Bank seeks to diversify portfolio and improve profitability amid market challenges
First Foundation, a Dallas-based bank heavily invested in commercial real estate, has announced a major strategy overhaul to diversify its loan portfolio after facing market challenges.
The bank, which received a $228 million capital infusion led by Fortress Investment Group earlier this month, revealed plans to reduce its exposure to multifamily loans, increase its allowance for credit losses, expand commercial and industrial (C&I) lending, and grow its presence in Texas and Florida.
During its second-quarter earnings call, First Foundation CEO Scott Kavanaugh said the $228 million investment, while diluting shareholders’ equity, has helped the bank’s stock partially recover after falling nearly 50% since January. Shares are now trading at $7.11, down about 25% year-to-date.
Kavanaugh said that the capital raise wasn’t due to regulatory concerns but aimed at supporting growth.
“I am incredibly proud of what we built at First Foundation over the course of the last 17 years,” he said during the investor presentation. “Much like our clients, we have evolved and have grown into the next chapter of the company’s life.”
First Foundation had significantly increased its exposure to multifamily housing during the early days of the pandemic, which now comprises more than half of its loan book. However, the value of these fixed-rate loans plummeted when interest rates began to rise in 2022.
Kavanaugh estimated that the Fortress-led investment would double First Foundation’s profitability over the next few years.
The bank aims for a 10% to 12% return on tangible common equity and a 0.9% to 1% return on average assets by the end of 2026. Currently, its return on tangible common equity and return on average assets stand at 1.3% and 0.09%, respectively.
In the near term, First Foundation will designate about 20% of its existing multifamily loans as held for sale, which could lead to losses as buyers seek discounts.
Chief operating officer Christopher Naghibi said the bank would “put in the time and work” to secure the best possible price for these assets, totaling more than $1 billion. He mentioned a potential relationship with Freddie Mac and the possibility of private-party sales.
First Foundation joins other banks in reducing their real estate lending as regulatory scrutiny increases. By the end of 2025, the bank aims to reduce its commercial real estate exposure below 400% of its total capital. As of March 31, 2024, First Foundation’s real estate loans were over 600% of its total capital. Regulators scrutinize banks with concentrations above 300%.
The bank is also actively building its commercial and industrial (C&I) lending business to diversify its portfolio. While C&I loans currently account for less than 30% of the loan portfolio, they have comprised nearly 90% of new loan fundings this year.
“While historically, multifamily originations outpaced C&I lending, First Foundation has been deeply steeped in C&I lending dating back to the bank’s inception,” Naghibi said. “A more robust C&I team was built out nearly 10 years ago in order to help balance out the concentration risk in the underlying loan portfolio.”
“First Foundation is not a real estate lender growing into the C&I business,” he added. “C&I lending has been a long-standing and important part of the underlying franchise value.”
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The bank also plans to increase its presence in North Texas and Southwest Florida markets, which currently represent only 11% of its loan portfolio. In 2021, First Foundation moved its headquarters to Dallas from Southern California and acquired a small bank in Naples, Fla.
Kavanaugh sees significant growth potential in these regions, stating, “We really have not had much of a chance to really expand into the markets. But we really believe that Texas and Florida [are] endless with [their] abilities to be able to grow.”
Additionally, First Foundation will review its allowance for credit losses methodology to align with peers. While the bank doesn’t anticipate immediate credit losses, it must prepare for “unprecedented” interest rate risks, Naghibi said.
The bank’s second-quarter results showed signs of improvement, with net income rising to $3.1 million from a $793,000 loss in the previous quarter. However, challenges remain, including the potential for economic downturn and increased competition.
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