FirstSun Capital Bancorp (FSUN) Earnings Call Transcript

Good morning and welcome to the FirstSun Capital Bancorp Third Quarter 2026 Earnings Conference Call. [Operator Instructions] Also, as a reminder, this call may be recorded. I'd now like to turn the call over to Ed Jacques, FirstSun's Director of Investor Relations and Business Development. You may begin.

Thank you and good morning. I'm joined today by Neal Arnold, our Chief Executive Officer and President; Rob Cafera, our Chief Financial Officer; and Jennifer Norris, our Chief Credit Officer. We will start the call with some brief remarks about our third quarter results before moving into questions. Our comments will reference the earnings release and earnings presentation, which you will find on our website under the Investor Relations section. During this call, we will comment on our financial performance using both GAAP metrics and non-GAAP financial measures. Important information about these non-GAAP financial measures, including reconciliations to comparable GAAP measures, is included in the appendix to our earnings presentation and in our earnings release. During this call, we will make remarks about future expectations, plans and prospects for the company that constitute forward-looking statements for the purposes of the safe harbor provisions under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors. Please refer to our earnings presentation, as well as our annual report on Form 10-K and our other SEC filings, for a further discussion of the company's risk factors and other important information regarding our forward-looking statements. We undertake no obligation to publicly revise or update any forward-looking statement, except as required by law. I will now turn the call over to Neal Arnold.

Thanks, Ed. Good morning and thank you for joining us. The third quarter represented another important milestone for FirstSun as we continue to progress on our strategic priorities and on the integration of the First Foundation businesses acquired. For the quarter, adjusted net income, which excluded merger-related expenses, totaled $48.2 million or $1.03 per diluted share, with an adjusted return on average assets of 1.23%. In addition to the strong bottom-line performance and continued integration of the acquired business, highlights in the third quarter included our net interest margin expansion to 3.82% over the last quarter and continued strong service fee income revenues, which again accounted for 21.9% of total revenue. We are very pleased with the progress we've made on our balance sheet profile. We significantly repositioned the acquired balance sheet in the second quarter, and the remix efforts continued into the third quarter as we move away from more rate-sensitive, non-relationship deposits and as our loan origination activity continues to be more heavily centered on floating-rate C&I loans versus the fixed-rate CRE loans. Our focus continues on expanding and deepening relationships across our entire customer base. A diversified and strong balance sheet enables us to focus on the growth opportunities across all of our great markets. All our work to reposition the acquired balance sheet, which helped to address the challenges inherent in the rate profile of that acquired balance sheet, was a key driver in the improved net interest margin that we saw in the third quarter. While deposit competition has been very strong, our focus has been on continued improvement in our net interest margin. We expect the balance sheet repositioning work to drive further incremental improvement in our net interest margin in Q4 and into the first quarter of 2027. Growing our service fee revenue businesses will also continue to be one of our strategic priorities. We believe a diversified revenue [Audio Gap] management side, but also in treasury management, syndication and swaps, provide a meaningful opportunity to deepen our client relationships and further enhance our overall revenue mix. Our capital position remains very strong and continues to provide us with meaningful flexibility as we execute on our overall strategy. During the third quarter, we repurchased approximately $50 million of common shares under our previously announced $150 million share repurchase program, and we currently expect to complete the remaining $100 million over the next 3 quarters. We believe the continued strength of our capital position provides us with the capacity to return capital to stockholders while also supporting our organic growth and maintaining overall balance sheet flexibility. On the asset quality side, we are encouraged by the improvement this quarter across several key measures, including a meaningful reduction in special mention loans of about $23.8 million, as well as a reduction in substandard of nearly $40 million. We continue to take a disciplined approach to underwriting, portfolio management, early risk identification, and we believe the improvement this quarter reflects the continued work of our teams to actively manage our loan portfolio. On the integration side, in late September, our team successfully completed the core system conversion of First Foundation. This was another important milestone in our integration plans and certainly resulted from a tremendous amount of hard work across the organization. We're pleased to have completed this phase of the business integration and look forward to expected additional operating synergies that will result. As we look forward to the next several quarters, we are seeing very strong pipelines in all of our major markets for both loan and deposit relationships. I believe the strong pipelines are the result of our investment that we made in further building our sales force over the last several years, particularly in Texas and Southern California. I expect this to be a driver of our organic growth going forward in 2027. Our priorities remain very focused: driving disciplined organic growth, deepening our client relationships, growing core deposits, improving service fee revenue and realizing the benefits from the integration of the First Foundation businesses and delivering strong financial results that result in sustained long-term value for our stockholders. Before turning the call over to Rob, I want to recognize and thank all of our teammates for the extraordinary effort that went into completing the recent core systems conversion. An undertaking of this scale requires significant planning, collaboration and execution across virtually every area of the company, and our teams delivered while continuing to serve clients throughout the process. I'm incredibly proud of the commitment and the teamwork and professionalism demonstrated by our team. It is a true reflection of the strength of our organization and our culture. [Audio Gap] financial results.

Thank you, Neal. I would also like to add my thanks to all our teammates for the very hard work that went into completing the recent core system conversion. The very inspiring teamwork shown by everybody involved is definitely a real testament to our culture here. Turning to our third quarter financial results, I'll start with the P&L and highlight several key drivers. As Neal noted, we're pleased with our earnings performance in the third quarter, with adjusted earnings per diluted share of $1.03. This excludes merger-related expenses incurred in the third quarter totaling $9.8 million on an after-tax basis or the equivalent of $0.21 in EPS. Further, our adjusted pretax pre-provision net income, or PPNR, which again excludes merger-related expenses, was $66.4 million or $1.42 per share in Q3, compared to $1.50 per share in Q2 and $1.32 per share in Q1 of this year. We're pleased with the expansion of our net interest margin in Q3, which increased 24 basis points to 3.82% compared to the 3.58% we saw in the second quarter. The improvement was largely attributable to both loan yields [Audio Gap]. We saw loan yields increase by 17 basis points over Q2, due primarily to the sales completed late in the second quarter of lower-yielding acquired multifamily and acquired public finance loans. In addition, given the heavier variable-rate nature of our loan portfolio, we have also benefited from the recent rising interest rate environment. On the funding side, despite the rising interest rate environment, our funding costs also improved [Audio Gap] disposition of acquired higher-cost certificates of deposit late in the second quarter and during the third quarter, as well as a favorable mix shift between our noninterest-bearing and interest-bearing deposits. We do see the competition for deposits of late intensifying, and certainly pricing pressure has resulted. Our objective is to continue to remain disciplined and to seek to balance rates and growth, particularly as we move into the fourth quarter and beyond. Service fee revenue totaled approximately $39.4 million in the third quarter, a decrease of approximately 4% compared to the prior quarter and representing 21.9% of total revenue. The decrease was driven primarily by a decrease in mortgage banking revenues, which was attributable to the slowing impact to origination activity as a result of the rising interest rates we saw during the quarter. Although I will note that mortgage revenues were up in the third quarter this year [Audio Gap] revenue trends we saw in Q3, we did see some nice improvement in service fee revenues across most of our other service fee revenue business lines, including wealth management, treasury management, consumer banking and swap and syndication activities for our commercial business customers. Overall, we continue to be very excited about the opportunities we are seeing to further grow and diversify our business mix from our service fee revenues. Turning to expenses, third quarter adjusted non-interest expenses, which exclude merger-related expenses, declined approximately $800,000 from the second quarter, with salaries and employee benefits expenses down approximately $5.4 million, partially offset by a $4.5 million increase in other noninterest expenses, which was primarily driven by higher loan collection expenses. In terms of realization of operating synergies from the First Foundation acquisition, during the third quarter, we were at an annualized run rate equivalent of approximately 70% of our original total cost savings target of $68.8 million. With the core system conversion now complete, we expect to capture the vast majority of the remaining incremental 30% run-rate savings in the fourth quarter. We're very pleased with our progress and continue to expect total cost savings to slightly exceed our original dollar target, with additional savings above that original target expected to come in the first quarter next year. Shifting to the balance sheet, on the loan side, balances declined approximately $110 million from the second quarter or 3.8% annualized. From a portfolio mix perspective, we saw encouraging growth in our C&I business, with balances increasing approximately $84 million from the second quarter or approximately 9% annualized. This growth was more than offset by paydowns across our commercial real estate, residential real estate and public finance portfolios, which collectively declined from the second quarter by approximately $173 million, including a decline of approximately $69 million in the multifamily portfolio. While we did experience a higher overall level of total loan portfolio paydowns this quarter, very similar to the elevated level in the second quarter, the proportional shift to more variable-rate C&I loans in the portfolio further improved our overall balance sheet sensitivity profile. [Audio Gap] million for the quarter, that's up 14% from $377 million in the second quarter. We also saw improvement in new loan pricing, with the average coupon on new loans increasing to 6.91% compared to 6.76% in the second quarter, which exceeded again this quarter the effective coupon being accreted on the acquired First Foundation loans, which was slightly below 6.2%. On the deposit side, we saw total balances decline approximately $447 million at quarter-end. While our deposit remixing strategy improved our overall portfolio mix and managed higher-rate acquired deposits, we did not generate net balance growth for the quarter due to the combination of intentional runoff and some attrition. In terms of the components of the Q3 balance decline, we saw approximately 80% of the decline related to either targeted runoff or seasonal contraction, with a breakdown of an approximate $40 million decline in brokered balances, an approximate $255 million decline in higher-rate non-relationship balances and an approximate $65 million decline due to typical seasonal contraction in the third quarter. The remaining approximate $85 million decline included some attrition and general balance decline across the customer base, including approximately $50 million in balance outflow involving the deployment by one customer of proceeds from the sale of the business. Our loan-to-deposit ratio was at 88.3% at the end of the quarter, and our wholesale funding ratio was at 6.7%. On the asset quality side, provision expense for the quarter was $4.4 million, primarily due to specific reserves on 2 CRE loans and partially offset by a decrease in the loan portfolio. Our allowance for credit losses as a percentage of loans was 1.52%, an increase of 2 basis points from the second quarter. Net charge-offs totaled $3.3 million or 11 basis points on an annualized basis and were concentrated primarily in 2 acquired credits. As Neal noted, we saw meaningful improvement in both special mention and substandard loans, which declined approximately $23.8 million and $39.9 million, respectively, compared to the second quarter. Overall, we are encouraged by the improvements in criticized credit rates this quarter and remain focused on our disciplined approach to portfolio management and early risk identification. On the capital side, we continue to strengthen our position as TBV per share improved to $35.60, up from $35.16 at the end of the second quarter. I'll further note, and as Neal referenced earlier, we repurchased approximately $50 million of common shares under our share repurchase program in the third quarter, and we still saw an increase in TBV per share over the second quarter. [Audio Gap] In terms of our expected financial outlook for the fourth quarter, I'll refer everybody to page 19 in the earnings presentation we filed last night. I'll underscore a few points on our Q4 outlook and key assumptions: mid-single-digit growth for loans and deposits, excluding brokered balances, we are seeing a very strong pipeline for the fourth quarter; net interest margin in the mid-3.80s, up slightly from our Q3 performance level; efficiency ratio in the low 60s and improved slightly from our Q3 performance level, as we expect to realize further cost synergies in the fourth quarter; and continued common share repurchases. So, overall, we're encouraged by our third quarter results and the significant progress we've made on our integration efforts for the acquired First Foundation business. We believe our balance sheet, liquidity and net interest margin profile, along with synergies on the expense side, position us well as we move into the fourth quarter and will ultimately keep us on track to drive further operating leverage and achieve our target performance for 2027. With that, I will now turn the call back to the moderator to open the line for questions.

[Operator Instructions] Your first question comes from the line of Matthew Clark with Piper Sandler.

Just on your reserves, do you have the credit mark on the First Foundation portfolio? So, if we were to add that back, what your gross reserve level would be?

The credit mark on the acquired First Foundation is included in the [ 152 ].

Okay. Got it. Just double-checking. And then in terms of your overall criticized loans, can you give us the percentage that's from First Foundation, again, that were marked?

Matthew, sorry, our line glitched there. We missed that.

Yes. Okay. Yes, part of the call is getting cut out. What percentage of your criticized loans are from First Foundation, assuming they were marked? Roughly?

Percentage of criticized from First Foundation, let me circle back to you on that one, Matthew. Give me a minute.

Okay. I think the broader question really is, would you consider selling some of these marked, criticized loans to get that percentage down to a more palatable level?

We're not looking at any bulk sales similar to the size that we did in the second quarter. Are we looking at one-off strategies that could involve a sale? I mean, we're constantly evaluating strategies on that side, but we're not looking at any bulk sales similar to the size that we did in the second quarter.

Okay. And then just on the cost of deposits being down, assuming you have some more brokered you'd like to run off, and I assume there are still some other higher-cost deposits that you'd like to exit. Do you have the spot rate on deposits at the end of September, and how we should think about your cost of deposits with the Fed hiking?

Yes. So on the deposit rate side, yes, so our third quarter interest-bearing deposit rate was at 2.75%. Our equivalent interest-bearing deposit cost at 9/30 was at 2.82%, and the month of September was -- the rate for the month of September was 2.78%. So you can see the progression; total quarter, month of September and then where we were positioned at the very end of September.

Your next question comes from the line of Michael Rose with Raymond James.

I just wanted to kind of circle back to comments that you guys reiterated last quarter around a $5-plus earnings trajectory for next year. It just seems like, given the balance sheet is a little bit smaller, what you gave for accretion, what you just talked about in terms of deposit costs, putting it all together with probably what I would assume to be is probably a lower run rate of mortgage, just given the higher-for-longer, particularly if we do get another hike or two. Is there a way to potentially level-set that number or maybe reiterate if that's what you're thinking? It just seems from the outside looking in, it's going to be kind of tough to hit that, just given some of the dynamics that have developed over the past couple of months.

Yes, sure, Michael. I would say on the balance sheet side that as we look at the second half of '26 here, on the loan side, we are still expecting to be in that low-single-digit territory. So from a total balance sheet perspective on the asset side, not too far off from where we were expecting to be by rewinding the clock three months ago. On the deposit side, I'd probably put that closer to flat, which you can kind of see inherent in the guide that we have for Q4, where Q4 on deposits ex-brokered, we're now in that mid-single-digit territory as compared to that low-single-digit for the second half. So in terms of the, if you will, the annuity base on the balance sheet, maybe a little bit lower, but not appreciably lower. think on the margin side, we still feel real good about the margin side. As we mentioned, we continue to be very focused on optimizing margin, and you see that in some of the trades that we're pursuing on the balance sheet. It's inherent in the components that I highlighted on the deposit side in terms of balance changes. I think as you think into the P&L, there is a little bit of a trade-off on margin and fee income depending upon the overall rate environment, and certainly focused on that mortgage line. I think, as Neal mentioned, very encouraged by what we're seeing in the other fee businesses, including wealth, including our loan syndication and swap business, on top of [Audio Gap] going to see some impact as a result of what's going on in the macro rate environment. But there's some natural economic hedge that we've always pointed out between spread income for our business and -- given the position -- the profile of our balance sheet and mortgage revenues. And then on the expense side, again, we're feeling real good about the work we've been able to accomplish on the expense side. We do think we're going to come in ahead of our original projections on total cost saves, with that excess coming into play in the first quarter. So we do remain feeling good about our target performance there for 2027.

Yes. I would just underscore -- I certainly understand your question. I think, given the inherited balance sheet that we acquired, our focus was probably more on margin, get through the conversion. Given the rate trajectory, I would just underscore that we're seeing pipelines that are the strongest I've ever seen here. So, across all our markets, we have a lot of activity going on. So I don't think we've thrown in the towel on anything. And I think you'll see more robust balance sheet growth, not just margin expansion.

Okay. That's very helpful. I appreciate all the color. Maybe just one follow-up for Rob. If you can just maybe help us level-set expenses for the fourth quarter. I know you said the majority of the 30% will come in this quarter, but you continue to invest and grow the business, right? So, I mean, how should we think about fourth quarter expenses? Should they step down further slightly again? And then as we think about those investments into next year, how should we think about a base level of expense growth for you guys?