Jefferies LLC's depository investment banking team scored with its latest private equity deal in bankland.
When Dallas-based First Foundation Inc. sought a capital injection, it garnered strong interest from private investors, a source involved in the transaction told S&P Global Market Intelligence. The offering was oversubscribed, with interest from private investors strong enough that the company did not have to tap the public market, they said.
First Foundation said July 2 that it raised $228 million from investors led by Fortress Investment Group LLC, Canyon Partners LLC, Strategic Value Bank Partners LLC and North Reef Capital. Jefferies advised on the high-interest raise, marking at least its third private equity investment credit in banks in the past year.
The First Foundation raise comes at a time when US bank equity offerings have been relatively slow since the regional bank failures in early 2023. Most capital raises done in the past year have been to bolster strategic initiatives, such as diversifying from commercial real estate (CRE). Jefferies has scored the credit on several of these high-profile raises.
In March, Jefferies advised New York Community Bancorp Inc. on its $1 billion capital raise led by Steven Mnuchin-backed Liberty Strategic Capital, Hudson Bay Capital Management LP and Reverence Capital Partners LP.
In a deal announced July 2023, Jefferies advised Warburg Pincus LLC and Centerbridge Partners LP, which provided $400 million for community bank Banc of California Inc. to acquire much larger target PacWest Bancorp in a reverse merger.
Right now, regulators recognize that private capital plays a critical role for banks to navigate current challenges in the banking system, and they have been "very constructive" about private equity's interest in banks, the source said.
Street reaction
While capital raises can help soften regulators' and investors' concerns about a CRE-concentrated book, these raises often come at a hefty discount and are extremely dilutive to shareholders.
In the case of First Foundation, the new investors will own 49% of the company and are buying common shares for $4.10 each, a 37.6% haircut to the company's $6.57 closing price prior to the announcement.
First Foundation opted for a capital raise in order to improve shareholder value for the bank, which has faced share price and earnings pressure, rather than sell from a position of weakness, the source said.
But the investor community was shocked at the announcement, with the company's shares closing down almost 24% the day after announcement. The company was already the fourth-cheapest US bank stock in June, logging a 42.9% price to tangible book value while the industry median was 125.9%.
Equity analysts were also shocked. Raymond James analyst David Feaster and Piper Sandler analyst Matthew Clark wrote in respective notes that they were surprised by the announcement.
"We fundamentally did not believe the bank needed to raise additional capital," Feaster wrote in a note July 3.
Wedbush Securities analyst David Chiaverini was also bearish on the dilutive raise, saying the company had a path to earnings recovery over the next two to three years without the capital raise since it was well capitalized, has strong credit quality and saw earnings trough in the first quarter, the analyst wrote.
"This leads us to conclude that the company's weak profitability in comparison to peers may have been expected to linger uncomfortably longer than we had originally assumed prior to this deal," Chiaverini wrote.
Moving away from multifamily
First Foundation defended the raise on an investor call to discuss the transaction July 2 by saying the funding helps it to "return to a posture towards offense," President and CEO Scott Kavanaugh said.
With the cash, the company plans to lower its multifamily concentration, which made up 51.8% of its total loans at March 31, by potential loan sales and making more commercial and industrial loans. That goal will help it to lower its CRE-to-risk based capital ratio, which is currently sitting at 519.26% — well above the 300% regulatory threshold.
The company also plans to use some of the cash to bolster its allowance for credit losses, though it does not believe that it needs to.
"To be crystal clear ... we believe our reserves are adequate, bottom line. But in this cycle that the banking sector seems to be in right now, I think most people would say that our reserves appear low," Kavanaugh said. "We are willing to throw more reserves into the qualitative side just in order to bring up with what we believe will be unnecessary builds in ACL but one that we believe the Street has looked at and said, 'It should be higher.'"
The raise will also help to boost the company's financial performance, which has dragged in recent years.
In 2023, its loss per share was $3.53, trending down from earnings per share of $1.96 in 2022 and $2.41 in 2021.
The weak profitability is in part due to low-yielding loans made when interest rates were low in 2020 and 2021. Moreover, rising deposit rates jacked up the company's funding costs. Those two dynamics started to squeeze its net interest margin, which sat at 1.18% at March 31, 2024, down from 3.00% in the first quarter of 2022.
