First Foundation Inc

NYSE:FFWM

Earnings Call Analysis

Earnings Call Transcript 2024-Q2

[Operator]

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

Before I hand the call over to Scott, please note that management will make certain predictive statements during today's call that reflect their current views and expectations about the company's performance and financial results. These forward-looking statements are made subject to the safe harbor statement included in today's earnings release. In addition, some of the discussion may include non-GAAP financial measures. For a more complete discussion of the risks and uncertainties that could cause actual results to differ materially from any forward-looking statements and reconciliations of non-GAAP financial measures, please see the company's filings with the Securities and Exchange Commission.

And now I would like to turn the call over to CEO, Scott Kavanaugh.

[Scott Kavanaugh, executive]

Hey, good morning, and welcome. Thank you for joining us for today's second quarter 2024 earnings call. Once again, First Foundation was able to generate earnings that were above consensus and exit the quarter with positive momentum. As I had mentioned in previous calls, I believe our earnings troughed in the first quarter of 2024. This is significant when coupled with the backdrop of strengthening our balance sheet with the recently announced $228 million capital raise. I want to be clear, the Board sought the additional capital to support the growth of the company, not to satisfy any regulatory concerns. This raise allows us to accomplish that goal.

I also want to emphasize First Foundation has never had a credit problem. Our NPAs remained at remarkably low levels, unchanged from last quarter. Charge-offs were almost nonexistent at 0.01%. Our recent performance issues stemmed from an interest rate risk positioning of our balance sheet, which surfaced in 2022 when fixed rate lending surpassed historical levels while the Federal Reserve began aggressively raising rates. As you know, this put tremendous stress on our net income and reduce the flexibility we had to navigate the turbulent economic environment.

With this capital raise, we will take actions to solve this issue and to begin to expand into the desirous geographic markets we are already in and have a presence. This will be outlined in our discussion by both Jamie and Chris. I noted in the first quarter that we had taken great strides to increase recurring revenue and reduce core expenses to benefit future profitability. And those efforts continued in the second quarter.

Once again, we are able to improve our loans-to-deposit ratio, increase our overall loan yield and continue the process of improving the sensitivity of our balance sheet to changing rates. Capital ratios were improved as well. First Foundation Advisors once again closed the quarter at near record assets under management with profitability at FFA remaining strong. The trust department posted another solid quarter as well.

For the second quarter, we reported net income attributable to common shareholders of $3.1 million or $0.05 per share for both basic and diluted shares. Tangible book value, which is a non-GAAP measure, ended the quarter up $0.08 from the first quarter of 2024 to $16.43. Pretax pre-provision revenue totaled $1.9 million compared to $460,000 in the prior quarter. Interest income totaled $150.9 million for the quarter, relatively unchanged from the $150.4 million in the first quarter and up from the $145.3 million in the second quarter of 2023.

Noninterest income as a percentage of total revenue was 23% for the quarter compared to 25% for the first quarter. Our net interest margin was 1.36% as compared to 1.17% for the first quarter of 2024. This was largely driven by the return of MSR deposits. Noninterest expense was $55.6 million in the quarter compared to $50.6 million in the prior quarter. Again, largely driven by an increase in the customer service expense related to the seasonally returning MSR deposits. Despite the increase in noninterest expense, our efficiency ratio improved to 96.1% compared to 98.4% for the first quarter 2024. Adjusted return on assets, a non-GAAP measure increased to 0.10% compared to 0.03% as of March 31, 2024.

Our loan-to-deposit ratio improved to 93.8% in the quarter compared to 94.8% as of March 31, 2024. This was largely driven by an increase in core deposits late in the quarter. We remain committed to continuing to improve this ratio through a combination of strategically lower -- reducing lower-yielding loan balances and continuing to grow core relationship deposits. Total deposits were $10.8 billion in the quarter compared to $10.6 billion in the first quarter. Core non-brokered deposits totaled to 62% during the quarter, compared to 64% in the first quarter of 2024.

Noninterest-bearing demand deposits increased to 20% for the quarter compared to 17% of total deposits as of March 31, 2024. Our insured and collateralized deposits remained relatively unchanged compared to the first quarter at 85% of total deposits. We maintained a strong liquidity position of $4.4 billion. At these levels, our available liquidity to uninsured and uncollateralized deposits ratio slightly increased to 2.8x.

Borrowings remained flat quarter-over-quarter at $1.7 billion as of June 30. Average borrowings outstanding were down to $1.4 billion or 10.4% of total average assets for the quarter compared to $1.6 billion or 11.8% of total average assets for the quarter. As I stated earlier, credit quality remains incredibly strong for our bank. Our nonperforming assets to total assets remained at 0.18% quarter-over-quarter. Loan balances ended the quarter at $10.1 billion, flat from the first quarter. C&I loans totaled 83% of loan fundings during the quarter and 86% of total fundings year-to-date.

Loan yields increased nicely to 4.77% in the second quarter from 4.70% in the first quarter. First Foundation Advisors assets under management was $5.5 billion, unchanged from the end of the first quarter. Our pipeline of new relationships remain strong. Assets under advisement at FFB's trust department was $1.1 billion for the quarter compared to $1.2 billion at the end of March 31, 2023.

Once again, I would like to close by reiterating my appreciation for the incredible efforts and unwavering dedication of our entire team. I remain incredibly thankful to each of the company's wonderful employees. I will now turn the call over to Jamie to cover the financials in greater detail.

[Jamie Britton, executive]

Thank you, Scott. Before diving into the capital raise and our strategic objectives, Chris and I will start with a brief review of the quarter. I'll begin with the balance sheet and the improvement in our net interest margin, which, as Scott mentioned, expanded 19 basis points during the quarter from 1.17% in the first to 1.36% in the second. Our earning asset yield continues to improve, increasing to 4.71% in Q2, which is 7 basis points above the 4.64% reported in Q1 and 20 basis points above the year ago period, 4.51%. After remaining relatively stable for the past several periods, loan yields made a larger contribution this quarter, increasing from 4.7% in Q1 to 4.77% in Q2.

Though the available-for-sale portfolios yield improved modestly this quarter by 2 basis points due in part to new investment yields of approximately 5.8% and a mix shift toward [indiscernible] maturity led to a slight reduction in the overall investment portfolio yield, which was down this quarter from 4.06% in the first to 4% in the second. As we have noted in past calls, we are comfortable using safe, high-quality securities in the investment portfolio to support our liquidity position, improve the balance sheet rate profile and more efficiently enhance recurring revenue. In this vein, I'd note, our ending balance for the quarter was higher than the quarter's average balance.

Turning to funding costs. Like last quarter, I'd like to start by highlighting the seasonal nature of our noninterest-bearing deposit portfolio and its MSR escrow balances, which, as expected, continued their return to the balance sheet this quarter following their normal annual outflows late in the fourth before beginning to rebuild late in the first. whereas the first quarter's mix towards interest-bearing liabilities, which, as a reminder, are temporarily ramped each year to replace the seasonally decline in noninterest MSR escrow balances weighed on our net interest margin in Q1, the opposite was true in the second. Coupled with the improvement in loan yields, the shift back to noninterest-bearing MSR deposits helped return the net interest margin to its Q4 level of 1.36%.

These shifts led to an improvement in net interest income for the quarter, which increased from $38.4 million in the first to $43.8 million in the second. The shift led to a commensurate increase in customer service costs as well, which also increased $5.4 million in the quarter. Net-net, the balance sheet's contribution to earnings remain stable.

Before leaving this topic, as I mentioned last quarter, though these seasonal fluctuations caused shifts in our net interest margin and noninterest expense each year, we appreciate the holistic nature of these relationships and are comfortable continuing to manage around their predictable seasonal inflows and outflows. I'd also note that given continued growth in these balances through the quarter, we would expect the third quarter's average balance and related customer service costs to be higher than the second quarter's by approximately 15%. As is typical in an elongated plateau during a rate cycle, we continue to experience modest pressure on interest-bearing liability costs, which are up 3 basis points this quarter from 4.24% in the first to 4.27% in the second. Both borrowing costs and interest-bearing deposit costs were slightly higher, though we reduced some of our higher cost deposits to account for the returning noninterest-bearing MSR escrow balances, which on its own helps costs, we took -- we also took advantage of relatively attractive broker deposit costs and shifted the $350 million of balances underlying our recently initiated cash flow hedge from short-term FHLB advances to short-term broker deposits.

The result of this move benefited net interest income, but it did cause a shift in cost towards deposits as well as a modest quarter-over-quarter increase in our brokered deposit concentration, which, as Scott alluded to, slightly increased this quarter. As noted on last [ cores call ] by taking advantage of the market's early year optimism for declining rates via the swap and additional securities balances, we were able to add new rate insensitive recurring revenue and we will continue to look for similar opportunities to both enhance revenue and stabilize our rate profile going forward.

Finally, I'd note that monthly trends in deposit costs exited the quarter consistent with quarterly averages with total interest-bearing deposit costs ending the month of June at 4.28%. We appreciate the work our teams are doing in each deposit channel to remain responsive to our clients' needs while holding the line on costs.

Shifting to the income statement. Interest income grew again this quarter. On a slightly smaller average earning asset base, we reported $150.9 million for the second quarter versus $150.5 million in the first. Interest expense saw a decline, which, as discussed, was due to lower balances resulting from the return of average noninterest-bearing MSR escrow deposits. Combined with a slight improvement in net interest income, the $5 million decrease in interest expense benefited net interest income by $5.4 million. We reported a negative provision expense for the quarter, driven by reductions in both the reserve on our investment portfolio and the reserve on unused commitments. The balance for our APL on loans, however, was stable again this quarter at 29 basis points. And as Scott mentioned, asset quality remains stable.

Wealth and trust-related fees were higher in the quarter, up from $8.6 million in the first to $9.2 million in the second. As Scott mentioned, AUM ended the quarter at $5.5 billion, consistent with the first quarter's ending balance and we are pleased with the pipelines we see in the business. As we'll discuss in a moment, we are excited about the opportunity to accelerate growth in First Foundation Advisors and the trust department following the capital raise.

Moving to noninterest expense. Outside of customer service costs remaining noninterest expense categories totaled $39.5 million for the quarter, slightly lower than the first quarter's $39.9 million. Compensation and benefits expense was lower by $0.3 million in the quarter as the impacts of the annual tax reset that elevate the expenses in the first quarter each year were not as much of a factor in the second. In addition, we recognized the full quarter benefit of our decision late in the first to exit our equipment finance business. As shown again this quarter, we are maintaining our disciplined approach to core expenses, and we continue to do so -- we plan to continue to do so even as we make strategic investments for future growth following the capital raise. We are committed to controlling our discretionary investments and ensuring any plans for measured investments going forward across our markets, are both in line with our strategic objectives and supported by commensurate growth in revenue and profitability.

Moving finally to capital and liquidity. We are pleased to highlight another quarter's improvement in First Foundation Inc's capital ratios. Our total risk-based capital ratio, which we estimate will be 12.6%, increased by 11 basis points in the quarter and by 84 basis points since Q2 of 2023. Our liquidity and funding positions also remained strong this quarter as uninsured and uncollateralized deposits remain low, available liquidity remains high. Our loan-to-deposit ratio declined and our core deposit concentration remained relatively stable.

Our capital ratios and liquidity position were strengthened further since quarter end by the announced capital raise, providing significant flexibility to further strengthen our balance sheet, capitalize on the opportunities ahead and improve our earnings profile going forward.

Before jumping into more detail in our plans here, I'll turn it over to Chris to provide our final thoughts on the quarter. Chris?

[Christopher Naghibi, executive]

Thank you, Jamie. Good morning. Today, I will quickly touch on our second quarter 2024 lending operations, deposits and the strength of our assets. As Jamie mentioned, before concluding the call, the management team and I want to provide further detail and insight into our newly announced capital raise initiative and discuss both near-term strategic implications for the forthcoming third quarter as well as our longer-term vision.

Let's first focus on the institution's lending operations. First Foundation continues to maintain a sharp focus on remediating our fixed rate lending portfolio's position in the current interest rate environment. Our goal has been and continues to be to reduce that exposure and diversify into index plus margin-based pricing, focusing on conservatively underwritten C&I lending where we prioritize relationships. I want to be clear that while historically, multifamily originations outpaced C&I lending, First Foundation has been deeply steeped in C&I lending dating back to the bank's inception. A more robust C&I team was built out nearly 10 years ago in order to help balance out the concentration risk in the underlying loan portfolio. First Foundation is not a real estate lender growing into the C&I business. C&I lending has been a long-standing and important part of the underlying franchise value.

To that effect, I would be remiss if we did not highlight how amazing this team has been. Over 85% of our loan origination volume this year has been from the maturation of a prolonged strategy building on C&I relationships. From our former C&I Chief Credit Officer, who is now our Chief Lending Officer, David Masucci; to Eric Graham, our Corporate Banking Director; to [ Riya Kumari, ] our Chief Commercial Credit Officer; to Lillian Gavin, our Chief Credit Officer, our C&I team has done incredible work. Our middle market focused teams are exceptional as well. From [ Scott Noren, ] our Commercial Banking Manager to Tobias Halbmaier, our Director of Guaranteed Lending, our teams have put in the work and have really helped drive relationship-focused C&I growth when we needed it most.

As I've stated on previous calls, C&I lending growth in the future, outpacing that in commercial real estate lending will provide justification for a continued increase in our CECL reserves as a byproduct of the asset class and historical data that supports it. This will be notable in both the growth of the reserve as a percentage of the portfolio as well as a total dollar amount of the reserve. One of the many complexities the market is still adapting to is navigating CECL's future forecast of life of loan losses at origination or acquisition of loans in the wake of 14 years of artificial interest rate deflation and a lack of meaningful historical loss data in some asset classes to support additional reserves. We continue to believe this increase in loan loss reserves will be a strong step in positioning the company in line with the risk profile of peers. As a reminder, given the relatively short duration of the multifamily asset class and the cash flow focus of most investors, we anticipate future benefit from anticipated repricing activity. Long term, we aim to diversify our asset base, which will gradually increase our CECL reserves as a more balanced portfolio will naturally require higher reserves. To help facilitate this transformation in the near term, First Foundation's strategic plan does include the thoughtful and strategic sale and/or securitization of loans into the market. This systematic and careful reduction in our multifamily concentration will provide some noteworthy and meaningful benefits.

First, it will allow the bank to blunt its interest rate risk exposure to the looming maturities in the portfolio. Specifically, reducing lower-yielding assets that mature during 2025, 2026 and potentially 2027 maturities that came from unprecedented growth in the bank's multifamily balance sheet over the last 3 years. Second, it will allow the bank to redeploy this capital into higher-yielding loans much sooner than waiting for the organic maturity of the underlying assets. The management team and I will further elaborate on this nuance in addition to identifying how we plan on leveraging our new capital to highlight our commitment to aligning our reserves with peers prior to the conclusion of this call.

Our loan portfolio as of June 30, 2024 can be summarized with the following composition: 51% multifamily loans, down from its height of approximately 54% as of Q3 of 2022; 32% commercial business loans, including owner-occupied commercial real estate and equipment finance compared to approximately 28% as of Q4 of 2022. 9% consumer and single-family residence loans; 6% nonowner-occupied commercial real estate and approximately 1% of land and construction loans. From an operational perspective, we continue to challenge our lending departments and adapt to a heavy focus on asset quality. We want to ensure the assets we do have on the books continue to remain as strong and are as reflective of the same credit culture today as they were at origination. If there are cracks coming in the economy, we want to spot them proactively. We continue to maintain our steadfast, cautious yet proactive approach to growing with best-in-class asset quality as indicated by our historical performance.

As you would expect, loan fundings continue to be comprised of primarily high-quality adjustable rate C&I, SBA and mortgage lending, totaling $516 million for the second quarter offset by loan paydowns and payoffs of $515 million for this quarter.

Moving quickly to deposit operations. The bank continues to focus on deeper relationships with our clients which we believe, combined with our value proposition of service distinguishes us in the marketplace. This ethos will be pivotal to the execution of deposit growth as we focus on greater organic growth and lessening the interest rate impacts from higher cost deposits and noncore funding. This will also be aided by the aforementioned multifamily concentration reductions and will assist in limiting exposure to changes in the deposit franchise. As you have heard on previous calls, we are still keeping a close eye on liquidity and funding in the near term but have already begun to refocus on our core funding growth efforts and have made sizable changes to reflect -- that reflected in the quarter. Continued improvement in funding and the additional capital will allow us to allocate more attention to driving down any overdependence on broker deposits and wholesale borrowings.

The breakdown of our current deposits is as follows: money market and savings at 30%; certificates of deposits, 29%, interest-bearing demand deposits, 27% and noninterest-bearing demand deposits at 14%. Our core deposits are geographically largely unchanged with California accounting for 36% of total deposits; Florida at 36% and Texas at 10%. Outside of this majority, Nevada, Hawaii and other states make up the remaining 18% of the total. The internal culture has seen a galvanized pivot from a defensive focused stance to an offensive leaning one where our teams in the digital branch and our physical branches can focus on delivering service and organically growing our business, the timing of which could not be better. While we operate with a rate neutral mindset, we have begun preparing for a changing landscape ahead of potential rate cuts during the 2024 calendar year by strategically deprioritizing marketing based on rate and instead highlighting relationships, community and service.

If we are fortunate enough to see a rate cut in 2024, the benefits to First Foundation's earnings will be felt quickly given the company's liability sensitivity. A lot is changing about the way we do business. And I would like to thank every single contributor at First Foundation for their support and commitment to improving what we do. I continue to be grateful for so many wonderful colleagues who genuinely care about the long-term viability of the company. We have endured a lot the last 2 years, but now it is time to shift our focus to offense. If adversity builds character, this team has developed a tremendous amount of character, and I can proudly tell you they are ready to prove what they can do next.

[Jamie Britton, executive]

Okay. Well, a terrific way to wrap up the quarter. As we continue to say, First Foundation's success is certainly a result of its people, and Chris' sentiment couldn't be a better way to kick off a discussion of the capital raise and where we see the company going from here because importantly, we value the culture our team has built and nurtured over the years, and we believe our focus on customer experience, providing a holistic set of banking options and leaning into our expertise to help build our bank and support our communities have been foundational to our success. Rather than using the capital raise as an inflection point to focus on new businesses or materially change our old, we hope to use it as an opportunity to get back to what we do best, leading with our people and sharing with our markets the hallmarks that have made First Foundation such a valued partner to our clients and a trusted steward of our shareholders' capital.

Before we can pivot entirely to offense, however, there are some near-term actions we would like to take to further strengthen the balance sheet and stabilize our earnings profile. In this first phase, which we expect to complete this quarter, we set out to successfully complete our capital raise, which we've done, move a portion of our lower-yielding multifamily loans to held for sale, initiate a detailed review of our ACL methodology to address once and for all various stakeholder concerns and begin ensuring that once we fully pivot back to offense, we will be ready with cascading organizational goals and incentive alignment necessary to ensure our measured investments achieve their goals.

Together, we believe these actions set us up for success, leaving us with a strengthened capital and liquidity position, a reduction to our multifamily concentration and ACL within range of similarly situated peers greater flexibility to decrease our reliance on wholesale funding going forward and of course, improvements to our net interest margin and core profitability that are necessary to make the investments available across our footprint which we believe will lead to further geographic and product diversification, growth in core funding and improved revenue mix based even larger part on stable recurring fee income and most of all, reduced through-cycle earnings variability that will lower our cost of equity and enhance long-term shareholder value.

Now the near-term actions are not without hard work, we have already initiated our detailed ACL methodology review, and we are confident it will be completed this quarter. But simply moving some of our lower-yielding multifamily loans to held for sale this quarter does not mean we are done. As we did with our new investors during the capital raise, we believe it is important to engage with those willing to dig into our portfolio, understand why we hold such conviction in its credit quality, model through the loans repricing characteristics and arrive at a fair execution price that we would be comfortable ultimately sharing on these calls with you. That takes time but we are committed to best execution, and our team is willing to do the hard work to ensure we get it.

As an organization, I can assure you we are excited to pivot again to offense. We are thrilled for the growth opportunities this will provide to our teammates who have already invested so much. We are honored for the opportunities to grow our existing relationships and build new ones across our markets and we look forward to the opportunity to return our financial performance to levels our shareholders deserve. By investing our resources and these strategic objectives, success will not occur overnight, but by the end of 2026, we are confident we can get First Foundation's ROA back to 90 to 100 basis points, ROTCE back to 10% to 12% and our CRE concentration below 400%. Coupled with the improvements we expect in our liquidity, interest rate and credit risk profiles, a long-term Tier 1 risk-based capital ratio in the 12% to 13% range will ready First Foundation with a strong risk capital balance poised for further growth in 2027 and beyond.

With that, I'd like to turn it to Chris to provide further detail.

[Christopher Naghibi, executive]

Thank you again, Jamie. As Jamie noted, and as you can see on Page 3 of the provided investor deck, the near-term actions in the third quarter of 2024 will be about repositioning the balance sheet and stabilizing earnings. A big part of the mechanics around achieving this goal will come from moving loans to held for sale as well as a thorough review of the bank's current ACL methodology. First Foundation intends to move approximately 20% of its existing multifamily loans to a held-for-sale designation. I would caution against looking at recent market transactions as the sole indicator of the potential marks we could see on the move. And I would certainly emphasize this point when considering final execution prices. As Jamie mentioned a moment ago, we are willing to put in the time and work here. First Foundation intends to explore every avenue to ensure best execution, including options through its relationship with Freddie Mac, as well as potential private party sales. First Foundation is a Freddie Mac seller servicer and has successfully completed numerous securitizations with Freddie in the past. While this is no longer a part of our normal business, we still have the expertise to invest, and we have historically found that upon doing so, execution and settlement can contrast market pricing based on the desirability of the bank's underlying affordable housing multifamily loan characteristics. The characteristics I detailed on last quarter's earnings call that support our credit quality, such as low-income housing components, rent-controlled properties and others assist in Freddie's duty-to-serve requirements as well. Our asset quality remains strong. So given there is an increasing likelihood of rate cuts to end 2024 and through 2025, we anticipate that the environment for execution will only improve through this process. Management is currently in the process of working with an outside third party to determine the potential mark as a result of a fair market value analysis, but I will reiterate again that we are committed to best execution as we work to ultimately disposition the assets and reduce our multifamily real estate and fixed rate asset exposures.

Despite the noteworthy strength of the loan portfolio and the historical lack of loan losses since the bank's inception, management recognizes the bank is a statistical outlier when compared to similarly situated peers. Because First Foundation's concentration in commercial real estate is narrowly tailored in the historically lower loss end of the multifamily asset class, the historical loss factor has not led to the bank setting aside large reserves under the current expected credit loss model. We do believe, however, that there is an element of interest rate risk in the market, which is truly unprecedented, and that First Foundation needs to initiate a detailed review of its ACL methodology as a result. I want to be clear, we do not believe we have credit losses on the horizon. As part of the month's long due diligence, Fortress not only conducted a thorough internal due diligence of the bank's underlying loan portfolio, but they also engaged a nationally recognized independent third-party due diligence and credit review. If there is one thing I can assure the market, it is that the confidence in our underlying credit quality relative to our peers is shared by management and our new investors. It helps that almost 70% of our portfolio is focused on relatively safe, multifamily, 1 to 4 single-family and municipal loans, but our success is another testament to the incredible team we have built and the seriousness with which our culture approaches credit.

As we have always done, we intend on providing confidence that our reserves are adequate to address any changes in credit quality or interest rate risk that may be present in the market, and we believe that to do so, a holistic review of our methodology is appropriate. A result of this review will likely conclude in an increase to the bank's reserve to be more in line with similarly sized and concentrated peers. Regarding the loans we are moving to held for sale. The move will focus on loans with balances approximately between $1.5 million and $4.5 million and which are set to reprice in the next 18 to 36 months. Reducing these balances will mute the impacts of the historical loan growth we saw in 2022 and the repricing uncertainty they could introduce on over the horizon. The market needs to be able to model this pivot, and we, as management, will provide additional detail of our findings during our Q3 earnings call.

The second phase of our strategic plan is the most exciting and we hope that it gives the market, our employees and our shareholders the confidence in the strategic vision for the medium and the long-term strength of First Foundation. Frankly put, we are going to go on the offensive with measured investments to capitalize on what will surely be market opportunities ahead. Before going into detail, it is important to note that the prolonged due diligence in capital raise discussions led by Fortress and Canyon also allowed for a thoughtful and strategic collaboration in which management, the legacy Board and our investors were all steeped. It is a proud result of active and ongoing planning that began as far back as the beginning of the second quarter of 2024.

As you know, First Foundation currently has a wide geographical presence, spanning from Florida to Texas to Nevada and California and all the way to Hawaii. Collectively, we believe there is tremendous untapped potential in these geographies we currently serve. Given that we have a physical presence in these locations and the mature infrastructure in our C&I lending business, the strategic vision anticipates the further diversification of the underlying loan portfolio. This diversification into C&I lending, which leverages the existing C&I infrastructure and enterprise will improve core funding, further reduce multifamily commercial real estate concentrations, increase loan yields and bolster deposit growth with a heavy focus on offering our platform to relationships and not transactions. New bankers in these markets will have loan goals and deposit goals, so they will be properly incentivized to focus on relationships, which are at least partially self-funding. As core deposits grow, we will, of course, want to focus on the concentrations in the underlying deposit portfolio as much as we do the loan portfolio. This will mean a reduced reliance on noncore funding and wholesale funding as well as a reduction in high-cost deposits. Goals, you have heard us speak about strategically for several quarters now. While we have made strides towards these objectives, we are far from satisfied that we have maximized these improvements. The proposed balance sheet changes should limit exposure to high-cost deposits and the enhancement to profitability will only be further bolstered by the tailwinds of rate cuts whenever they do come.

With that, I will turn it back over to Scott to now cover wealth advisory, trust services and address some of the changes in the Board structure.

[Scott Kavanaugh, executive]

Thanks, Chris. First, sorry that the script is taking longer than normal, but we frankly believe that the emphasis of this call needs to be on the capital raise. So sorry, please bear with us. We hope that all the strategic direction detail provided by Jamie and Chris and summarized in the provided investor presentation gives everyone some insight in how the transformative we believe this capital has already been and is going to be. The benefits will also in order to the wealth advisory platform, First Foundation Advisors. As a logical natural byproduct of the steps we have detailed for the bank, you can anticipate accelerated FFA growth and further increases in fee income.

While FFA has continued to hit its growth milestones over the course of the last 2 years, management believes that First Foundation's expansion deeper into the existing markets will only benefit FFA as these markets with significant high note worth household concentrations and attractive in-migration demographics. It should also be noted that having a wealth advisory arm is a very valuable thing for the bank and serves to make relationships stickier and longer lasting across the First Foundation platform. Speaking of which, the bank's trust division will continue to grow and season in these markets as bankers and wealth advisers identify the need for their services and the growth of the client-based compounds.

I am proud that the enterprise value of this franchise has been and will continue to be our ability to provide an unparalleled value proposition of service, service that comes from the talent and abilities of our team so that we can capture and grow with our target demographic as they age and even as they relocate through chapters of their lives.

I am incredibly proud of what we built at First Foundation over the course of the last 17 years. Much like our clients, we have evolved and have grown into the next chapter of the company's life. With growth comes change, and it is with a heavy heart and a tremendous amount of gratitude that I think some of our departing legacy Board members for their tenure and commitment to helping us build First Foundation into what it is today. At the same time, I'm grateful for the gift of fresh eyes and perspectives from our incoming cohort of directors, who I can tell you are already aligned with our culture. Together, management and I know that we have found the right partners with this capital raise, and we are thankful for their commitment to preserving our enterprise value and honoring the legacy of First Foundation.

Lastly, I cannot thank our team of employees enough. The tellers on the front lines of challenging discussions during volatile times in the stock market, the managers who concerned customers calling to hear the First Foundation was strong. The management team, and I want you to know that this capital raise and the resulting strategic plan will position us all to be on the offense again. And I want you all to know that we appreciate your commitment. Thank you for being a part of our team. Thank you for trusting us and to execute and deliver a stronger bank. And now I will turn the call back to the operator for questions.

[Operator]

[Operator Instructions] Your first question comes from the line of David Feaster from Raymond James.

[David Feaster, analyst]

Wanted to touch on -- I mean, you guys gave a lot of color, and it was great. But just kind of touching on the potential for optimization of the balance sheet. Just kind of reading between the lines, it sounds like securitization could be a near-term opportunity, just especially just given your experience, your track record. Could you just help think about -- I mean, given the prior securitizations in the $400 million to $500 million realm, would you expect a couple tranches? Or do you think you could do a larger transaction? And just, I guess, as you've tested the market and kind of curious your sense of appetite for it and what the secondary markets like right now?

[Christopher Naghibi, executive]

It's always a pleasure. It's Chris. So I think the maximum they generally allow at Freddie would typically be up to $500 million. We've obviously done a little bit more than that historically, but I would expect that we would aim for something that size. Again, this is somewhat speculative in that there would have to be pricing and some initial conversations and work that goes into it. But typically speaking, that would be the -- we will always aim for the max. And the reason why is there's efficiencies of time and usage. So you want to do as much as you can as GPs associated with the transaction. So we would aim for about $0.5 billion is my target. And then private party sales and anything else we would explore as an opportunity presents itself.

[Scott Kavanaugh, executive]

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

[David Feaster, analyst]

Okay. That's helpful. And maybe just -- I'm curious how you think about the size of the balance sheet, right? I mean we've used some excess liquidity this quarter to buy some securities. We've got the securitization to potentially free up some excess liquidity. I guess, would your priorities be -- you obviously got some loan growth coming. And I'm just curious, would your priorities be to delever the balance sheet and shrink and reduce wholesale funding? Or maybe help drive some of the C&I remix more quickly?

[Jamie Britton, executive]

David, this is Jamie. Absolutely the first thing that we would do with any transactions on the multifamily would be to focus on the wholesale funding on the right-hand side of the balance sheet. That -- and potentially some higher cost core deposits. But the lean would be towards wholesale funding. We have an excess there in our opinion. And -- though some of it, a majority of it on the deposit side is in brokered CDs with different maturity links. We would focus on exiting the wholesale funding first. I think over time, as we move forward, we do want to make sure the earning asset base continues to support the investments we want to make. We don't want to be in the business anymore of low earnings. We want to see growth from here. So we will look to keep earning assets in cash or high-quality liquid securities to support the investments we want to make. And as we get more into it, I think we'll have a better understanding of the timing as we start to talk with different lenders and teams in the markets, identifying when it may be possible to bring people in. We'll balance that in those expenses and those investments with our decisions on the size of the balance sheet and whether we need anything outside of loans to support the investments that we want to make.

[David Feaster, analyst]

Okay. That's terrific. And to that point, I guess, I mean, it seems like a lot of the focus is in Florida and Texas because as you talk -- as Chris, you talked about the untapped potential in some of the newer geographies, could you maybe elaborate a bit on what you're expecting to do? And it sounds like we're going to -- we're looking for some new hires, are there any new markets that you're focused on? I'm just kind of curious if you could just elaborate a bit on the strategy and what you guys are considering?

[Christopher Naghibi, executive]

Yes. So obviously, we have our corporate headquarters located in Texas, and we have unlimited top potential in the market. There's a lot of business there that we need to really capture. Our plan as it is right now would entail growth there. It would also consider really tapping in heavily into Southwestern Florida markets where we have geographic presence. But one of the things I can tell you that we haven't done is allocated people on the front lines to originate business. Obviously, the last 2 years were really a defensive focus as the narrative really alluded to. So getting people there that can originate relationships and focus on those franchises, I think, will help bolster significantly. But there's still potential in California as well. I don't want to minimize where we are here. Northern California, Southern California, in particular, has a pretty growing expansion. The interesting thing from a dynamic perspective is we see a lot of people from a relationship position leaves the state of California and go into the states that are typically tax shelters like Texas and Florida. And because of that, we've been able to follow them there, that's a great entry point into introductions and additional business there. So we have a very warm handoff in those 2 states, and it makes the most logical sense for growth in the immediate future.

[Scott Kavanaugh, executive]

The only thing I would add, David, is we expanded into Texas. We expanded into Florida and then COVID and of course, the challenging economic times started to happen. So we really have not had much of a chance to really expand into the markets. We immediately found ourselves having to get into a defensive mode. So we're -- as Chris alluded to, we still see huge opportunity in the California marketplace. But we really believe that Texas and Florida is endless with its abilities to be able to grow. In terms of your question about other markets, we got a lot to focus on just with those markets. So right now, I don't see us really expanding into any other markets than the markets we already serve.

[David Feaster, analyst]

Okay. And just one quick follow-up. I appreciate the profitability targets. I was curious, do you have a time line to achieving those or getting -- approaching those? Obviously, somewhat dependent on the ability to execute on the securitization and selling some of the multifamily ones, but I don't know if you had a...

[Scott Kavanaugh, executive]

I think we were targeting towards the end of 2026.

[Jamie Britton, executive]

That's right. Yes. I appreciate that question. And as a finance [ chief ] look forward to the next few months of planning and budget season, we'll be getting into the market and starting to talk to more folks here in terms of the hiring we just talked through. We're going to take the high-level plans and really do a bottoms-up budget process, which I think will help provide some timing on the trajectory -- and the trajectory for profitability improvements. But like you said, I mean, a lot of it on the restructuring of the balance sheet and the improvements that come from that will depend on the work we do on the multifamily loans that we moved to held for sale and how quickly we can arrive at best execution and prices we're comfortable with there. So probably a bit too soon to start talking through definitive trajectories on the profitability side. But we do feel comfortable with the goals we laid out for exiting '26 and where we want to be long term with regard to our multifamily concentration and CRE concentration overall and where..

[Scott Kavanaugh, executive]

And profitability.

[Jamie Britton, executive]

And profitability and where we want to hold capital longer term.

[Operator]

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

[Gary Tenner, analyst]

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

[Jamie Britton, executive]

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

[Gary Tenner, analyst]

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

[Christopher Naghibi, executive]

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

[Scott Kavanaugh, executive]

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

[Gary Tenner, analyst]

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

[Jamie Britton, executive]

The total for customer service deposits, and this is MSR escrow balances as well as others, like 1031 exchange was -- the average was close to [ 1.2 ] for the second quarter.

[Gary Tenner, analyst]

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

[Unknown Attendee]

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

[Operator]

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

[Andrew Terrell, analyst]

I just wanted to ask on the profitability targets, the 90 to 100 basis point, 4Q '26 ROA, as you kind of compare that pre and post capital raise, what you -- what could you have gotten to organically without the capital raise by 4Q '26?

[Scott Kavanaugh, executive]

It'd be much more muted. I don't know that -- gosh, we have to go back to old forecast and try to figure it out. But I would say it would probably be cut in half.

[Andrew Terrell, analyst]

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

[Christopher Naghibi, executive]

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

[Operator]

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

[Matthew Clark, analyst]

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

[Jamie Britton, executive]

Matthew, this is Jamie. We absolutely will. We're still getting everything ticked and tied in the books. There is net settlement on the warrants. So that will come into play as the stock price moves. But we will be extra clear on share counts. And I think we want to take some time to make sure we're clearly providing trajectories on EPS, on ROTCE, both on an actual but also on a fully diluted basis. As you know, the timing will shift there as the different types of preferred and the nonvoting common equivalents, if those were to come into play, move from the existing investors to other investors. But that will be a focus of ours. And as we get into it, we'd certainly appreciate any feedback that you'd be willing to offer so that we make sure that we are being clear and it's coming across to the investment committee and -- investment community and to you guys.

[Matthew Clark, analyst]

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

[Scott Kavanaugh, executive]

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

[Jamie Britton, executive]

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

[Scott Kavanaugh, executive]

A shout out to Josh' team at [ Shepard Mo ]

[Matthew Clark, analyst]

Great. And then on your customer service cost outlook, what are you assuming for 4Q just based on the seasonality and the number of rate cuts might be -- that you might be assuming there as well?

[Jamie Britton, executive]

Yes. That's the big question is the rate cuts. The 4 curve is showing a couple at this point. We saw some big names come out in the last few days that are arguing for the Fed to get on with it and maybe even consider one next week. So I think there's still some uncertainty there. I don't want to provide you with a target at this point. But a couple of things to think about is the trajectory as we've come into the second has -- it has gone up until the rates grown as we expected. As I mentioned in my comments, we would expect some more growth in the third. And we'd expect to see normal seasonal declines in the fourth and then again in the first. And those declines should be consistent with what we've seen in the past but maybe a little lower on a percentage basis than what we saw in the end of 2023 just because, as I think we mentioned maybe on the January call or on the April call, we did have one client that had assessed their concentrations of their -- with their banks and they decided to pull out a little more than they normally would have, which as I mentioned, we appreciate it. And then there is another client during the fourth quarter that was going through their risk review and decided to take out imbalances while that process is going on. So there were a couple of those items in the fourth of 2023 that may have exacerbated the runoff that we've seen historically. But for Q4 '24, I expect it to return to normal historical trends.

[Matthew Clark, analyst]

Okay. And then just on the margin, you have the average margin in June and the spot rate on deposits at the end of June.

[Jamie Britton, executive]

Yes, just a second. For the margin, we were at [ 1.42 ] in June and the spot rate for total deposits was [ $428. ] Yes,

[Matthew Clark, analyst]

[ $428 ] on interest bearing.

[Jamie Britton, executive]

Correct. Yes.

[Operator]

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

[Scott Kavanaugh, executive]

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

[Operator]

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