First Western Financial Inc Q3 FY2022 Earnings Call

Good day, and thank you for standing by. Welcome to First Western Financial’s Third Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Tony Rossi with Financial Profiles. Please go ahead, sir.

Thank you, Norma. Good morning, everyone, and thank you for joining us today for First Western Financial's third quarter ‘22 earnings call. Joining us from First Western's management team are Scott Wylie, Chairman and Chief Executive Officer; and Julie Courkamp, Chief Financial and Chief Operating Officer. We will use a slide presentation as part of our discussion this morning. If you have not done so already, please visit the Events and 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 with respect to the future performance and financial condition of First Western Financial that involve risks and uncertainties. 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, and good morning, everybody. We delivered a very strong financial performance in the third quarter that was driven by our diverse lending platform that we built that enables us to pursue the most attractive lending opportunities at any given point in time. This has become particularly valuable in the current environment as higher rates are having various degrees of impact on loan demand across asset classes. In general though, we continue to see healthy economic conditions to loan demand across our markets, which resulted in another quarter of strong, well-balanced loan growth. We had increases across most of our major portfolios, leading to 38% annualized loan growth in the quarter. There are many catalysts for our continued strong loan growth, including our stronger commercial banking platform, the new banking talent we've added, and our improved business development capabilities in Wyoming following the Teton acquisition. More recently, the bank has grown both in size and reputation and we're effectively moving up market and working with clients with larger borrowing needs, which is positively impacting our loan production and loan growth. With the strong loan growth in the third quarter driving increases in net interest income, expansion in our net interest margin, and a higher level of efficiencies, we were able to generate a substantial increase in net income and earnings per share, despite the unfavorable environment that continues to impact our largest fee-generating business. Our pretax pre-provision income increased by more than 50% from the prior quarter to $10 million. Most importantly, we're generating profitable growth as our return on average assets, return on average equity, and return on average tangible equity were all significantly higher than the prior quarter. We also continue to have exceptional asset quality with both non-performing loans and non-performing assets declining, as well as another quarter of an immaterial amount of net charge-offs. Moving to slide four, we generated net income of $6.2 million or $0.64 per diluted share in the third quarter or $0.66 per share when acquisition-related costs are excluded. Our strong profitability, along with our effective management of the investment portfolio has enabled us to continue driving increases in both book value and tangible book value per share. In the third quarter, book value per share increased 2.8% from the prior quarter and tangible book value per share increased 3.4%. Over the past year, both metrics have increased by more than 13%, reflecting the strong value that we're creating for shareholders. Turning to slide five, we'll look at the trends in our loan portfolio. We had another quarter of strong loan production originating $289 million in loans. While this was down a bit from the prior quarter, the average rate on new production increased by more than 100 basis points, so we're still generating strong production without compromising on pricing. We're also seeing payoffs start to moderate, so more of our loan production is translating into net loan growth and total loans held for investment increased $205 million from the end of the prior quarter. Our loan production was well diversified. We had increases across most of our major categories with C&I, CRE, constructions, and 1-4 family residential portfolio all up between $30 million to $100 million in the quarter. As with the prior quarter, most of what we're adding to 1-4 family residential portfolio are jumbo ARMs that provide attractive risk-adjusted yields. Our loan production was consistent throughout the quarter and our end of period loans were $114 million higher than our average loans during the quarter. So we have a nice tailwind going into the fourth quarter in terms of driving higher net interest income. Moving to slide six, we'll take a closer look at our deposit trends. Our total deposits were essentially unchanged from the end of the prior quarter with minor fluctuations in each category. In general, we've seen increased competition for deposits, which is impacting deposit gathering and the cost of interest-bearing deposits. Turning to trust investment management on slide seven, our total assets under management decreased $359 million from the end of the prior quarter due to market declines, which more than offset the continued inflow we're seeing from new accounts.

Thanks, Scott. Looking at our gross revenue, we saw an increase of $2.4 million or 8.8% from the previous quarter, primarily due to greater net interest income fueled by our strong loan growth. This supports the consistent growth trend in our commercial and private banking services. Excluding gains from mortgage sales, our gross revenue increased at an annualized rate of 41% from the last quarter. Our net interest income rose 13% from the prior quarter, mainly because of higher average loan balances and a better net interest margin, which increased by 40 basis points in the third quarter to 3.75%. Excluding PPP fees and accretion on acquired loans, our net interest margin improved by 47 basis points to 3.77%. This improvement was supported by an uptick in total loan balances, which rose to 92.2% of our total earning assets in the third quarter, compared to 83.7% in the previous quarter. We also observed a 41 basis point rise in our average loan yields, driven by higher pricing on new loan originations and increases in cash yield and our investment securities portfolio. This more than counterbalanced a 30 basis point increase in our deposit costs. Additionally, we raised our FHLB borrowings to fund our substantial loan production, focusing on overnight borrowings to provide a more flexible funding source amidst current conditions. We anticipate that managing funding costs might become more difficult ahead. While we expect our yield on earning assets to continue rising, we believe we've reached a near-term peak in our net interest margin, leading us to foresee a decrease in margin levels from what we experienced in the third quarter. Shifting to our non-interest income, we noted a 7% decline from the previous quarter, primarily due to decreased net gains from mortgage loans. The volume of mortgage loans locked for sale fell by 25%, with about 94% of originations being purchased loans, reflecting diminished demand for refinancing amid rising mortgage rates. Slight increases in bank fees and risk management and insurance fees partially offset the decline in mortgage loan gains. Regarding our expenses, our non-interest expense decreased by 6% from the previous quarter, largely due to lower salaries and employee benefits influenced by higher deferred loan fees tied to robust loan production, reduced incentive compensation, and decreases in health insurance and payroll taxes. Additionally, savings accrued from the system conversion and branch consolidation related to the Teton acquisition, completed in mid-May, contributed to the overall decline in expenses. We have fully realized all projected cost savings from this transaction and now expect our non-interest expense to be between $20.5 million to $21.5 million in the fourth quarter of '22. Regarding asset quality, we continue to see favorable trends across our portfolio. Non-performing loans dropped by 2 basis points to 16 basis points of total loans, and non-performing assets decreased by 3 basis points to 14 basis points of total assets. We also reported another quarter of minimal portfolio losses, with a provision for loan losses of $1.8 million driven by the loan portfolio's growth and shifting mix. This maintained our allowance for loan losses at 77 basis points of adjusted total loans, consistent with the prior quarter and reflective of our strong credit quality and low loss levels in the portfolio.

Thanks, Julie. Turning to slide 13, I'll wrap up with some comments about our outlook. While economic conditions remain healthy in our markets, we've always run the bank with a conservative approach. Given the potential for an economic slowdown, we believe it's prudent to make some adjustments in our underwriting and loan pricing to reflect the uncertainty of the economic outlook. We believe this will likely lead to some re-moderation in our level of loan growth. However, with the diverse loan production platform we built and the new banking talent we have added in Colorado, Montana, and Arizona, starting to make larger contributions, we believe we can continue generating significant loan growth even with more conservative underwriting and pricing. I mentioned in the past that throughout the history of our bank, we've typically had no problem attracting deposits and we typically run the bank with a loan to deposit ratio in the low to mid-90s. Over the past few years, we focused on adding banking talent that can positively impact our loan production. We’ve been very successful in this regard and the redeployment of excess liquidity into higher yielding earning assets has been a key driver of earnings growth and the higher level of returns we're now generating. One of our priorities going forward is to shift some of that business development focus of the organization back to core deposits so we can have a better balance between loan and deposit growth. This includes making some adjustments to incentive compensation to give our bankers and profit centers more opportunities to benefit from bringing in more core deposits. As Julie mentioned, we expect our expense levels to be relatively stable as our near-term market expansion efforts in Colorado, Arizona, and Montana are largely completed. With our continued loan revenue growth, we should continue to realize improved efficiencies and deliver a higher level of financial performance for our shareholders, while maintaining strong asset quality and capital levels even if we see an economic slowdown as we've consistently done during previous periods of economic stress. And with that, we're happy to take your questions. Norma, please open up the call.

Thank you. Our first question comes from Brady Gailey with KBW. Your line is now open.

Thanks. Good morning, guys.

Good morning, Brady.

So I heard the 4Q expense guidance of around $21 million plus or minus. How do we think about the expense growth rate as we look to next year? All the banks are talking about especially wage inflation. So how do we think about what the expense creep could be in 2023?

I believe this will be a challenge for us as well. We have managed our expenses effectively this year, and we are exploring ways to continue managing expenses into 2023. However, given the current inflation rates, we can expect significant wage pressure. Additionally, the competition in our markets adds to this wage pressure. You are correct that we will face ongoing wage pressures next year. To address this, we have prioritized associate engagement, launching an initiative 18 months ago focused on putting people first. We've taken steps in career tracking, training, and enhancing associate activities to foster a sense of belonging, which we hope will help mitigate some wage pressures. We have also implemented non-wage adjustments to support lower-income employees amid inflation, managing their benefits costs in 2023. Overall, I agree that wage pressure will be present next year.

Alright, that's good color. And then when I look at how loan growth has outpaced deposit growth, especially the last couple of quarters. I mean, the loan to deposit ratios had a big move here. It's now up to 109, so how do you think about those dynamics. I know you're guiding the kind of moderation in loan growth, but how do you think about the loan or deposit ratio, are you fine to have it at 110 to 115? Are you going to actively work to get that number back to 100 or lower?

Well, for the short-term, we'd like to see that back to 100. For the mid-term, we've historically operated in the low to mid-90s and I think we're comfortable there. But already I would tell you we're very focused on getting that number back to 100 and hopefully below.

Alright, and then finally from me, another quarter of really nice net interest margin expansion, one theme that we've heard so far through earnings season is just that it feels like the NIM will expand at a decelerating rate. So how do you think about, kind of, the outlook from the NIM? Do you think it goes up by a much smaller amount and kind of hits the max level at some point in the first half of next year?

No. I just would start this by saying that it feels to me like it's an extraordinarily difficult time to predict what's going to happen. The Fed moving rates is something we really haven’t seen at this pace in my career of 30-some years. And then the competitive environment is really kind of strange too, we were talking right before the call started among the group here in the conference room that we have clients that are telling us that big national banks are still doing mortgages in the 4s today. When you have that kind of stuff going on, it's just very difficult to predict the competitive response we're going to have to attract deposits, retain deposits, attract the borrowers that we want, retain the borrowers that we want. So I think it's hard to predict. But having said that, just kind of being in day-to-day operations, I think we've seen a lot of NIM growth this year and we've had a lot of success with that. As you said, we've gone from 80% loan to deposit in Q1 to over 100% in record time. And so if that moderates, what it's going to, we will make sure that gets back down below 100%. If we continue to be competitive on deposit rates, which we will, I think we're going to see this NIM that we're reporting this quarter at a peak. I don't think we're going back down to where we were a year ago either. So I think the stronger numbers we're seeing today, we're going to continue to benefit from, but I think we're seeing, kind of, peak rates for the short term; for the longer term, who knows. But definitely, I think that's going to moderate a little bit in Q4.

And if my voice holds out here, I can add a little bit extra, which I would agree that we don't really manage our NIM to achieve a particular outcome. It's an output of all the rest of the decisions we're making on the balance sheet. So as we think about how to generate appropriate risk-adjusted returns on capital, we're really pulling all of that into account. So looking at the longer-term approach, we're not going to pass up on opportunities to add new client relationships, kind of back to your loan to deposit ratio question. Even if we have to use some of the higher-cost sources of funding in the near-term to fund the initial loans and then work on bringing in the relationships over time. You've mentioned that you've seen really high loan growth in the last two quarters, and our expectation is we'll be able to fulfill a bigger broader relationship with those clients over the kind of mid-term here. So I think we have a lot of good opportunities just in our current book to improve that. But overall, we want to continue to be very profitable while bringing in long-term clients. So even if that has a near-term negative impact on our NIM, I think we're looking at what's in the best interest of the company for the long-term and the shareholder for the long term.

And drives growing net interest income.

Got it. Thanks, guys.

Thank you, one moment for our next question. And our next question comes from Clark Matthew with Piper Stanley. Your line is now open.

Like that, like the sound of that. I feel bad for asking questions just because I think we all want to see Julie's voice quite. I'll try to ask a couple of brief ones for Julie. Do you have the spot rate on deposits, either interest-bearing or total at the end of September?

Yes, at the end of September and I appreciate that. But I think I'm doing okay. At the end of September, our spot rate for deposits was 99 basis points.

Okay, okay. And then I guess have you talked internally about your thoughts on the cycle beta assuming we get $450 million, $475 million, kind of total move in Fed funds? Where you could shake out? I know it's pretty fluid and pretty competitive and but when you think about last cycle, obviously, it's a lot different this time. I would assume we take the over, but any commentary around deposit betas this time around in total?

We have an advantage in analyzing deposit betas because a portion of our deposit portfolio has nearly a 100% beta, like our trust deposits, where we need to offer competitive rates compared to money market mutual funds. There's typically a month-long lag before this adjustment occurs, but it remains close to 100%. For other deposits, like demand deposits and other interest-bearing accounts, the competition drives rates. In the last quarter, we aimed to stay ahead of this by implementing some higher rates. We realized that if clients notice the Fed tightening rates while their money market accounts yield just 0.01%, they won't be satisfied, leading us to make necessary adjustments. So, in the second and third quarters, we offered a lot of exception pricing, and toward the end of Q3, we adjusted rates across the board, which is reflected in the spot rate we discussed. I am optimistic that we will see moderate behavior in Q4 regarding deposit betas for those interest-bearing accounts that are neither fully interest-bearing nor non-interest-bearing. However, predicting this is challenging due to the competitive landscape, which has surprised us at times.

Okay. And Julie, that 99 basis points was total or interest-bearing? I'm sorry.

That was total.

Okay, okay. And then the weighted average rate on new loans, I think from the release is up over 100 basis points. Do you have that rate for the quarter?

Our pipeline of loans for the fourth quarter is currently in the high 6s to low 7s and is in a situation where they are set to close. Depending on the timing of the closures and the next rate hike, those rates could increase further. In September, our net interest margin dipped to 3.61, but that figure does not fully reflect the impact of the changes in deposit pricing that occurred later in the month.

Okay, understood. Regarding the borrowings, it seems you indicated an addition in the quarter, mentioning possibly 3.25 or higher on new borrowings. Are you considering adding more, or do you think that slower loan growth might allow you to attract some wholesale deposits to offset that?

Yes, it's overnight. The borrowing base is overnight. You're right about 3.25 just under 3 for dividend adjusted. But our whole focus right now is bringing in core deposits. So as we are able to do that, we'll be able to pay down those borrowings and/or any of that kind of brokered. We'll just manage accordingly to what makes the most sense for us, but our core focus is bringing in deposits based on the loans that we just added in.

Great. Thank you.

Thank you.

Thank you, Matt. Unless we have to start calling you Clark now.

One moment for our next question. Our next question comes from Bill Dezellem with Tieton Capital Management.

Thank you. I had a couple of questions. First of all, relative to the mortgage loans held for sale, it was more than cut in half, sequentially $13 million versus $26 million last quarter. Could you discuss just the dynamics behind the scenes with that? And then secondarily the construction and development loans were up a fair amount sequentially and provide your thoughts and color on that if you would also please?

Sure. Well, the loans held for sale are sort of 30-days of activity more or less of the production of the mortgages that are going to the secondary market. So when that drops off a cliff, we're going to see the loans held for sale drop. So that's all that is. The construction lending, with the housing shortage here, we're seeing a lot of interest in that. We launched a one-close mortgage product, a construction product in Q3 that's had a lot of interest in it, and is a profitable product for us and a good product for playing offense and attracting our type of clients with. So we have seen some growth in that. I think some of the growth that showed up in the numbers in the quarter was actually from construction loans made in prior quarters that are now funding. I think the things that we probably closed in Q3, I don't know that they really would have balances at the end of the quarter, but we have seen some nice growth in our C&I approved credits that are now showing up as funded credits.

Great. Thank you.

Sure. Thank you, Bill.

Thank you. And I'm currently showing no further questions at this time. I'd like to hand the conference back over to management for any closing remarks.

Yes. Well, thanks everybody for dialing in and Julie thanks for powering through your lost voice there. Good job. I'm really proud of the work that the First Western team has done this year and I think it really shows up in the numbers again in Q3. We've had strong growth in core revenues and core earnings. We've brought our legacy RMB team and clients on board and converted them. We converted their core trust of us as a management system last quarter onto a new state-of-the-art system that's much more flexible and powerful for internal production and for clients. We've seen nice operating leverage gains with efficiency ratio back in the right trend, the way that we had anticipated. We do have some work to do growing our non-interest income and getting our loan deposit back where it should be managing our NIM and expenses. But overall, we're very well positioned with a strong team and strong capital and good earnings outlook for Q4 and into '23. So thanks so much for dialing in. We really appreciate your interest in First Western.

This concludes today's conference call. Thank you for your participation. You may now disconnect. Everyone have a wonderful day.