -- Piper Jaffray -- Analyst

Can you break down your deposits by channel and just kind of quantify how much you have in wholesale, how much do you have in specialty, and then what the related cost is on both And what the new rates are coming in at?

John Michel -- Chief Financial Officer

Yes, in terms of break down, as Dave mentioned, 46% of our deposits are at the branch level. We don't have the breakdown between the rates right in front of us here, Matt. So I'd have to get back to you on that in terms of breakdown between the different groups.

David DePillo -- President, First Foundation Bank

I can kind of give you a sense of directionally where we're heading. We do have continued growth in specialty, however, we're focusing on areas that are low costing currently compared to our existing higher-cost segments that we've had in the portfolio traditionally, ones that are less sensitive to -- at rate moves and more as an accommodation to those types of clients. So at the branch level, although, we run a few deposit specials here and there, we've been very happy with the lag in the cost of funds in the -- at the branch level as those deposits are much more granular and continue to be very granular. So as we continue to grow our branch network up to 20, roughly half of our deposit base, as John mentioned, that will continue to grow.

And our expectations for next year is to grow approximately 50-50 between the two channels.

Scott Kavanaugh -- Chief Executive Officer

Yes. Certainly, the acquisitions have really benefited us in a rising interest rate environment while we've got these additional branches. I have been very pleased with the growth in those branches. And quite honestly, it doesn't take a lot to actually move the needle when you have 20 offices.

David DePillo -- President, First Foundation Bank

I think the bigger issue for us is, as we were aggregating our securitization loans, we were a little more dependent on wholesale borrowings, which over the last year have the -- rate of increase on those have much further outpaced any increase that we've had on the deposits or the cost side. So not being dependent on holding borrowings will certainly help the -- and will help going forward.

Matthew Clark -- Piper Jaffray -- Analyst

OK. And you may have mentioned it during your prepared remarks, but the weighted average rate on new business, new loans?

David DePillo -- President, First Foundation Bank

Well, right now, we have benefited from the medium end of the curve being fairly robust from what we've seen in prior years. But if you just take roughly a 3% benchmark five year and add a couple of hundred basis points, plus or minus, we're certainly -- our retail offerings typically to the street are over 5%. And that's just on the multifamily side, a little bit less on residential, but certainly higher on the C&I side. We're prime one plus typically on that.

So again, across the board, our weighted average yield on assets coming on the books today are certainly a lot greater than they were even two to three months ago.

Matthew Clark -- Piper Jaffray -- Analyst

OK. And then just as it relates to the margin, I guess, how do you -- is there some additional benefit from the recent restructuring still to come through the numbers? Or was that largely played out? Just want to get your sense...

Scott Kavanaugh -- Chief Executive Officer

Well, I think so. I think we're going to get additional benefit as we add more loans. And I think what we're also trying to get across is you'll probably see us do another securitization next year. So we'll be a little bit in the aggregation mode again.

But we're putting on some pretty decent coupons right now. And I think we will continue to see some benefits. Largely, I would say the remix was very successful in my opinion. And probably a majority of it is largely played out.

John Michel -- Chief Financial Officer

Yes. In terms of the securities themselves, they weren't put on till the very end of the quarter. So the benefit from the securities are replacing the cash that we had held before. Secondly, the reduction in the borrowings occurred during the quarter.

And at the end of the quarter, we're able to pay it down significantly. So those two aspects will be benefits for us in future quarters, both the yield and the securities, and the yield -- the lower debt offerings. And obviously, there will be some other counter pressures with rising interest rates.

David DePillo -- President, First Foundation Bank

So if you look at -- although we're more of an intermediate-arm lender, we tend to have a higher CPR on those portfolios. And anywhere from 12% to 15% of the portfolio naturally will turn year over year, which will benefit anywhere from 75 to 100 basis points higher based on current rates. Plus the fact that if we do another securitization of approximately the same size, that could be anywhere between another 10% and 15% of our loans remixing at higher rates. So anywhere between 20% to 30% of our loan portfolio can turn year over year at higher rates, which certainly helps maintain spreads even if we have continued pressure on the short end of funding cost.

Scott Kavanaugh -- Chief Executive Officer

Honestly, I think this goes back to what I said in the prepared comments about having a very fungible balance sheet. Having a large percentage of multifamily in the portfolio, I think we've demonstrated clearly now in previous years and even this year. In previous years, it was selling loans to financial institutions. This year, it was the securitization.

And so I think it shows in a rising interest rate environment that we have more than just one option at our hand that we have multiple options. And I don't think that's necessarily the case for every bank in those countries.

Matthew Clark -- Piper Jaffray -- Analyst

OK. Great. Thank you.

Operator

Our next question is from Steve Moss with B. Riley FBR.

Zach Weiss -- B. Riley FBR -- Analyst

Hi, good morning, everyone. This is actually Zach Weiss filling in for Steve this morning. I would appreciate any color or outlook on loan growth that you all have right now.

David DePillo -- President, First Foundation Bank

So our pipelines are really strong, and our expectations are we're going to probably originate as much as we did last year. I think the unique situation that we have is, we've far outpaced our ability to balance the assets at any level above probably what we've done through half of the year, let alone three quarters of the year. So our expectations are we should finish the year probably closer to exactly what we did last year, maybe a little bit higher. As we've indicated year over year, our third quarter is always a cyclical downturn in originations for us due to the summertime, just lack in demand during the period.

Second quarter and fourth quarters are usually our largest. So we anticipate -- our pipelines are strong. We'll have a really strong fourth quarter. And then there is -- our expectations are next year should be as good or better than what we did this year.

So I don't see any slowdown in loan growth at this point. We are by the way getting very good traction in our C&I channel. That's been almost four-year build-out for the bank. We're really starting to see good traction in that on good-quality C&I.

In a time where C&I is very competitive, we're getting good quality at where we feel is respectful rates in the market. And our other channels just continue to push along. We definitely have room for growth, and we still have capacity in our channels. So that's always a good sign.

Zach Weiss -- B. Riley FBR -- Analyst

All right, that's helpful. Thank you very much. And then in terms of expenses, is this level right here for the third quarter a good run rate? Or should we see any further improvements or cost reductions from the recent acquisition?

David DePillo -- President, First Foundation Bank

You know we have core systems integrations that will be completed in the fourth quarter. We just actually completed the first leg of that this weekend. So we still have some overhang of additional staffing that will be with us through the end of the year. And a little bit into the first part of next year.

I can tell you this that, given our platform and what we've added, our expectations is we shouldn't see material growth in our G&A expense, especially around our headcount. So we should see some benefit from that. We have very little on the way of new hires coming on, but I think the current run rate is probably reasonable.

John Michel -- Chief Financial Officer

Yes, it's reasonable. There is always two things that are cyclical in nature, one is on the customer service cost sides. We tend to have the balances and deposits go down during the winter months. So the costs related to the customer service costs are expected to go down over the fourth quarter and first quarter.

On the other side of the coin, as consistent with past years, in the first quarter, we always get hit 1) with raises; and 2) with larger proportion of our taxes, employer taxes, because of the payouts and the bonuses. So it's a rather substantial number, significantly higher than fourth quarter. And then it smooths out through the years, yet again decreasing into the fourth quarter. So that's something that's cyclical, and you can look at the last five years and you can see that kind of percentage change on that side.

So those are the two driving things. And then as Dave mentioned, the completion in the fourth quarter of the conversion will allow us to continue to have some cost saves going into next year.

Zach Weiss -- B. Riley FBR -- Analyst

All right. Thank you very much.

Operator

[Operator instructions] And our next question comes from the line of Andrew Liesch with Sandler O'Neill.

Andrew Liesch -- Sandler O'Neill -- Analyst

Good morning, everyone.

David DePillo -- President, First Foundation Bank

Good morning, Andrew.

John Michel -- Chief Financial Officer

Good morning, Andrew.

Andrew Liesch -- Sandler O'Neill -- Analyst

Just a question, John, on the $1.5 million or so of the payoffs from the acquired loans. Should we be assuming some level of payoff every quarter benefiting the margin? Or are these just more one-off in nature?

John Michel -- Chief Financial Officer

So these are more one-off in nature. I can tell you that actually, a third of that cost was from a loan that we acquired in 2015. Other activity is, just depends on the PCI loans. So these are the purchase credit impaired loans that when they picked up that we have reserves on.

This isn't a normal amortization of the loss of discount. The $1.5 million is actually on purchase credit impaired loans, so that's rather significant. That's what drives the number. But there's no predictability to it.

It's just the loans perform and pay off. At an earlier time or when they're exposed to, then we'll receive some benefits on reserves we set aside. But there's no guarantee, and I can tell you that I have no predictability over the last four levels that we have.

Andrew Liesch -- Sandler O'Neill -- Analyst

And then just on credit, no real questions there or any concerns. But I'm curious if you're seeing anything in the market that's giving you guys any concern. Any underwriting weakness anywhere? Or anything that's giving you guys some pause going forward?

David DePillo -- President, First Foundation Bank

Well, obviously, there's sort of few very, very large players in our market, one of which is the largest bank around, and they're actually holding their credit standards extremely strong. I think in general, what we're seeing is lenders are more cautious today than they were a year ago or two years ago because we -- everyone feels we're somewhere at the latter end of the cycle. We're not sure if there is a major correction two years out, one year out, three years out, but it's certainly, it's not '09 going into a 10-year of growth. So I think, everyone in the market is more cautious.

Our LTVs are at historical lows at origination. Part of that is, there is less cash flow spread around over higher interest cost. We're seeing our C&I clients be a little bit more cautious around excessive borrowings due to the fact that they've seen the cost of borrowings almost double in the last few years, given that most of them borrowed at the short end. And then on the residential side, we are seeing a little bit of slowdown in the appreciation and asking prices in the market.

But our average LTVs are in the 50s on that book of business as well. So there's a lot of room to fall still. Yes, I would say lenders are little more cautious, which are moderating the market and is what we like to see. What we aren't participating in is people chasing yield and other asset classes that tend to get a little overheated when you are toward the middle to the latter part of a growth cycle.

So we're going continue to focus on our core growth, which is our markets here in multifamily, our continued cautious growth in the C&I world and then our traditional client support in the consumer side. But outside of the few anomalies we've seen from other people reporting credits that are now starting to show weakness, we're not seeing competition going down a rabbit hole, so to speak, on credits.

Andrew Liesch -- Sandler O'Neill -- Analyst

All right. That's good to hear. Thanks, I'll step back.

Operator

Our next question comes from the line of Gary Tenner with D.A. Davidson.

Gary Tenner -- D.A. Davidson -- Analyst

Thanks. Good morning

John Michel -- Chief Financial Officer

Good morning, Gary.

Gary Tenner -- D.A. Davidson -- Analyst

Just wanted to ask about balance sheet management and capacity with the securities portfolio growth this quarter with the proceeds of the securitization. Is that number near $800 million kind of where you'd like to maintain it? Or as you think about utilizing cash flows from the portfolio to fund future loan growth? How do you think of the balance there in terms of using the cash?

Scott Kavanaugh -- Chief Executive Officer

Well, as you know, the regulators expect all banks to keep a certain percentage of liquidity. I'll say that we kept it -- with this -- we obviously believed in the loans that we have securitized through Freddie on the Q-Deal. And quite honestly, I did not add to the securities portfolio in the last two years, because the yield curve -- actually almost three, I guess, because the yield curve was so flat. I've always stayed pretty simplistic by just buying 15-year pass-throughs.

And so as the yield curve flattened out, it didn't make sense to put on seven-year duration mortgage-backed securities yielding with a two handle. So as a result, this was a great opportunity for us to be able to replenish the securities portfolio. But what I would say, Gary, is expect to see that draw back down over the course of time. One of the things I did not want to do, and what we realized was during the quarter, if you looked at last quarter's balance sheet, we were selling approximately $350 million in cash.

Well, we were selling that at a loss, and that hurt net interest margins obviously a lot. So I think we've seized on an opportunity to be able to put on some securities of what we thought were good yield. And now you'll see that as prepays come in month to month, you'll see that circle back down.

Gary Tenner -- D.A. Davidson -- Analyst

OK. And just as a reminder, the incremental securities put on from the securitization are about 100 basis points lower than the loan yield would would have been? On the like...

David DePillo -- President, First Foundation Bank

No. It's actually less than that.

John Michel -- Chief Financial Officer

About 80.

Scott Kavanaugh -- Chief Executive Officer

It is less than that.

David DePillo -- President, First Foundation Bank

About 80.

Scott Kavanaugh -- Chief Executive Officer

Yes. Well, that whack on the loans was 381. The effective yield on the securities was 320.

David DePillo -- President, First Foundation Bank

Yes, so 60.

Scott Kavanaugh -- Chief Executive Officer

60.

Gary Tenner -- D.A. Davidson -- Analyst

OK. Perfect. Thank you.

Scott Kavanaugh -- Chief Executive Officer

But you got to remember, Gary, we were selling cash at 190 or 195.

David DePillo -- President, First Foundation Bank

Yes. The way we look at it is, if you're -- it's the replacement of securities, short duration, about three and a half years with a 320 effective yield which is -- it's pretty hard to find that in the market anywhere. Hopefully, that's been there at extremely high cash flow.

Scott Kavanaugh -- Chief Executive Officer

Yes.

Gary Tenner -- D.A. Davidson -- Analyst

Great. Thank you.

Operator

Our next question comes the line of Don Worthington with Raymond James.

Don Worthington -- Raymond James -- Analyst

Thank you. Good morning, everyone.

John Michel -- Chief Financial Officer

Good morning.

David DePillo -- President, First Foundation Bank

Good morning.

Scott Kavanaugh -- Chief Executive Officer

Good morning.

Don Worthington -- Raymond James -- Analyst

Just following up a little bit on the discussion of getting traction in the C&I sector. What's the average loan size of your C&I book, and any sector concentrations there?

David DePillo -- President, First Foundation Bank

Yes. I would say, we would consider ourselves mid-market and below. And when I say mid-market, we touch mid-market, I would say at the lower end. The average size of our loans were a few million dollars.

We do have some larger relationships. So we're really -- by adding a small balanced program through a product called Mirador at our branch level, adding SBA 7(a) along with 504 over the past several years. And then now having a traditional, what I would say, more of a community bank focus on C&I, our granularity is terribly good. So sector-wise, we're about as diversified as you could probably hope for with, I would say, a little bit of concentration around real estate services just because California tends to be a little more focused around real estate services.

But we don't have any, I would say, concentration in one specific area. It's a very broad-based book, and we monitor it very closely from that perspective. So it's anywhere from service manufacture all the way to pure real estate services, and then we have some very little on the way of agriculture.

Scott Kavanaugh -- Chief Executive Officer

Manufacturing.

David DePillo -- President, First Foundation Bank

We have obviously, some manufacturing within California. We actually have some in Hawaii and a little bit in Nevada as well.

John Michel -- Chief Financial Officer

Yes. And geographically, it's pretty diversified also. It's not concentrated in any one area in California.

Scott Kavanaugh -- Chief Executive Officer

Yes.

Don Worthington -- Raymond James -- Analyst

OK. Great. All right. Thank you.

Operator

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

Scott Kavanaugh -- Chief Executive Officer

Thank you everyone for taking the time today. We certainly appreciate it. Overall, we are pleased with our results and look forward to speaking with you next quarter. Have a great remainder of your day, and thank you once again.

Operator

[Operator signoff]

Duration: 33 minutes

Call Participants:

Scott Kavanaugh -- Chief Executive Officer

John Michel -- Chief Financial Officer

David DePillo -- President, First Foundation Bank

John Hakopian -- President, First Foundation Advisors

Matthew Clark -- Piper Jaffray -- Analyst

Zach Weiss -- B. Riley FBR -- Analyst

Andrew Liesch -- Sandler O'Neill -- Analyst

Gary Tenner -- D.A. Davidson -- Analyst

Don Worthington -- Raymond James -- Analyst

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