First Foundation Inc (FFWM) 2022 Q2 法說會逐字稿

Greetings, and welcome to First Foundation's Second Quarter 2022 Earnings Conference Call. Today's call is being recorded. (Operator Instructions) Speaking today will be Scott Kavanaugh, First Foundation's Chief Executive Officer; Kevin Thompson, Chief Financial Officer; and David DePillo, 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, see the company's filings with the Securities and Exchange Commission.

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

Good morning, and welcome. Thank you for joining our second quarter 2022 earnings conference call. Today, we will be delivering some prepared remarks, highlighting our activities and accomplishments this quarter. At the conclusion of the prepared remarks, we will open the line for questions. This quarter, we delivered strong results as our business model continues to perform well.

Our earnings for the second quarter were $33.3 million or $0.59 per share, which represents a 7% increase over the first quarter of 2022. Total revenues were $95.2 million for the quarter, a 6% increase from the first quarter of 2022 and a 32% increase year-over-year.

Our tangible book value per share ended the quarter higher at $15.61. We also declared and paid our second quarter cash dividend of $0.11 per share. As you are well aware, there are a lot of headwinds facing our industry and the economy right now, yet each of our lines of business have continued to perform well, and we have contributed in meaningful ways to this quarter's results.

Our strong financial performance is a testament to the dedication of our employees who continue to deliver across all areas of the company. It also is a demonstration of the quality of our clients and our pipeline across banking, wealth management and trust services. We continue to strategically build upon our growth story via organic opportunities while we also capitalize on our recent M&A activities.

Furthermore, core deposits continue to increase so that we remain largely self-funded, a strategic advantage in the current environment. The favorable results we reported today reflect the strength of our institution and our continued positive outlook that our business model is working very well across the diverse and dynamic markets we serve.

Loan originations hit record levels with $2.2 billion in new loans for the quarter, a truly remarkable feat. Another highlight in the quarter was our impressive balance sheet growth, which expanded from $10.4 billion to $11.2 billion, and we would have even been greater had we not put our excess cash to use. NPAs continue to remain low at 15 basis points for the quarter as our lending team does a fantastic job maintaining our high credit standards. We have established a well-balanced loan portfolio that continues to perform very well. Dave will touch more on that later in the call.

Our deposit profile remains diversified and attractive with core deposits at 99% of total deposits. Deposits increased by $581 million for the quarter, driven by our ability to continue to attract high-quality clients from online, retail and commercial channels. All of this speaks to the strength of our deposit team and the attractiveness of our offerings.

Our Wealth Management and Trust business continues to provide meaningful contributions to the firm and have been successful in retaining existing clients and attracting new ones. Assets under management ended the quarter at $4.8 billion, largely due to market conditions expands in the first months of the quarter. The all-weather portfolios we manage for our clients performed well with respect to their benchmarks, even as the S&P 500 and NASDAQ saw significant declines during the quarter. It is times like these that our investor clients take our advice more than ever. We are actively working with each one of them.

We successfully expanded our wealth management and trust offering into Florida with the addition of talented new team members, and we are pleased at the initial results we are seeing. As I have mentioned in the past, this is an excellent market for private wealth management services. We also secured trust powers in both the state of Texas and the state of Florida, which will allow us to offer a full suite of trust services to clients in these important markets.

Looking more at our expansion efforts, the final step in the acquisition of First Florida Integrity Bank occurred when we converted our core systems in May. Florida is now up and running on our industry-leading technology platform, and we are successfully working with the new client base as we work to deepen these relationships and acquire new ones. To that end, we have already begun discussions with many of our Florida clients and have uncovered additional ways we can support them, whether it is through additional banking services or wealth planning, investment management or trust services. It's been a tremendous effort by the team, and I am so grateful for everyone who has worked hard to make this happen, especially all of our colleagues in Florida.

Texas continues to present unparalleled opportunity for us. It produces 9% of U.S. GDP, second only to California as the nation's largest annual state population growth. And in 2022, the number of businesses moving into Texas are on the rise. We officially opened the doors to our de novo branch in the city of Plano, Texas. This will serve as a valuable banking center to serve clients in one of the most business-friendly regions as we operate. We expect great things from this branch, and we are pleased at the warm reception we have received by the community of Plano.

During the quarter, we also repurchased $2.5 million of stock at a weighted average price of $21 per share. Management will continue to utilize the stock buyback option should it be warranted. Also, we continue to invest in technologies to enhance our operational efficiency, which is as important as ever as we expand and grow our team across multiple states and time zones.

In this tight labor market, we have taken additional steps to ensure our employees are engaged and thriving. This includes offering advanced training for our future leaders, hybrid work setups for those who can work remotely, ongoing employee recognition and constant benchmarking of salaries to ensure we stay competitive in our markets. One of our best assets is our people, and we strive to make First Foundation a great place for our employees to call home.

As we look ahead to a continuing rising rate environment and the transitioning economic cycle, First Foundation remains well positioned with a strong balance sheet and excellent credit quality. Demand for our services is at peak levels, and our pipelines across all business lines are very robust. I'm very grateful for all that we've accomplished in the quarter and the first half of the year.

I want to conclude my opening remarks by saying how pleased I am with the entire team at First Foundation. We have a group of talented and dedicated professionals who are very committed to serving clients and building a valuable business. We also have amazing clients who entrust us with their financial well-being. It is truly an honor to be able to lead this organization.

And now I'll turn the call over to our CFO, Kevin Thompson.

Thank you, Scott. As mentioned, earnings per diluted share was $0.59 in the second quarter. The return on assets was strong at 1.24% with a return on tangible common equity of 15.5%. The net interest margin expanded 18 basis points to 3.18% in the quarter. The NIM increase was driven by our strong loan production as we utilized our excess liquidity and by an increase in the yield on interest-earning assets, which expanded to 3.5%. This was offset partially by an increase in our cost of deposits from 15 to 28 basis points as customer deposit rates have been adjusting to the rising rate environment.

Credit metrics remain strong in all our loan portfolios, the allowance for credit losses for loans increased by $339,000 in the quarter to $33.2 million, primarily as a result of increased loan balances, offset by the release of specific reserves related to purchase credit deteriorated loans from prior acquisitions. The reserve ratio decreased from 44 to 37 basis points of total loans.

Our noninterest income for the quarter was $13.4 million, driven primarily by wealth management revenues of $7.7 million, $2.1 million in trust administration and consulting fees and the balance in banking-related fees. Our advisory and trust divisions achieved a combined pretax profit margin of 24%.

Noninterest expense was $48.8 million for the quarter, which represents a slight uptick of 2.5% from the first quarter. Customer service costs increased by $2.8 million due to increases in the earnings credit rates paid on the related deposit balances. We saw a decrease in compensation and benefits, primarily due to merit increases in annual bonus and commission payouts that took place in the first quarter.

The efficiency ratio for the quarter was 50.7%. With strong expense management and the investments we have made in our infrastructure, we continue to realize benefits from operational leverage and efficiencies. Finally, our effective tax rate for the second quarter was 27.9% compared to 28.4% for the prior quarter. We are just beginning to realize benefits from our tax strategy that should continue to grow over the next several years.

I will now turn the call over to David DePillo.

Thank you, Kevin. As Scott mentioned, we originated a record amount of loans with loan originations totaling $2.2 billion for the quarter, which is a 96% increase from the first quarter and 98% increase year-over-year. Looking at the breakdown of loans that were originated in the quarter, the percentages are as follows: commercial, including owner-occupied commercial real estate, 51%; multifamily, 40%; single-family, 4%; land and construction, 2%; and 3% other.

Contributing to loan originations during the quarter, our Commercial business division funded a record $1.2 billion of new commercial loans during the second quarter of 2022, which is a 30% -- with 30% of those being adjustable commercial revolving lines of credit. Of note, C&I originations included $518 million of public finance loans, $289 million of commercial term loans, $33 million of owner-occupied commercial real estate loans and $32 million of equipment finance loans.

The large increase in public finance loans was driven by an increase in demand for bank loans away from the bond market by public municipalities. Following dramatic interest rate movements in the second quarter, we expect this increase in demand to be somewhat temporary given our unique positioning in the channel. We anticipate heightened originations in this channel through July as we fund out the majority of the pipeline and return to our historical run rate starting in August.

Our public finance division has become a strategic component of our business originations, benefiting both from credit quality with historically low loan losses, while also offering an ability to lower our effective tax rate over time and providing a compelling tax equivalent return.

Looking ahead to overall loan pipeline, we see continued strong demand heading into the third quarter in all lending channels. It is always important to note that we accomplished this record quarter of originations without changing our high underwriting standards as our NPAs fell to below 15 basis points for the quarter.

Speaking more specifically about loan yields, we achieved a weighted average rate of 3.73% on originations, which increased from the first quarter, that was 3.36%. This quarter, we started to see the impact of higher rate funding due to increases in the long end of the yield curve over the past few months.

As of June 2022, our loans held from maturity consisted of the following: 44% multifamily loans, 35% commercial business loans, 8% nonowner-occupied CRE, 11% consumer and SFR loans and 2% land and construction. Our deposit business also experienced a strong growth during the quarter. Deposits increased by $581 million for the quarter, which is a 6.5% increase from the first quarter and an increase of 34.2% year-over-year. Deposit growth during the second quarter of 2022 compared to the first quarter of 2022 was primarily driven by an increase of $291 million or 8.8% in noninterest-bearing demand deposits, largely attributed to our commercial deposit services division and an increase in money market and savings accounts of $277 million or 10.7%, largely attributed to our retail branch and digital bank channels.

Our noninterest-bearing deposits account for 38% of our total deposit balances. Our loan-to-deposit ratio measured 98.8% as of June 30 compared to 88.2% as of March 31 and 86.6% as of June of last year. This represents an increase from historical low levels experienced during the past few quarters as we have successfully deployed excess liquidity but still have a manageable ratio for a bank of our size.

All the success in the quarter could not have been achieved without the great team we have in place. I am so grateful for their dedication and hard work. At this time, we are ready to take questions, and I'll hand it back to the operator.

(Operator Instructions) We'll take our first question from Matthew Clark from Piper Sandler.

Maybe starting on the margin. Do you happen to have the spot rate on interest-bearing or total deposits at the end of June? And what's your expectation for the cumulative deposit beta for this cycle?

Scott, I can take that first part. The spot rate on total deposits dipped into the mid-30 basis points area near the end of the quarter.

Okay. And then -- go ahead.

In terms of beta, we are seeing, as you know, an unprecedented increase in the rate environment. And bank customers are adapting very quickly to that. So where the last rate cycle of the beta was quite slow on deposits, we're seeing the opposite this time. And loans, as you know, take longer to get through a pipeline. So in the last cycle, loan betas were much quicker than deposit betas. And this particular cycle for all banks, what we're seeing is the opposite, and we need a little time for the loan betas to catch up with those deposit betas. So we're seeing pretty...

What, I would say, Matthew, is I don't think there's a bank in this country that's not having the raise rates somewhat similar. It's a very competitive environment. Deposits and I've noted this and reading a lot of the reports that even you've stuck out that deposits have declined at many banks. So it's expected that the Fed will increase rates tomorrow, I believe, is the next Fed rate meeting, and we will meet shortly thereafter. What the beta is off that is anybody's guess. But I don't think anybody has been through a cycle where you've seen 100 basis points or more move in less than 60 days. So the answer is deposit costs will go up by, but by how much we're not exactly sure.

So Matthew, we are benefiting somewhat from our consumer and retail channel, especially in Florida and some of our legacy branches. So those tend to move slower than certainly money available on the margins. So as we continue to experience a large growth marginal deposits will obviously be more expensive. But the betas at our branch level are pretty consistent with what we see in the market.

Okay. And then just switching over to the loan yields, a little bit of an uptick, but a nice increase in the new production in terms of rate. Any update on pricing in multifamily these days? And it sounds like we should see kind of an acceleration in loan yields here beginning next quarter.

So obviously, the book of business is relatively large. And even though we're starting to fund out at higher levels than we have historically. If you look at our current run rate, it's significantly higher than what we've seen in the past. That being said, as you noted, we did have some movement during the quarter on our yields going up which was nice. In June, we were getting close to that 4% number. But we were funding out a lot of loans that were rate locked in previous -- before that dramatic rate increase that we saw. So we had to work through those portions of the pipeline.

Current rates on multifamily, we've been averaging, I would say, mid-4s right now. So about 150 basis points higher than what we saw at the trough when rates were significantly lower. When our competition was close to 3%, we're close to 4.5%. We will start seeing the benefit of that in the third and fourth quarter, but really, that really starts to gain momentum going into next year as we see a larger portion of our overall balances.

So from that perspective, that's a net-net positive to us. The other benefit we're seeing on rate yields movement is certainly in our commercial book, a lot of that is either prime LIBOR or SOFR based. And those -- we expect to see also those settling in, in the mid- to upper 4s depending on the business line. And in some cases, in 5% to 6%. So the good news is, going into the latter half of the year, loan yields should be coming on at a significantly higher rate than what we've seen certainly in the first half of the year.

Okay. It's encouraging to hear your loan yield was tracking close to 4% in June. So putting it all together, is it fair to assume some -- a little more modest NIM expansion from here and try to hold the line with new loan yields or excuse me, loan yield expansion kind of mitigating or offsetting the deposit increase.

So the way we have kind of seen it right now is we'll probably have maybe a little bit of catch-up on deposit costs, but it should start to stabilize and then expand out. So as we've already told you, we kind of operate in like the 3% to 3.25% range. Near term, we may see a little bit of compression on that as we're waiting for some of these newer loans to come on...

It depends on what the Fed has to do. It all depends on the Fed. But the reality is, I think you're fairly accurate, Matthew.

Okay. Great. And then maybe for Kevin, can you give us what you're assuming for customer service costs in terms of dollars for this year, full year and next year?

Yes. We have forecasted that, and it depends on many factors, what the Federal Reserve does. So I don't think that's something we want to give an exact number on. But the Fed is moving quickly. We'll find out next Wednesday what this next move is, and it really will be the telling factor. We, like other banks are seeing a strong deposit beta upfront in these moves. And we will continue -- in this quarter, you saw a Fed increase in mid-May, in June.

Those still aren't fully baked into our customer service numbers as there's some impact to those and depending on what happens next week, all those will play out, and we will see an increase in customer service costs over the year. It won't be 100% beta. We still have good relationships with these clients. We have technology that's unusual for a bank our size that they couldn't find in other banks. So we will manage it well. And I think you'll see it play out as we talked about in our net interest margin.

So yes, I think the way we view it is when rates are low, our efficiency ratio operates at the lower end of the spectrum. When rates are higher, we look closer to what an efficiency ratio you would see at a typical commercial bank. So part of it is a trade-off of NIM versus G&A ratio. So we expect some near-term pressure on our efficiency ratio over the next couple of quarters, and then that will kind of subside as our balance sheet growth and earnings kind of lever into that. But in the next couple of quarters, you'll probably see a little more impact certainly than we'll see next year and beyond.

Okay. And then just any updated thoughts on the current run rate of noninterest expense in the third quarter?

Yes. So you saw that we had -- other than our customer service costs were actually as expected are down a little bit in the first -- in the second quarter. First quarter is our seasonally high area. So we're -- we plan to, most importantly, keep our efficiency ratio low for the full year to the low mid-50s. And we will see some increase in that expense line as -- first of all, of customer service, but also as our business is expanding rapidly, we do have some investments in employees and other things over time, but maintaining that efficiency ratio in the low to mid-50s for the year.

Matthew, we are from an employee standpoint trying to be very careful during this time frame to make sure that we don't expand too much into certain areas. Stuff that we had built in to the budget from an employee standpoint or whatever, we're pushing those out if at all possible. But when it comes to compliance, BSA, those types of things, we will always make sure that we have the proper staff to manage that properly.

Our next question comes from Andrew Terrell from Stephens.

So one, congratulations on really kind of phenomenal production quarter this quarter. Just wanted to kind of get a sense of kind of across business lines where kind of new loan pipelines were at going into the third quarter and kind of your thoughts on how production volumes should trend throughout the balance of this year.

Terrell, if you look at our run rate in backed out some of the bulk that we had for the municipal finance group, you would probably see a run rate that's closer to $1.3 billion to $1.5 billion run rate, which for us has put us on a run rate that's effectively almost double what we've seen. So the current pipelines are continuing to show robust demand across all business lines, including multifamily commercial even in some of our more, specific smaller lines of business such as equipment finance.

We are starting to see positive impact from our SBA division. We've kind of retooled that and revamped it and their pipeline is growing nicely. So we will have some benefit from some smaller balance C&I as well. So unlike what we've seen potentially in other slowdowns in the economy, we expect that to be a little more consumer-driven at least that's what the market is telling us based on activity. It should have less of an impact on our commercial customers in the segments that we tend to focus on as well as the multifamily and CRE sectors that we typically see a benefit in demand during various cycles.

So what I would say is we expected a little more of a slowdown as rates moved up precipitously from where we saw. But given the market activity, the demand is still at a very, very high level.

Yes. Great. That's encouraging. And I guess maybe could you speak to it, it sounds like, I mean, still kind of positive loan growth trends. Could you speak to kind of the growth you're expecting on the other side of the balance sheet? Do you expect to kind of fully core fund this level of loan growth or perhaps kind of need to go to the broker market for funding in future quarters? Just can you talk through the deposit growth dynamics?

I think we have a pipeline that can hold up pretty well. I will say that the loan originations that we put forth the first 2 quarters and definitely, the third quarter is trending very favorably as well, has definitely put a stress on trying to make sure that we stay core-funded. That being said, our pipeline is pretty robust on the deposit side. So I don't think at this time that we will need to go to the brokered market if it -- if we did have to, it would be minimal.

We have, I would say, between our branch delivery, our online delivery our commercial deposit areas, it will probably keep us out of the higher costing broker market for a while. And as Scott said, there's big opportunities. Unfortunately, in this cycle, marginal costs are more expensive. So we don't have the luxury because of our large outsized growth of relying of low growth, low beta environment that some banks may experience.

However, profit, its profit, and we brand the models. And we've looked at, should we slow down growth or continue to grow on the margin. And even though it may have some metric compression in the near term, the forecast looks much more favorable to continue with a large scale growth.

Got it. Okay. And we should still expect kind of no securitizations this year?

No.

Yes, not at this point.

Our next question comes from David Feaster from Raymond James.

Maybe just -- I'd like to get a sense of the competitive landscape that you're seeing. Obviously, you guys are taking share. But I'd especially like to hear your thoughts on some of the newer markets in Texas and Florida. I mean these are both highly competitive markets. What do you find and that's your competitive advantage that's allowing you to gain share both on the loan side as well as the new lender side?

Sure. So if we -- let's start with Florida. Part of our focus has been to refocus and remix some of their activity. They were a little more heavily focused on nonowner-occupied CRE of way for multifamily, and they certainly had a footholds -- about an equal foothold in the commercial business lending. So that continues year-to-date. They're on pace to do about the same as what they did last year, plus or minus.

But what we've seen is we've redirected efforts and I think you'll see in the latter half of the year that there is a strong demand for our multifamily product in the Florida as well as the Texas market. Specifically in Florida, we're gaining good traction. So we're seeing, I would say, significant pipeline growth on a relative basis out of Florida. So strong demand for that. I would say the commercial business lending is no more competitive than what we see in California and some of our other major markets.

So I think we're given some of the tenure of the originators in the market that we have in the legacy of the bank, we still see demand there. So I think we feel good about the fact that we're still seeing good originations as we kind of retool and fold the organizations together because that does tend to create some level of disruption. So good positive activity there.

In Texas, it's been, I would say, equally as favorable. We actually out funded in year-to-date in Texas than we have in Florida. And I think that's a testimony to the teams that we've put in place, and they're just starting to hit levels of strides. So that's been a little more focused in the C&I side of the business, but we still are seeing good demand and good penetration on the multifamily. So we will continue to see our product being successful in those markets.

Texas is unique in the fact that the agencies came in several years ago with kind of the small balance product and really started to gain significant market share and our product competes very well against the agency. So it's a model that we've seen across the country. So we've been able to kind of push our product into the market, get good visibility and good demand for it, and we're starting to see some of the fruits of that labor pay off. So I would say net-net, both markets seem to be going in a positive direction and a lot of market acceptance.

[Dave] we were talking through our pipelines the other day, we kind of had some numbers of what Florida and Texas look like?

Yes. Yes. I would say from a pipeline standpoint, we're seeing extremely good growth in those markets and the momentum is certainly...

It has been over $100 million in each market.

Several hundred million in each market is, yes, of current pipeline. But that was just one channel alone. So...

Right. I just want to give flavor that we're actually seeing some decent inroads into both Texas and Florida.

That's great. And maybe just kind of taking all this growth commentary together. I mean like this -- it sounds like this was not just a pull forward of demand that this is true core demand and market share gains. Could you just help us maybe think about how to think about net organic growth going forward just given the combination of new hires, market expansion, pipeline growth as well as expectations for potentially slowing payoffs and paydowns. Just as we put all this together, how do you think about organic growth going forward?

Well, to be quite, David, M&A is nice. But I think if you look back at the history of First Foundation and you see the transactions we've done, none of them have amounted to enough to really -- other than possibly First Florida Integrity to really grow the balance sheet tremendously. I think it's a real testament to our team to have gone from a $1.1 billion origination quarter to $2.2 billion. And we have a third quarter that's shaping up nicely.

If we did nothing but grow organically, I think you would continue to see the balance sheet expand at a greater growth pace than most banks in this country. So what Dave's put together on the lending team and the team that we have out there in all those markets, this shows that we can step up to the plate and continue to fund at pretty high paces.

Yes. We would expect low to mid-20s on a loan growth rate for next year, and that slows down slightly in the outer years because the denominator is larger, but -- and we're not forecasting significant growth beyond what we're achieving today. But we're probably looking at kind of a mid-20s loan book, organic growth year-over-year.

Yes. That's incredible. And then maybe just touching on something else that I know you guys have been working on. Just wanted to get an update on the NYDIG partnership and where we are with that rollout. Obviously, the partnership has gone extremely well. There's been some volatility in crypto, but just curious where we are there? And any updates you could provide?

Sure. David?

We're now to the point where the workflows completed, the integration is ready to go, and we're now doing an internal employee pilot, kind of our first test on a go-live basis. So everything is kind of on track, I would say. We delayed it a few months given all the activity that we had going along in relation to integrating our TGR into our environment. But we've got an internal beta going and then our next will be a public beta, and that should be rolling out shortly after our internal beta. And then after that, it will be a go-live.

And specifically Bitcoin related. And despite the compression in Bitcoin prices over time, we still believe there's good consumer demand -- for customers to work through their trusted bank to access the Bitcoin markets. And we also believe that this -- the blockchain technology is very important and that having our legacy systems have the ability to plug into this modern technology that works differently would be really important for banking going forward.

Honestly, David, I would say that you've seen some bankruptcies and other things recently. I think there's been positioning that whatever client coins were out there, weren't their coins. I think this would make it even stronger for people to want to work through their trusted bank than through a company that they don't know what happens in turbulent times like what we're seeing right now. So I'm actually very optimistic on this.

Yes. I think that's a very good point, Scott, and the fact that some of these exchange bankruptcies, your deemed and unsecured creditor and [went through] their user agreements, it was -- you didn't really have a perfected interest in your asset that you thought you had. In this case, you had unilateral right through cold storage to access your ownership position. So the fact that it's going to bank rails and it's going to probably the industry standard for cold storage. I would say to your point, Scott, it would be an advantage to the market given the turbulence.

Our next question comes from Steve Moss from B. Riley Securities.

Just maybe following up on expense point. And I heard Scott mention you're pushing some things out. Kind of curious if that impacts any of your hiring plans in Texas and Florida or what thoughts you may have there?

Well, no. I mean to the extent that we find people, good production people that can continue to expand in the marketplace, we will not step back and refrain from hiring people. We will always continue to try to expand into additional marketplaces as we deem necessary.

So I don't want to give that impression. But there are initiatives, some on the technology side, just some on the hiring side where instead of going through the normal channels, we can live without having to have that added employee for another 6 months or something.

So the answer is, we're trying to manage expenses as best we can, but we're going to continue to expand into marketplaces. Look, it all depends on the teams that you find out there. And I'll say the First Foundation has had some great opportunities to hire production people, and we have not slowed that process down at all. And I think again, it shows to a testament of how the balance sheet has grown. But that being said, I think the management team owes it to shareholders to try to manage expenses as best as possible during a time where that's giving us a great uncertainty.

I would say, Steve, outside of our recent expansion in SBA, we really haven't contemplated any significant ramp-up of new business lines or anything that would have a longer payback period. So when we talk about kind of managing expenses, do we need that absolute additional higher on the margin? Or are those [nice apps]? Or is there a way to create additional efficiencies around our processes to create scale and growth? I think going through a conversion down in Florida and getting all those new customers onboarded, it put a lot of pressure on us to get through that gauntlet. And now that kind of subsided at the end of this quarter.

So customers are now, by and large, converted to our mobile and desktop platforms and are now integrated into the company. That did create a little bit of near-term pressure on some of our current staff as well as our staffs in the market. So expectations are now that we're kind of through that. We can look for more efficiencies and other operations. And to Scott's comments in his opening remarks, we're constantly looking at refining our business model to create efficiencies where we may not have seen opportunities before.

But we are going through a lot of refinement right now. Some of that is technology driven through some of our AI and robotics to get rid of a lot of manual process. Some of it is just getting rid of paper and processes that have been around for a while that we are always challenging. So it's a comment upon us to become more efficient over time, and we're certainly dedicated to do that.

Okay. That's helpful. And then just on the reserve here, meaningful decline in loan loss reserve ratio. Just maybe any color you can give around the inputs or the assumptions going from here.

So it's kind of interesting. We held our kind of baseline model constant this quarter. Last quarter, we shifted a little more to downside risk just because of the thought of the economy. And Kevin, correct me if I wrong, are we 55 base -- 45 downside in Moody's modeling.

That's right.

The results of that keep coming back more positive every quarter and in the business lines that we focus on, the metrics keep getting better and better. So I would say that although we thought we would probably have a little bit of provision, we have been getting some nice recoveries on the purchase impaired loans that we had acquired previously.

So but all the metrics are coming back as good or better than we've seen. So we're still trying to balance that how much qualitative reserve we can continue to maintain. And we kind of, every quarter kind of just model around a baseline percentage of where we ended up in the quarter before. So that's kind of what we're -- where it's coming out but all the metrics and correct me, if I'm wrong, nothing showed any negative decline based on the new production in the existing portfolio.

That's right. The economic scenario is trending nicely. That may change. We're able to use some conservative measures because of the interest rate environment and value chain issues in the economy, et cetera. But we're very comfortable with the approach we've taken.

Our next question comes from Gary Tenner from D.A. Davidson.

I wanted to ask about the C&I portfolio of the $2.6 billion at quarter end. What amount of that is prime LIBOR or SOFR based? And then was there any delays in repricing over the course of the second quarter, whether it be floors or just timing of repricing?

I don't have the -- and we can probably get that for future calls, Gary. There's been a significant shift in our C&I portfolio from historical from kind of medium-term lending to more straight adjustable. In previous quarters, we were running about 70-30. That was a little bit shifted this quarter because of the municipal finance area, which tends to be medium term to longer. So typically, we're running about 70-30, if you exclude the owner-oc piece.

As far as floors, a lot of those, because we've grown the portfolio fairly significantly during times where floors became much more important that we're not burning through a lot of floors on that side. But we will have some that we need to burn through. The prime -- the book right now, and I don't think we have the statistics in front of us, Kevin.

Historically, a lot of it was prime based because they were smaller to medium-sized credits. A lot of our larger credits are LIBOR/SOFR based. And a lot of those have had floors in place for a while. So we're getting the kind of the direct benefit of the movements subsequent to the previous moves by the Fed. So I think we're going to see some more positive momentum probably in the latter half of the year and going into next year as those start to cycle through.

And we shifted away from LIBOR.

Yes, we're SOFR-based now. So I guess the long story short, I don't have the metrics in front of me to give you that breakdown today.

About $1 billion of our portfolio is variable. Most of that SOFR and prime.

Okay. And then on the funding side, to revisit that a bit. I mean, obviously, this quarter, you were able to really use the liquidity on the balance sheet to fund the immense loan growth you had even at a slower pace of net growth, let's say, in the third quarter, although it sounds certainly because that's going to be a good quarter. You would need to effectively double the pace of deposit growth versus what it was in the second quarter to kind of fund that dollar for dollar and keep that loan deposit ratio in the ballpark where it is. So to be clear, you're suggesting your different channels can support that amount of deposit growth without resorting to the wholesale market or otherwise?

No. It wouldn't be too far out in the future on that. But I would say in the third quarter, I feel fairly positive that we can fund that with deposits that are in our pipeline. I will say deposits tend to be sometimes lumpy. Stuff that we thought would hit in the second quarter didn't hit in the second quarter. But I am optimistic they'll hit in the third quarter. Beyond that, it could be that we have to have some reliance if our -- on something less core provided that our loan growth continues at the torrid pace that it's been at.

I think what Scott is alluding to is typically, in the fourth quarter, we have some seasonality around some of our commercial deposits that tend to run down during tax. A lot of the MSR-related deposits where people are paying their taxes. That's historically where we see that there may be a need to kind of plug that gap for a short period of time and then those balances build back up.

But there's plenty of deposits in the market available. They are more expensive at the margin. So we will cost us more to fund out the margin. But there is some of the channels that we're taking advantage now that we don't necessarily want to go into on a call give us cheaper opportunities than some of the others that are available and certainly seem to be cheaper than anything in the wholesale side of the business.

Well, I appreciate those thoughts. And then so to put that all together, I guess, in a sense, the balance sheet growth is certainly going to drive at least we expect to certainly drive pretty robust NII growth. But it seems reasonable to think we may be possibly at the peak NIM for this rate cycle here in the second quarter. Is that something you'd be thinking of?

I would say we're -- again, we're somewhat range-bound. But yes, I would say that growth on the margin could have some impact there near term, but we expect it to kind of normalize. Again, we always expect to normalize between 3% and 3.25%. We don't know where the Fed is going. If they continue to increase, we've modeled -- we've looked at the sensitivity around that. If we see the economy slow down rapidly and the Fed turns course, and obviously, that creates a lot more tailwind.

So we kind of run kind of typical forward curves based on market information. And based on that future periods, margins start to expand out. But yes, I would say maybe a little bit near term but within a range.

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

Thank you again for participating in today's call. I just would like to take a moment to thank all of the First Foundation employees for the hard work that they have put forth in the last several quarters, especially the integration of First Florida Integrity. As we entered the second half of 2022, I am optimistic about the opportunities ahead of us.

Thank you, and have a great remainder of your day.

This does conclude today's program. Thank you for your participation. You may now disconnect.