Prepared remarks
Thank you. Good morning and welcome to the First Son Capital Bank Corp. Second Quarter 2026 Earnings Conference Call. At this time, all participants are in listen-only mode. Later, we will conduct a question-and-answer session. If you would like to ask a question at that time, simply press star followed by the number one on your telephone keypad. If you would like to withdraw your question, press star one again. Also, as a reminder, this call may be recorded. I'd now like to turn the call over to Ed Jacques, First Son's Director of Investor Relations and Business Development. Ed, you may begin.
Thank you and good morning. I'm joined today by Neal Arnold, our Chief Executive Officer and President, Robert Cafera, our Chief Financial Officer, and Jennifer Norse, our Chief Credit Officer. We'll start the call with some brief remarks to highlight commentary around our second 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 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 also make remarks about future expectations and plans 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. And I'll turn the call over to Neal Arnold.
Thanks, Ed, and good morning, and thank you for joining us. The second quarter marks an important milestone for First Son as we completed our acquisition of First Foundation on April 1st and continued the hard work of integrating their businesses. We believe the expanded footprint in the Southern California markets and their premier management platform have added significantly, strengthen our franchise, and position us for future success. The middle market business opportunity in Southern California aligns well with our C&I playbook. I would argue that Southern California is the best core deposit market in the United States, as some of you have heard me say. I believe that, coupled with adding our Southwest Florida markets to our existing deposit markets across Texas, Kansas, New Mexico, Colorado, and Arizona, we are well positioned to drive future growth. We're very excited about all the growth opportunities in front of us with this acquisition.
Our second quarter financial results were certainly mixed. Bottom line, we reported a net loss of $23 million, which included $44 million in after-tax merger-related expenses and included $30 million in after-tax credit loss provisioning. Earlier this month, we provided a credit update on two larger loan charge-offs totaling $26 million after tax. This significantly contributed to our larger loan loss provisioning in the quarter. While the bottom line performance this quarter was below our expectations, we did see significant progress in several areas. Starting with the balance sheet repositioning, which we've emphasized throughout as a key strategic step in our integration plan for the First Foundation business. I'm very pleased to tell you that we've completed all of the downsizing that was part of our plan in the second quarter. Our teams executed the plan with discipline and efficiency.
The repositioning strategy that we executed was a very important strategic step to reduce the risk profile of the balance sheet we acquired. We believe we have a stronger balance sheet with less concentration risk, less liquidity risk, less interest-rate sensitivity, and a stronger capital profile as a result of these repositioning actions. On the deposit side, we saw adjusted annualized growth of approximately 5%, which excludes the impact of the acquired First Foundation deposits net of the downsizing. Notably, deposit growth in Southern California drove the adjusted annualized growth rate that I mentioned. Our service fee revenue performance in the second quarter was strong as well, representing 22% of revenues this quarter, further evidencing our diversified business model. We also saw significant progress in the cost-save realization in the second quarter, following the closing of our acquisition.
As Rob noted in last quarter's call, we believe we'll overachieve the level of cost saves that we deliver in conjunction with fully integrating and converting the First Foundation business. We are also pleased to note that the level of tangible book value dilution related to the acquisition is less than our original estimate we announced last October, with the overall level coming in at only approximately 10%. Our capital position is strong. Yesterday we also announced a share repurchase program totaling up to $150 million with repurchases targeted over the next four quarters and starting here in the third quarter. We see this as an integral component to driving shareholder value and realizing the impact of this transaction. On the asset quality side, we saw an elevated level of losses in the second quarter with two notable larger losses. The first relates to a situation involving what we believe to be a fraudulent misrepresentation by a borrower in the materials distribution business.
The second, which is unrelated to the first, relates to a technology company that experienced deterioration in financial performance during the second quarter. The charge-offs on these two loans totaled approximately $35 million pre-tax and materially drove the increase in our credit loss provisioning and charge-offs in the second quarter. While these losses were disappointing, they were driven by borrower-specific situations rather than, in our belief, an indication of broad-based significant loss content across our portfolio. Further, while the dollar amount of non-performing loans at June 30th increased from the end of the first quarter, we haven't seen a large increase in the number of C&I loans in non-performing status. So again, we don't believe it's an indicator of any broad-based deterioration in our C&I loan relationships across our portfolio. Our underwriting processes are thorough and include stress testing.
Our loan grading considers the effect of principal and interest amortization even if a loan is on interest-only currently, and our recurring portfolio-review activities emphasize identifying potential risks early. We maintain strong borrower engagement and we work to take timely action to preserve the asset quality of the overall organization. As we've said before, we don't take larger risks within our portfolio. We have no loans approaching any of our legal lending limits. Again, we are disappointed in the loan losses that we experienced in the past quarter. However, we believe that loan losses and provisions at this level are isolated. As I look forward to the third quarter and beyond, I believe we're making significant progress in our franchise buildup. The acquisition has enabled us to enhance our presence in attractive high-growth markets and increase our scale across many of our core businesses.
Our expanded branch network strengthens our ability to serve clients locally while enhancing our deposit-gathering capabilities and overall relationship density. We believe we have enhanced our long-term growth profile, improved our revenue diversification, and further strengthened the durability of this franchise. Our near-term focus is on completing our remaining integration work, including the core system conversion, which is scheduled for this quarter in late September. As many of you know, acquisitions involve a fair amount of work beyond just computer conversions. Finally, I want to thank all our teammates for their tremendous commitment and hard work through all this integration work. Their dedication to serving our clients and our communities while executing on a large transaction like this has been exceptional. I'm very proud of everything they have contributed to continue to help us accomplish. With that, I'll pass the call over to Rob to review our results in more detail.
Thank you, Neal. I'll start off by underscoring the appreciation Neal just mentioned for all the hard work across all of our teams as we continue to progress with the business integration efforts. The collaboration and teamwork from everybody has been very inspiring. There's a lot of activity this quarter with the merger closing and all the related significant merger activities, as well as developments on the credit side. We've added information into the earnings presentation we filed, and I'll break out some data to try to provide clarity on these matters, as well as our underlying core operations. On the strategic side, I'm very pleased to say that all the balance sheet repositioning associated with the acquisition that we targeted for the second quarter was indeed completed. This was certainly one of our highest strategic priorities immediately following the closing of the acquisition, and we can now shift our focus to leveraging our business model across our expanded geography.
In terms of particulars on the downsizing during the second quarter, on the asset side, we successfully reduced acquired assets by approximately $3.9 billion, including $1.4 billion in the acquired securities portfolio and $1.3 billion in the acquired loan portfolio. The loan portfolio included approximately $901 million of multifamily loans, approximately $337 million of municipal loans, and almost $100 million in SNC loans. On the liability side, we improved our funding profile with an approximate $3.9 billion total reduction in acquired funding, including $2.2 billion in broker deposits, approximately $330 million in higher-cost non-relationship deposits, and $1.4 billion in non-relationship deposits and FHLB borrowings. Our wholesale funding ratio was 6.8% at the end of the quarter. So we accomplished what we set out to do on that side. A wholesale funding ratio in line with our historical legacy First Son levels.
Through these repositioning actions, we believe we have meaningfully strengthened our balance sheet by improving our funding mix, reducing wholesale funding dependency, lowering loan concentration risk, enhancing capital and liquidity flexibility, and lessening our interest-rate sensitivity, which we believe will position the company with a stronger foundation to support future profitable growth. Aside from the acquired deposits net of downsizing, in terms of core deposits, we saw approximately 5% adjusted annualized balance growth in the second quarter. Again, this excludes the acquired balances net of downsizing. From a deposit-mix perspective at the end of the quarter, non-interest-bearing deposits were 18.1% of the total, down from 23.1% at the end of the first quarter. Combined savings and money market balances were 40.4% of the total, up from 38% at the end of the first quarter. Balance growth in our Los Angeles and Orange County markets led the deposit performance during the quarter.
I will note that the non-interest-bearing deposit balance mix reduction was largely due to our strategic exiting of acquired higher-rate deposits that had an economic interest cost to them, but are classified as customer-service expense, which is part of non-interest expense as opposed to interest expense. These are deposits that are classified as non-interest-bearing on the balance sheet but had economic costs. There is a subtlety here in terms of where this cost resides in the P&L. On the loan side, at the end of the second quarter, excluding the impact of acquired loans and net of downsizing, we saw core loan balances decline 6% on an annualized basis. New loan fundings in the second quarter totaled $377 million, down 29% from first-quarter new loan funding, and line utilization decreased by 4%. While new loan volume in Q2 was more muted, we did see stronger new loan volume in the first quarter and our core loan balance growth through the first six months of this year, excluding the impact of First Foundation acquired loans and net of downsizing, was 9.7%.
Coupons on second-quarter new loan originations were 6.76%, very similar to the first quarter level of 6.72%. I will note that these average coupon levels for the new loan originations in both quarters are above the effective coupon being created on the acquired First Foundation loans. Shifting over to the P&L side, as Neal mentioned, second quarter results were mixed. Bottom-line results reflected a net loss of $23 million, or $0.49 per diluted share, with merger-related costs representing $0.94 per share. Our adjusted pre-tax pre-provision net income, or PPNR, which excludes merger-related expenses, was $70 million or $1.50 per share. That compares to $37.3 million or $1.32 per share in the first quarter. So we're pleased with the growth in core business per-share results. Net interest margin was 3.58% in the second quarter, which is a decline from 4.25% in the first quarter, with the decline significantly influenced by the acquired loan portfolio and higher funding costs.
There were several moving pieces on the margin side this quarter. I'll start with the timing across all the repositioning actions. All of the loan downsizing via sales occurred in the month of June. So net interest margin for the first two months of the quarter saw compression from the lower stated coupons on these acquired loans. The weighted average stated coupon for the loans sold in June was 3.94%. To be clear, there was no accrual for purchase accounting marks on these sold loans as they were all held for sale. Similarly, while we reduced high-cost deposit balances as a result of the $2.5 billion combined reduction in deposits associated with our repositioning activities, the timing was also spread throughout the quarter. Progress in total cost of deposits during the quarter was impactful, as deposit costs for the month of June were 20 basis points lower than the month of April. Further, when we look at what combined deposit costs would have been for the first quarter of this year, assuming First Foundation was part of our company at that time, we see a reduction in cost of deposits of 35 basis points comparing June deposits to the first-quarter deposit cost.
We are quite pleased with bringing down our deposit funding costs in a meaningful fashion. Given the timing of all the repositioning activities throughout the quarter, progress in net interest margin is also notable as it improved 29 basis points comparing June versus April with June net interest margin at 3.76%. For those interested in the component related to the accretion of the purchase accounting fair value marks: the fair value marks are the largest component of the tangible book dilution in the deal, and the accretion in net interest income is the mechanism to get the loan values back to contractual par. You will find the netting impact from fair value mark accretion in interest income in the filings we made with the SEC. On the service-fee revenue side, we saw growth of 50.7% compared to the first quarter, primarily related to the impact of the acquisition. We experienced organic growth in mortgage revenues and treasury management revenues, while the growth in trust and investment advisory revenue was acquisition related.
Mortgage revenues and wealth revenues on a combined basis account for 62.3% of total service-fee revenues in the second quarter. Adjusted non-interest expenses in the second quarter, which exclude merger-related expenses, were up 57% compared to the first quarter, and again, this was primarily related to the impact of the acquisition. As Neal indicated, we are already realizing some significant cost savings following the acquisition closing, with an annualized run-rate equivalent realized in Q2 of approximately 65% of our original total cost-savings target of $68 million estimated at the announcement date for the acquisition. We are pleased with our progress on cost saves as we are ahead of schedule on phasing through the end of the second quarter. On the asset-quality side, provision expense for the second quarter was $40.4 million and charge-offs were $42.4 million, or 145 basis points.
Provisioning and charge-offs were significantly impacted by the two credit events we disclosed in the 8-K filing from earlier this month. The magnitude of those two credits represented 86% of second quarter's loan-loss provision and 82% of our total Q2 charge-offs. The situation involving what we believe to be fraudulent misrepresentations by a borrower in the materials distribution business alone represents 75 basis points of the total 145 basis points in annualized charge-off ratio for the second quarter. Aside from the provisioning for these two larger loan losses we've noted, the remaining $5 million in net loan-loss provisioning primarily related to net downgrades. Our level of criticized loans and the non-performing component of criticized loans both increased at the end of the second quarter in comparison to the end of the first quarter. Criticized loans represent 7.7% of total loans compared to 4.3% at March 31.
Non-performing loans represent 164 basis points of total loans compared to 86 basis points at March 31. In terms of activity through the end of the second quarter, approximately 76% of the increase in criticized loans relates to the acquired First Foundation loan portfolio. As a reminder, in conjunction with purchase accounting, the entire First Foundation loan portfolio was fair valued at the acquisition date, including the level of loan loss reserve on the entire acquired loan portfolio, which was assessed at 172 basis points, and the level on just the criticized component was 685 basis points. Considering 76% of the increase in criticized loans relates to the acquired loans, that leaves 24% of the increase in criticized loans relating to legacy First Son loans or $143 million in balances. Approximately $94 million of that $143 million relates to non-performing loans. We provided industry breakdowns in the earnings deck to highlight the largest drivers of the increase in both criticized loans and the non-performing component of criticized loans.
Seven different NAICS categories represent 93% of the total increase in criticized loan balances from March 31, with the multifamily component alone representing 60% of that increase. We regraded the entire acquired loan portfolio and our grades consider the impact of principal-and-interest amortization, even if a loan is currently in interest-only mode. We believe we've taken a conservative view on loan grades on the acquired book. The multifamily component of criticized loans at 6/30 alone represents 3.1% of total loans or approximately 40% of the criticized total. In general, we believe the LTVs on the multifamily loans support our carrying values, with the weighted loan-to-value for all multifamily criticized loans being 68%. On the non-performing side, NPLs increased to 1.64% of total loans, up from 0.86% last quarter. Five different NAICS categories represent 96% of the total increase in non-performing loans at 6/30, and these same five NAICS categories represented 79% of total NPLs.
Looking at these five NAICS categories for NPLs, the multifamily component is represented by six different relationships. On a combined basis, this group has a 600-basis-point ACL reserve at June 30. We have guarantees in place on approximately 94% of all of our multifamily criticized loans. So between LTV coverage and guarantees, we believe we have strong support for carrying values, primarily driven by one non-performing loan supported by a property that has experienced a decline in value which necessitated a specific reserve. Three of the five NAICS categories capture C&I businesses in either the information-technology space, the transportation space, or across certain professional and technical fields. The total number of relationships represented for each of these three NAICS categories is small — only nine in total. While these C&I companies are all experiencing varying levels of operating shortfalls, several of the larger exposures are supported by private-equity sponsors with meaningful equity investments, and we believe those sponsors have the ability to continue to support the borrowers.
We also have one NPL that's fully guaranteed by a well-capitalized and profitable corporate entity. In terms of meaningful dollars across these three NPL NAICS, we also have the remaining balance of the technology company that we realized in an approximate $12.9 million charge-off in the second quarter. That loan was charged down to our view of realizable value. So in general, we believe there's stronger sponsor support in many of these cases across these three NAICS categories as companies work through their operating challenges. The other NAICS category in this NPL bucket is the residential mortgage component, and in general, we believe the LTVs there support our carrying values. I'll summarize the level of NPL increase this quarter as being largely concentrated in several larger credits as opposed to widespread stress across many borrowers in the loan portfolio. Additionally, we believe we have adequately reserved for potential loan losses through our loss assessments on the legacy First Son portfolio, wherein we realized a 15-basis-point increase in the level of reserve compared to March 31, and via the loss assessments completed in conjunction with purchase accounting on the acquired loan portfolio, wherein we increased the level of reserve by 49 basis points above the level in the legacy First Foundation balance sheet at March 31.
In total, the level of ACL at 6/30 was 150 basis points, up from 120 basis points at March 31. On the capital side, tangible book value per share was $35.16, down almost 9% from March 31. As we noted in the earnings presentation, dilution from the acquisition was approximately 10%, down from the estimated 14% at announcement. The lesser level of tangible-book-value dilution from the acquisition is attributable to a lesser overall level of estimated total merger-related expenses and a better overall level of net fair value impacts compared to original estimates, with the net fair value impact primarily driven by better performance on the loan downsizing and higher values on resulting tax assets, including the acquired NOLs. Our capital ratios, while down from the higher levels at March 31, remain quite strong: Common Equity Tier 1 at 11.95%, total risk-based capital at 14.13%, and Tier 1 leverage at 9.47%.
Capital priorities are focused on supporting organic growth as well as supporting share buyback activities. To that end, and as Neal noted earlier, yesterday we announced a share repurchase program totaling up to $150 million, with repurchases targeted over the next four quarters starting in August. Our capital priorities are currently based on our company-wide risk assessments and risk attitudes and are calibrated in our plans with maintaining an 11% minimum targeted operating level for CET1. Next, I'd like to make some comments on our full-year 2026 financial outlook, including the fourth quarter. You should also refer to page 24 in the earnings presentation deck for more information on key assumptions. On the balance-sheet side, for loans, we expect low single-digit balance growth compared to the Q2 period end through the end of the year, and then we expect mid-single-digit growth as we look to next year.
While we expect healthy new loan origination levels, we also expect to continue to remix the acquired First Foundation loan portfolio. This means we will have additional balance runoff pressure. In terms of the acquired multifamily loan portfolio and near-term scheduled repricing, we expect an estimated $100 million in balance runoff in the second half of this year, and up to an estimated $285 million in balance runoff in 2027. Our focus in the multifamily book will be on keeping true relationships rather than where it's simply a credit-only situation. To us, credit-only is not a valued relationship, and this is where we want to continue to refocus the portfolio. Again, as we look to next year, we expect mid-single-digit balance growth. In terms of deposits, given our continued focus on remixing the acquired balances and scheduled maturities of broker deposits, we also expect low single-digit balance growth through the end of the year compared to Q2 period end, and then mid-single-digit growth as we look to next year.
We have approximately $300 million in brokered maturities coming during the second half of this year with a weighted rate of 4.77% today on those $300 million in brokered maturities, and we have another approximately $340 million in brokered maturities coming in 2027 with a weighted rate of 4.83% on those brokered maturities. So we believe we will see some repricing benefit ahead in the broker deposits. In terms of the wholesale funding ratio percentage, as I noted earlier, at the end of Q2 our ratio was relatively in line with our historical legacy First Son levels, and that's our expectation going forward. On the NIM side, the timing of all the repositioning in Q2 had a significant impact on margin, as we saw margin increase 29 basis points from April to June with the month of June finishing at 3.76%. Our focus is on continuing to improve our cost of funds, as we believe it will be the primary driver of our margin improvement over the second half of this year.
We expect to see margin increase slightly in the third quarter from our June level, with a further increase into the mid-3.80s in the fourth quarter. We expect to see this margin trend continue into the first quarter of 2027 where we expect to be in the high 3.80s range. In terms of revenue mix for both the full year and the fourth quarter of 2026, we expect our level of non-interest income to total revenue to be in the low 20s. In terms of adjusted efficiency ratio, which excludes merger-related expenses, we expect to operate in the mid-to-low 60s range in the second half of 2026, with the fourth quarter expected to be in the low 60s. We expect additional cost savings to be realized in the fourth quarter following our core system conversion scheduled for the end of September, which we expect to result in an efficiency ratio in the first quarter of 2027 in the high 50s to low 60s range. In terms of net charge-offs to average loans, as we noted in our 8-K filing earlier this month, we expect the charge-off level for the full year to be in the high 50s basis-point range.
Looking at the math, that translates to an expectation of an annualized charge-off level of the mid-teens for the second half of this year to get to that full-year level in the high 50s range. Further, we expect the ACL to loans to be in the mid-140s to 150-basis-point range for the full year. We believe we'll return to a more normalized level of charge-offs to average loans looking forward into 2027, which we'd expect to be in line with the projected 4Q26 level. We are pleased with the significant progress that we've made on integrating the First Foundation business so far, and we believe the combined earnings profile will further emerge in Q3 and then further again in Q4 following the late-September core system conversion, as our NIM and efficiency ratios stabilize in the normalized range we expect to operate in. We believe this earnings profile is taking the shape of what you have been accustomed to from legacy First Son. I will now turn the call back to the moderator to open the line for questions.
Questions and answers
To raise your question, press star one. We ask that you pick up your handset when asking the question to allow for optimum sound quality. If you are muted locally, please remember to unmute your device. Please stand by while we compile the Q&A roster. Your first question comes from the line of Matt Olney with Stephens. Matt, your line is open. Please go ahead.
Hey, thanks, and I appreciate you taking my question. You mentioned that much of the downsizing strategy occurred toward the end of the quarter in 2Q. Any more color on the average earning asset outlook for the third quarter as it compares to, I think that Q2 number was closer to $16 billion? Any color there?
Yes, Matt, on that, in terms of our guidance on low single-digit growth from a period-end perspective, I guide you to the same on an average basis. On the lower end of low single-digit growth, if you're looking at average versus the third-quarter average versus a Q2 month end. So low single-digit growth on both a period-end and an average basis compared to the period end of Q2 is your range.
Okay, appreciate that, Rob. And then as far as the margin improvement in the back half of the year relative to that June margin you disclosed — I think you mentioned much of that would be on lower cost of funds — any more color on this? Or is it just going to be working down the broker-deposit balance and replacing that with core? Or do you plan to replace higher-cost brokered with more current brokered deposits? Any color on that strategy?
Yes, absolutely. You're right. Given the timing on the downsizing, the margin picture for each of the three months in the second quarter was dramatically different, where we landed at 3.76% in the month of June. As I referenced, looking out to the fourth quarter on the margin side, we do see that margin picking up to the mid-3.80s. Cost of funds is where we see the most outsized potential for continuing to improve that. Bringing down those broker rates, which are at the 4.80% level, will have a meaningful impact and will include some remix toward normal core deposits versus brokered. I think the overall level of wholesale funding ratio — where we landed at 6.8% — is pretty in line with our historic First Son levels. I'd expect that to come down just a little bit, which is a bit more of that remix, and that will favorably impact margin, as you were highlighting in your question, Matt.
Okay, thanks for the color. I'll step back.
Your next question comes from the line of Michael Rose with Raymond James. Michael, your line is open. Please go ahead.
Hey, good morning, guys. Thanks for taking my questions. I just wanted to go back to credit. I appreciate all the color that you walked through, Rob. I guess the bigger question is: when I look at slide 28, I see criticized loans increased about 50% on a balance basis. I certainly understand that a good portion of that is multifamily. When I look at slide 28, almost every category except for one was up sequentially. I guess the real question is: how should investors feel comfortable that you have the underwriting process under control? We've seen some larger charge-offs here over the past couple of years, and many others haven't seen similar types of events. Have you guys done or started the process of a third-party credit review just to get a better appreciation of how investors can be comfortable that you have the portfolio under control and that losses will normalize, because they have been elevated now for the past couple of years relative to peers? I know there's a lot in there, but any color would be helpful.
Thanks, Michael. We don't like losing money any better than anyone else. A couple of points: we're more of a C&I lender than a lot of peers, so our results can be lumpier. We have no loans close to our legal lending limit, and we take concentration seriously. If you look by category, we don't have large dollar exposures to the common worry points. We haven't changed our underwriting approach; we've always been thoughtful about it. Things do happen in this-size credit space, but I would say we constantly go back and look by industry and compare what's going on. Once a quarter, we do deep dives in those categories. It's hard to forecast when an operator deteriorates. That does not mean our process is flawed; it's more about borrower-specific events as our portfolio matures. We don't see this coming from one geography or one industry. We don't see it happening in a way that suggests we made a systemic underwriting error.
We've looked hard at this multiple times and constantly challenge ourselves to determine if we're missing something. In conjunction with the due diligence on the merger, we did have a third party review our portfolio, and First Foundation had the same. We try to be clear on our exposures so investors can evaluate them; we are not running from these issues. We are a meaningful lender, and we generally take smaller position sizes than banks of similar size. We've looked top-down at concentrations and have not come away saying we should avoid lending to those segments entirely. Jennifer, do you want to add anything?
One item to emphasize is the nature of our business is different than many peers in our size category, so of course we are always monitoring credit performance closely. We also look at credit-adjusted NIM, which adjusts for differences in mix between CRE and C&I to give another economic measure. Credit-adjusted NIM is something we look at from a performance and relativity standpoint, and our credit-adjusted NIM is above peer levels. That said, we continue to monitor closely.
Yes, I agree with what Neal and Rob said. We've taken deep dives into these credits in terms of process and underwriting. As Rob mentioned, the increases are related to a limited number of loans, and the number of impacted relationships is small. We are monitoring and engaging with borrowers and sponsors and taking appropriate actions as needed.
Okay, I appreciate all the color and discussion. Rob, maybe just one verification going back to the customer-service expense. I want to make sure I understand. I think what happened here is you ran off those deposits, which resulted in a lower reported NII but also lower operating costs. So those two kind of net out. Is that the way to understand it?
That's exactly right, Michael. We ultimately don't know how negotiations with some of the larger, higher-rate depositors are going to go. First Foundation had some larger, higher-rate non-interest-bearing deposits that had economic costs, which flowed through customer-service expense rather than interest expense. We have been working through those relationships and saw hundreds of millions run off, which was part of our high-rate runoff. Those rates were well above market, so reducing those balances is a good trade. We accelerated some of the activity in Q2 that we intended to address throughout the remainder of the year. So yes, on the deposit side, we acquired some high-cost non-interest-bearing deposits and have removed a significant portion of that already.
Okay, very helpful. And then just a last follow-up: how should we think about NII growth in the back half of the year? And then based on the earlier cost savings, is the $5-plus EPS target for next year still in play?
On NIM, as I mentioned earlier, we expect to be in the mid-3.80s for the fourth quarter. With the balance-sheet guidance of low single-digit growth for the remainder of the year, that gets you to fairly stable absolute net interest income; it should be slightly up in Q4 over Q2. Looking into 2027, with the balance-sheet growth we referenced, the margin expectations, our expectations on credit, and the efficiency ratio improvements, combined with the share buyback program, we believe we can be north of $5 in EPS for 2027. We are optimistic about performance next year.
Yes, Michael, the second quarter was busy with integration work. We have the core system conversion coming, and we recognize we still have cleanup to do on the acquired portfolio and the credit piece. When we bought First Foundation we knew there would be work to do, and we're not shy about rolling up our sleeves and tackling it. There's nothing we've discovered that makes us believe the profile of the underlying franchise is at risk. We are completing the strategic playbook to build across the Southwest. We now have a meaningful presence in Southern California and added Southwest Florida. Driving core deposits is our everyday job. We think the fee-income story is strong and improving. I believe we have the flexibility in this balance sheet and franchise to grow organically and navigate changes in interest rates or economic conditions. We know we have work to do, and you'll see us continue to execute.
All right, thanks. I'll step back. Appreciate the call.
We have reached the end of the Q&A session. I will now turn the call back to Neal Arnold for closing remarks.
We thank you all for joining us this morning. As always, we appreciate your interest in continuing to follow us. Thank you.
This concludes today's call. Thank you for attending. You may now disconnect.