First Foundation: This Bank Is Suffering From The Choices Of 2022 (NYSE:FFWM)

First Foundation (NYSE:FFWM) is a small bank based in Dallas, Texas. It operates mainly in California, Florida, Texas, Hawaii, and Nevada.

The current macroeconomic environment is putting it in serious trouble; in fact, NIM has plummeted precipitously in recent quarters. The main problem was mismanagement of capital allocation in 2022, and to date the bank is paying the consequences. The Q4 2023 results were sluggish and not too exciting.

Loans and NPLs

The loan portfolio reached $10.17 billion, down 1.07% from the previous quarter and 5.13% from last year. Certainly, demand for credit has decreased given current market rates, but this does not justify such a result. The main problem is that the LTD ratio is on 95% and deposits are also struggling to increase. So, the bank does not have much room to maneuver, which represents a missed opportunity in my opinion.

The yield on originations this quarter was 8.47%, and issuing a good amount of new loans today would have made a difference. In fact, FFWM’s yield on loans is only 4.70%, and it would have made a decent improvement by lending at current rates.

Instead, as we can see from this image, total originations fail to offset prepayments and line paydowns/scheduled payments; neither on a quarterly nor annual basis. This is why the loan portfolio is declining.

In my view, At the root of the growth problem was a mismanagement regarding loan origination in 2022. After the Fed’s expansionary monetary policy, the bank got a large injection of liquidity and thought that the best use of this capital was to lend it out. However, starting in mid-2022, the sharp rise in the Fed Funds Rate began, and all the fixed-rate loans made in that year turned out to be the wrong investment. In fact, they still weigh heavily on the current yield on loans.

In other words, the bank should not have lent nearly $6 billion in 2022, but should have stayed at the levels of previous years. This mistake is costing dearly, as now that liquidity is still tied up and the LTD ratio has shot up. In fact, in 2021 it was only 78%.

So the mistake was in the timing; as far as credit risk is concerned, we are in the opposite situation.

In fact, the NPLs ratio is only 0.12%, far below the peers’ average of 0.39%. So, the bank lent to the right people/businesses, but at the wrong time.

In light of these considerations, growth prospects cannot be exciting given the bank’s rigid financial structure. In addition, demand is much more sluggish than in the past:

We’re not seeing where balances can grow tremendously off the C&I. To be honest, again we’ve all been about credit and so we’re just not going to participate in a market that we don’t believe that the credit is fully where First Foundation should be. So that being said, we believe C&I can continue to grow, but it’s going to be much more modest than relative to the current balance that we have on C&I. Multifamily, yes, there are opportunities there, I would say, the rates right now in that sector. Now, say that there is a lot of people that have pulled back.

CEO Scott Kavanaugh

C&I loans may continue to be the most attractive ones; after all, 91% of Q4 2023 loan originations belonged to this category. In any case, future growth is rather scaled down compared to the past. At the moment, the only real growth driver is the repricing of $1.50 billion of multifamily loans in the next year and a half. This cash inflow could be reinvested at higher rates, assuming the Fed Funds Rate is not reduced significantly in the next 18 months; otherwise, the opportunity would fade.

Deposits and NIM

Total deposits are following the downward trend of loans; in fact, they decreased by 1.13% from the previous quarter. Their growth has stalled, but what is most problematic is the continuing shift from non-interest bearing deposits to interest-bearing deposits. This trend shows no sign of stopping almost 2 years after the first-rate hike: non-interest bearing deposits have plummeted by $945 million in just 3 months. Management reiterated that this is a seasonal component, but it is still a disappointing result.

With interest earning assets increasing their yield by only 6 basis points and interest-bearing liabilities increasing 3 times as much, it is inevitable that the NIM will continue to collapse. Basically, this deterioration lasts since the first Fed Funds Rate hike, which gives an idea of the harm of granting so many fixed-rate loans in 2022. Even if FFWM’s credit risks are minimal, an NIM of 1.36% is too little.

The only factor that could really help this bank is the Fed with a rate cut before lending. In fact, FFWM is a liability-sensitive bank, which means that it will get a profitability benefit if rates fall: as much as $3 billion of its deposits have a cost linked to key market rates. So if the Fed reduces rates, these deposits are repriced immediately to the downside; assets would respond more slowly, being primarily fixed-rate.

Conclusion

First Foundation is a bank that miscalculated the timing with which to invest the large amounts of capital available to it after the pandemic outbreak. The frenzy to make as many loans as possible in 2022 has stalled the bank’s current operations, leading it to not take advantage of current market rates. Meanwhile, the cost of deposits continues to rise, while the LTD ratio is quite high, 95%. The growth outlook is not the best, but this could change if the Fed reduces rates earlier than expected.

I personally expect the negative period to continue for months more, but of course this does not affect the bank’s existence.

Nevertheless, First Foundation remains a financially sound bank, with a steadily increasing TBV per share and good levels of capitalization. If on the loan side management has not been excellent, at least on the investment portfolio side a good performance has been made. Many peers are struggling with unrealized losses of 10-20-30% of their equity: for FFWM, this problem does not exist.