First Foundation Inc. (FFWM) Q1 2024 Earnings Call Transcript

First Foundation Inc. (NYSE:FFWM) Q1 2024 Earnings Conference Call April 25, 2024 11:00 AM ET

Company Participants

Scott Kavanaugh – President & Chief Executive Officer
Jamie Britton – Chief Financial Officer
Chris Naghibi – Chief Operating Officer

Conference Call Participants

David Feaster – Raymond James
Gary Tenner – D.A. Davidson
Andrew Terrell – Stephens

Operator

Greetings and welcome to First Foundation’s First Quarter 2024 Earnings Conference Call. Today’s call is being recorded. Speaking today will be Scott Kavanaugh, First Foundation’s President and Chief Executive Officer; Jamie Britton, First Foundation’s Chief Financial Officer; and Chris Naghibi, Chief Operating Officer.

Before I hand the call over to Scott, please note that management will make certain predictive statements during todays 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 President and CEO, Scott Kavanaugh. Please go ahead.

Scott Kavanaugh

Hey, good morning, and welcome everyone. Thank you for joining us for today’s first quarter 2024 earnings call. As the banking industry continues to face headwinds and a continued inverted yield curve, I am proud of our team for the effort put forth to make the company stronger. I have never felt as comfortable with a management team in my entire career as I fill with the team that we currently have in place.

Once again, we were able to improve our loan-to-deposit ratio, maintain overall loan yield, and continued the process of improving the sensitivity of our balance sheet to changing interest rates.

Most importantly, we took great strides to improve recurring revenue and reduced core expenses to increase future profitability. First Foundation advisors closed the quarter at near record assets under management and the trust department posted another good quarter.

For the first quarter, we reported net income attributable to common shareholders of $793,000 or $0.014 per share for the basic and diluted shares. Tangible book value, which is a non-GAAP measure ended the quarter up $0.05 from the fourth quarter of 2023 and ended at $16.35.

Pre-tax pre-provision revenue totaled $0.5 million essentially unchanged from the fourth quarter. Interest income totaled $150.5 million for the quarter compared to $146.6 million as of December 31, 2023 and $137 million for the first quarter of 2023.

Non-interest income as a percentage of total revenue was 25% for the quarter compared to 25% for the fourth quarter of 2023. Our net interest margin was 1.17% as compared to 1.36% for the fourth quarter of 2023. This was largely driven by the return of MSR deposits returning later in the quarter as opposed to earlier in the quarter. Non-interest expense decreased to $50.6 million in the quarter compared to $55.9 million in the prior quarter.

Our efficiency ratio improved to 98.4% compared to 98.5% for the fourth quarter of 2023. Adjusted return on assets again another non-GAAP measure ended the quarter at 0.03% compared to 0.09% as of December 31, 2023. Our loan-to-deposit ratio improved to 94.8% in the quarter compared to 95.2% as of December 31, 2023. 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. I just returned from Florida visiting our branches and I am extremely encouraged by the growth we are experiencing in many of those branches and throughout our entire branch network. Our deposit pipeline remains robust into the second quarter.

Management made a strategic decision to exit the equipment finance operations late in the first quarter. As most of these loans were originated using third parties, we felt that it did not fit our overall goals of getting back to our roots of relationship banking. We still will be able to accommodate our value clients’ needs as necessary for any of their equipment financing needs.

We currently plan to continue servicing the remaining loan portfolio, but exiting the space will provide approximately $1.5 million in annualized cost saves. Total deposits were $10.64 million in the quarter compared to $10.69 million in the fourth quarter. Core non-brokered deposits increased to 64% during the quarter compared to 60% in the fourth quarter of 2023.

Noninterest-bearing demand deposits increased to 17% for the quarter compared to 14% of the deposits in the fourth quarter of last year. As indicated earlier, our deposit pipeline remains healthy, with most of the pipeline being a noninterest-bearing category. Our insured and collateralized deposits were at 85% of total deposits at the end of the quarter compared to 87% of total deposits in the fourth quarter.

We maintained a strong liquidity position of $4.4 billion. At these levels, our liquidity to uninsured and uncollateralized deposits ratio was 2.7 times. Borrowings were $1.7 billion as of March 31, 2024 compared to $1.4 billion at the end of the fourth quarter.

Average borrowings outstanding were $1.6 billion or 11.8% of total average assets for the quarter compared to $1.1 billion or 8.7% of total average deposits for the prior quarter. The increased average borrowings from the prior quarter were used to enhance on-balance sheet liquidity and as cash and cash equivalents increased to 11.7% at the end of the first quarter from 10% at the end of the fourth quarter of last year.

Credit quality continues to serve as a crucial differentiator for First Foundation. Our nonperforming assets to total assets was 0.18% and at the end of the first quarter compared to 0.15% as of December 31, 2023. Loan balances ended the quarter at $10.1 billion, a reduction of $100 million compared to December 31, 2023.

It is important to note that loans would have grown for the quarter, but we had several C&I loans totaling approximately $200 million pushed into the second quarter. Many of these loans have already funded or will fund in the next several weeks. These additional C&I loans will have a net spread of over 3%.

Multifamily remains a strong asset class for the bank. Our underwriting on these loans has never wavered since the company’s inception. This sector of the CRE gained refocused attention in the first quarter with events on the East Coast. Chris will provide significant detail on this segment later in the call.

First Foundation Advisors grew approximately $200 million to end the first quarter at $5.5 billion, compared to $5.3 billion at December 31. Our pipeline of new relationships remain strong. Assets under advisement at FFBs trust department was $1.2 billion for the quarter compared to $1.3 billion in the fourth quarter.

During the quarter, management worked diligently to build additional recurring revenue. Most of the revenue generation was added in the middle of the first quarter or as I mentioned, funded at the beginning of the second quarter so the full benefit were not reflected during the first quarter. This included adding investment securities to our AFS portfolio and swapping rates to a fix a spread and adding additional C&I loans and core deposits.

We will continue to strategically add hedges to both improve recurring revenues and reduce our interest rate sensitivity. Jamie will provide greater insight on this section. Once again I will close by reiterating my appreciation for the incredible efforts and unwavering dedication of our entire team.

I will now turn the call over to Jamie to cover the financials in greater detail.

Jamie Britton

Thank you, Scott. I’ll start with the balance sheet and our net interest margin. As Scott mentioned, NIM contracted 19 basis points during the quarter from 1.36% in the fourth to 1.17% in the first. There’s another slight improvement in our earning asset yield this quarter, which increased from 4.62% in Q4 to 4.64% in Q1.

Earning asset yields begin with loan yields, which remained stable at 4.7%. The held-to-maturity portfolio yield improved slightly by two basis points, while the yield on the available-for-sale portfolio declined modestly by seven basis points as we continue to reposition the investment portfolio to support our liquidity position, improve the balance sheet rate profile, and more efficiently enhance recurring revenue.

There were several factors contributing to the change in the AFS portfolio yield, but the most noteworthy was taking advantage of the market’s early quarter optimism for declining rates by adding securities in conjunction with new short-term funding which we swap to a more attractive longer-term fixed rate. This transaction provides additional rate insensitive recurring revenue and due to the execution timing several weeks into the first quarter, we expect it to provide additional benefit in the second and beyond.

As I mentioned, we are open to acquiring safe highly liquid securities at attractive yields and considering transactions that help us to achieve our desired long-term interest rate risk profile and mitigate the earnings risk of future short-term rate increases. To the extent we can use some of our improving capital position to also enhance recurring revenue in this type of safe and prudent way all the better.

Moving to the right-hand side of the balance sheet, the most important thing to highlight is the seasonal nature of our non-interest-bearing deposit portfolio and its MSR escrow balances which began their normal annual outflows later in the fourth quarter before beginning to rebuild late in the first.

As we noted on last quarter’s call, amidst the seasonal transition we also had some balances leave the bank due to our customers’ desire to diversify their exposure across additional banks. This too drove some of the quarter-over-quarter decline we saw in average balances.

We appreciate our customers’ proactive approach to their own risk management and welcome the improved diversification it provides in our own deposit portfolio as well. We believe the strong multiproduct relationships we foster in this business are contributing to its overall growth and we fully expect more deposit balances to continue building in the second quarter.

Accompanying the decline in average non-interest-bearing deposits was another quarterly decline in customer service costs, which we have seen decline from $24.7 million in the third quarter of 2023 to $16.4 million last quarter and only $10.7 million in the first.

As we’ve discussed previously the mix to interest-bearing liabilities, which we secure to replace declining non-interest-bearing balances, will begin — will weigh on our net interest margin and it was a factor again this quarter.

But the quarter’s balance sheet actions overall were net accretive to earnings when considering both net interest income and customer service costs. Given the holistic nature of these relationships, we are comfortable with the seasonal fluctuations they will cause in our margin.

Interest-bearing liability costs increased modestly this quarter from 4.19% in the fourth to 4.24% in the first. Though borrowing costs remained relatively stable, interest-bearing deposit costs increased by seven basis points to 4.28%. Factors included an increase in our mix of higher cost deposits, which as I mentioned a moment ago, we’re used to absorb the seasonal declines in non-interest-bearing MSR balances.

Additional client migration to higher rate products such as CDs, ahead of potential declines in short-term market rates and continued competition in the market for balances driving rate accommodations in the retail channel. We remain pleased with our retail business’ performance and believe it is an important driver of our long-term success despite the modest increases, it may continue to drive in the bank’s deposit costs near term.

Stepping back to consider overall deposit costs, monthly trends exited the quarter favorably. A majority of our products showed improvement throughout the quarter and March’s total interest-bearing deposit costs were in line with the quarterly average of 4.28%. We have improved our monitoring and analytics in this area and our teams are working as proactively as possible to hold the line while we wait for greater certainty in the rate market.

As you will see, we continue to make progress on strengthening our balance sheet both our on-hand liquidity and our capital positions are much stronger than they were before we entered this phase of market uncertainty. And as Scott mentioned, our focus on full relationship banking is paying dividends in terms of recurring revenue and earnings stability.

The new securities we added in conjunction with swapped fixed rate funding, over $150 million of outstanding loan balances, fully self-funded by customer deposits at 3% spread and the savings gain by exiting the Equipment Finance business, will generate almost $13 million of recurring annualized pre-provision net revenue.

We will continue to monitor the rate environment for opportunities to take advantage of our liability sensitivity and pivot towards a more sustainable long-term interest rate risk profile but our continued focus on relationship banking and day-to-day execution will continue to be the keys to drive long-term shareholder value. We’re encouraged by our successes in the first quarter as well as here in the start of the second and we remain optimistic on the year ahead.

Moving to the income statement. Interest income continued to grow ending the quarter at $150.5 million versus $146.6 million realized in the fourth. As discussed, interest expense was added to account for the quarterly declines in average non-interest-bearing MSR deposit balances.

Though this drove a 19 basis point reduction in our net interest margin and a $4.1 million decline in net interest income, when considering the concurrent $5.7 million decline in customer service costs, the balance sheet’s overall contribution to pre-tax pre-provision net revenue improved for the quarter.

We expect the net interest income to benefit from increasing non-interest-bearing deposit balances in the second quarter but more importantly, we believe the actions we are taking to improve recurring revenue will continue to enhance balance sheet contribution.

Moving to the rest of the income statement. Wealth and Trust related fees were flat for the quarter at $8.6 million, as Scott mentioned, however, AUM continued its strong performance increasing point-to-point again this quarter and exceeding the $200 million of growth seen in the fourth.

AUM ended the quarter at $5.5 billion, $300 million higher than at year-end 2023 and $500 million higher than at the end of the third quarter. We are encouraged by the FFA team’s continued success and look forward to taking our history of exceptional proven customer service to the high-growth Texas and Florida markets.

Outside of customer service costs remaining non-interest expense categories totaled $39.9 million for the quarter, modestly higher than the fourth quarter’s $39.5 million. As expected, compensation and benefits increased this quarter as a result of annual adjustments and tax resets while all other categories saw modest quarter-over-quarter declines.

Maintaining core expenses at responsible levels remains a focus. And as I mentioned, we expect the decisions made to exit equipment finance to mitigate growth here. As Scott and I have mentioned several times, the entire organization is laser-focused on improving operating efficiency and controlling these discretionary costs.

First Foundation made some very difficult decisions in 2023 to reduce expense during the market’s volatility. As profitability returns, taking advantage of the opportunities available in North Texas and Southwest Florida will require measured investment, but holding aside customer service costs, we intend to maintain our best-in-class expense to assets ratio.

Moving finally to capital and liquidity. We expect another significant improvement in First Foundation Inc’s total risk-based capital ratio, which we estimate will be 12.49% and or 22 basis points higher than that in Q4 and 105 basis points higher than its Q1 2023 level. We believe our strong capital base positions us well for growth, once uncertainty around the economic environment subsides.

It also provides a relatively strong risk capital balance versus peer when considering our held-to-maturity portfolio is favorable after-tax unrealized loss position of $60.1 million or only 6.6% of tangible common equity, which is slightly higher than last quarter, but still well positioned relative to peer and second, our strong liquidity position and low levels of uninsured and uncollateralized deposits, which, as a reminder, are those that prove to be the most vulnerable during times of significant stress.

As noted, our uninsured and uncollateralized deposits stand at only 15% of total deposits, and this will continue to improve through the year as MSR-related deposit balances return.

As I mentioned before, we are pleased with the stability we have achieved in our liquidity position and we are comfortable with the level of on-balance sheet liquidity we are holding today and confident our total available liquidity of 2.7 times uninsured and uncollateralized deposits is more than sufficient to mitigate risk should market volatility return.

I echo Scott’s comments on the team’s continued efforts and dedication to First Foundation, and I remain confident we are positioned for success moving forward.

With that, I’ll now turn it over to Chris to provide additional detail on our loan portfolio, asset quality and important distinctions and opportunities within our multifamily portfolio. Chris?

Chris Naghibi

Thank you, Jamie. I will be spending a fair amount of time addressing our multifamily portfolio, our reserves and the benefits of rent control in the marketplace that are being wildly misunderstood by the market.

I will also speak to the stability and growth of our deposit franchise. As quarter-over-quarter comparison illustrates, we continue to reduce our multifamily concentration exposure by leveraging our existing robust C&I platform to diversify into index plus margin-based product. This renewed relationship prioritized focus has yielded quarter-over-quarter deposit growth and truly signals the strategic pivot and return to our core ethos of a franchise value driven by relationships and not transactions.

We continue to be committed to a healthy gradual cadence of an increasing CECL reserve, which will be a natural byproduct of greater C&I growth in the portfolio. Characteristics of the C&I asset class as well as the historical data supports greater reserves for C&I product than those for multifamily real estate.

I will be discussing this specifically as it relates to multifamily in detail shortly. For now, let us quickly summarize the metrics of our diverse and strong loan portfolio, which as of March 31, 2024, remains composed of 51.9% multifamily loans down from its height of approximately 54% as of Q3 2022. 32% commercial business loans, including owner-occupied commercial real estate and legacy equipment finance compared to approximately 28% as of Q4 2022. 9% consumer and single-family residential loans, 6% non-owner-occupied commercial real estate and approximately 1% of land and construction loans.

Loan fundings continue to be comprised of primarily high-quality adjustable rate C&I, SBA and mortgage lending totaling $302 million for the first quarter offset by loan paydowns and payoffs of $393 million in the quarter as lower yielding fixed rate loans continue to pay down, you can anticipate seeing the benefits in the net interest margin as well as the aforementioned reserve increasing.

Driving down our commercial real estate exposure to yield a greater balance between fixed and variable rate lending we’ll take a measured long-term approach. As a reminder, over the near term, we are taking a cautious protectionary lending approach with our existing multi-family portfolio.

And as a result, the fixed rate portion of the portfolio will comprise a smaller and smaller percentage of the whole. Given the relatively short duration of the multifamily asset class, which is less than two years, the cash flow focus of most investors, we anticipate a future benefit of anticipated re-pricing activity.

As shown in a new slide, within the investor presentation, we believe the repricing opportunity in a higher rate environment is meaningful, and we are proactively working with our clients to ensure they are prepared well in advance of considering their alternatives.

On a long-term basis, we need to be and we will be more diversified overall on all our underlying assets. Despite regional pressures in rhetoric around certain geographical challenges in multifamily housing, we remain confident in the asset class, particularly, our unique workforce housing exposure within the broadly defined sector.

On previous calls you have heard our teams speak to the value of workforce housing in the face of record low housing affordability. I want to spend some time here and break down the nuances of the asset class with a focus on our California concentration and specifically Los Angeles County where approximately 51% of our multifamily real estate portfolio is concentrated as a proxy for the widespread misunderstanding contributing to unfounding comparisons to different markets.

Workforce housing refers to residential units that are affordably priced for middle-income workers such as teachers, firefighters and healthcare workers, who are essential to the functioning of a local economy in our primary lending area. These housing units are typically priced to be affordable for individuals and families earning between 60% and 120% of the area median income.

Looking at Los Angeles County as an example, as of 2023 the area median income for a four-person household was set to $10,900 by the Los Angeles County Planning Authority. The goal of workforce housing is to provide housing options that are within a reasonable cost range allowing these workers to live near their places of employment. This is not only beneficial for the employees, but also supports the overall economic health and sustainability of our communities.

As a financial institution, our investment in workforce housing represents a strategic opportunity to foster community development, while stabilizing our asset base with real estate that historically has evidenced steady demand through economic cycles.

Going on the real estate offensive, Blackstone’s $10 billion acquisition of private Apartment Income REIT an owner of upscale apartment buildings is Blackstone’s largest transaction in the multifamily market according to the Wall Street Journal.

AIR communities touts a portfolio of underlying assets primarily in coastal communities like Boston, Miami and Los Angeles. As I mentioned a moment ago, approximately 51% of First Foundation Bank’s portfolio of multifamily residential is located in Los Angeles County. These assets have a current weighted average loan-to-value of 54.8% with a conservative best-in-class underwritten weighted average current principal and interest debt service coverage ratio of 1.36x.

If we can learn anything from the behaviors in the market right now it is that CRE and multifamily pricing indices based on stock prices are not always the best proxies for real-world valuations. Blackstone’s CEO, Jon Gray has even gone so far in recent months to make the case that commercial real estate prices were bottoming and that now is a “good time to buy.”

If you that according to rental housing economist J. Parsons is increasingly accepted in multifamily where the consensus outlook now seems to be that multifamily is well-positioned for growth by 2025 through 2026 after working through a multi-decade high supply wave. This is on the heels of US apartments posting the strongest Q1 leasing demand in 20-plus years following a healthier than anticipated Q4 2023 according to real data.

From a historical perspective Moody’s Analytics data highlights that the lowest occupancy rate in Los Angeles since 2007 has been 95.20%, which occurred in 2009 and as of 2023 the occupancy rate was approximately 96.80%.

During this time asking rents have increased in all but three years 2009, 2020 and 2023 which saw decreases of negative 4%, negative 4% and negative 2.3%, respectively. Asking rents in aggregate from 2007 to 2023 including these decreases totaled approximately 59.3% or an average increase of 3.49% per year.

Strong occupancy and steady rent increases are obviously very positive for multifamily and a couple of the reasons First Foundation Bank has never experienced a loss in its multifamily portfolio. Across the same 17-year Moody’s analysis period for all California commercial banks average net losses in multifamily were reported in only five years 2008, 2009, 2010, 2011 and 2012 with losses of 0.03%, 0.2%, 0.29%, 0.13% and 0.03%, respectively. These losses came at a time when the Great Recession had exposed some liberal underwriting standards, including underwriting to pro forma rents, underwriting to low or even breakeven debt service coverage ratios and/or underwriting to the subject property without considering sponsorship. At no point in First Foundation’s history has the bank ever underwritten with anything other than its stable conservative time-tested methodology.

This includes a lower of in-place or market rents averaging historical, repairs and maintenance of a period no less than two years the greater of actual vacancy or market vacancy and grossed up expense costs. The bank underwrites to full principal and interest payments even for interest-only loans and the bank underwrites a sponsorship on all non-recourse loans. As a reminder, California is a single action state under California’s one action rule a lender can only take one action against you, whether it is to conduct a trustee sale so on the promissory note for the balance of the debt or judicially foreclose.

This saves a tremendous amount of time in the worst case event scenario of a default when compared to many other states. Another question we received is whether we stressed expenses enough during the underwriting, as there has been a lot of conjecture about expense increases in the state of California, particularly insurance and taxes, which many falsely believe will guarantee degraded cash flow over time. I wish I could say California has ever been a cheap state to insurance it has not.

Wildfires flooding and earthquakes have long impacted the state and insurance costs have reflected this for decades. Regions like Florida and Texas have seen significant increases with average insurance cost per unit growing approximately 37% and 43% respectively from 2020 to 2022. California’s insurance market is tightly regulated with Proposition 103 passed by voters on November 8, 1988 requiring insurers to obtain state approval for rate changes. This regulation can and does influence the overall insurance cost landscape, but it didn’t stop the average insurance cost per unit for multifamily apartments from jumping approximately 33% over the three-year period from 2020 to 2022.

While impactful to bank’s underwriting pro forma insurance coverage in California assumes no less than a 20% or more increase per year for a new loan. When it comes to taxes, Proposition 13 passed by California voters in 1978 significantly impacts all real estate properties in California, including multifamily apartments. Its primary effects are on the property tax rate assessment procedures and reassessment time lines, which have broad implications for property owners including First Foundation’s customers owning and managing multifamily apartment buildings.

Proposition 13 capped the annual real estate property tax at 1% of the assessed value plus any voter-approved local taxes and assessments. This cap applies to multifamily apartments providing a predictable tax expense for property owners by limiting how much property taxes can increase each year Proposition 13 has made it somewhat more feasible for investors to hold on to multifamily properties over the long-term without facing significant tax hikes providing for predictable future expense figures and is an incentive to hold assets long-term.

The proposition also restricts the assessment of property values to when the property is bought, newly constructed or undergoes a change in ownership. For multifamily apartments, this means that the property tax basis is essentially set at the time of purchase and only increases at a maximum of 2% per year until the property is sold or significantly renovated. This also means that the repairs and maintenance figures for capital expenditures averaged over two years or more generally captures units being renovated as units turn over.

To answer directly those asking whether we sufficiently stress expenses during our underwriting, yes. We assume enough stress in our underwriting. With stabilized predictable expenses and conservatively underwritten gross potential income clarified the elephant in the room, as it relates to multifamily in California is the unwarranted stigma around rent control laws. I will say it here clearly, when underwritten appropriately rent control insulates lenders from risk and potential downside. It also makes for stable predictable returns for multifamily investors.

Rent control laws in the United States to exhibit significant variance influenced by state-specific legislations and the autonomy granted to local governments. Notably 31 states restrict local authorities from enacting rent control measures, underscoring a complex national landscape of housing regulations. Unfortunately to understand how this impacts multifamily loans and those making them requires a deep regional and nuance based understanding of each submarket.

Take for example California and New York, which offer two distinct approaches to rent control. In California the statewide rent control law signed by Governor Newsom in 2019 caps rent increases at 5% plus inflation subject to certain conditions and exceptions. This legislation empowers local jurisdictions to adopt stricter controls, highlighting California’s layered response to rent control deeply rooted in its housing history.

Los Angeles for instance has been grappling with rent control and affordability housing since the 1940s, marking a significant legislative milestone in the early 1940s and in the late 1970s, which are far more restrictive in the recent statewide legislature. Conversely, New York’s rent control paradigm is notably more localized and intricate with a focus on New York City. The state’s legislative framework distinguishes between rent-controlled and rent-stabilized units, reflecting a tailored approach to address the city’s unique housing market dynamics.

The Housing Stability and Tenant Protection Act of 2019 further expanded tenant protections indicating New York’s progressive stance on housing regulation. All of this to say that the changes made to New York City’s rent control appear to have been the catalyst for the challenges in their multifamily market. The loose landlord-friendly regulation in place for more than 20 years before 2019 gave way to what appears to have been some degradation of lending and underwriting standards by market area banks, which is contributing to hypothetical unrealized potential losses today.

Weaker underwriting requirements closely tracked what was allowable under the law instead of the more conservative and more normalized practices for similarly situated properties in other states. As money poured into the market to take advantage of the pre-2019 regulations, it is impossible to say whether underwriting to rents in place alone would have contained the asset price bubble that developed over time, but it certainly would have helped those holding the loans today.

Differences between the two states rent control measures can be characterized by the scope and application of their respective laws. The presence or absence of vacancy bonuses and vacancy decontrol and their historical context. California statewide policy broadly applies to most rental properties with local jurisdictions capable of enforcing stricter laws and has done so for decades. New York’s rent regulation is deeply ingrained with in New York City’s housing market, highlighting a long-standing commitment to tenant protections and housing affordability, which after a period of flexibility got significantly more restrictive in 2019.

The historical evolution of rent control in both states reflects their unique responses to housing crisises, with California adopting a more uniform approach in recent years, while New York maintains a complex city-focused regulatory environment. When underwriting in California for workforce housing, it is clear to see that in one respect, California has a more predictable, consistent approach to rent control on buildings that are also generally not as old as those in New York which require a much greater investment in repairs and maintenance and capital expenditures to stay competitive. All of this explains why when you look at our portfolio its strength is evident in both the continued credit quality metrics and the low NPAs to total assets ratio for the first quarter of 18 basis points, compared to 15 basis points from the prior quarter.

The bank’s return to profoundly deeper relationships with our clients has been fruitful and we continue to believe that when combined with our value proposition of service, we’ll both distinguish us in the marketplace, while making the clients stickier. Maintaining a close eye on our near-term liquidity and funding, we have begun to see a return on our investments in culture and growth quarter-over-quarter within our core funding up from $9.4 billion as of fiscal year-end 2023 to over $9.7 billion as of Q1 2024. This growth can be attributed to both the return of our seasonal MSR deposit tax and insurance impound account outflows in Q4 of 2023, as well as both growth of existing relationships and new relationships to the organization.

Our strategy to drive down any long-term overdependence on broker deposits and home loan bank advances is taking shape. The breakdown of our current deposits is as follows. Money market and savings 29%, certificates of deposits 28%, interest-bearing demand deposits 23%, noninterest-bearing demand deposits at 20%. Our core deposits are diversified geographically with California accounting for 28% of total core deposits Florida at 24% and Texas at 6%. Outside of this majority in Nevada, Hawaii and other states make up the remaining total. We believe both the Texas and Florida markets have tremendous untapped upside potential for additional deposit growth in the near future.

We continue to be pleased with the growth of our digital branches online account opening infrastructure and technology. The seamless account opening and funding with real-time risk mitigation and fraud detection is already prepared for deployment in our physical branches. It will initially be utilized for consumer accounts so that we can free up more time to focus on the high-touch needs of our business clients and the complexities of their banking needs.

As we noted last quarter, we have begun to change the culture of our physical branches to empower and incentivize employees to aggressively grow our granular core retail deposit franchise. We want to foster and enable an outbound network of active participants in the communities we serve. We also want to ensure that parts of First Foundation are properly compensated and incentivized to grow the franchise.

From a timing perspective, we have begun preparing for a challenging landscape ahead of potential rate cuts during the 2024 calendar year. However, we are prepared for a worst-case scenario in which there may be none. We continue to strategically deprioritize marketing based on rate and instead highlighting relationships, community and service, a trend we have seen in the marketplace as several large banks have already begun cutting their deposit rates.

In the ever-evolving landscape of banking regardless of size, we are proud of how our teams have been able to pivot and adjust during challenging times. In 2023, we learned how resilient we were. However in 2024, we strive to highlight our team’s ability to grow and pivot to an offensive growth strategy.

While there are certainly volatile and challenging economic times ahead, the management team and I are incredibly grateful for the support and confidence of our clients and our employees.

I will now hand the call back to the operator for questions.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] Your first question comes from the line of David Feaster from Raymond James. Please go ahead.

David Feaster

Hi. Good morning everybody.

Scott Kavanaugh

Hi, David.

Jamie Britton

Hi, David.

David Feaster

That was a lot of great color Chris. I really appreciate that. And the slide that you gave on the contractual repricing is extremely helpful. We’ve talked in the past though about how oftentimes borrowers are interested in refinancing ahead of it — of the contractual terms but loan shift to full P&I. Just given the significant amount of growth that was originated in 2021 and 2022, we’re going to be coming up on some of that right?

First, I guess my question is am I thinking about that correctly? And secondarily, are you hearing this, you’re starting to see this from borrowers? And maybe how do you think of a realistic pace of repricing that may be coming in the next 12 to 18 months so rather than relative to that $700 million or so that is scheduled.

Chris Naghibi

Well, yeah, I think you are thinking about it the right way. Look I know that there’s a lot of concern in the market about the behaviors that we’re seeing and there has been a bit of a pause. These are — real estate investors have been doing this for decades and in some cases multi-generations.

So they’re looking at the volatility in the market and they’re saying to themselves I’m going to wait and see what happens. If you start to see the 10-year rise, which I expect us to see and you start to see pricing in this particular space start to creep up, they’re going to start locking in and being thoughtful and proactive.

As of right now, they aren’t concerned enough with what they’re seeing in the repricing market to be hyper-aggressive with locking in. These guys also are going from P&I — I’m sorry interest only in some cases the principal and interest they’re going to be really interested in locking back in interest only.

So, yeah, I think you think about it the right way. I think you’re going to see a pretty normal cadence of refinance activity. They’re not going to get quite the cash flow they once did certainly as rates have changed, but they’ll all cash flow fine and they’ll be very happy to do so.

Scott Kavanaugh

David just to put some real stuff in your question there. I would tell you that when it looked like at the start of this year that interest rates were going to decline precipitously, a lot of people were holding out, some of the data that’s come out recently as maybe suggested that the Fed is going to pause for a period of time rather than reduce rates.

In talking to our Chief Lending Officer yesterday, we — in our pipeline just to give you an anecdote is about $20 million that is now coming into the pipeline or in the pipeline, I should say that is going to be exiting in the very low 3s and coming back on in the mid to low 6s.

David Feaster

That’s terrific. So I guess the way I’m thinking about it is like this is almost the baseline of what’s going to be repricing. It’s probably actually higher than what we’ve laid out in this slide.

Chris Naghibi

I truly believe so, yes.

Scott Kavanaugh

Yes. I think the slide that we put in there, those are the absolute role periods that somebody has to do something or it rolls. But I think as Chris described just a couple of minutes ago, you’re going to see some people start to step up and want to lock in. Again, I would tell you and Chris would tell you, that multifamily borrowers are really all about cash flow. And they’re trying to figure out, what their cash flow can be. So them locking it in right now, I think is very prudent on their part. And for us, you’re seeing margins improve somewhere around 3% — over 3% just on those that are being refinanced.

Chris Naghibi

And David, I’d also like to point out that one of the things we started doing well over a year ago was, we started looking at asset quality review financials that come in, re-underwriting this stuff and calling people proactively to say “Hey, look, let’s talk about refinancing your loan well in advance and letting them know what their scenarios were. So, we know what their financial positions are. We know what their refinance would look like and we’re very confident in those numbers.

Jamie Britton

I would just add to you David not to pile on, but all of these outcomes are beneficial for First Foundation. They either move to floating, which is illustrated on the slide they refinance at a higher fixed rate again like Scott described, and we hate to lose a customer. But even if those relationships decide to refinance a loan or two elsewhere, that’s a benefit to us as well because we’re able to extinguish higher cost funding from balance sheet. So, we see these as all these attractive options and benefits to the bank.

David Feaster

Absolutely. That was kind of my point is, it seems like this is — the opportunity could be even larger than what is laid out on that slide. Okay. That’s, great. And then maybe touching on the deposit side. It was great to see the NIB growth in the quarter. I appreciate the color on the seasonal dynamics, and the customer diversification. But I’m curious, how are things heading into the second quarter, you alluded to a healthy deposit pipeline. But just curious, what strategies you’re most focused on? And where are you having the most success at this point? And how you think about deposit trends going forward?

Scott Kavanaugh

Chris?

Chris Naghibi

Yes. So obviously, everything we’re talking about right now is relationship focused. You heard it in the narrative quite a few times from all three of us. With that, we’re really highlighting the C&I business growth, both the middle markets the small balance stuff and all the way up to your larger corporate credits. And the reason why is those come with compensating balances, those come with a holistic relationship. We still have an entire wealth advisory business, with a ton of high net worth individuals, who are still in very much in business today and they’re looking at this current economic climate, as an opportunity to grow.

So anything we can do to help expand those relationships and bring deposits in. We are, for strategic – strategically, you heard me talk a little bit about the moving to a more outbound, really client-focused deposit gathering network. I don’t want branch managers in the branches. I want them physically outgoing to talk to clients and being proactive. The one that really differentiates one bank from another these days, is the value proposition of service. We want to be out in front of people, and the bank that’s in front of them asking for their business and giving them what they need.

Scott Kavanaugh

So our pipeline right now is about $300 million, to be more specific. And it’s pretty definitive that those deposits are going to come back. And we, as we — as I think all three of us said, we’re really refocusing our energy just on relationships, on people, I went to a presentation of one of our loan clients the other day. As I was talking to the Treasurer, I actually asked do we have a deposit relationship with you. I was there with a couple of our credit folks and he said “Well, no you never asked.” And I said, “Well, I’m asking.” Well, we just set up those accounts two days ago, and they are transferring the funds in, which is part of that $300 million.

We have another client that’s doing something similar, that we’ve had loans outstanding and never before did we really go after those clients and shame on us, for not being more definitive. But now, we’re circling back with a lot of our great relationships and me too. I’m making outbound calls, as much as anybody and we’re having great success doing it.

David Feaster

That’s terrific. Glad to hear it. And then last one for me. Scott, you talked about an increase in C&I fundings in the second quarter so far, which is encouraging. Curious maybe, where are you seeing opportunity? How is demand trending? And then I’m just curious maybe broadly what you’re seeing in Texas and Florida, whether there’s timing issue, originations were down in those markets. I’m just curious whether this timing issue was a part of that. So just kind of curious about the C&I pipeline where you’re seeing opportunities in Texas and Florida, specifically?

Scott Kavanaugh

Well, our C&I has been pretty diversified, overall. We’ve got great teams in California. Frankly, we’ve got good teams in Nevada. I will tell you Florida, we’ve got some pretty good teams. But I would say that leading up to and recently when I was in Florida just a week or so ago, I sat down with our C&I teams. And I would say there was a period as Chris described, we were playing a bit defense and we were probably a little too restrictive. So conversations have been – being had between credit, our lending teams and I think there’s a lot of opportunities for instance I want to say we have like eight or nine C&I bankers in Florida.

We’re reinvigorating sitting back down with them talking to say, yes, probably we were a little bit restrictive at the time. If you remember, it wasn’t six months or so ago that I was basically telling everybody, we were going to shrink the balance sheet. And we’ve kind of pivoted since that point in time and we’re looking to expand. And the only way to do that is to set our teams free. So I’m very – I’m of the belief that Florida has the capacity, definitely California has the capacity.

I will tell you Dallas, we are lacking, C&I teams. And as we continue to improve our recurring revenue, that is going to be a major, major focus for us. I mean I’m sure you guys have read the same thing that I have that the Dallas-Fort Worth Metroplex is supposed to be the largest Metroplex in the country in the next 10 years. We came here for a reason and we want to expand in this marketplace. And I feel like we’re on the precipice of being able to do that

David Feaster

That’s great. And so just this growth that you’re talking about just taking kind of all this commentary together, it seems like you think you’re going to be able to fund your growth with core deposits.

Scott Kavanaugh

Yes.

David Feaster

Got you. Terrific. All right. Thanks, everybody.

Scott Kavanaugh

Thank you, David.

Operator

Your next question comes from the line of Gary Tenner from D.A. Davidson. Please go ahead.

Gary Tenner

Hi, thanks. Good morning.

Scott Kavanaugh

Good morning, Gary.

Gary Tenner

I wanted to ask a little bit about the non-customer service cost expenses. I think Jamie you may have alluded to this a little bit in your comments. But obviously, a lot of attention not pushing down deposit – or excuse me, expenses over the past year or so and you made this push into C&I lending. As you think of the runway of C&I growth opportunities with your existing workforce or business development people? Just wondering how you’re thinking about growing that over time and what background that looks like from an expense perspective as well?

Jamie Britton

Hey Gary I think we’re going to — like I mentioned we’re going to remain really prudent and measured on this. And as Scott said, as recurring revenue returns and we’re able to basically afford investing in those teams, we’ll start to do so.

So, I would expect the expenses to grow modestly. Hopefully that’s through this year. as we see recurring revenue improve and knock on wood if we do get some benefit from the rate environment. But either way, we’ll make sure that investments remain in line with referring revenue and profitability so that we’re not sacrificing operating leverage going forward.

Scott Kavanaugh

The one thing I would tell you Gary, sorry, is that just of the few relationships that I have happened to reach out to they are coming in at substantially lower pricing than wholesale funding. So we’re hopeful that we can continue that trend and get better more granular deposits at lower deposit costs.

Gary Tenner

And Jamie I apologize if I missed this through your prepared remarks. But did you say what the average deposits were that were customer service cost-oriented deposits in the quarter.

Jamie Britton

I’m sorry Gary I’m not sure I understand. Can you just–?

Gary Tenner

The amount of deposits that were — that you had those customer service costs on in the quarter the average deposit balance there?

Jamie Britton

No, you didn’t miss it. I didn’t mention that. I’d say it was probably in the $500 million or $600 million range on average for the quarter. Sorry that’s for MSR deposits. There’s probably another $300 million or $400 million on average for the remaining customer service. Yes, you got 1031 exchange title escrow stuff like that.

Gary Tenner

Okay. So, then a little bit versus the quarter prior but obviously the dollar amount of expense came down. So, I’m curious just kind of as you’ve been negotiating with those depositors and the ability to reduce those costs. I mean how has that gone?

And how much more pressure — or not pressure, but how much more downward push can you make on the customer service costs ahead of rate cuts?

Jamie Britton

Well, unfortunately there’s not a ton of opportunity there and we’re investing in that business. I mean some of the best relationships we have are from MSR clients who we provide loans to add attractive spreads even to the deposit that they bring in and at the cost where they are.

And so the customer service costs will increase as deposits return deposits were on average lower in the first quarter than they were in the fourth because they didn’t start returning until later in the first and we do have some of those already in the pipeline returning here in the second.

So, the rate “on those deposits” isn’t likely to come down, but we are still pleased with the benefits their core deposits they’re insured. And oftentimes they bring more products like loans at attractive spreads.

Gary Tenner

Thanks very much,

Jamie Britton

You bet.

Operator

The next question comes from the line of Andrew Terrell from Stephens. Please go ahead.

Andrew Terrell

Hey. Good morning.

Jamie Britton

Hey Andrew.

Scott Kavanaugh

Hi Andrew.

Andrew Terrell

Hey guys. Maybe just a quick question, you guys provide a lot of color around some of the moving pieces around deposits and kind of the loan repricing and margin. But maybe just simply put would you expect that the first quarter is the trough on net interest income? And then, as it relates to margins specifically how much margin expansion would you expect over the next 12 months?

Jamie Britton

Well, the first question is a little easier. I think as the customer service deposits return that will provide some relief to interest expense and improved net interest income, the recurring revenue that we mentioned a few times will also continue to help.

We’ll also look to opportunistically pull some more of our liability sensitivity forward, here and there. So I would be comfortable saying that net interest income barring a rate increase from here is troughing here in the first.

On the NIM expansion that’s a much tougher question to answer. I think it depends on the rate environment. And just how much success we have on the customer service deposits and continuing to build relationships there. So I don’t know that we’re prepared to provide any guidance on NIM at this point.

Andrew Terrell

Okay. Understood, I appreciate it. And then, maybe just a similar question on the customer service cost kind of line items specifically, just given kind of the seasonality there, can you help us understand maybe in terms of dollars of magnitude just how much this line item kind of builds going from 1Q into 2Q and beyond?

Jamie Britton

Yeah. I’d say it’s anecdotally given some of the wins that are back on into the second quarter here coupled with just the normal seasonal flows. I would expect us to have a good build in the second. I don’t know that we get back to 4Q levels of expense here in the second quarter. But I’d say they’d be several million off the Q1 number. Is that helpful?

Andrew Terrell

Yeah. Okay. So maybe fair to just think about split in the middle of 1Q and 4Q somewhere in that neighborhood.

Jamie Britton

Yeah. Probably, I’d probably err on the side of higher, but I think that’s a good starting point.

Andrew Terrell

Okay. Thanks for the questions. Chris, I appreciate all the comments in more detail and that’s helpful.

Chris Naghibi

Yeah. Thanks Andrew.

Jamie Britton

Thanks Andrew.

Operator

There are no further questions at this time. I would like to turn the call over back to Scott, for closing remarks.