First Foundation Inc. (NASDAQ:FFWM) Q2 2023 Earnings Conference Call July 27, 2023 11:00 AM ET
Company Participants
Scott Kavanaugh – President and CEO
Chris Naghibi – Chief Operating Officer
Amy Djou – Interim Chief Financial Officer
Conference Call Participants
David Feaster – Raymond James
Andrew Terrell – Stephens
Gary Tenner – D.A. Davidson
Adam Butler – Piper Sandler
Operator
Greetings. And welcome to First Foundation’s Second Quarter 2023 Earnings Conference Call. Today’s call is being recorded. Speaking today will be Scott Kavanaugh, First Foundation’s President and Chief Executive 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 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 President and CEO, Scott Kavanaugh. Please go ahead.
Scott Kavanaugh
Good morning and welcome. Thank you for joining today’s earnings conference call. Following the disruption in the financial industry in the first quarter, we have seen stabilization across the entire banking sector, and in the second quarter, we were able to squarely focus on executing against our strategy.
We are extremely proud of the dedication and diligence of our team, as we experienced total deposit growth, loan portfolio average yield increases, and continued strength in our Advisory and Trust business.
We were able to get our loan-to-deposit ratio back below 100% and our percentage of insured and collateralized deposits to 88% of total deposits as of June 30, 2023, which we believe is an exceptional number comparatively.
For the second quarter, we reported a net loss attributable to common shareholders of $212.3 million, representing $3.7 — a loss of $3.76 per share, including a second quarter 2023 results is a non-cash goodwill impairment charge totaling $215.3 million. The goodwill impairment is a non-cash charge and has no impact on regulatory capital ratios, cash flows, liquidity position for the operations of the company and our ability to meet our client’s needs.
Goodwill is evaluated for impairment annually in the fourth quarter. but the drastic change in the macroeconomic conditions and the Fed rate hikes that have negatively impacted our market valuation triggered an updated assessment. Excluding the impact of the goodwill impairment charge and the other adjustments, adjusted net income, which is a non-GAAP measure for the quarter totaled $3.7 million or $0.07 per share.
Adjusted net income attributable to common shareholders also a non-GAAP measure, was $3.7 million for the second quarter, which excludes the goodwill impairment and other adjustments compared to the $8.3 million for the first quarter of 2023.
Total revenues were $61.1 million for the quarter, a decrease of 13%, compared to the $70.5% million for the first quarter due to a decrease in net interest income.
Our adjusted return on average assets, a non-GAAP measure ended the quarter at 0.11%, a decrease from the 0.25% in the prior quarter. Our operations remain stable and we remain confident in our business given that we are seeing significant improvements in our deposit and loan profiles, as well as stability in our liquidity and credit quality.
As for our expectations for the year, I truly believe interest rate costs are troughing based on the fact that inflation is cooling and all indications are that the Fed is towards the end of the tightening cycle. If this is the case, we should start to see improvements in our balance sheet and earnings.
Related to operational efficiencies during the quarter, we continued to focus on cutting costs, including a small reduction in staff. Reevaluations of all vendor management solutions and setting travel restrictions to manage cost better.
In the quarter, we had $280,000 in severance costs recognized as a result of the reductions in force, achieving an estimated annualized cost savings of $2.5 million plus 15% benefits. Cost saving initiatives along with the shrinking of the balance sheet remain a key focus in controlling expenses to improve our margin profile.
We have also been working to achieve strategic alignment throughout our business with the significant synergies realized between our banking and Wealth Management teams that will lead to cost savings by trimming expenses.
Our deposits increased from $10.1 billion in the first quarter to $10.8 billion in the second quarter, up from the $9.5 billion as of June 30, 2022. Deposit levels hit a low point in the prior quarter and increased by $755 million during the current quarter as our deposit inflows and outflows normalize.
Of the $755 million increase in deposits for the quarter, brokered deposits accounted for $318 million, while $437 million were core deposits. This brings total brokered deposits to 20.4% of total deposits as of June 30, 2023, compared to the 18.8% as of March 31, 2023, whereas core deposits were 80% as of June 30, 2023 and 81% as of March 31, 2023.
The digital banking channel continues to grow as a source of new depository accounts. While account balances totaling $913 million at June 30, 2023, accounting for over 90% of all new client accounts. Also deposits increased to 2.85% for the second quarter of 2023, compared to 2.38% for the prior quarter and 0.28% for the second quarter of 2022.
Insured and collateralized deposits accounted for approximately 88% of total deposits as of June 30, 2023, compared to 85% of total deposits as of March 31, 2023. Strong core deposits are very key to every bank in terms of building franchise value and our pipeline of our core deposits remain strong, while we continue to make significant strides on that front. We are encouraged by the levels of deposits that have continued to return. Chris will touch more on this in a minute.
Our loan-to-deposit ratio has continued to fall. It was 97.9% as of June 30, 2023 and 93.1% as of July 20, 2023. This is a significant improvement to the 106.1% as of March 31, 2023. This ratio is now below 100%. We believe this will continue to improve and we look to modestly shrink the balance sheet while adding deposits.
This improvement in liquidity comes primarily from our clients returning, with some of the change coming from broker deposits. Deposits have been a large focus for us on the front line and we are continuing to make steady progress.
Many customers who left in the days following the regional banking panic have returned, in large part because of our attractive rates on deposits and exceptional client terms. The improvement in the loan-to-deposit ratio is a primary focus for us and we continue to monitor and manage this closely. We continue to have confidence in the markets we are in, notably, our new headers in Dallas, which continues to be a primary destination for many corporations evaluating relocation.
In terms of our deposits by type, we remain balanced among non-interest-bearing, interest-bearing, money market and savings and certificates of deposits. Non-interest-bearing demand deposits measured 25% of deposits as of June 30th, compared to 23% as of March 31st. Certificates of deposits accounted for 26% of total deposits as of June 30, 2023 and 24% as of March 31, 2023.
Borrowings were $976 million as of June 30, 2023, compared to the $2.3 billion and $494 million as of March 31, 2023 and June 30, 2022, respectively. The decrease in borrowings compared to the prior quarter was primarily due to the paydown of $390 million in variable rate FHLB advances and $900 million in fixed rate FHLB advances.
As deposit levels stabilize and began to return to previous levels during the second quarter of 2023, some of these additional borrowings were paid down. Borrowings have declined further to $584 million as of July 20, 2023.
First Foundation continues to benefit from a growing liquidity position. Our on- and off-balance sheet liquidity increased to $4.3 billion for the quarter. To drill in a little bit our on-balance sheet liquidity as of June 30th was $926 million in cash and cash equivalents, representing 7.2% of total deposits on balance sheet.
Our off-balance sheet consisted of available credit facilities of $2.3 billion with the Federal Home Loan Bank, $900 million with the Federal Reserve discount window and $145 million available in uncommitted credit lines.
The ratio of liquidity to uninsured and collateralized deposits is 3.3 times coverage, which is notable as our liquidity profile continues to be an important differentiator for First Foundation.
Looking at our Wealth Management and Trust business, we are close to reaching our historical high for assets under management, as FFA has seen strong performance and secured new client relationships. This is especially impressive considering the tough times that we have had over the previous few years.
We continue to experience meaningful contributions to the firm as evidenced by a combined business unit revenue of $9 million for the quarter. This includes $7.1 million in investment advisory fees and $1.9 million in trust administration and consulting fees. This combined business unit revenue coupled with other recurring sources of non-interest income from our banking unit accounted for 20% of the company’s total revenue for the quarter.
Assets under management increased by $100 million during the second quarter to $5.3 billion, compared to $5.2 billion at the end of the first quarter. Trust assets under advisement ended the quarter at $1.2 billion, compared to $1.3 billion as of the first quarter, but we believe continues to have a very strong pipeline.
We remain well capitalized with a Tier 1 risk-based capital ratio of 11.34% at quarter and exceeding all Basel III regulatory requirements to be considered a well-capitalized deposit institution. Our risk-based capital ratios improved this quarter.
We also declared an approved subject to regulatory improvement a second quarter cash dividend of $0.02 per share. Tangible book value per share ended the quarter at $16.12, compared to $16.17 for the prior quarter. The difference of $0.05 per share resulted from a $0.02 dividend paid to shareholders and $0.03 in AOCI.
I will close by saying again how appreciative I am for the team’s hard work and dedication. It’s been a challenging time, but I am confident that we have continued to take all the right measures to right size the business and put First Foundation on the current path going forward. We are able to weather these challenging times and emerge with increased deposits while maintaining our strong liquidity position.
The credit quality of our portfolio remains a key differentiator for us and we continue to grow the Wealth and Trust business, and exceed all minimum regulatory requirements to be considered a well-capitalized depository institution. All of our risk-based capital ratios improved as did our ratio of uninsured to insured and collateralized deposits, which makes us proud of how far we have come in a short period of time.
We recognize that there are aspects of our business if we can and cannot control. We can control our revenues and expenses, but we can’t control the Fed’s decisions around interest rates. We are focusing on the areas of our business that we can control and remaining diligent in mitigating the risk and the aspects we can. As always, client service remains a top priority of First Foundation and is what draws clients to the bank with us.
We remain proactive in helping clients manage all of these important financial decisions from everyday deposits to Wealth Management solutions. Navigating market conditions with client-first mentality is the key to our business and core franchise and has only gotten stronger.
Now I will turn the call over to Chris and we will go over the portfolio in more detail.
Chris Naghibi
Thank you, Scott. As Scott mentioned, we are happy to see the stabilization in the financial services sector following one of the most challenging quarters in recent history. Moving to our lending operations.
As of June 30, 2023, our loan portfolio is comprised of 50% multifamily loans, 33% commercial business loans, 9% consumer and single-family residential loans, 6% non-owner-occupied commercial real estate and 2% of land and construction loans, which are selectively and carefully considered for our most valued clients. The loan portfolio composition did not change materially from the first quarter of 2023.
Loan portfolio average yield increased to 4.69% in the second quarter, compared to 4.54% in the prior quarter and 3.86% in the second quarter of 2022, respectively. Average yields on new loan fundings were 7.90% in the second quarter, compared to 7.4% in the prior quarter and 3.73% in the second quarter of 2022, respectively.
We have continued to strategically temper loan originations. Loan originations were $474 million for the quarter, which were primarily high quality adjustable rates, C&I, SBA and mortgage lending.
Loan balances decreased to $10.6 billion as of June 30, 2023, compared to $10.7 billion as of March 31, 2023, an increase $1.6 billion or 18%, compared to $8.9 billion as of June 30, 2022. Loan fundings totaled $474 million, offset by loan payoffs of $559 million in the quarter.
Our net loan activity over the quarter was decreased by line paydowns and scheduled payments and prepayments. Our cost of funds is stabilizing, which is moving our loan portfolio in the right direction.
Looking at the breakdown of loans that we have originated so far year-to-date, the percentages are as follows. Commercial business loans 91%, multifamily 3%, single-family 2% and other investments at 4%.
We have significantly decreased the number of multifamily originations this year as a part of our strategy to halt fixed rate lending. Our commercial business portfolio is diversified with no sector comprising more than a third of the portfolio and only 12% of the portfolio exposed to commercial real estate.
It is always important to note that we accomplished this without changing our high underwriting standards and our NPAs increased to 12 basis points for the quarter. This is also reflected in our conservative underwriting standards as evidenced by our LTV of 54% for multifamily loans and 49% for single-family loans.
This highlights the bank’s high credit quality conservative underwriting and disciplined lending practices during these uncertain financial conditions. We have maintained an appropriate risk appetite.
We continue to temper all fixed rate lending in multifamily, and for the most part, in single-family and remain focused on making adjustable rate loans, including C&I, MSR and SBA. These are upper tier credit instruments that give us good deposit opportunities by higher yielding C&I straight adjustable loans are helping to offset our fixed rate loans.
Let’s pivot to multifamily. Although we have been originating far fewer multifamily loans, our multifamily loan portfolio remains a significant proportion of our loan portfolio and remains a best-in-class asset. Multifamily loans continue to be the strongest performing asset class across all commercial real estate. Our loan-to-value ratio of our multifamily portfolio has fallen to 54%. Our multifamily portfolio is diversified across geographies, with the largest concentration in California.
We have also been proactive in restructuring some of our multifamily portfolio, moving it to a weighted average portfolio in line with current market rates. This will take some time, but we have already started to see the benefits of these efforts. I am proud to reiterate that we have never defaulted on our multifamily loans in the history of this firm and I want to remind everyone that we have very little to no exposure to construction, hotels or commercial office space.
Our credit quality remains pristine and our NPA ratio decreased to 12 basis points. Our total delinquent loans as a percentage of total loans decreased to 0.16% as of June 30, 2023, from 0.45% as of March 31, 2023, maintaining good credit quality is a cornerstone of our business model.
As Scott mentioned, our percentage of insured and collateralized deposits increased to 88% as of June 30, 2023, an increase from the 85% as of last quarter end. We are pleased to see continued growth in our insured and collateralized deposits. Our deposit costs increased to 2.85% for the second quarter, compared to 2.38% for the prior quarter and 0.28% for the second quarter of 2022.
Unlike many other banks that were defending their low rates on deposits, we were willing to move client funds of commiserate with how the Fed was moving rates, an important distinction as people have realized they can make money on their deposits. Therefore, our deposit costs have already reflective of the current economic environment, whereas other banks have or will have to play catch up to the Fed.
The breakdown of our current deposits is as follows. Money market and savings 29%, certificates of deposit 26%, interest-bearing demand deposit 21%, non-interest-bearing demand deposits of 25%.
Our deposits to diversify with geographic distribution with California accounting for 36% of total deposits, Florida at 19% and Texas at 9%, which makes up the majority of our deposit portfolio and other states making up 32% of the total.
Moving to NIM. Net interest income was $49 million for the second quarter of 2023, compared to $59 million in the prior quarter. Interest income increased from $137 million in the first quarter to $145 million in the second quarter of 2023 due to increases in both average interest-earning asset balances, as well as average yields earned on such balances.
Interest expense was $96.3 million for the second quarter of 2023, compared with 78.2 million for the prior quarter. This increase was due to increases in both average interest-bearing liability balances, as well as average rates paid on such balances.
Our NIM for the second quarter was 1.51%, compared to 1.83% for the prior quarter, which reflects the interest rate environment and the continued pressure by the Fed action. We will continue to strategically strengthen the balance sheet slightly to regain profitability.
Non-interest income was $12.1 million for the second quarter, compared to $11.7 million in the first quarter and $13.4 million in the second quarter of 2022.
Non-interest expense was $272.8 million in the second quarter, which included $215.3 million in a goodwill impairment charge. Excluding goodwill impairment charges, non-interest expense was $57.5 million in the second quarter, compared to $59.3 million for the first quarter and $48.8 million in the second quarter of 2022.
Our efficiency ratio for the second quarter was 92.5%, compared to 84.5% for the first quarter. The quarter increase in the efficiency ratio is largely attributable to the aforementioned reduction in net interest income during the quarter, as the ratio is a measure of non-interest expense to revenue, net interest income plus non-interest income on an adjusted basis.
Compensation and benefits were $21 million in the second quarter of 2023, compared to $25.3 million in the first quarter and $207.6 million in the second quarter of 2022. The decrease in compensation and benefits is the result of efforts to maximize efficiency and optimize the workforce in the face of slowing loan growth and higher interest expense.
Now let’s briefly touch on our securities portfolio. Our security portfolio totaled $1 billion, with HTM of $815 million and AFS of $201 million, down from $1.1 billion from the prior quarter. The allowance for credit losses for investments was $8.5 million for the quarter, compared to $12.3 million in the prior quarter and $11.2 million for the second quarter of 2022.
The decreases from the prior quarter were primarily due to the reversal of $4 million in allowances for credit losses recorded on several interest-only strip securities that were fully written off during the quarter, results — and resulting in a net income statement impact of only $15,000. Investment securities portfolio average yield decreased to 2.39% in the quarter, compared to 2.73% in the prior quarter.
At this time, we are ready to take questions and I will hand it back to the Operator.
Question-and-Answer Session
Operator
[Operator Instructions] Our first question comes from David Feaster with Raymond James. Please go ahead.
David Feaster
Hi. Good morning, everybody.
Chris Naghibi
Hi.
Scott Kavanaugh
David, how are you doing?
David Feaster
I am doing great. Congratulations on a great quarter. Nice to see the stock reacting favorably. Just — I did just want to touch on maybe some of the deposit trends that you guys saw in the quarter. And if you could help us understand maybe how flows trended, you touched on it, Scott, a bit, some of the clients coming back. But — maybe just help us understand kind of how flows were in the quarter and your thoughts on deposit growth going forward. It sounds like this — the trends that you saw, maybe we saw growth later in the quarter and it’s actually persisted here in the third quarter with your point that borrowings are continuing to paydown. Just curious what you are seeing out there?
Scott Kavanaugh
Yeah. So, we were very fortunate. We have got great clients. Of course, I think, after the failures of several banks out there, a lot of people got scared and did a reactionary thing by moving out. But I think as time went by and people had a chance to think about things, some went to the larger banks that aren’t paying well and have time to think about it. They started returning some of their deposits.
Many of them never truly withdraw all their balances. They withdrew a big portion and so they started bringing back some of those deposits over a period of time. They have continued to grow, while at the same time — well, we have a pretty good pipeline building of other deposits.
And I will say, David, to the extent that we are doing any lending, so I am going to go ahead and touch on that. We are really requiring or severely looking to add to deposit relationships. So our pipeline is really pretty healthy. I think August will be good. We have got some relationships, I think, are going to come in the September time frame.
I would caveat that the difference between quarter end and July 20th that we talked about, that was pretty strong growth and it probably would temper the growth and say on an annualized basis, you won’t see 70% growth.
But I will still tell you, I think, deposit trends are going to continue, our loan balances are going to continue to shrink, our goal is to continue to payoff any borrowings that we have out there and get to a point that we are in a position where our borrowings are less, and then, obviously, we will start focusing on brokered, reducing broker deposit balances.
I probably should add that during just recently, maybe a couple of weeks ago, we took $100 million and went out five years on the — with the Home Loan Bank advance. That saved us about 120 basis points in interest cost that really was not borne out in the second quarter and we will be more realized starting in the third quarter.
And we did another $200 million with the Federal Home Loan Bank that reduced our interest expense I believe a total of 170 basis points. So that should help also reduce our interest cost on a go forward basis.
David Feaster
That’s extremely helpful. And maybe let’s dig into that a bit. So, we got the Fed hike yesterday, right? So if we are assuming that deposit costs do stabilize here that the Fed pauses, could you help us maybe think through where roll-off rates are on the loan portfolio, obviously, new loan yields you talked about in the 7.90%s, but just kind of — again the pace of roll off in the next 12 months and where roll-off rates are? Just trying to get a sense of the asset repricing side and basically where NIM could trough and how to think about the pace of expansion going forward as deposits costs stabilize and we continue to reprice higher?
Scott Kavanaugh
Well, I will touch a little bit on some of the yields that we are putting on. Last quarter, like, you said, the average yield coming on with 7.90%. That has since improved and I — the average yield going on is about 8.25% to maybe slightly higher overall, and of course, that will go higher just like some of the deposit costs will.
But like I said, I think initially, some of the deposits will go up commensurate, I think, you are going to see betas for us trend down relative to what you have seen in prior quarters, which is hugely important for us, which is also why I think there’s going to be a trough, but with the yields that are coming on are coming on at higher levels.
But I think in terms of payoffs, right now, I would tell you, some of the multifamily stuff seasonality-wise, some of the multifamily stock has slowed down on the prepayments. We are still seeing some $3.5 million, $3.75 million in coupons payoff and I know people find that astounding.
We just had a $2 million and 5 million [ph] single-family payoffs in the portfolio. But I think, historically, we have had somewhere between $550 million, $600 million payoff. The summer months do tend to slowdown and then you see activity pick back up late in August, early September, and I think, you will see a stream of prepayments pick back up — that will pick back up, including some of the multifamily.
But I would expect, I think, this quarter from a funding perspective will be slightly less than what we did last quarter. But I think the payoffs will be about the same. So you will probably see a little bit more shrinkage in the loan balance this quarter. Chris, do you want to add anything.
Chris Naghibi
No. I think I covered it early, the seasonality aspect is really interesting. What I will also add is, if you are looking to project forward, there are a little bit of growth — historical growth considerations to think about there. We grew exponentially in the last several years, and in that, you are going to see more payoffs coming due from industrial [ph] rate mortgage loans that are on multifamily book particularly after we enter into 2024.
David Feaster
Okay. Okay. That’s helpful. And then maybe just staying on the multifamily side. Chris, you touched on it a bit, but it feels like maybe there’s some misperceptions out there when I talk to investors on multifamily and differences in rent control versus non-rent control and just the health of the multifamily market maybe on the West Coast. Could you maybe just expound on kind of what you were talking about, what you are seeing out there, what you are hearing from clients and just any other commentary on the multifamily book and the health of from a credit perspective on those loans?
Chris Naghibi
Yeah. Thank you for asking the question. I mean, this is something we spend a lot of time on and I don’t want to go as far as to say we are something about our expert on it, but we spent a lot of time and effort and energy really understanding behavioral economics and the implications of the nuance based business of multifamily in different regions and markets that we are in.
There’s only, I believe, five rent control states truly California being one of them. And with such a majority of our multifamily properties in that space, rent control offers the benefits, if you will, of acting as a buffer both upward and downward in price.
It almost gives you a little bit of stability for real rudimentary explanation, the income approach to value is really what drives multifamily, particularly work force multifamily housing, which is the ponderance of our portfolio, because of that driven path, most people are unwilling to move to have to re-rent at a much higher rental rate for a similar situated properties somewhere else.
And as a result of the high interest rate market, it’s economically unviable for most people who are renting right now to pivot over to homeownership unless they completely leave the state and because of the slowdown we are seeing both in migration in and out of the state on some level and because of the construction units coming online largely in the Sunbelt region being high end luxury deliveries, our workforce housing is actually not seeing any impact whatsoever.
As a matter of fact, the numbers remain to be strong and this is echoed in the data provided by Moody’s Analytics, which have filed recently, as well as what we are seeing in the portfolio trending now. Does that answer the question, David?
David Feaster
That’s super helpful. That’s super helpful. Thank you.
Operator
The next question comes from Andrew Terrell with Stephens. Please go ahead.
Andrew Terrell
Hey. Good morning.
Scott Kavanaugh
Good morning.
Andrew Terrell
Chris, if I could go back to some of the kind of roll-on, roll-off dynamics on the loan portfolio. I guess if I take some of the commentary there in terms of new originations and the rate that’s coming on at, call it, eight — low eight-territory and then the payoffs, if those stay around the same level, maybe a bit elevated but are coming off at a, call it, high three, low four territory. I mean if you take those two together, it implies probably a 15-basis-point lift in loan yields per quarter just from, like, assuming no real changes in the interest rate environment or no more moves from the Fed. I guess then as you are looking through the model, does that make sense to you that like in a static environment, loan yields could go up kind of 10 basis points per quarter, 15 basis points per quarter just with no Fed changes?
Chris Naghibi
I am sure Scott will want to opine on this. We spend a lot of time looking at that same question. But, yes, the short answer is that, that’s about what we pick it as well and that is actually what we believe will be the plan, which is why we have been very methodical and pragmatic about the paydowns and putting new loans on the books and that’s the business strategy. Scott?
Scott Kavanaugh
No. I would agree with that. And I would say, yeah, if I am right and there’s seasonality where there’s a few — fewer payoffs on the multifamily during the summer months. I believe that will pick up in the fall and winter months and I think you could see even slightly better improvements month-to-month.
Andrew Terrell
Okay. Got it. And then on the deposit front, do you have what the spot cost of deposit was exiting the second quarter, either interest-bearing or the total?
Chris Naghibi
Amy, do you have that?
Amy Djou
Yes. So if you are — good morning. So if you are looking at the spot rate, weighted average rate on the deposits, you are looking at about 3.72% for the quarter?
Andrew Terrell
Yeah. So that was 3.72% weighted average interest-bearing costs for the quarter. Do you have that equivalent number at June 30th at the end of the quarter or where it’s at to start July?
Amy Djou
Oh! Yeah. You are looking at 1.58% and…
Scott Kavanaugh
1.
Amy Djou
… 1.58% for the quarter — for the June.
Scott Kavanaugh
Yeah.
Amy Djou
That’s like net interest, hold on 1 second, let me see, yeah, 3.86%.
Andrew Terrell
3.86%.
Scott Kavanaugh
3.
Andrew Terrell
Okay. Got it. So I guess, with — also coming in at 3.86%. But taking your commentary, Scott, around the reduction in borrowings. It feels like the cost of funds could potentially be flattish in the third quarter or maybe even down and taking that with kind of your — the loan commentary. I mean, we should see a pretty meaningful lift in the margin heading into the third quarter. Is that right?
Scott Kavanaugh
I believe so. Those trends are all heading in the right direction. Yeah. That’s what I think.
Andrew Terrell
Okay. And then I have one more on the operating expense line item. Just weighing together some of the actions you have taken over the past quarter in terms of the headcount reduction, just — and then also, the customer service costs that were up this quarter, I would assume might lift a little more into the third quarter. But, overall, just where do you see customer service costs heading and then the overall operating expense line item, do you have a good guide for that into the third quarter?
Scott Kavanaugh
Amy, you want to, yeah, I will say.
Amy Djou
Yeah.
Scott Kavanaugh
Go ahead and answer that question and then I will talk about the risks and whatever else.
Amy Djou
Well, because — well, Scott just mentioned, the risk that we were — we had in the first two quarters, we are really looking at projecting kind of annualized and benefits in the third quarter. So compensation and benefits will definitely project slow coming down a little bit in the third quarter and even a little bit more in the fourth quarter.
Occupancies and other professional costs is going to be remain steady. Customer service costs, we do expect a little bit higher probably just due to the recent Fed increase. So all in all, it probably will net to a very minimal increase in the third quarter.
Scott Kavanaugh
The third risk that we did, Andrew, was recent, it was less than — I think it was about two weeks ago. So really we saw no benefit in the second quarter from the third. It’s — you guys know this and I am going to state the obvious, which is, it’s not something we wanted to do. But it’s something that we needed to do in order to navigate our way through this situation.
But it should be impactful. We continue to find some programs, IT initiatives, other things that we have back burnered or canceled altogether. That — don’t seem all that meaningful, but 40 grant a month or whatever, those start adding up. So we continue to look for any cost saves we can.
Andrew Terrell
Yeah. Okay. I appreciate the color there and if I could ask one more, Scott, just on the dividend. It does feel like we have hit maybe an inflection point in earnings, taking some of the commentary here together. The dividend is obviously a lot lower today. But just as the earnings profile improves over time, how are you thinking about the dividend rising. Should it be, I guess, in line with that or will it be kind of sporadic. I guess, can you help us think about how the dividend should improve from here?
Scott Kavanaugh
Yeah. Provided that NIM starts increasing, which we believe it’s going to, that is trough. As our earnings continue to grow, we will do an analysis of the dividend and make sure that we have the support to increase the dividend. But is fully within my wanting to bring the dividend back to where it was post this nightmare that I will call it.
So I think, as you know, I guess, what I am saying is, yeah, we did the prudent thing by bringing the dividend from $0.11 down to $0.02. But I believe as our revenues start on the way back up, you will see us look to increase the dividend commensurately in alignment with the revenues.
Andrew Terrell
Understood. Okay. Thank you for taking the questions and congrats on a good quarter.
Scott Kavanaugh
Thank you.
Chris Naghibi
Thanks.
Operator
The next question comes from Gary Tenner with D.A. Davidson. Please go ahead.
Gary Tenner
Thanks. Good morning.
Scott Kavanaugh
Good morning.
Chris Naghibi
Good morning.
Gary Tenner
Hey. So lots of questions asked and answered. Just as you talk about, Scott, the further decline in borrowings that you flagged through July 20th. Is there any shift in kind of the on-balance sheet cash liquidity from that or is that really just a function of deposit inflows being used to paydowns in March?
Scott Kavanaugh
It was really — well, we did bring our on-balance sheet cash from $1.3 billion in the first quarter, down to $600 million, $700 million, whatever the number was, it was $790 million or whatever in the second quarter. And of course, that was used to paydown. The deal was we had provided additional collateral to the Federal Reserve Bank and to the Federal Home Loan Bank to get additional borrowings.
And to be honest, I think, it was important for us in the initial days of those few banks that failed to carry an abundance of on-balance sheet cash, but as we had additional borrowings that we could tap into, which frankly, are quicker than you could sell off securities or anything else. We just didn’t — we felt that as the everything stabilized in the marketplace that we didn’t need to be at $1.3 billion on-balance sheet cash.
So we brought it back down to a more manageable level in my mind, and by the way, that saves about $700,000 in interest expense that we would otherwise be putting to carry a bunch of on-balance sheet cash that, frankly, we don’t think we need.
Gary we will continue to monitor that, and if it’s warranted, we will either increase or decrease on-balance sheet cash, depending on events that could create either challenges or benefits to us. So we are trying to take a closer eye to say where should on-balance sheet cash be and especially relative to our ability to tap into the Home Loan Bank and the Federal Reserve Bank. But the first quarter, I guess, is what I am trying to say, I think, was prudent at the $1.3 billion. I think where we are at right now is prudent for how I feel like the environment is today.
Gary Tenner
I appreciate it. And then in terms of your commentary about probably still some decline in loans from here, if I heard that right. Any sense of where loan balances may bottom out and should — are you thinking about in terms of kind of a target loan deposit ratio, how do you kind of think about triangulating around loan balances versus funding?
Scott Kavanaugh
Well, it — sure. No. I don’t know that we have set a number that the total loan should be at. As you know, we have cut back on multifamily lending, it’s almost non-existent. I would tell you it is non-existent.
The only thing that we truly are focused on is equipment finance, SBA and truly adjustable C&I production. Single-family, multifamily, all of which tend to be more fixed rate in nature, anything else, we are just not really looking to do at this time.
So the answer is, it’s going to continue to shrink. We are hyper focused on the loan-to-deposit ratio, which is also key. I am proud of the fact that we brought it down as of July 20th to 93.1%. But I want to continue to bring that number down.
Where is that? I don’t even know I have an answer to that. But my objective in the near-term is 90% and I wouldn’t be surprised if we even strive to get it a little lower than that over a period of time.
Gary Tenner
Appreciate it. You flagged in your comments the $100 million FHLB term events, the five-year events that saved $120 and then you mentioned $200 million more that reduces your cost by that 170 basis points. How long is that fixture?
Scott Kavanaugh
That particular one was a different structure and it was a five-year put-able six months. So the Home Loan Bank has the right to put it back to us in six months. I think now is the perfect time to do it, given the backdrop of the Fed, pretty much being done with raising rates. If — the street is right on expectations for the Fed rate cycle, that was put on at a 3.62%, I believe, Gary. So it was a five-year put-able 6 months. So it would be put-table. I’d like to think of it as a call, but put-able in January.
Gary Tenner
Okay. Great. And then last question. Obviously, the focus over the last four months by investors has been pretty squarely on deposits. But there are questions, obviously, around asset quality for the industry overall. And as it relates to First Foundation, obviously, your allowance is pretty low on a relative basis of 30 basis points of loans, even if you assume multifamily is a zero loss asset, that translates to 60 basis points in the rest of the portfolio. So can you talk a little bit about the allowance as it relates to the non-multifamily portfolio and comfort with that level you are at?
Chris Naghibi
Yeah. It’s Chris. Yeah. It’s a great question and one we spend a lot of time thinking about, obviously, having started the bank with the loss history that we have, we have to rely a lot on the outside data for CECL and stress testing purposes.
We run a combination of scenarios with Moody’s Analytics being the backdrop for that. And the scenarios are weighted for their baseline and the Fed Severe Adverse Case scenario, as well as the potential upside.
Obviously, as you would imagine, we even played it much heavier towards the Severe Adverse scenario and taking a more conservative approach and that’s really reflected in the overall number.
But we feel really strongly about our portfolio. Look, our credit portfolio has been very conservative for a long period of time and we don’t really sacrifice credit quality for rates, which is really the interest rate risk position that we are — that led us to where we are at today, even the C&I lending that we have done has been equally as conservative and strong underwriting characteristics are there.
Do we expect to see some degradation over time? Possibly. But that’s accounted for with the stress test and an equally conservative approach. So we do feel confident that the numbers are more than enough that the backstop our position and we are not seeing a degradation in the credit cycle yet.
We are hopeful that as we continue to go in this business, we are maintaining credit standards at the same degree and I don’t expect it to be a challenge. But over time, you may see that number increase as the C&I base of the model grows.
Scott Kavanaugh
Well, we will. I want to be clear about that, Gary. As multifamily pays off and we put on more C&I or just we put on more C&I, there is no doubt that our loan loss reserves will increase as a result of.
So — and looking across, we have had some Ps and Ds that have taken away. There’s been some additions. But net debt, there is not a doubt in my mind that as we continue to put on C&I lending, which obviously, are going to require more loan loss reserves, you will see that percentage grow. It grew this quarter, not a lot, but it grew a little bit this quarter, but you also had a shrinkage of the loan portfolio as well.
Gary Tenner
Great. Thanks, guys. Appreciate the color.
Scott Kavanaugh
Thank you.
Operator
The next question comes from Adam Butler with Piper Sandler. Please go ahead.
Adam Butler
Hey. Good morning, everybody.
Chris Naghibi
Good morning.
Adam Butler
If I could just ask a follow-up on the — on expenses. I know that the customer service deposit line is sourced from earnings credit rate on non-interest-bearing deposits. I was curious if you could ask — if you could answer a few questions surrounding that, what proportion of the non-interest-bearing growth this quarter was tied to those rates. What proportion of current non-interest-bearing are tied to those rates and what they are priced at right now?
Scott Kavanaugh
Well, the non-interest-bearing deposits only went from 24-point something to 25-point. So whatever the increase was, my bet would be that a majority of that would be in that center that we pay credits to.
Adam Butler
Okay. And…
Scott Kavanaugh
Yeah. When pay the payment [ph].
Adam Butler
Also I was just curious if we look at the forward curve and we get about 100 basis points impact next year. Could you see some relief in that expense line and I like to confirm…
Scott Kavanaugh
I am trying to…
Adam Butler
… China did search for how to model?
Scott Kavanaugh
Sure. I am trying to tell everybody that when it comes to those types of deposits, when we have Fed rate increases, it is pretty much basis point for basis point. When we have Fed decreases, which a lot of people are starting to point to that, it is also basis point for basis point. So to the extent that the Fed reduces rates, you will see a commensurate drop basis point for basis point that the Fed drops rates should they do so.
Adam Butler
Okay. Great. That’s good to hear. And just a housekeeping item. What is the good tax rate to expect going forward?
Scott Kavanaugh
Amy?
Amy Djou
You are really looking at an effective tax rate is about 16% annualized. So it really depends on net income before tax, how we are going to do it on third quarter and fourth quarter. But as of today, we are projecting about — effective tax rate about 14%.
Adam Butler
Okay. Great. Those are all my questions. Congrats on the good quarter.
Scott Kavanaugh
Thank you.
Chris Naghibi
Thank you.
Operator
It appears there are no further questions at this time. I will now hand it back over to Scott Kavanaugh for any additional remarks.
Scott Kavanaugh
We continue to work through some of the challenges stemming from the disruption of the financial industry earlier in the year and we are encouraged by the quick rebound in the market and our business. I’d like to use the analogy that we are a big ship and we are starting to find return.
We are thank you — thankful for the continued support of our stockholders as they continue to believe in our long-term strategy during a pivotable — pivotal time for the industry, demonstrated by electing all 10 of the company’s nominees for the Board of Directors at our 2023 Annual Meeting, while rejecting the activist nominee by a substantial margin.
Going into the back half of the year, we are more focused than ever on growing deposits, remaining selective on loans, identifying efficiencies, reducing expenses and continuing to serve our clients well.
We have a strong liquidity position that provides financial flexibility, limited exposure to uninsured deposits and a securities portfolio that allows us to actively manage our interest rate risk and gives us balance sheet flexibility.
We are able to give personalized attention to our clients and that they remain our First Foundation priority. As a regional bank, we remain nimble and able to provide first-class white glove served to our clients. We are proud of the continued resiliency by our team and the loyalty of our customers and we navigate through this challenging macroeconomic environment.
There have been a lot of people that have stood up and gone above and beyond for First Foundation and I look forward to all that we will accomplish in the second half of 2023 and into 2024.
As a reminder, our earnings report and investor presentation can be found on the Investor Relations section of our website. Thank you and have a great remainder of your day.
Operator
This does conclude today’s program. Thank you for your participation. You may disconnect at any time.
