KBRA Affirms Ratings for First Foundation, Inc.

KBRA affirms the senior unsecured debt rating of BBB, the subordinated debt rating of BBB-, and the short-term debt rating of K3 for Dallas, Texas-based First Foundation, Inc. (NASDAQ: FFWM) ("the company"). In addition, KBRA affirms the deposit and senior unsecured debt ratings of BBB+, the subordinated debt rating of BBB, and the short-term deposit and debt ratings of K2 for First Foundation Bank, the main subsidiary. The Outlook for the long-term ratings is revised to Negative from Stable.

Key Credit Considerations

The revision of FFWM’s Outlook to Negative from Stable is largely predicated on a more challenging earnings outlook for the company over the short-to-intermediate term, one that is accentuated by the company’s traditionally liability sensitive balance sheet. In this respect, FFWM’s recent earnings performance (9M23 adjusted ROA of 0.15%) has been materially impacted by the sharp climb in market interest rates. Most notably, the company’s cost sensitive deposit base, which includes a large proportion of complex, sophisticated commercial customers who often get paid a near market interest rate, has contributed to a current cycle deposit beta that is among the highest of its peers. At the same time, stubbornly stable loan yields – a function of FFWM’s heavy proportion of generally low-yielding, fixed rate multifamily and 1-4 family loans – have risen much more modestly. Such balance sheet composition, along with a proactive increased utilization of more expensive wholesale funding in recent quarters to enhance liquidity and combat industry uncertainty, has naturally led to NIM contraction (-79 bps YTD23), and the company’s margin as of 3Q23 (1.66%) is well below that of peers. While we expect marginal incremental improvement on a go forward basis, we think earnings will likely remain challenged at FFWM until there is a material change in the interest rate environment.

Though the composition of FFWM’s loan portfolio contributes to subdued earning asset sensitivity, we continue to believe that the company’s comparatively overweighted exposure to relatively safer asset classes such as multifamily housing and residential mortgage will result in asset quality outperformance vs. peers if and when the credit environment normalizes. Additionally, we highlight that FFWM’s historical credit track record has been pristine, noting that there have been no charge-offs in the multifamily portfolio since the bank’s creation in 2007. Furthermore, lower exposure to construction lending and non-owner occupied CRE (multifamily aside) is also viewed positively. Elsewhere, core capital metrics have declined at FFWM in recent years primarily due to particularly strong loan growth (+44% and +55% in 2021 and 2022, respectively). As a result, the company’s 3Q23 CET1 capital ratio of 9.8% is on the lower side of similarly rated institutions, and when combined with a comparatively smaller ALLL of 0.28%, we believe FFWM has somewhat weaker than peer total loss absorbing capacity. That said, we appreciate that management has built capital higher through 9M23 (CET1 capital +62 bps since YE22), and we continue to assess FFWM’s capital as adequate for the current rating category, acknowledging that lower than peer capital is not necessarily inconsistent with the company’s risk profile, which includes a loan portfolio that we consider more conservative than most.

Rating Sensitivities

Over time, a return to stronger levels of core profitability, thereby allowing for stronger organic capital generation, if achieved with a continued appropriate liquidity and credit profile, could result in a revision of the Outlook to Stable. Alternatively, the failure of the company to maintain core profitability, whether it be due to continued interest rate headwinds or a deterioration in credit quality, would likely lead to a downgrade of FFWM’s ratings. Such earnings would likely hamper any efforts to rebuild capital higher, which would also be viewed negatively. Finally, considering that FFWM’s current ratings are tied to our belief that the company will outperform on the credit front, a greater than peer deterioration in credit quality could also lead to a downgrade.

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