First Western Financial Inc Q3 FY2021 Earnings Call

Good afternoon ladies and gentlemen, thank you for standing by. And welcome to the First Western Financial Q3 Twenty Twenty One Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. As a reminder, this conference call may be recorded.

Thank you, everyone, and thank you for joining us today for First Western Financial's second quarter 2021 earnings call. Joining us from First Western's management team are Scott Wylie, Chairman and Chief Executive Officer; and Julie Courkamp, Chief Financial Officer. We'll use a slide presentation as part of our discussion this morning. If you have not done so already, please visit the Events & Presentations page of First Western's Investor Relations website to download a copy of the presentation. Before we begin, I'd like to remind you that this conference call contains forward-looking statements regarding the future performance and financial condition of First Western Financial that involve risks and uncertainties including the impact of the COVID-19 pandemic. Various factors could cause actual results to be materially different from any future results expressed or implied by such forward-looking statements. These factors are discussed in the company's SEC filings, which are available on the company's website. I would also direct you to read the disclaimers in our earnings release and investor presentation. The company disclaims any obligation to update any forward-looking statements made during the call. Additionally, management may refer to non-GAAP measures, which are intended to supplement, but not substitute for, the most directly comparable GAAP measures. The press release available on the website contains the financial and other quantitative information to be discussed today, as well as the reconciliation of the GAAP to non-GAAP measures. And with that, I'd like to turn the call over to Scott.

Thanks, Tony. Good morning, everybody. Our third quarter results represent a continuation of the positive trends we've seen this year, with growth in our private commercial banking operations generating higher levels of revenue and operating leverage, and increased profitability. In the third quarter, we generated net income of six point four million dollars, earnings per share of zero point seven eight dollars, and ROA of one point two seven percent, all of which are improvements over our second quarter results. On an adjusted basis, excluding acquisition-related expenses, our earnings per share were up to zero point eight one dollars from zero point seventy seven dollars in the prior quarter. We continue to have good momentum in business development, which is driving higher levels of loans, deposits, and assets under management. Our total loans held for investment increased at a nineteen percent annualized rate in the third quarter. We also continue to see strong deposit flows; total deposits were up six point one percent from the end of the prior quarter with all growth coming in our lower-cost categories. We're also seeing steady growth in our assets under management and higher trust and investment management fees. Our private and commercial banking model is working exceptionally well. We're seeing high-quality, well-diversified loan growth, funding these loans with low-cost deposits and effectively cross-selling additional products and services, increasing the overall profitability of these relationships. As a result, we're seeing improvement across most of our key financial metrics. Compared to the prior quarter, our gross revenue was up nearly seven percent. Our net interest margin increased thirteen basis points, and our efficiency ratio improved forty-four basis points. More importantly, as we continue to grow prudently, this is reflected in our continued strong asset quality and exceptionally low levels of losses in the portfolio. Our improved financial performance is not only driving earnings growth, but also strong increases in our book value and tangible book value. During the third quarter, our book value increased four point one percent, while our tangible book value per share increased four point eight percent. This profitable growth we're generating is a reflection of our strong execution across all of our growth strategies. Our more mature profit centers continue to add new clients and generate organic growth, and the new offices we've opened up over the last couple of years continue to scale and are making large contributions. And we're accelerating our growth through accretive acquisitions like the branch assumption transaction last year and the pending acquisition of Teton Financial Services in Jackson. Turning to the performance of our private banking and commercial banking and trust and investment management businesses, this is represented by the pre-tax earnings of our non-mortgage segment. On a year-over-year basis, our pre-tax earnings more than doubled in this segment after the outsized earnings that we generated in the mortgage business last year. We're seeing other businesses clearly in that earnings scale, so to speak, with a more sustainable source of earnings growth, while our mortgage business returns to its intended role as a complementary source of income. We had another good quarter of loan production with total production coming in one hundred and thirty-three point four million dollars, relatively similar to the prior quarter, while loan payoffs were down a bit. Our total loans held for investment increased thirty point four million dollars from the end of the prior quarter or seventy point nine million dollars when PPP loans are excluded. Most areas of the portfolio increased from the end of the prior quarter, with the strongest growth coming from commercial real estate, while a high level of payoffs resulted in a small decline in the C&I portfolio. It's notable that our cash, securities, and other portfolio were able to contribute to our total loan growth despite the continued runoff of PPP loans that are held in that category. We saw more demand this quarter among our private banking clients for the type of investment management secured lines of credit that comprise the bulk of this portfolio. Our total deposits increased one hundred and three point two million dollars from the end of the prior quarter. All of the growth was in lower-cost deposit categories, which continues to drive improvement in our deposit mix. Over the past year, our non-interest-bearing accounts have increased to thirty-three point five percent of total deposits from thirty point two percent, while time deposits have declined to seven point seven percent of total deposits from eleven point three percent. We had one large deposit come in towards the end of the quarter as that client had a liquidity event, and temporarily placed about sixty million dollars in a money market account, which we expect to be withdrawn during the fourth quarter as proceeds from the liquidity event are distributed to partners of this real estate investment fund. Turning to our progress in building our commercial banking platform, this is providing more loan diversification and improving our deposit base by adding low-cost transaction deposits. Commercial loans increased fifty-one million dollars from the prior quarter and one hundred and ninety-six million dollars from the prior year. Commercial deposits increased one hundred and thirty million dollars from the prior quarter and two hundred twenty-seven million dollars from the prior year. In each case, this represents twenty-four percent growth over the prior year and is reflective of the strong momentum we have in growing commercial banking. We've added a new slide to the presentation to show the increasing contribution we're getting from our new offices. As you can see, we're getting a larger contribution as the offices gain more traction and build new business pipelines that produce consistently. We've done a good job of identifying areas for new offices that have the type of clients we target and attract banking talent with established relationships to build these offices. These new bankers have been successful in marketing First Western's value proposition, bringing in new clients and then expanding those relationships over time. Opening new offices has been a key part of our growth strategy throughout our history, and we plan to continue opening one or two new offices each year, with a primary focus on expanding in Colorado, Arizona, Wyoming, and Montana. During the third quarter, our total assets under management increased by one hundred and forty-three point eight million dollars from the end of the quarter. This increase was due to a combination of contributions to existing accounts and new accounts, as well as improving market conditions resulting in the increase in the value of assets under management. Now I'll turn the call over to Julie for further discussion of our financial results.

Thank you, Scott. On slide eleven, we have provided an update on our participation in the PPP program and how it impacted various metrics in the third quarter. As of September thirty, we had sixty-one point nine million dollars in PPP loans remaining on our balance sheet, which is a decline of forty-one point two million dollars from the end of the prior quarter. We recognized approximately nine hundred thousand dollars in fees during the quarter and had one point two million dollars in fees remaining to be recognized at September thirty. PPP income had a nine basis point positive impact on our net interest margin in the quarter. As the PPP loans are forgiven, our borrowings from the PPP liquidity facility that were used to fund the loan originations also decline. On September thirty, our borrowings from that facility were down to forty-three point six million dollars. Turning to slide twelve, we look at our gross revenue. Our total gross revenue increased six point eight percent from the prior quarter. The growth was well-balanced across the banks with an increase in net interest income as well as all of our non-interest income-generating areas. Our net interest income increased four point four percent from the prior quarter, despite a four hundred thousand dollar decline in PPP fees recognized in the third quarter. The increase is due to higher average balances of non-PPP loans and an increase in our net interest margins. On a reported basis, our net interest margin increased thirteen basis points from the prior quarter to three point one four percent when the impact of PPP loans and purchase accounting adjustments are excluded. Our net interest margin increased eighteen basis points from the prior quarter. The increase in our net interest margin was primarily due to a favorable shift in the mix of earning assets, as we were able to reinvest more of our cash into the loan portfolio, as well as an increase in average loan yields. Looking ahead, we expect our net interest margin to trend slightly down in the fourth quarter, due primarily to the increased trend in excess liquidity from the temporary deposit that Scott mentioned earlier, which we are keeping in cash balances. Longer term, looking at the potential for higher interest rates, we continue to run the bank to be neutral in terms of interest rates. Any addition of Teton won't have a material impact on our sensitivity. Coverage due to the improvements we've made in our deposit mix over the past few years, a higher percentage of non-interest-bearing deposits have made us more assets sensitive, which should enable us to benefit to a larger degree from higher interest rates than we did in the last pricing interest rate cycle. Our non-interest income increased ten point five percent from the prior quarter as we saw an increase in all income areas. Trust and investment management fees were up three point two percent from the prior quarter and seven percent higher than a year ago despite the sale of our LA fixed income team during the fourth quarter of twenty twenty. We also had a fourteen point five percent increase in net gain on mortgage loans due to increases in volume for both purchased and refinancing as well as a reduction in variable costs. Our non-interest expense increased by six point one percent from the prior quarter. This included approximately three hundred thousand dollars of acquisition-related expenses. The remainder of the increase was primarily attributed to higher salaries and benefits expense, resulting from bonus accruals relating to our strong loan and deposit production, as well as higher insurance benefit costs. With our revenue growth exceeding our expense growth, our efficiency ratio improved to sixty-five percent from sixty-five point four percent in the prior quarter. Looking ahead to the fourth quarter, we expect our non-interest expense, excluding any acquisition-related expenses, to increase slightly over the third quarter level. We continue to see generally positive trends across the portfolio. We have one commercial loan that was placed on non-accrual during the quarter, which resulted in an increase in our nonperforming assets of one point two million dollars. This loan is well secured, and we do not expect to incur any loss at this time. We continue to see minimal losses in the portfolio and had a small amount of net recoveries in the quarter. We recorded a provision for loan loss of approximately four hundred thousand dollars which was related to the growth in total loans.

Thanks, Julie. Turning to slide eighteen, I'll wrap up with some comments about our outlook. We expect the continuation of the positive trends we're seeing in the business and continued strong growth in our core commercial and private banking operations. We expect the growth in these areas for the business to continue replacing the earnings that were generated by our mortgage operations in twenty twenty. Our loan pipeline is consistently strong and should continue to drive organic loan growth across most areas of the portfolio. We continue to win business based on our expertise, responsiveness, quality service, and overall value propositions. This has enabled us to generate loan growth without compromising our structure or underwriting criteria as many competing banks have been forced to do. We expect continued growth in our Trust and Investment Management Fees as we're consistently adding new clients and increasing our assets under management. This will help offset lower mortgage activity as we enter the seasonally slower periods of the year. As I mentioned earlier, we're successfully adding new banking talent and expanding to new markets. Most recently, we made investments in the Montana and Arizona markets, and we believe both markets will be good sources of additional organic growth for us. We continue to supplement our strong organic growth with accretive acquisitions. Our pending acquisition of Teton Financial Services is expected to close late this quarter or early in twenty twenty-two. Since announcing the transaction, we've made good progress on our integration planning. Our teams are collaborating well together and determining the best ways to leverage the strengths of each organization. In closing, we believe we're executing at a very high level and should continue to deliver a strong finish to the year. With the combination of our continued strong organic growth and the accretive benefit of the Teton acquisition, we believe we're well positioned to deliver another strong year of profitable growth in twenty twenty-two. With that, we're happy to take your questions. Amy, please open up the call.

Thank you, everyone. The first question comes from the line of an unidentified speaker. Your line is open. You may ask your question.

Hey, good morning.

Good morning.

Good morning.

Maybe Julie, can you give, if you could, the dollar amount of a loan recovery in the quarter, how much was that?

It was in the material under one hundred thousand dollars, a little bit of recoveries, but not anything material that shows up in the chart on the deck.

Okay. And then with your prepared commentary, you mentioned that you think the margin would be a little softer in the fourth quarter, following the improvement in Q3. I think you've got one point two million dollars in loss of PPP related fees. Is the linked quarter decline a function of expecting that one point two million dollars to drag out into next year? Any color you could provide on how you're thinking about the margin in the fourth quarter in terms of the yield side?

I think generally, we're expecting a favorable trend in our net interest margin in Q3. We had a couple of one-time things that increased the net interest margin, such as PPP and then there were additional payments on a non-accrual loan. So the remaining payments from the client come in as interest, all of these slightly inflated the net interest margin in Q3 as well. So, I think the concern that we won't see that increase in net interest margin in Q4 is really just smoothing out the trend that we're observing. Generally, we're seeing better rates on loans, better rates on deposits, and overall improving net interest margin going into twenty twenty-two.

Yes. I would agree, I think we're looking to continue the improvement in our earning asset mix as we're using up this liquidity. So net interest margin should follow that trend.

Okay. That's helpful. And then was just curious, I know mortgages are tough to predict, but any thoughts on the fourth quarter? Do you think revenue will be lower than twenty-one or do you think you can gain market share relative to the MBA forecast?

We have the trends in there on slide fifteen. It seems like we can produce something like four million or five million dollars in revenues and a couple of million dollars in earnings out of mortgages, and I think that's going to continue. We've talked about our desire to hire more loan officers, and the extent that we can find people that are a good fit for our strategy, we're focusing on building our mortgage base. The important trend here is the way that the core wealth and commercial business has picked up from the earnings benefit we had from mortgages last year. If we can see twenty twenty-two in line with where we were in twenty twenty-one, that would be a nice complement, but it's really not driving the story as it did in twenty twenty.

Okay. And then Scott, just lastly from you, did I hear you correctly? It sounds like you're anticipating some additional potential movement of lenders, any sense of the magnitude in terms of the number that you might see in the first or in the next couple of quarters?

Well, we have started building a team in both Montana and Arizona. I think there are great opportunities there. The preliminary work that that team is doing is yielding positive results in the pipeline. I hope to have some good news to report here in the next couple of quarters from the expansion into Montana and Arizona. We've identified that market as having good demographics and an attractive competitive environment, and it's just a matter of getting the right team in place. These are things that will play out over coming quarters, but you won't see a jump in expenses in Q4 or anything like that. We're building these teams to ensure that our revenue growth matches or exceeds our expense growth.

Okay. That's helpful color. Congrats on the quarter.

Thanks, Brad.

Thank you, sir. We have the next question from Brady Gailey. Your line is open. You may ask your question.

Hey, thanks. Good morning, guys.

Morning, Brady.

Good morning.

So over the last couple of years, we have seen some nice operating leverage and we've seen your ROA expand pretty nicely. It was one fifty last year, and I know it was popped up by a great mortgage year, but this year, it's running around one hundred and twenty-five basis points. Given your business model and taking into account you're still growing the company, what do you expect would be an appropriate range for your ROA over the next couple of years? Do you think it's consistent with the one hundred and twenty-five we've seen year-to-date, or do you think you could do modestly better than that?

While I don't want to over-expect, we do think that we are improving the operating leverage within our business model. We continue to see that especially in the organic part of our business. What we are doing with the expansion provides future earnings power, and what we're doing with acquisitions has certainly been additive. Just in the organic business, the next dollar of revenues doesn’t take much in costs, and we continue to show that especially over the last six or eight quarters.

I know you guys like to open one to two new offices a year. With Teton in the mix, do you take a pause on that organic growth, or does that continue even in the midst of the Teton acquisition?

We've kind of changed our business model for new offices. We used to open a new office and spend around one million dollars in expense the first year. By the end of the first year to the second year, they would have about one million dollars in revenues, so maybe break-even the second year. We've been incubating these last few offices in existing offices, for both Jackson and Broomfield. We see really good growth in the new office that we're incubating. We hope to get to a point where we're doing it right from the start, so Broomfield just opened in their physical location. We had the grand opening here forty-five days or so ago in Q3, and we see a path here to continue to open new spaces as we test the market first.

All right. And then one question specific to the Teton transaction. Do they have anything on the wealth management side, any products or services that First Western doesn't or vice versa? Is there an opportunity on the wealth management side to see some nice revenue synergies?

Yes. Teton's wealth management business is largely outsourced, so of the four hundred million dollars they have outsourced. We're looking at which complementary services that provider might add to what we have, but we have a much broader and deeper range of services that we can sell into the Teton client base. We're planning to seek synergies from our teams in Jackson and the Teton Team, particularly for new business in twenty twenty-two.

Okay. Got it. Thanks, Scott.

Thank you, sir. We have another question from the line of Ross Haberman. Your line is open. You may ask your question.

Good morning, Scott, how are you?

Good morning, Ross.

Could you comment? I just want to take a step back and ask you more what have you seen in terms of your markets in the end market migration? Are you still seeing the growth, maybe not as much as we saw during COVID or pre-COVID?

Yes, I believe that first part of the question is a positive one. The immigration we're seeing into our markets has been strong and continues to be very strong. We are not only seeing that in the resort markets but also in our urban markets. We're continuously seeing a big influx of individuals, especially from the coasts, and some from the Midwest. That trend appears to be ongoing and contributing significantly to our mortgage and overall banking business.

If we look at this chart on fifteen, looking at the income, would it be an eight million dollar average run rate?

Yes, I believe a number of factors are important. Volume, margins, and mix of business all play a role. We have seen the mix from refinance to purchase coming back, and that should help us in Q4. Our expectations are that twenty twenty-two looks a lot like twenty twenty-one in terms of mortgage revenues and earnings.

Are you looking for other banks to buy in the Montana or Arizona markets?

We are actively looking and have made two offers on small bank deals over the last three months. In both cases, we were outbid, but I think there are banks being aggressive in their bidding because they can't grow organically. That's not our situation. We can remain disciplined with our pricing, and the only things we pursue have to make economic and strategic sense. There are plenty of opportunities for us to continue to maintain our discipline and still complete deals with organizations that understand how they will benefit from a merger with us.

Thanks again, take care.

Thank you, Ross.

Thank you, sir. We have another question from Bill Dezellem. Your line is open. You may ask your question.

Thank you. I'd like to start with mortgages. What are you seeing with mortgage activity here in October, and your thoughts relative to the fourth quarter versus the normal level of seasonality?

Hi, Bill. It's good to hear from you. I would expect Q4 to be seasonably slower, and preliminary results so far this quarter are bearing that out. There's still a lot of demand but not much supply, and that is limiting our mortgage activity. We expect that to start improving, but ultimately, Q4 is shaping up to be slower than Q2 and Q3.

With that pent-up demand, are you expecting the seasonality to be muted here in the fourth quarter?

It's hard to answer because of the unusual year last year. The last few quarters have generated pretty steady revenue levels in the kind of four point five million dollars to five million dollars range. I think generally, we’re expecting a little slower performance in Q4 and Q1. We've talked about our desire to expand our mortgage operation in Arizona to offset some of that seasonality, and continue working on finding the right team to support that effort.

That sounds fair. Let me shift to C&I loans. You mentioned that Q3 saw payoffs in C&I. What will it take to rejuvenate that C&I loan growth?

If you cut things off once a quarter and look at what happened, there is noise in the numbers. I believe there's no reason to think that the awesome C&I progress we've made won’t continue. Looking into Q4, we have pipelines aligned with where we were in prior quarters and expect continued strong loan demand across all categories.

Thank you. The non-interest-bearing deposits were up forty-two million dollars in Q3 versus Q2. What led to that growth in non-interest-bearing?

The growth in non-interest-bearing deposits is part of our commercial focus. Since the end of twenty eighteen, we’ve seen our DDA’s triple while we about doubled our deposits. We expect this trend to continue with Teton being helpful as they have a nice deposit mix. The sixty million dollar deposit is an interesting story as it came from a client liquidity event; this doesn't happen unusually but represents the dynamic nature of our business.

Great. Thank you.

Good. Thank you.

There are no additional questions at this time. I will now turn the call back to management for closing remarks.

Thank you, Amy. We have seen really nice continued progress growing our business, improving our margins, demonstrating the operating leverage of our business model, and creating shareholder value here in Q3 with our continued organic growth and the ongoing expansion and the addition of the Teton team. We have lots of momentum going into twenty twenty-two. Thank you all for your time and interest today. We appreciate your support and look forward to speaking again next quarter.

Ladies and gentlemen, this concludes today's conference call. You may now disconnect. Thank you for participating.