First Foundation Inc. (FFWM)

Executive Summary / Key Takeaways

• Balance Sheet Transformation in Progress: First Foundation is executing a deliberate and costly exit from its low-coupon CRE portfolio, having disposed of $858 million in Q2 2024 alone, with the goal of full exit by year-end. This strategic pivot, while creating near-term earnings volatility, is designed to reduce CRE concentration from over 600% to 365% of regulatory capital and eliminate the drag of high-cost wholesale funding.

• NIM Recovery Trajectory Intact but Challenged: Management maintains its guidance for NIM to reach 1.8-1.9% by Q4 2025 and 2.1-2.2% by Q4 2026, driven by loan remix toward higher-yielding C&I and deposit cost reduction. However, Q3 2024 NIM of 1.60% shows the path remains uneven, with the quarterly provision spike revealing persistent credit headwinds that could derail the timeline.

• Credit Risk Reassessment Creates Earnings Volatility: A $64.4 million ACL increase in Q3 2024, driven by methodology changes and a single large C&I loan, demonstrates management's shift to a more conservative reserving posture. This aligns peer reserve levels but introduces unpredictable quarterly volatility, making earnings forecasting unreliable until the new methodology stabilizes.

• Merger with FirstSun Reshapes Competitive Position: The announced all-stock merger with FirstSun Capital Bancorp (FSUN), valuing the combined entity at approximately $785 million, will create a $30+ billion asset institution. This provides necessary scale to compete with larger regional players like Banc of California (BANC) and CVB Financial (CVBF), but integration risks and balance sheet repositioning costs could consume management attention for 12-18 months.

• Wealth Management Stagnation Undermines Diversification: AUM declined to $5.2 billion in Q3 2024 from $5.5 billion a year prior, with segment pre-tax income collapsing to $0.7 million. This underperformance versus the banking segment's transformation suggests the integrated wealth-banking model is not delivering the promised cross-sell synergies, limiting overall earnings diversification.

Setting the Scene: A Regional Bank Rebuilding Its Foundation

First Foundation Inc., founded in 1985 and headquartered in Dallas, Texas, operates as a financial services holding company through its wholly-owned subsidiaries First Foundation Bank (FFB) and First Foundation Advisors (FFA). The company provides a full spectrum of banking and wealth management services across California, Nevada, Florida, Texas, and Hawaii, positioning itself as a relationship-driven alternative to larger regional players. Unlike pure-play commercial lenders, FFWM's integrated model aims to capture both sides of client balance sheets—lending and asset management—creating stickier relationships and multiple revenue streams.

The company's current predicament stems from a strategic miscalculation in its loan portfolio composition. For years, First Foundation built a substantial multifamily CRE book featuring low-coupon fixed-rate loans funded by high-cost wholesale deposits and brokered CDs. This asset-liability mismatch created severe margin compression as rates rose, culminating in the Q3 2024 decision to reclassify $1.9 billion of multifamily loans to held-for-sale status, triggering a $117.5 million fair value adjustment loss. This moment marked the beginning of a painful but necessary balance sheet rehabilitation.

First Foundation competes in fragmented regional markets against larger, better-capitalized institutions. Banc of California, with $35 billion in assets, commands superior scale and deposit gathering power in Southern California. CVB Financial maintains a conservative, relationship-driven model with 194 consecutive profitable quarters, representing operational stability FFWM currently lacks. Bank of Hawaii (BOH) dominates its island market with monopoly-like pricing power, while First Business Financial (FBIZ) demonstrates how niche specialization can deliver superior margins. FFWM's multi-state footprint provides geographic diversification that single-state peers lack, but its $11.9 billion asset base remains subscale, limiting pricing power and operational efficiency.

Financial Performance & Segment Dynamics: The Cost of Rehabilitation

Banking Segment: Margin Pressure Meets Strategic Progress

The banking segment's Q3 2024 results illustrate the tension between strategic progress and financial reality. Net interest income declined 5.3% year-over-year to $48.1 million, reflecting the intentional shrinkage of the balance sheet. Average interest-earning assets fell 12.2% to $11.6 billion as loan sales and paydowns exceeded new originations. This contraction, while painful, serves the strategic goal of exiting low-yielding CRE loans that were funding at spreads that destroyed value.

The NIM trajectory tells a more nuanced story. At 1.60% in Q3 2024, NIM improved from 1.50% in the year-ago quarter but compressed sequentially from 1.68% in Q2. Management attributes this to timing effects from loan sales and expects the margin to inflect upward as higher-yielding C&I loans replace CRE runoff and deposit costs continue falling. The cost of deposits decreased to 2.95% from 3.04% in the prior quarter, with digital banking deposits surpassing $1 billion for the first time, representing 12% of total deposits. This granular deposit growth reduces reliance on brokered funding, which fell by $811 million year-to-date.

Credit quality remains the critical variable. Nonperforming loans held stable at 35 basis points, and net charge-offs were negligible at $135,000. However, the $64.4 million ACL build—combining methodology changes and a $16.8 million specific reserve on one large C&I loan—signals that management is front-loading credit costs during the transition. The shift to incorporate peer loss data and increase LGD floors for CRE loans aligns reserve levels with industry norms but creates earnings volatility. For investors, this raises a key question: Is this a one-time reset or the new normal for quarterly provisioning?

Wealth Management Segment: A Broken Growth Engine

The wealth management segment's deterioration undermines the integrated banking model's core thesis. AUM fell to $5.2 billion in Q3 2024 from $5.5 billion a year prior, driven by $872 million in net withdrawals and terminations that overwhelmed $447 million in market gains and $136 million in new accounts. Pre-tax income collapsed to $0.7 million from $1.9 million in Q3 2024, as a $0.7 million revenue decline combined with a $0.6 million expense increase from talent retention investments.

This performance stands in stark contrast to peers. While CVB Financial's modest wealth arm provides stable fee income and Bank of Hawaii leverages its local dominance to capture Hawaii's affluent retirees, FFWM's wealth business is bleeding assets. Management's commentary about "reenergizing focus on private banking" and optimism about "pipelines" rings hollow against nine consecutive months of net outflows. The segment's 13% operating margin pales beside First Business Financial's specialty lending profitability, suggesting the cross-sell synergies that justified the integrated model have failed to materialize.

Outlook, Management Guidance, and Execution Risk

Management's guidance paints a clear path to margin recovery but requires flawless execution on multiple fronts. The reiterated NIM target of 1.8-1.9% by Q4 2025 and 2.1-2.2% by Q4 2026 depends on three assumptions: successful completion of the CRE exit, continued deposit cost reduction, and C&I loan growth filling the volume gap. The $975 million in higher-cost deposits paid down through Q2 loan sales provides tangible evidence of progress, but the remaining held-for-sale portfolio still creates earnings noise.

The CRE exit timeline carries execution risk. Management expects to be "fully out of the held-for-sale CRE portfolio by the end of 2025," but the Q2 experience showed execution challenges. The April loan sale of $377 million generated an $11.8 million pretax loss, while the June securitization of $481 million produced only a $0.2 million gain. As CFO Jamie Britton noted, "execution is more competitive in the securitization market," suggesting future dispositions may require pricing concessions that erode capital.

The pending FirstSun Capital Bancorp merger adds another layer of complexity. The all-stock transaction, expected to close in Q2 2026, will create a $30+ billion asset institution with enhanced scale and geographic reach. FirstSun Capital Bancorp stockholders will own 59.5% of the combined company, implying FFWM is effectively selling control to accelerate its transformation. While the combined entity will have better competitive positioning against Banc of California and CVB Financial, integration costs and balance sheet repositioning could distract management for 12-18 months, potentially delaying the NIM recovery timeline.

Risks and Asymmetries: What Can Go Wrong

Credit Risk Remains Under-Reserved Despite ACL Build: While the Q3 ACL increase appears conservative, the $101.9 million reserve represents approximately 88 basis points of loans held for investment. This remains well below peer levels—CVB Financial maintains reserves near 1.2% and Banc of California near 1.0%—suggesting further builds may be needed as C&I lending expands. The $16.8 million specific reserve on one loan indicates concentration risk in the C&I portfolio that could produce similar surprises.

Merger Integration Could Derail Standalone Progress: The FirstSun Capital Bancorp deal involves merging two institutions undergoing simultaneous balance sheet transformations. If integration proves "more difficult, costly, or time-consuming than expected," as disclosed in risk factors, management attention could shift from FFWM's CRE exit to systems integration, delaying margin recovery. The $19.5 million hedge strategy cost to mitigate merger-related fair value risk already represents a tangible expense that reduces net income.

Deposit Franchise Vulnerability: While digital deposits grew to $1 billion, this represents only 12% of total deposits. The remaining 88% includes $1.4 billion in FHLB advances at 3.74% weighted average cost and $400 million in term advances at 4.95%. If deposit competition intensifies—whether from Banc of California's aggressive retail pricing or fintechs offering 4.5%+ APY—FFWM could face margin compression even as loan yields improve.

Wealth Management Drag Persists: The segment's inability to retain assets despite market gains suggests structural issues beyond market conditions. If AUM continues declining at the current $300 million quarterly pace, the segment could become a persistent earnings drag, undermining the integrated model's strategic rationale and making FFWM's valuation discount to pure-play banks like First Business Financial harder to justify.

Valuation Context: Pricing a Work-in-Progress

At $6.07 per share, First Foundation trades at a market capitalization of $500.6 million and an enterprise value of $378.3 million, reflecting a 0.60x price-to-book multiple and 2.55x price-to-sales ratio. The discount to book value signals market skepticism about asset quality and earnings power, while the P/S multiple sits below profitable peers like Banc of California (2.91x) and CVB Financial (5.62x), suggesting investors are pricing in execution risk.

Given the current unprofitability, traditional earnings multiples are meaningless. More relevant metrics include the loan-to-deposit ratio of 83.6% (improved from 93.4% at year-end), available liquidity ratio of 51.4% (well above the 25% policy minimum), and tangible capital cushion of $539 million above well-capitalized thresholds. These balance sheet strengths provide a buffer but don't address the core earnings problem.

Comparing valuation multiples reveals the market's view. First Business Financial, a profitable niche lender, trades at 2.84x sales with superior margins (32.5% profit margin) and returns (15.34% ROE). Bank of Hawaii commands 4.03x sales due to its Hawaii monopoly and 27.18% profit margin. FFWM's 2.55x multiple reflects a "show me" discount—reasonable if management executes the CRE exit and NIM recovery, but punitive if credit costs balloon or the merger stumbles.

Conclusion: A Transformation Story with High Execution Hurdles

First Foundation's strategic pivot from CRE-dependent lender to diversified relationship bank represents the right long-term move, but the execution path is fraught with earnings volatility and integration risk. The Q3 ACL build and NIM compression demonstrate that balance sheet rehabilitation creates near-term pain, while the FirstSun Capital Bancorp merger offers scale but consumes management bandwidth.

The investment thesis hinges on two variables: successful completion of the CRE exit by year-end without further material losses, and achievement of the guided NIM recovery to 1.8-1.9% by Q4 2025. If management delivers, the current valuation discount to peers should narrow, and the combined FirstSun Capital Bancorp entity will be positioned for sustainable profitability. If credit costs continue surprising or merger integration falters, the stock could languish until tangible earnings power emerges.

For investors, this is a transformation story priced with a margin of safety, but one that requires patience and tolerance for quarterly noise. The wealth management segment's deterioration and persistent credit provisioning suggest the market's skepticism is warranted until proven otherwise.