UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

(Mark One)

For the quarterly period ended June 30, 2017

OR

For the transition period from             to             

Commission File Number 001-36461

 

FIRST FOUNDATION INC.

(Exact name of Registrant as specified in its charter)

 

 

(949) 202-4160

(Registrant’s telephone number, including area code)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports); and (2) has been subject to such filing requirements for the past 90 days.    Yes  ☒    No  ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every interactive data file required to be submitted and posted pursuant to Rule 405 of Regulation S-T (section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ☒    No  ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.) (Check one): 

 

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ☐    No   ☒

 

As of August 7, 2017, there were 34,463,755 shares of registrant’s common stock outstanding

 

 

 

 

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FIRST FOUNDATION INC.

QUARTERLY REPORT ON FORM 10-Q

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2017

TABLE OF CONTENTS

 

 

 

 

(i)

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PART I — FINANCIAL INFORMATION

 

FIRST FOUNDATION INC.

CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per share amounts)

 

 

 

 

 

 

 

 

 

 

 

 

 

(See accompanying notes to the consolidated financial statements)

 

 

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FIRST FOUNDATION INC.

CONSOLIDATED INCOME STATEMENTS - UNAUDITED

(In thousands, except share and per share amounts)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(See accompanying notes to the consolidated financial statements)

 

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FIRST FOUNDATION INC.

CONSOLIDATED STATEMENT OF CHANGES

IN SHAREHOLDERS’ EQUITY - Unaudited

(In thousands, except share amounts)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(See accompanying notes to the consolidated financial statements)

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FIRST FOUNDATION INC.

CONSOLIDATED STATEMENTS OF

COMPREHENSIVE INCOME - UNAUDITED

(In thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(See accompanying notes to the consolidated financial statements)

 

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FIRST FOUNDATION INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS - UNAUDITED

(In thousands)

 

 

 

 

(See accompanying notes to the consolidated financial statements)

 

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FIRST FOUNDATION INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the Six Months Ended June 30, 2017 - UNAUDITED

 

NOTE 1: BASIS OF PRESENTATION

The consolidated financial statements include First Foundation Inc. (“FFI”) and its wholly owned subsidiaries: First Foundation Advisors (“FFA”) and First Foundation Bank (“FFB” or the “Bank”) and the wholly owned subsidiaries of FFB, First Foundation Insurance Services (“FFIS”) and Blue Moon Management, LLC (collectively referred to as the “Company”). All inter-company balances and transactions have been eliminated in consolidation. The results of operations reflect any interim adjustments, all of which are of a normal recurring nature and which, in the opinion of management, are necessary for a fair presentation of the results for the interim period presented. The results for the 2017 interim periods are not necessarily indicative of the results expected for the full year.

The consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America and prevailing practices within the banking industry. In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and revenues and expenses for the period. Actual results could differ significantly from those estimates.

The accompanying unaudited consolidated financial statements include all information and footnotes required for interim financial statement presentation. Those financial statements assume that readers of this Report have read the most recent Annual Report on Form 10-K which contains the latest available audited consolidated financial statements and notes thereto as of and for the year ended December 31, 2016.

On January 18, 2017, the Company completed a two-for-one stock split in the form of a stock dividend. Each stockholder of record at the close of business of January 4, 2017 received one additional share of common stock for every share held. All share and per share amounts included in the financial statements have been adjusted to reflect the effect of this stock split.

Certain reclassifications have been made to the prior year consolidated financial statements to conform to the 2017 presentation.

In February 2017, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Update (“ASU”) 2017-05 “Other Income-Gains and Losses from the Derecognition of Nonfinancial Assets (Subtopic 610-20): Clarifying the Scope of Asset Derecognition Guidance and Accounting for Partial Sales of Nonfinancial Assets” which clarifies that the guidance in Accounting Standards Codification (“ASC”) 610-20 on accounting for derecognition of a nonfinancial asset and in-substance nonfinancial asset applies only when the asset (or asset group) does not meet the definition of a business and provides guidance for partial sales of nonfinancial assets.  The adoption of ASU No. 2017-05 is not expected to have a material impact on the Company’s consolidated financial statements.

In January 2017, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Update (“ASU”) 2017-04 “Intangibles – Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment” which provides updated guidance on how an entity is required to test goodwill for impairment. This update is effective for the Company for annual periods beginning after December 15, 2019, and interim periods within those annual periods. The adoption of ASU No. 2017-04 is not expected to have a material impact on the Company’s consolidated financial statements.

In January 2017, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Update (“ASU”) 2017-01 “Business Combinations (Topic 805): Clarifying the Definition of a Business” which provides guidance in clarifying the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses.  The adoption of ASU No. 2017-01 is not expected to have a material impact on the Company’s consolidated financial statements.

In August 2016, the FASB issued ASU 2016-15 “Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments” which provides guidance for eight specific cash flow issues. FASB issued the standard to clarify areas where GAAP has been either unclear or lacking in specific guidance. This update is effective for the Company for annual periods beginning after December 15, 2017, and interim periods within those annual periods. The adoption of ASU No. 2016-15 is not expected to have a material impact on the Company’s consolidated financial statements.

In June 2016, the FASB issued ASU 2016-13 “Financial Instruments – Credit Losses (Topic 326):  Measurement of Credit Losses on Financial Instruments” which introduces new guidance for the accounting for credit losses on certain types of financial instruments.  It also modifies the impairment model for available-for-sale debt securities and provides for a simplified accounting model for purchased financial assets with credit deterioration since their origination.  The new model, referred to as the current expected credit losses (CECL) model, will apply to financial assets subject to credit losses and measured at amortized cost, and certain

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FIRST FOUNDATION INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the Six Months Ended June 30, 2017 – UNAUDITED

 

off-balance sheet credit exposures.  Upon initial recognition of the exposure, the CECL model requires an entity to estimate the credit losses expected over the life of an exposure. This update is effective for the Company for annual periods beginning after December 15, 2019, and interim periods within those annual periods. The Company has begun analyzing the data requirements needed to implement   the adoption of ASU 2016-13 and we expect that the adoption of ASU 2016-13 may have a significant impact on the Company’s recording of its allowance for loan losses. The impact of the implementation of ASU 2016-13 is undeterminable at this time.

On February 25, 2016, the FASB issued ASU 2016-02, Leases (Topic 842).  The most significant change for lessees is the requirement under the new guidance to recognize right-of-use assets and lease liabilities for all leases not considered short-term leases, which is generally defined as a lease term of less than 12 months.  This change will result in lessees recognizing right-of-use assets and lease liabilities for most leases accounted for as operating leases under current lease accounting guidance.  The amendments in this Update are effective for interim and annual periods beginning after December 15, 2018.  We expect the adoption of ASU 2016-02 to impact the Company’s accounting for its building leases at each of its locations and the Company is evaluating the effects of the adoption of ASU 2016-02 on its financial statements and disclosures.

On January 5, 2016, the FASB issued ASU 2016-01, Financial Instruments–Overall: Recognition and Measurement of Financial Assets and Financial Liabilities (Subtopic 825-10).  Changes made to the current measurement model primarily affect the accounting for equity securities with readily determinable fair values, where changes in fair value will impact earnings instead of other comprehensive income.  The accounting for other financial instruments, such as loans, investments in debt securities, and financial liabilities is largely unchanged.  The Update also changes the presentation and disclosure requirements for financial instruments including a requirement that public business entities use exit price when measuring the fair value of financial instruments measured at amortized cost for disclosure purposes.  This Update is generally effective for public business entities in fiscal years beginning after December 15, 2017, including interim periods within those fiscal years.  The adoption of ASU No. 2016-01 is not expected to have a material impact on the Company’s consolidated financial statements.

 

 

NOTE 2: FAIR VALUE MEASUREMENTS

Assets Measured at Fair Value on a Recurring Basis

Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.  Current accounting guidance establishes a fair value hierarchy, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.  There are three levels of inputs that may be used to measure fair values:

 

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

 

Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

 

Level 3: Significant unobservable inputs that reflect the Company's own assumptions about the assumptions that market participants would use in pricing an asset or liability.

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FIRST FOUNDATION INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the Six Months Ended June 30, 2017 – UNAUDITED

 

 

The following tables show the recorded amounts of assets and liabilities measured at fair value on a recurring basis as of:

 

 

The decrease in level 3 assets from December 31, 2016 was due to Beneficial interest – FHLMC securitization maturities.  

 

Fair Value of Financial Instruments

We have elected to use fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. Securities available for sale are measured at fair value on a recurring basis. Additionally, from time to time, we may be required to measure at fair value other assets on a nonrecurring basis. These nonrecurring fair value adjustments typically involve application of lower of cost or market accounting or write-downs of individual assets.

Fair value estimates are made at a discrete point in time based on relevant market information and other information about the financial instruments. Because no active market exists for a significant portion of our financial instruments, fair value estimates are based in large part on judgments we make primarily regarding current economic conditions, risk characteristics of various financial instruments, prepayment rates, and future expected loss experience. These estimates are subjective in nature and invariably involve some inherent uncertainties. Additionally, unexpected changes in events or circumstances can occur that could require us to make changes to our assumptions and which, in turn, could significantly affect and require us to make changes to our previous estimates of fair value.

In addition, the fair value estimates are based on existing on and off-balance sheet financial instruments without attempting to estimate the value of existing and anticipated future customer relationships and the value of assets and liabilities that are not considered financial instruments, such as premises and equipment and other real estate owned.

The following methods and assumptions were used to estimate the fair value of financial instruments.

Cash and Cash Equivalents. The fair value of cash and cash equivalents approximates its carrying value.

Investment Securities Available for Sale. Investment securities available-for-sale are measured at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. When a market is illiquid or there is a lack of transparency around the inputs to valuation, the securities are classified as Level 3 and reliance is placed upon internally developed models, and management judgment and evaluation for valuation. Level 1 securities include those traded on an active exchange, such as the New York Stock Exchange, U.S. Treasury securities that are traded by dealers or brokers in active over-the-counter markets and money market funds. Level 2 securities include mortgage-backed securities issued by government sponsored entities, municipal bonds and corporate debt securities. Securities classified as level 3 include beneficial interests – FHLMC securitization.  Significant assumptions in the valuation of these Level 3 securities as of June 30, 2017 included a prepayment rate of 15% and discount rates ranging from 4.0% to 10%.

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FIRST FOUNDATION INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the Six Months Ended June 30, 2017 – UNAUDITED

 

Federal Home Loan Bank Stock. The Bank is a member of the Federal Home Loan Bank (the “FHLB”). As a member, we are required to own stock of the FHLB, the amount of which is based primarily on the level of our borrowings from this institution. The fair value of that stock is equal to the carrying amount, is classified as restricted securities and is periodically evaluated for impairment based on our assessment of the ultimate recoverability of our investments in that stock. Any cash or stock dividends paid to us on such stock are reported as income.

Loans, other than impaired loans. The fair value for loans with variable interest rates is the carrying amount. The fair value of fixed rate loans is derived by calculating the discounted value of future cash flows expected to be received by the various homogeneous categories of loans. All loans have been adjusted to reflect changes in credit risk.

Deposits. The fair value of demand deposits, savings deposits, and money market deposits is defined as the amounts payable on demand at quarter-end. The fair value of fixed maturity certificates of deposit is estimated based on the discounted value of the future cash flows expected to be paid on the deposits.

Borrowings. The fair value of $436 million in borrowings is the carrying value of overnight FHLB advances that approximate fair value because of the short-term maturity of this instrument, resulting in a Level 2 classification. The fair value of term borrowings is derived by calculating the discounted value of future cash flows expected to be paid out by the Company. The $25 million holding company line of credit is a variable rate loan for which the rate adjusts quarterly, and as such, its fair value is based on its carrying value resulting in a Level 3 classification.

Assets Measured at Fair Value on a Nonrecurring Basis

Impaired Loans. ASC 820-10 applies to loans measured for impairment in accordance with ASC 310-10, “Accounting by Creditors for Impairment of a Loan”, at the fair value of the loan’s collateral (if the loan is collateral dependent) less estimated selling costs.  When the fair value of the collateral is based on an observable market price or a current appraised value, we measure the impaired loan at nonrecurring Level 2. When an appraised value is not available, or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price or a discounted cash flow has been used to determine the fair value, we measure the impaired loan at nonrecurring Level 3.  The total collateral dependent impaired Level 3 loans were $3.9 million and $9.0 million at June 30, 2017 and December 31, 2016, respectively.  There were no specific reserves related to these loans at June 30, 2017 and December 31, 2016.

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FIRST FOUNDATION INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the Six Months Ended June 30, 2017 – UNAUDITED

 

Real Estate Owned.  The fair value of real estate owned is based on external appraised values that include adjustments for estimated selling costs and assumptions of market conditions that are not directly observable, resulting in a Level 3 classification.  As of June 30, 2017 and December 31, 2016, the fair value of real estate owned was $1.4 million and $1.7 million, respectively.

The carrying amounts and estimated fair values of financial instruments are as follows as of:

 

 

 

NOTE 3: SECURITIES

The following table provides a summary of the Company’s securities AFS portfolio as of:

 

The US Treasury securities are pledged as collateral to the State of California to meet regulatory requirements related to the Bank’s trust operations.

 

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FIRST FOUNDATION INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the Six Months Ended June 30, 2017 – UNAUDITED

 

The table below indicates, as of June 30, 2017 the gross unrealized losses and fair values of our investments, aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position.

 

 

Unrealized losses in beneficial interests in FHLMC securitizations have not been recognized into income because the issuer bonds are of high credit quality, management does not intend to sell, it is not more likely than not that management would be required to sell the securities prior to their anticipated recovery, and the decline in fair value is largely due to changes in discount rates and assumptions regarding future interest rates. The fair value is expected to recover as the bonds approach maturity.

The scheduled maturities of securities AFS and the related weighted average yields were as follows as of June 30, 2017:

 

Agency mortgage backed securities and beneficial interests in FHLMC securitizations are excluded from the above table because such securities are not due at a single maturity date. The weighted average yield of the agency mortgage backed securities and beneficial interests as of June 30, 2017 was 2.54%.

 

NOTE 4: LOANS

The following is a summary of our loans as of:

 

As of June 30, 2017 and December 31, 2016, the principal balances shown above are net of unaccreted discount related to loans acquired in an acquisition of $1.3 million and $1.6 million, respectively.

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FIRST FOUNDATION INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the Six Months Ended June 30, 2017 – UNAUDITED

 

In 2012 and 2015, the Company purchased loans, for which there was, at acquisition, evidence of deterioration of credit quality since origination and it was probable, at acquisition, that all contractually required payments would not be collected. The carrying amount of these purchased credit impaired loans is as follows as of:

 

Accretable yield, or income expected to be collected on purchased credit impaired loans, and the related changes, is as follows for the periods indicated:

 

The following table summarizes our delinquent and nonaccrual loans as of:

 

The level of delinquent loans and nonaccrual loans have been adversely impacted by the loans acquired from acquisitions. As of June 30, 2017, of the $9.1 million in loans over 90 days past due, including loans on nonaccrual, $3.6 million, or 40% were loans acquired from acquisitions.

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FIRST FOUNDATION INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the Six Months Ended June 30, 2017 – UNAUDITED

 

Accrual of interest on loans is discontinued when reasonable doubt exists as to the full, timely collection of interest or principal and, generally, when a loan becomes contractually past due for sixty days or more with respect to principal or interest. The accrual of interest may be continued on a well-secured loan contractually past due sixty days or more with respect to principal or interest if the loan is in the process of collection or collection of the principal and interest is deemed probable. The Bank considers a loan to be impaired when, based upon current information and events, it believes it is probable that the Bank will be unable to collect all amounts due according to the contractual terms of the loan agreement. The determination of past due, nonaccrual or impairment status of loans acquired in an acquisition, other than loans deemed purchased impaired, is the same as loans we originate.

During the first six months of 2017 the Company did not have additional loans classified as troubled debt restructurings (“TDR”).  As of June 30, 2017 and December 31, 2016, the Company had five loans classified as TDR which are included as nonaccrual in the table below.  These loans have been paying in accordance with the terms of their restructure.

 

 

These loans were classified as a TDR as a result of a reduction in required principal payments and/or an extension of the maturity date of the loans.

 

 

NOTE 5: ALLOWANCE FOR LOAN LOSSES

The following is a roll forward of the Bank’s allowance for loan losses for the following periods:

 

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FIRST FOUNDATION INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the Six Months Ended June 30, 2017 – UNAUDITED

 

The following table presents the balance in the allowance for loan losses and the recorded investment in loans by impairment method as of:

 

The column labeled “Unaccreted Credit Component Other Loans” represents the amount of unaccreted credit component discount for loans acquired in an acquisition that were not classified as purchased impaired or individually evaluated for impairment as of the dates indicated, and the stated principal balance of the related loans. The unaccreted credit component discount is equal to 0.70% and 0.73% of the stated principal balance of these loans as of June 30, 2017 and December 31, 2016, respectively. In addition to this unaccreted credit component discount, an additional $0.5 million of the ALLL has been provided for these loans as of June 30, 2017 and December 31, 2016, respectively.

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FIRST FOUNDATION INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the Six Months Ended June 30, 2017 – UNAUDITED

 

The Bank categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as current financial information, historical payment experience, collateral adequacy, credit documentation, and current economic trends, among other factors. The Bank analyzes loans individually by classifying the loans as to credit risk. This analysis typically includes larger, non-homogeneous loans such as loans secured by multifamily or commercial real estate and commercial and industrial loans. This analysis is performed on an ongoing basis as new information is obtained. The Bank uses the following definitions for risk ratings:

Pass: Loans classified as pass are strong credits with no existing or known potential weaknesses deserving of management’s close attention.

Special Mention: Loans classified as special mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution’s credit position at some future date.

Substandard: Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.

Impaired: A loan is considered impaired, when, based on current information and events, it is probable that the Bank will be unable to collect all amounts due according to the contractual terms of the loan agreement.

Additionally, all loans classified as TDRs are considered impaired at the time they are restructured. Purchased credit impaired loans are not considered impaired loans for these purposes.

Loans listed as pass include larger non-homogeneous loans not meeting the risk rating definitions above and smaller, homogeneous loans not assessed on an individual basis.

Based on the most recent analysis performed, the risk category of loans by class of loans is as follows as of:

 

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FIRST FOUNDATION INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the Six Months Ended June 30, 2017 – UNAUDITED

 

Impaired loans evaluated individually and any related allowance are as follows as of:

 

The weighted average annualized average balance of the recorded investment for impaired loans, beginning from when the loan became impaired, and any interest income recorded on impaired loans after they became impaired is as follows for the:

 

There was no interest income recognized on a cash basis in either 2017 or 2016 on impaired loans.

 

 

NOTE 6: LOAN SALES AND MORTGAGE SERVICING RIGHTS

 

During the first six months of 2017, FFB recognized $2.4 million of gains on the sale of $174 million of multifamily loans and recorded mortgage servicing rights of $1.1 million on the sale of those loans. As of June 30, 2017 and December 31, 2016, mortgage servicing rights were $3.0 million and $2.2 million, respectively, and the amount of loans serviced for others totaled $516 million and $379 million, respectively. Servicing fees collected in the first six months of 2017 and in all of 2016 were $0.5 million and $0.3 million, respectively.

 

 

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FIRST FOUNDATION INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the Six Months Ended June 30, 2017 – UNAUDITED

 

NOTE 7: DEPOSITS

The following table summarizes the outstanding balance of deposits and average rates paid thereon as of:

 

At June 30, 2017, of the $235.5 million of certificates of deposits of $250,000 or more, $199.6  million mature within one year and $35.9 million mature after one year. Of the $612.2 million of certificates of deposit of less than $250,000, $574.0 million mature within one year and $38.2 million mature after one year. At December 31, 2016, of the $189.9 million of certificates of deposits of $250,000 or more, $182.8 million mature within one year and $7.1 million mature after one year.  Of the $439.5 million of certificates of deposit of less than $250,000, $416.3 million mature within one year and $23.2 million mature after one year.  

 

 

NOTE 8: BORROWINGS

At June 30, 2017, our borrowings consisted of $436 million of overnight FHLB advances at the Bank and $25 million of borrowings under a holding company line of credit. At December 31, 2016, our borrowings consisted of $1.3 billion of overnight FHLB advances. The FHLB advances were paid in full in the early part of July 2017 and January 2016, respectively, and bore interest rates of 1.09% and 0.56%, respectively. Because the Bank utilizes overnight borrowings, the balance of outstanding borrowings fluctuates on a daily basis. The average balance of overnight borrowings during the first six months of 2017 was $607.6 million, as compared to $507.0 million during all of 2016.

During the first quarter of 2017, the Company entered into a loan agreement with an unaffiliated lender that provides for a revolving line of credit for up to $25 million. This line of credit was amended in the second quarter of 2017 to increase the maximum loan amount to $50 million. The loan agreement matures in five years, with an option to extend the maturity date subject to certain conditions, and bears interest at 90 day LIBOR plus 350 basis points (3.50%). We are required to meet certain financial covenants during the term of the loan, including minimum capital levels and limits on classified assets. The Company’s obligations under the loan agreement are secured by, among other things, a pledge of all of its equity in FFB.  As of June 30, 2017, the balance was $25.0 million at a rate of 4.65%.

 

 

NOTE 9: EARNINGS PER SHARE

Basic earnings per share excludes dilution and is computed by dividing net income or loss available to common stockholders by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if contracts to issue common stock were exercised or converted into common stock that would then share in earnings. The following table sets forth the Company’s unaudited earnings per share calculations for the periods indicated:

 

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FIRST FOUNDATION INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the Six Months Ended June 30, 2017 – UNAUDITED

 

 

 

 

Based on a weighted average basis, options to purchase 13,350 shares of common stock were excluded for the six months ended June 30, 2016, respectively, because their effect would have been anti-dilutive.    

 

 

NOTE 10: SEGMENT REPORTING

For the quarter and six months ended June 30, 2017 and 2016, the Company had two reportable business segments: Banking (FFB and FFIS) and Wealth Management (FFA). The results of FFI and any elimination entries are included in the column labeled Other. The following tables show key operating results for each of our business segments used to arrive at our consolidated totals for the following periods:

 

 

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FIRST FOUNDATION INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the Six Months Ended June 30, 2017 – UNAUDITED

 

 

 

 

         

 

 

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The following discussion and analysis is intended to facilitate the understanding and assessment of significant changes and trends in our businesses that accounted for the changes in our results of operations in the quarter and six months ended June 30, 2017 as compared to our results of operations in the quarter and six months ended June 30, 2016; and our financial condition at June 30, 2017 as compared to our financial condition at December 31, 2016. This discussion and analysis is based on and should be read in conjunction with our consolidated financial statements and the accompanying notes thereto contained elsewhere in this report and our audited consolidated financial statements for the year ended December 31, 2016, and the notes thereto, which are set forth in Item 8 of our Annual Report on Form 10-K (our “2016 10-K”) which we filed with the Securities and Exchange Commission (“SEC”) on March 15, 2017.

Forward-Looking Statements

Statements contained in this report that are not historical facts or that discuss our expectations, beliefs or views regarding our future financial performance or future financial condition, or financial or other trends in our business or in the markets in which we operate, constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”).  Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts.  Often, they include words such as “believe,” “expect,” “anticipate,” “intend,” “plan,” “estimate,” “project,” “forecast” or words of similar meaning, or future or conditional verbs such as “will,” “would,” “should,” “could,” or “may.”  Such forward-looking statements are based on current information that is available to us, and on assumptions that we make, about future events or economic or financial conditions or trends over which we do not have control.  In addition, our businesses and the markets in which we operate are subject to a number of risks and uncertainties.  Those risks and uncertainties, and unexpected future events, could cause our financial condition or actual operating results in the future to differ, possibly significantly, from our expected financial condition and operating results that are set forth in the forward-looking statements contained in this report.

The principal risks and uncertainties to which our businesses are subject are discussed in Item 1A in our 2016 10-K and in this Item 2 below.  Therefore, you are urged to read not only the information contained in this Item 2, but also the risk factors and other cautionary information contained in Item 1A of our 2016 10-K, which qualify the forward-looking statements contained in this report.

Due to these risks and uncertainties, you are cautioned not to place undue reliance on the forward-looking statements contained in this report and not to make predictions about our future financial performance based solely on our historical financial performance. We also disclaim any obligation to update forward-looking statements contained in this report or in our 2016 10-K, except as may otherwise be required by applicable law or government regulations.

Critical Accounting Policies

Our consolidated financial statements are prepared in accordance with generally accepted accounting principles in the United States (“GAAP”) and accounting practices in the banking industry. Certain of those accounting policies are considered critical accounting policies, because they require us to make estimates and assumptions regarding circumstances or trends that could materially affect the value of those assets, such as economic conditions or trends that could impact our ability to fully collect our loans or ultimately realize the carrying value of certain of our other assets. Those estimates and assumptions are made based on current information available to us regarding those economic conditions or trends or other circumstances. If changes were to occur in the events, trends or other circumstances on which our estimates or assumptions were based, or other unanticipated events were to occur that might affect our operations, we may be required under GAAP to adjust our earlier estimates and to reduce the carrying values of the affected assets on our balance sheet, generally by means of charges against income, which could also affect our results of operations in the fiscal periods when those charges are recognized.

Utilization and Valuation of Deferred Income Tax Benefits. We record as a “deferred tax asset” on our balance sheet an amount equal to the tax credit and tax loss carryforwards and tax deductions (collectively “tax benefits”) that we believe will be available to us to offset or reduce income taxes in future periods. Under applicable federal and state income tax laws and regulations, tax benefits related to tax loss carryforwards will expire if they cannot be used within specified periods of time. Accordingly, the ability to fully use our deferred tax asset related to tax loss carryforwards to reduce income taxes in the future depends on the amount of taxable income that we generate during those time periods. At least once each year, or more frequently, if warranted, we make estimates of future taxable income that we believe we are likely to generate during those future periods. If we conclude, on the basis of those estimates and the amount of the tax benefits available to us, that it is more likely, than not, that we will be able to fully utilize those tax benefits prior to their expiration, we recognize the deferred tax asset in full on our balance sheet. On the other hand, if we conclude on the basis of those estimates and the amount of the tax benefits available to us that it has become more likely, than not, that we will be unable to utilize those tax benefits in full prior to their expiration, then, we would establish a valuation allowance to reduce

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the deferred tax asset on our balance sheet to the amount with respect to which we believe it is still more likely, than not, that we will be able to use to offset or reduce taxes in the future. The establishment of such a valuation allowance, or any increase in an existing valuation allowance, would be effectuated through a charge to the provision for income taxes or a reduction in any income tax credit for the period in which such valuation allowance is established or increased.

 

Allowance for Loan and Lease Losses. Our ALLL is established through a provision for loan losses charged to expense and may be reduced by a recapture of previously established loss reserves, which are also reflected in the statement of income. Loans are charged against the ALLL when management believes that collectability of the principal is unlikely. The ALLL is an amount that management believes will be adequate to absorb estimated losses on existing loans that may become uncollectible based on an evaluation of the collectability of loans and prior loan loss experience. This evaluation also takes into consideration such factors as changes in the nature and volume of the loan portfolio, overall portfolio quality, review of specific problem loans, current economic conditions and certain other subjective factors that may affect the borrower’s ability to pay. While we use the best information available to make this evaluation, future adjustments to our ALLL may be necessary if there are significant changes in economic or other conditions that can affect the collectability in full of loans in our loan portfolio.

Adoption of new or revised accounting standards. For some accounting standards, we may elect to take advantage of the extended transition period afforded by the JOBS Act, for the implementation of new or revised accounting standards. As a result, we may not be required to comply with new or revised accounting standards that have different effective dates for public and private companies until those standards apply to private companies or we cease to be an “emerging growth” company as defined in the JOBS Act. As a result of this election, our financial statements may not be comparable to the financials statements of companies that comply with public company effective dates.

We have two business segments, “Banking” and “Investment Management and Wealth Planning” (“Wealth Management”). Banking includes the operations of FFB and FFIS and Wealth Management includes the operations of FFA. The financial position and operating results of the stand-alone holding company, FFI, are included under the caption “Other” in certain of the tables that follow, along with any consolidation elimination entries.

Recent Developments and Overview

We experienced strong growth during the first six months of 2017 with loan originations of $816 million, deposit growth of $681 million and a $418 million increase in our assets under management (“AUM”) in Wealth Management. Revenues and income before taxes continue to increase due to the higher level of interest earnings assets.

During the first six months of 2017, the Company sold 654,578 shares of its common stock through its ATM offering at an average price of $16.37 per share, generating net proceeds of $10.5 million.

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Results of Operations

Our net income for the quarter and six months ending June 30, 2017 was $9.6 million and $15.7 million, respectively as compared to $3.9 million and $7.7 million for the corresponding periods in 2016. Income before taxes for the quarter and six months ending June 30, 2017 was $14.3 million and $23.3 million, respectively, as compared to $5.7 million and $12.3 million for the corresponding periods in 2016.

The effective tax rate for the first six months of 2017 was 32.6% as compared to 37.0% for the first six months of 2016, and as compared to a statutory rate of approximately 41.5%, as the Company benefited from reductions in taxes on income related to excess tax benefits resulting from the exercise of stock awards in both periods.

The primary sources of revenue for Banking are net interest income, fees from its deposits, trust and insurance services, certain loan fees, and consulting fees. The primary source of revenue for Wealth Management is asset management fees assessed on the balance of AUM. Compensation and benefit costs, which represent the largest component of noninterest expense, accounted for 59% and 78%, respectively, of the total noninterest expense for Banking and Wealth Management in the first six months of 2017.

The following table shows key operating results for each of our business segments for the quarter ended June 30:

 

General. Consolidated income before taxes for the second quarter of 2017 was $14.3 million as compared to $5.7 million for the second quarter of 2016. The increase in income before taxes was primarily the result of a $9.1 million increase in income before taxes for Banking. The increase in Banking was due to higher net interest income and higher noninterest income which was partially offset by higher noninterest expenses. Income before taxes for Wealth Management for the second quarter of 2017 was $0.7 million as compared to $0.6 million in the second quarter of 2016 as increases in noninterest income were offset by increases in noninterest expenses. Corporate interest expenses are related to the holding company line of credit which did not exist in 2016. Corporate noninterest expenses increased by $0.3 million due to higher charitable contributions and other increases in costs, including legal and marketing.

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The following table shows key operating results for each of our business segments for the six months ended June 30:

 

General. Consolidated income before taxes for the first six months of 2017 was $23.3 million as compared to $12.3 million for the first six months of 2016. The increase in income before taxes was the result of an $11.9 million increase in income before taxes for Banking and a $0.2 million increase in income before taxes for Wealth Management, which were partially offset by a $0.9 million increase in corporate expenses. The increase in Banking was due to higher net interest income, a lower provision for loan losses and higher noninterest income which was partially offset by higher noninterest expenses. The increase in Wealth Management was due to higher noninterest income which was partially offset by higher noninterest expense. Corporate interest expenses are related to the holding company line of credit which did not exist in 2016. Corporate noninterest expenses increased by $0.7 million due to costs related to strategic activities, including the Company’s at the market stock offering, higher charitable contributions and other increases in costs, including legal and marketing.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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Net Interest Income. The following tables set forth, for the periods indicated, information regarding (i) the total dollar amount of interest income from interest-earning assets and the resultant average yields on those assets; (ii) the total dollar amount of interest expense and the average rate of interest on our interest-bearing liabilities; (iii) net interest income; (iv) net interest rate spread; and (v) net yield on interest-earning assets:

 

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Net interest income is impacted by the volume (changes in volume multiplied by prior rate), interest rate (changes in rate multiplied by prior volume) and mix of interest-earning assets and interest-bearing liabilities. The following table provides a breakdown of the changes in net interest income due to volume and rate changes for the quarter and six months ended June 30, 2017, as compared to corresponding periods in 2016:

 

 

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Net interest income for Banking increased 28% from $21.9 million in the second quarter of 2016, to $28.1 million in the second quarter of 2017 due to a 37% increase in interest-earning assets, which was partially offset by a decrease in our net interest rate spread. The decrease in the net interest rate spread from 2.97% in the second quarter of 2016 to 2.68% in the second quarter of 2017 was due to an increase in the cost of interest-bearing liabilities from 0.54% in the second quarter of 2016 to 0.84% in the second quarter of 2017. The yield on interest-earning assets remained relatively flat as a decrease in the yield on loans, due to prepayments of higher yielding loans, was offset by an increase in our yield on securities. The increase in the cost of interest-bearing liabilities was due to increased costs of interest-bearing deposits, resulting from increases in deposit market rates, and increased costs of borrowings as the average rate on FHLB advances increased from 0.43% in the second quarter of 2016 to 0.94% in the second quarter of 2017. In addition, the Company borrowed on its holding company line of credit during the second quarter of 2017.  

Net interest income for Banking increased 31% from $41.3 million in the first six months of 2016, to $54.2 million in the first six months of 2017 due to a 40% increase in interest-earning assets, which was partially offset by a decrease in our net interest rate spread. The decrease in the net interest rate spread from 2.99% in the first six months of 2016 to 2.72% in the first six months of 2017 was due to a decrease in the yield on interest-earning assets and an increase in the cost of interest-bearing liabilities. The yield on interest-earning assets decreased from 3.53% to 3.49% due to a decrease in the yield on loans due to prepayments of higher yielding loans and the addition of loans at market rates in the latter half of 2016 which were lower than the then-current yield on our loan portfolio. The cost of interest-bearing liabilities increased from 0.54% to 0.77% due to increased costs of interest-bearing deposits, resulting from increases in deposit market rates, and increased costs of borrowings as the average rate on FHLB advances increased from 0.43% in the first six months of 2016 to 0.82% in the first six months of 2017. In addition, the Company borrowed on its holding company line of credit during the first six months of 2017.  

Provision for loan losses. The provision for loan losses represents our estimate of the amount necessary to be charged against the current period’s earnings to maintain the ALLL at a level that we consider adequate in relation to the estimated losses inherent in the loan portfolio. The provision for loan losses is impacted by changes in loan balances as well as changes in estimated loss assumptions and charge-offs and recoveries. The amount of the provision also takes into consideration such factors as changes in the nature and volume of the loan portfolio, overall portfolio quality, review of specific problem loans, current economic conditions and certain other subjective factors that may affect the ability of borrowers to meet their repayment obligations to us. For the quarter and six months ended June 30, 2017, we recorded provisions for loan losses of $1.1 million and $1.2 million, respectively, as compared to $1.3 million and $1.7 million, respectively, for the quarter and six months ended June 30, 2016. During the first six months of 2017, the Bank realized $0.2 million of recoveries and experienced improving credit trends in its criticized loans.

Noninterest income. Noninterest income for Banking includes fees charged to clients for trust services and deposit services, consulting fees, prepayment and late fees charged on loans and insurance commissions. The following table provides a breakdown of noninterest income for Banking for the quarter and six months ended June 30:

 

Noninterest income in Banking was $4.2 million in the second quarter of 2017 as compared to a $0.2 million loss in the second quarter of 2016. During the second quarter of 2017, we realized $2.1 million in gains on the sale of $153 million of multifamily loans, while in the second quarter of 2016, we recognized a $2.4 million loss relating to hedging activities.  

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Noninterest income in Banking increased from $1.6 million in the first six months of 2016 to $6.7 million in the first six months of 2017. During the first six months of 2017, we realized $2.4 million in gains on the sale of $174 million of multifamily loans, while in the first six months of 2016, we recognized a $2.0 million loss relating to hedging activities.

Noninterest income for Wealth Management includes fees charged to high net-worth clients for managing their assets and for providing financial planning consulting services. The following table provides a breakdown of noninterest income for Wealth Management for the quarter and six months ended June 30:

 

 

Noninterest revenue for Wealth Management increased by $0.5 million in the second quarter and $0.6 million for the six months ended June 30, 2017 when compared to the corresponding periods in 2016 due to higher levels of AUM balances on which the asset management fees are calculated. AUM, which totaled $4.0 billion at June 30, 2017, increased by $418 million during the first six months of 2017 as new account growth of $245 million and portfolio gains of $251 million were partially offset by net withdrawals and account terminations of $79 million.

Noninterest Expense. The following table provides a breakdown of noninterest expense for Banking and Wealth Management for the quarter and six months ended June 30:

 

Noninterest expense in Banking increased from $14.3 million in the second quarter of 2016 to $15.8 million in the second quarter of 2017 due to increases in staffing and costs associated with the Bank’s expansion, the growth of its balances of loans and deposits, which was partially offset by lower legal costs. Compensation and benefits for Banking increased $1.5 million or 18% during the second quarter of 2017 as compared to the second quarter of 2016 as the number of full time equivalent employees (“FTE”) in Banking increased to 305.8 from 261.0 as a result of the increased staffing related to the December 2016 acquisition of two branches and additional personnel added to support the growth in loans and deposits. A $1.0 million increase in occupancy and depreciation for Banking in the second quarter of 2017 as compared to the second quarter of 2016 was due to costs associated with our expansion into additional corporate space and the acquisition and opening of new offices during 2016 and increases in our data processing costs due to increased volumes and the implementation of enhancements. Litigation related costs for Banking were $2.2 million lower in the second quarter of 2017 as compared to the second quarter of 2016 due to the reimbursement from our insurance providers of $1.8 million of previously incurred legal costs and costs incurred for a litigation matter in the second quarter of 2016. The $1.5 million increase in other expenses in Banking in the second quarter of 2017 as compared to the second quarter of 2016 was due to a $1.0 million increase in customer service costs related to the increases in noninterest demand deposits and costs related to our growth, including deposit insurance.

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Noninterest expense in Banking increased from $27.6 million in the first six months of 2016 to $34.2 million in the first six months of 2017 due to increases in staffing and costs associated with the Bank’s expansion, the growth of its balances of loans and deposits, which was partially offset by lower legal costs. Compensation and benefits for Banking increased $3.4 million or 21% during the first six months of 2017 as compared to the first six months of 2016 as the number of FTE in Banking increased to 297.9 from 251.2 as a result of the increased staffing related to the December 2016 acquisition of two branches and additional personnel added to support the growth in loans and deposits. A $1.6 million increase in occupancy and depreciation for Banking in the first six months of 2017 as compared to the first six months of 2016 was due to costs associated with our expansion into additional corporate space and the acquisition and opening of new offices during 2016 and increases in our data processing costs due to increased volumes and the implementation of enhancements. Litigation related costs for Banking were $0.8 million lower in the first six months of 2017 as compared to the first six months of 2016 due to the reimbursement from our insurance providers of $1.8 million of previously incurred legal costs which was offset by costs related to the resolution of an outstanding litigation matter in the first quarter of 2017. A $2.5 million increase in other expenses in Banking in the first six months of 2017 as compared to the first six months of 2016 was due to a $1.6 million increase in customer service costs related to the increases in noninterest demand deposits and costs related to our growth, including deposit insurance.

The increases in noninterest expense in Wealth Management for the second quarter and six months of 2017 as compared to the corresponding periods in 2016 were due to increases of $0.5 million in both periods in compensation and benefits. The increases in compensation and benefits were due to increases in FTE and cost of living increases.

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Financial Condition

The following table shows the financial position for each of our business segments, and of FFI and elimination entries used to arrive at our consolidated totals which are included in the column labeled Other and Eliminations, as of:

 

Our consolidated balance sheet is primarily affected by changes occurring in our Banking operations as our Wealth Management operations do not maintain significant levels of assets. Banking has experienced and is expected to continue to experience increases in its total assets as a result of our growth strategy.

During the first six months of 2017, cash and cash equivalents decreased by $469 million, loans and loans held for sale increased by $435 million and deposits increased by $685 million. Total borrowings, which included $25 million outstanding on our holding company line of credit, decreased by $789 million.

Cash and cash equivalents, certificates of deposit and securities. Cash and cash equivalents, which primarily consist of funds held at the Federal Reserve Bank or at correspondent banks, including fed funds, decreased $469 million during the first six months of 2017. Changes in cash equivalents are primarily affected by the funding of loans, investments in securities, and changes in our sources of funding: deposits, FHLB advances and FFI borrowings.  

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Securities available for sale. The following table provides a summary of the Company’s AFS securities portfolio as of:

 

The US Treasury securities are pledged as collateral to the State of California to meet regulatory requirements related to FFB’s trust operations.

The scheduled maturities of securities AFS, other than agency mortgage-backed securities, and the related weighted average yield is as follows as of June 30, 2017:

 

Agency mortgage backed securities and beneficial interest – FHLMC securitizations are excluded from the above table because such securities are not due at a single maturity date. The weighted average yield of the agency mortgage backed securities as of June 30, 2017 was 2.54%.

Loans. The following table sets forth our loans, by loan category, as of:

 

Total loans, including loans held for sale, increased $435 million during the first six months of 2017 as a result of $816 million of originations and $8 million of purchases which were partially offset by the sale of $174 million of multifamily loans and payoffs or scheduled payments of $215 million.

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Deposits. The following table sets forth information with respect to our deposits and the average rates paid on deposits, as of:

 

During the first six months of 2017, the weighted average rate of our interest-bearing deposits increased from 0.62% at December 31, 2016 to 0.84% at June 30, 2017, while the weighted average interest rates of both interest-bearing and noninterest-bearing deposits increased from 0.45% at December 31, 2016 to 0.59% at June 30, 2017. The increase in the weighted average rate of our interest-bearing deposits was the result of increases in market rates, the use of higher than market promotional rates to attract new clients and our success in attracting higher balance accounts which generally bear higher interest rates. The increase in our overall cost of deposits was less than the increase in interest-bearing deposits as a result of a higher proportion of noninterest-bearing deposits at June 30, 2017 when compared to December 31, 2016.

The $681 million growth in deposits during the first six months of 2017 was primarily due to the organic growth in deposits from our specialty deposit group, which increased by 39%, and our branch offices, which increased by 13%.

The maturities of our Certificates of deposit of $100,000 or more were as follows as of June 30, 2017:

 

FFB utilizes third party programs called CDARs and ICS which allows FFB to transfer funds of its clients in excess of the FDIC insurance limit (currently $250,000) to other institutions in exchange for an equal amount of funds from clients of these other institutions. This has allowed FFB to provide FDIC insurance coverage to its clients. Under certain regulatory guidelines, these deposits are considered brokered deposits. From time to time, the Bank will utilize brokered deposits as a source of funding. As of June 30, 2017 the Bank held $499 million of deposits which are classified as brokered deposits, including $29 million of CDARs and ICS reciprocal deposits.

Borrowings. At June 30, 2017 our borrowings consisted of $436 million in overnight FHLB advances and $25 million of borrowings on our holding company line of credit. At December 31, 2016, our borrowings consisted of $1.3 billion in overnight FHLB advances. The FHLB advances were paid in full in the early parts of July 2017 and January 2017, respectively. Because FFB utilizes overnight borrowings, the balance of outstanding borrowings fluctuates on a daily basis. The average balance of overnight borrowings during the first six months of 2017 was $608 million, as compared to $568 million during the first six months of 2016. The weighted average interest rate on these overnight borrowings was 0.82% for the first six months of 2017, as compared to 0.43% during 2016. The maximum amount of overnight borrowings outstanding at any month-end during the first six months of 2017 and 2016 was $818 million and $938 million, respectively.  

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Delinquent Loans, Nonperforming Assets and Provision for Credit Losses

Loans are considered past due following the date when either interest or principal is contractually due and unpaid. Loans on which the accrual of interest has been discontinued are designated as nonaccrual loans. Accrual of interest on loans is discontinued when reasonable doubt exists as to the full, timely collection of interest or principal and, generally, when a loan becomes contractually past due for 90 days or more with respect to principal or interest. However, the accrual of interest may be continued on a well-secured loan contractually past due 90 days or more with respect to principal or interest if the loan is in the process of collection or collection of the principal and interest is deemed probable. The following tables provide a summary of past due and nonaccrual loans as of:

 

The following table presents the composition of TDRs by accrual and nonaccrual status as of:

 

 

 

 

 

 

 

 

 

 

 

 

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The following is a breakdown of our loan portfolio by the risk category of loans as of:

 

We consider a loan to be impaired when, based upon current information and events, we believe that it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan. We measure impairment using either the present value of the expected future cash flows discounted at the loan’s effective interest rate, or the fair value of the properties collateralizing the loan, for collateral dependent loans. Impairment losses are included in the ALLL through a charge to provision for loan losses. Adjustments to impairment losses due to changes in the fair value of the property collateralizing an impaired loan are considered in computing the provision for loan losses. Loans collectively reviewed for impairment include all loans except for loans which are individually reviewed based on specific criteria, such as delinquency, debt coverage, adequacy of collateral and condition of property collateralizing the loans. Impaired loans include nonaccrual loans (excluding those collectively reviewed for impairment), certain restructured loans and certain performing loans less than 90 days delinquent (“other impaired loans”) which we believe are not likely to be collected in accordance with the contractual terms of the loans.

In 2015, we purchased loans, for which there was, at acquisition, evidence of deterioration of credit quality since origination and it was probable, at acquisition, that all contractually required payments would not be collected. The carrying amount of these purchased credit impaired loans is as follows as of:

 

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 Allowance for Loan Losses. The following table summarizes the activity in our ALLL for the periods indicated:

 

Excluding the loans acquired in acquisitions, our ALLL represented 0.54%, and 0.60% of total loans outstanding as of June 30, 2017 and December 31, 2016, respectively.

The amount of the ALLL is adjusted periodically by charges to operations (referred to in our income statement as the “provision for loan losses”) (i) to replenish the ALLL after it has been reduced due to loan write-downs or charge-offs, (ii) to reflect increases in the volume of outstanding loans, and (iii) to take account of changes in the risk of potential loan losses due to a deterioration in the condition of borrowers or in the value of property securing non–performing loans or adverse changes in economic conditions. The amounts of the provisions we make for loan losses are based on our estimate of losses in our loan portfolio. In estimating such losses, we use economic and loss migration models that are based on bank regulatory guidelines and industry standards, and our historical charge-off experience and loan delinquency rates, local and national economic conditions, a borrower’s ability to repay its borrowings, and the value of any property collateralizing the loan, as well as a number of subjective factors. However, these determinations involve judgments about changes and trends in current economic conditions and other events that can affect the ability of borrowers to meet their loan obligations to us and a weighting among the quantitative and qualitative factors we consider in determining the sufficiency of the ALLL. Moreover, the duration and anticipated effects of prevailing economic conditions or trends can be uncertain and can be affected by a number of risks and circumstances that are outside of our control. If changes in economic or market conditions or unexpected subsequent events were to occur, or if changes were made to bank regulatory guidelines or industry standards that are used to assess the sufficiency of the ALLL, it could become necessary for us to incur additional, and possibly significant, charges to increase the ALLL, which would have the effect of reducing our income.

In addition, the FDIC and the California Department of Business Oversight, as an integral part of their examination processes, periodically review the adequacy of our ALLL. These agencies may require us to make additional provisions for loan losses, over and above the provisions that we have already made, the effect of which would be to reduce our income.

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The following table presents the balance in the ALLL and the recorded investment in loans by impairment method as of:

 

 

The column labeled “Unaccreted Credit Component Other Loans” represents the amount of unaccreted credit component discount for loans acquired in an acquisition  that were not classified as purchased credit impaired or individually evaluated for impairment as of the dates indicated, and the stated principal balances of the related loans. The unaccreted credit component discount is equal to 0.70% and 0.73% of the stated principal balances of these loans as of June 30, 2017 and December 31, 2016, respectively. In addition to this unaccreted credit component discount, an additional $0.5 million of the ALLL were provided for these loans as of June 30, 2017 and December 31, 2016.

Liquidity

Liquidity management focuses on our ability to generate, on a timely and cost-effective basis, cash sufficient to meet the funding needs of current loan demand, deposit withdrawals, principal and interest payments with respect to outstanding borrowings and to pay operating expenses. Our liquidity management is both a daily and long-term function of funds management. Liquid assets are generally invested in marketable securities or held as cash at the Federal Reserve Bank, or other financial institutions.

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We monitor our liquidity in accordance with guidelines established by our Board of Directors and applicable regulatory requirements. Our need for liquidity is affected by our loan activity, net changes in deposit levels and the maturities of our borrowings. The principal sources of our liquidity consist of deposits, loan interest and principal payments and prepayments, investment management and consulting fees, FHLB advances and proceeds from borrowings and sales of shares by FFI. The remaining balances of the Bank’s lines of credit available to draw down totaled $1.0 billion at June 30, 2017.  

Cash Flows Provided by Operating Activities. During the six months ended June 30, 2017, operating activities provided net cash of $18.3 million, comprised primarily of our net income of $15.7 million, and $3.5 million increase in accounts payable and other liabilities. During the six months ended June 30, 2016, operating activities provided net cash of $5.4 million, comprised primarily of our net income of $7.1 million, and $3.0 million of non-cash charges, including provisions for loan losses, stock based compensation expense, and depreciation and amortization, offset partially by a $1.2 million increase in other assets and $2.8 million decrease in accounts payable and other liabilities.

Cash Flows Used in Investing Activities. During the six months ended June 30, 2017, investing activities used net cash of $393.2 million, primarily to fund a $608.5 million net increase in loans, offset partially by $176 million in loan sales and $33.6 million in cash received in proceeds from the sale, principal collection, and maturities of securities. During the six months ended June 30, 2016, investing activities used net cash of $665 million, primarily to fund a $707 million net increase in loans and $31 million of securities purchases, offset partially by $77 million in cash received in proceeds from the sale, principal collection, and maturities of securities.

Cash Flow Provided by Financing Activities. During the six months ended June 30, 2017, financing activities used net cash of $94.1 million, consisting primarily of an $814 million decrease in FHLB advances, offset partially by a $680.6 million increase in deposits, $25 million in proceeds from a holding company line of credit and $14.2 million in proceeds from the sale of stock. During the six months ended June 30, 2016, financing activities provided net cash of $888 million, consisting primarily of a net increase of $743 million in deposits, and a $142 million increase in FHLB advances.

Ratio of Loans to Deposits. The relationship between gross loans and total deposits can provide a useful measure of a bank’s liquidity. Since repayment of loans tends to be less predictable than the maturity of investments and other liquid resources, the higher the loan-to-deposit ratio, the less liquid are our assets. On the other hand, since we realize greater yields on loans than we do on other interest-earning assets, a lower loan-to-deposit ratio can adversely affect interest income and earnings. As a result, our goal is to achieve a loan-to-deposit ratio that appropriately balances the requirements of liquidity and the need to generate a fair return on our assets. At June 30, 2017 and December 31, 2016, the loan-to-deposit ratios at the Bank were 104% and 116%, respectively.

Off-Balance Sheet Arrangements

The following table provides the off-balance sheet arrangements of the Company as of June 30, 2017:

 

Some of the commitments to fund existing loans, lines of credit and letters of credit are expected to expire without being drawn upon. Therefore, the total commitments do not necessarily represent future cash requirements. As of June 30, 2017, the Bank was obligated on $157 million of letters of credit to the FHLB which were being used as collateral for public fund deposits, including $136 million of deposits from the State of California.

Capital Resources and Dividend Policy

On February 16, 2017, the Company and the Bank entered into an Equity Distribution Agreement (the “Distribution Agreement”) with FBR Capital Markets & Co., Raymond James & Associates, Inc., Sandler O’Neill & Partners, L.P., and D.A. Davidson & Co. (collectively, the “Distribution Agents”) to sell shares of the Company’s common stock, par value $0.001 per share (the “ATM Shares”), having an aggregate offering price of up to $80 million, from time to time, through an “at-the-market” equity offering program (the “ATM Program”).

The sales of the ATM Shares may be made in negotiated transactions or transactions that are deemed to be “at-the-market offerings” as defined in Rule 415 under the Securities Act of 1933, as amended, including sales made directly on or through the NASDAQ Global Market, sales made to or through a market maker other than on an exchange, in negotiated transactions at market prices prevailing at the time of sale or at prices related to such market prices, or any other method permitted by law. Subject to the terms and conditions of the Distribution Agreement, upon its acceptance of written instructions from the Company, the Distribution Agent designated by the Company to sell ATM Shares will use its commercially reasonable efforts to sell on the Company’s behalf all

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of the designated ATM Shares. The Company may also sell ATM Shares under the Distribution Agreement to each of the Distribution Agents, as principals for their respective accounts, at a price per share agreed upon at the time of sale. Actual sales will depend on a variety of factors to be determined by the Company from time to time.  The Company has no obligation to sell any of the ATM Shares under the Distribution Agreement, and may at any time suspend sales of the ATM Shares under the Distribution Agreement. The Company will pay the Distribution Agents’ commissions for their services in acting as agent in the sale of ATM Shares, and the Company advanced $90,000 to the Distribution Agents for their out-of-pocket legal fees incurred in connection with the ATM Program.  The Distribution Agents will be entitled to compensation at a commission rate equal to 2.0% of the gross proceeds from the sale of ATM Shares pursuant to the Distribution Agreement; provided, however, that the compensation payable to each Distribution Agent upon the sale of ATM Shares pursuant to the Distribution Agreement will be reduced by $22,500 in a manner such that no compensation will be paid to a Distribution Agent until the amount of the commission earned by such Distribution Agent exceeds $22,500. The Distribution Agreement contains representations and warranties and covenants that are customary for transactions of this type. In addition, the Company has agreed to indemnify the Distribution Agents against certain liabilities on customary terms, subject to limitations on such arrangements imposed by applicable law and regulation.

During the second quarter of 2017, we commenced sales of common stock through the ATM Program. The details of the shares of common stock sold through the ATM Program during the second quarter of 2017 are as follows:

 

As of June 30, 2017, the remaining dollar value of common stock we had available to sell under the ATM Program was $69.3 million.  The actual number of shares of our common stock, if any, that may be sold under the ATM Program in the future will depend upon the sale price for such shares.

Under federal banking regulations that apply to all United States based bank holding companies and federally insured banks, the Company (on a consolidated basis) and FFB (on a stand-alone basis) must meet specific capital adequacy requirements that, for the most part, involve quantitative measures, primarily in terms of the ratios of their capital to their assets, liabilities, and certain off-balance sheet items, calculated under regulatory accounting practices. Under those regulations, which are based primarily on those quantitative measures, each bank holding company must meet a minimum capital ratio and each federally insured bank is determined by its primary federal bank regulatory agency to come within one of the following capital adequacy categories on the basis of its capital ratios: (i) well capitalized; (ii) adequately capitalized; (iii) undercapitalized; (iv) significantly undercapitalized; or (v) critically undercapitalized.

Certain qualitative assessments also are made by a banking institution’s primary federal regulatory agency that could lead the agency to determine that the banking institution should be assigned to a lower capital category than the one indicated by the quantitative measures used to assess the institution’s capital adequacy. At each successive lower capital category, a banking institution is subject to greater operating restrictions and increased regulatory supervision by its federal bank regulatory agency.

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The following table sets forth the capital and capital ratios of FFI (on a consolidated basis) and FFB as of the respective dates indicated below, as compared to the respective regulatory requirements applicable to them:

 

As of each of the dates set forth in the above table, the Company (on a consolidated basis) exceeded the minimum required capital ratios applicable to it and FFB (on a stand-alone basis) qualified as a well-capitalized depository institution under the capital adequacy guidelines described above.

As of June 30, 2017, the amount of capital at FFB in excess of amounts required to be Well Capitalized was $154.9 million for the CET-1 capital ratio, $131.8 million for the Tier 1 leverage ratio, $115.7 million for the Tier 1 risk-based capital ratio and $81 million for the Total risk-based capital ratio.

The “Basel III” rules adopted by the Federal Reserve Board and the FDIC (the “New Capital Rules”) introduced a capital conservation buffer which is an increment added to the minimum capital ratios.  If a banking organization does not hold a capital conservation buffer composed of common equity tier 1 capital above its minimum risk-based capital requirements, it will face constraints on dividends, equity repurchases and executive compensation based on the amount of the shortfall. The capital buffer is measured against risk weighted assets and is therefore not applicable to the tier 1 leverage ratio. The implementation of the capital conservation buffer began on January 1, 2016 at 0.625%, and will increase by 0.625% on each subsequent January 1, until it reaches 2.5% on January 1, 2019. The following table sets forth the minimum capital ratios plus the applicable increment of the capital conservation buffer as of the current year and when it is fully implemented in 2019:

 

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During the six months of 2017, and during the entirety of 2016, FFI made cash capital contributions to FFB of $35 million and $40 million, respectively. As of June 30, 2017, FFI had $17 million of available capital and, therefore, has the ability and financial resources to contribute additional capital to FFB, if needed.

We did not pay dividends in 2017 or 2016 and we have no plans to pay dividends at least for the foreseeable future. Instead, it is our intention to retain internally generated cash flow to support our growth. Moreover, the payment of dividends is subject to certain regulatory restrictions.

We had no material commitments for capital expenditures as of June 30, 2017.

 

 

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We are exposed to certain financial risks, which are discussed in detail in Management's Discussion and Analysis of Financial Condition and Results of Operations in the section titled Asset and Liability Management: Interest Rate Risk in our Annual Report on Form 10-K which we filed with the Securities and Exchange Commission on March 15, 2017.  There have been no material changes to our quantitative and qualitative disclosures about market risk since December 31, 2016.

 

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer to allow timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, our management recognized that any system of controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, as ours are designed to do, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.  

In accordance with SEC rules, an evaluation was performed under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer of the effectiveness, as of June 30 2017, of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act). Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of June 30, 2017, the Company’s disclosure controls and procedures were effective to provide reasonable assurance that information required to be disclosed in our reports that we file under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure.

There was no change in our internal control over financial reporting that occurred during the quarter ended June 30, 2017 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

PART II—OTHER INFORMATION

 

There have been no material changes in the risk factors that were disclosed in Item 1A, under the caption “Risk Factors” in Part I of our Annual Report on Form 10-K for the year ended December 31, 2016, which we filed with the SEC on March 15, 2017.

 

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

 

 

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INDEX TO EXHIBITS

 

 

 

 

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