First Western Financial Inc Q1 FY2023 Earnings Call

Good day and thank you for standing. Welcome to First Western Financial First Quarter 2023 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 call is being recorded. I would now like to turn the conference over to your speaker today, Tony Rossi of Financial Profiles. Please go ahead.

Thank you, Valerie. Good morning, everyone, and thank you for joining us today for First Western Financial's first quarter 2023 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. Good morning, everyone. Because of the prudent approach we have always taken to risk management, First Western has been a consistent source of strength and stability for our clients, and that was never more true than over the past couple of months. At the same time, we never benefited more from the strong relationships we have built with our clients. As part of the ordinary course of business, we are in regular contact with our clients so that we can stay appraised of any changes in their business or personalize services to ensure that we continue to meet their financial needs. When the recent bank failures occurred, we didn't have to do anything other than what we usually do, which is to continue to remain in regular contact with our clients. Our clients know that we are a conservatively managed financial institution, so there was essentially no concern expressed by our clients. Due to the deep relationships we have built and the value our clients place on the service and expertise that we provide, the stickiness of the deposit base we built was never more apparent. Earlier in the quarter in January, we had some liquidity events among our clients that resulted in some meaningful but routine deposit outflows. However, in both February and March, we had net deposit inflows, which speaks to the stability of the deposit base we have built. In fact, we have been the beneficiary of the recent upheaval in the banking industry, with many new clients coming to First Western as they wanted to move their banking relationship to a stronger financial institution. During March, we added $42 million in new deposit relationships with only $5 million of deposit relationships leaving the bank. While we saw good stability in the deposit base, we took some balance sheet management actions that had an impact on our level of profitability in the first quarter, but we believe we were prudent from a risk management standpoint. This included holding a higher level of cash on the balance sheet. Our level of FHLB borrowings also increased, but this was not related to issues being experienced in the banking industry. We had already decided to increase our borrowings as they provided a less expensive source of funding, given the extremely competitive deposit pricing environment that we are seeing. As I indicated earlier, on a short-term basis, we have chosen to hold most of the increase in borrowings in cash rather than deploying them into loan funding or new purchases of vested securities. We also chose to sell some non-relationship loans, most of which were added through acquisitions. These were loans where we had no deposit relationships, and they were relatively low yielding. While the sale of these loans did have an impact on our profitability this quarter, we felt that the benefit we would get in terms of capital and liquidity was more important in the current environment, while also improving the risk profile of the loan portfolio. Because of our prudent approach to risk management and the conservative manner in which we run the company, the fundamentals of our franchise remain extremely strong. We have $1.5 billion available in liquidity, which is 1.7 times our level of uninsured deposits, which represents just 37% of our total deposits. We have a diverse client base with no meaningful industry concentrations. Our asset quality remains exceptionally strong with an immaterial level of losses, and we have a well-diversified CRE loan portfolio with minimal exposure to non-owner occupied office properties where there is broader concern. I'll provide some additional information about our CRE portfolio later in the call. We generated a net income of $3.8 million or $0.39 per diluted share in the first quarter in spite of some significant industry headwinds. While there are small non-operating items every quarter, the combination of the loan fair value mark, severance payments, and a small loss on loans sold added about 6% per share in impact in Q1. Over the past year, we have seen increases in both book value and tangible book value per share despite the impact on capital resulting from our adoption of CECL at the beginning of the year.

Thank you, Scott. Turning to Slide 9, we'll look at our gross revenue. Our gross revenue declined 10% in the prior quarter due to lower levels of both net interest income and non-interest income. However, due to the higher average asset yields and the growth we have had in our balance sheet on a year-over-year basis, our interest income increased 74.6%, while our net interest income increased 5.8% compared to the first quarter of 2022. Our net interest income decreased 10% from the prior quarter due to an increase in interest expense resulting from a higher average cost of deposits as well as the impact of holding higher cash balances. In March, our net interest margin decreased 37 basis points to 2.93% due to the higher average cost of deposits and the excess liquidity we carried in the quarter. Much of the funding we have added is in the form of borrowings and time deposits that are short term and/or callable, which gives us the flexibility to quickly make adjustments in our funding mix as market conditions change. Our non-interest income decreased 11% from the prior quarter, primarily due to lower bank fees and risk management and insurance fees. The lower bank fees were partially attributed to a decrease in prepayment penalty fees, while the decline in risk management and insurance fees primarily follows the seasonal bump we see in the fourth quarter. The decline in these areas offset a 6% increase in trust and investment management fees and higher net gain on mortgage loans. The increase in net gain on mortgage loans is primarily attributed to the increased loan production we are seeing from our expanded team in Arizona, which more than offset the seasonality we typically see in first quarter production in Colorado. The volume of lock sum mortgage loans originated for sale increased 41% from the prior quarter with 96% of the originations being for purchase loans. Our net interest expense increased 3% from the prior quarter, primarily due to the seasonal impact of higher payroll taxes, as well as lower deferred compensation resulting from the decline in loan origination. Additionally, the higher FDIC assessment rate now in place contributed to the increase in non-interest expense. These increases were partially offset by a decline in technology and marketing expense as part of our regular review of expenses. We recently made some adjustments throughout the organization in areas such as staffing, software spending, and real estate, all of which reflect the changing nature of our business and areas we no longer focus on growing. A portion of the cost savings from these adjustments will be reinvested into other areas of the company. Overall, these adjustments will help us maintain expense control and should result in our non-interest expense being in the range of $19 million to $20 million per quarter for the remainder of 2023. On a broad basis, the loan portfolio continues to perform very well as our non-performing assets were essentially unchanged from the end of the prior quarter, and we had another quarter of minimal losses. Following the adoption of CECL at the beginning of the year, our allowance for credit losses stood at 81 basis points at March 31st. This is down 3 basis points from our CECL Day One coverage, as we had a small reserve release during the quarter due to changes in loan volumes and the mix in the portfolio.

Thanks, Julie. Turning to Slide 14, I want to take a moment and review our strong track record of value creation for our shareholders. This slide shows our trend in tangible book value per share since our IPO in 2018. As you can see, we've consistently increased our tangible book value per share throughout a variety of economic cycles, including the pandemic, and then the higher rate and high inflation environment we've seen over the last year. We believe this reflects our strong execution of our strategies for generating profitable growth while prudently managing our balance sheet, as well as our commitment to protecting shareholder value by not conducting capital raises that are diluted to shareholders and being disciplined in our acquisition pricing. As you may recall, our acquisition of Teton Financial Services was immediately accretive to tangible book value per share. Our core wealth management earnings have also shown great progress in recent years, although they too have come under pressure in the last two quarters. I'll wrap up with some comments about our near-term outlook. While the banking system remains under stress and there's a high degree of economic uncertainty, we're going to continue to prioritize prudent risk management, even if that impacts our level of profitability in the short term. We will also continue to focus on disciplined expense control so that we can realize more operating leverage as we continue to grow our balance sheet.

And our first question is from Brett Rabatin with Hovde Group. Your line is open.

Hi, good morning, Scott and Julie. Wanted to just start off on margin, and then just thinking about the balance sheet and maybe dollars of NII. Could you maybe give us a little bit of flavor for where you're seeing new deposit rates come on the balance sheet and just thinking about NII dollars this year? If the margin is down but the balance sheet grows, can NII kind of hold in or increase a little bit? Or do you think that is too aggressive given the deposit outlook?

Well, I'll start with a high-level answer and then ask Julie to give you more of the numbers if I can. I think that we had projected a tightening in our NIM in Q1, which certainly we saw, and that seems likely to continue into Q2. We do think that, because of the nature of our business, we've probably seen more pressure earlier than most banks on our interest expense side and our interest income side. We've actually seen really nice progress there, which we would expect to continue. Julie mentioned in her prepared remarks that our interest income is up 74% year-over-year from the first quarter of last year to the first quarter of this year. But our interest expense is up like 10x. So, I think that kind of pressure is a really strong headwind, and the fact that we've been able to grow net interest income in dollars year-over-year is pretty impressive. So, that would be my general answer. Julie, if you want to highlight some of the numbers behind our NIM progress and outlook.

So NIM for March was 2.97%. So if you just look at the month of March, our spot rate on deposits or the cost of deposits was 2.57% at the end of March. I think our new deposits were coming in quite a bit higher than that, more at the 3.69% level. We would expect to see some compression, as Scott mentioned, in the second quarter, but that really depends on our loan growth and what happens in the rest of the rate environment and competition. So, we're not really giving guidance on NIM. As a secondary point, we haven't raised rates in April or at the end of March. We are continuing to hold our rate sheet where it is and then making exception pricing as needed to win or retain client deposits.

Okay. That's helpful. Julie, what was the 2.97 number for March?

That's NIM for March.

Okay. NIM for March. Okay. Great. And then the other thing I just wanted to ask was thinking about that $41 million of bucket that you exited non-relationship and any other color around that just didn't fit in any of the boxes from a relationship perspective going forward or any additional color that would obviously lower rate, but anything else that made those loans sensible to move on from?

Nope. With our acquisitions, we've acquired some loans that weren't really part of our core business. If they are attractive and they're not distracting us, that's fine, but if it's taking up balance sheet space that we don't need, and we were able to sell them at a small loss... I think we took a $175,000 loss, something like that in the quarter.

In a principal balance kind of perspective, but when you look at the allowance and the purchased credits on it, it was actually accretive to overall earnings for the quarter. So, we look at all of the factors on each of the loans and make sure that it makes sense from a P&L as well as a going forward balance sheet management perspective.

And our next question comes from Matthew Clark with Piper Sandler. Your line is open.

Good morning. Just want to clarify the margin in the month of March. Did you say 2.57% or 2.97%?

2.97%.

Okay. Thank you. And then also to clarify... Scott Wylie: Matthew, excuse me, the other number that she gave was the cost of deposits at the end of March and that spot cost of 2.57. Yes, that's what I was going to ask. Thank you. Great. Your comments on loan growth suggest it should slow to some amount that's below your previous mid-teens expectations, which is understandable. We probably wouldn't want mid-teens growth right now anyway. How should we view deposit growth moving forward and the changes in the mix?

We have said that we want to get our longer deposit ratio down below 100%. We traditionally operate in the 95% loans to deposit range. I think if we could get it down below 100% by year-end, that would be good for us. We are pretty flat in Q1. I think that's probably a good accomplishment considering the drama of the quarter in the industry. We are going to look to continue to grow deposits at a pace that's probably higher than the rate we anticipate growing loans. Hopefully, a lot of those are core deposits that will create a strong core deposit base for the future.

Okay, great. And then on the uninsured deposits at the end of the quarter, any plans to reduce that amount further? Is there anything else you can do to increase the coverage there?

I think our clients have indicated with their feedback and with their actions that they are comfortable with the deposits they have here. We have seen people looking to move to products that have 100% deposit insurance, whether that's FDIC or similar options. So, we have seen a bit more of that at the margin. Overall, I think our deposit base has been very stable. I mentioned in the slide deck and in the prepared comments that we have actually seen nice growth in existing depositors and new deposits in February, March, and April. Historically, we see significant outflows in Q2 for tax payments. Our client base tends to put deposits in when they have their various liquidity events and then pay their taxes in April. I don't know how that'll play out this quarter. Month-to-date, we've seen I think $65 million in net deposit increases here in April and $91 million in new deposits. So, we are seeing the continued trend we saw in February and March. We'll see how it plays out over the quarter.

Okay, great. And then last one for me, just on the reserve and CECL, can you give us a sense for some of the underlying assumptions you assumed with adopting CECL? Just how conservative they might be and trying to get a sense for the flexibility of that reserve going forward and whether or not we should assume it continues to migrate higher with deterioration in the macro factors.

So, I don't know that I can give you all the core details of the modeling, but we used the most, I would say complicated modeling in the DCF modeling, and we went down to a very low level of categories of loans to do a lot of work on that. We did a pretty deep dive on peer sets that, obviously, that's our hardest area because of our lack of loan loss in our portfolio. Finding peers that might be somewhat consistent with us in our loan book and loan types has been a bit more challenging. We feel we have a pretty good handle, and we've been running it parallel for about a year now. We're keeping a close eye on the different factors and levers within the modeling to make sure that we're properly reserved. We provided a lot of information on the different impact there was a decent amount of reserve put on the unfunded commitments and then an additional amount of model of our $2 million that was put on the purchase loans as part of implementing CECL.

Would you say, Julie, to be a little more direct from what we know today, assuming a relatively stable economic and asset quality environment, that we don’t think that the extra $5 million we put in January is a trend, right? That would be reflective of our future?

Correct. That was a one-time transition cost going into the CECL modeling and from here it will really just be modifications based on any economic changes or the mix and volume of portfolio growth.

And our next question is from Brady Gailey with KBW. Your line is open.

Thanks, good morning. So, the $40 million of non-relationship loans that were sold in the quarter, are there other non-relationship loans that something similar could happen in future quarters?

I would say not material. Although, having said that, we do keep a list here of broken promises. If clients say that they're going to bring over relationships and they don't do it, we'll call them up and follow up. During this time when we're looking to grow deposits, we'd probably pay more attention to the broken promises list than we might otherwise. So definitely, as an organization, we're paying attention to that. I don’t anticipate doing more of that, Brady, but we do expect our clients to honor their promises when we make loans with them.

All right. And then with forward growth slowing, potentially you're going to be building some capital here. The stock is at 80% of tangible book value, so a decent discount to tangible book price. How do you think about share buybacks going forward?

I think I'd love to do share buybacks. Obviously, from our perspective at this price, it's very attractive. But we have to be conservative and preserve capital here. Our actions are to work on the margins, work on the fees, and manage expenses to ensure that our earnings are continuing to improve. Historically, we've been opportunistic, and if we get to a point where we feel comfortable doing that we will. However, we currently have a strong credit history and experience. We're not facing unrealized losses in our investment portfolio, and the issues that might put stress on our capital at other banks are not an issue for us here. We don't want to put ourselves in a position where we have to raise capital when we wouldn't want to do that either.

And our next question is from Ross Haberman with RLH Investment. Your line is open.

You were fairly optimistic about the Arizona market, the Wyoming market, and Montana. Could you talk about the growth of those markets relative to where you see them today compared to where you viewed them six or nine months ago? And could you also comment on a small deal announced last night in the Phoenix area, roughly at book value? If you look at that, was that attractive to you? If something like that came up, would you rather use your money to do something like that as opposed to buying back your own shares? Thanks. Bye.

Yes, thanks, Ross. Good questions. For the optimistic view, I'll go first. Julie, if you want to issue a rebuttal, go ahead. We have talked for a long time about our desire to expand in Arizona and add the mortgage team there that could help us counter-cyclically. The key part of the Arizona franchise is the numerous connections between Colorado and Arizona from cultural, business, and personal perspectives, but also in mortgage operations, which is an attractive piece of it. We added an Arizona mortgage team in the latter half of last year. I'm not sure exactly when they are getting ramped up, but we actually saw a nice benefit of that in Q1. March was our first month of making money in mortgages in quite a while. So, it was great to see some progress there. We have added mortgage loan originators in our resort communities. We have some coverage in Wyoming and would like to expand that into Montana. The broader core business, I think we have great opportunities in all three of those markets. Montana has been a really pleasant surprise for us. We are very small there. Our permanent office, we just have an LPO right now. Our permanent office will be opening, Julie, in the third quarter. You still think it?

September-ish.

I think that will be an important next step for us. The Wyoming folks are doing great and it has continued to pleasantly surprise us with our partnership with the former Rocky Mountain Bank team there. Overall, these are all relatively small compared to our core footprint in Colorado, but they are all really important and valuable components for long-term shareholder value. Each of these markets presents opportunities to grow. As to your question about M&A, I think it is tricky right now. With our stock where it is and with the uncertainty out there, we don't think we're really interested in doing lots of deals. When we see opportunities that are small or aren't that great a fit, we will evaluate them to see if it makes sense. But realistically, we prefer to do things that can be either strategically meaningful or financially impactful—or both—for us.

And just one follow-up question in terms of competition, local competition, who would you say is your toughest local competition? Is it the Alpine Banks of Colorado or some of the bigger banks?

The competitive landscape is really interesting right now. On the deposit side, it’s very tough. We're seeing strong competition from all kinds of bank and non-bank players. Frankly, one of the questions we've heard the most from clients over the last six months is, 'Will you guys open a trust account for me and build a bond ladder?' That’s a challenge on the deposit side. On the loan side, particularly CRE, what we're seeing is a few banks that are still being competitive and operating as they did before interest rates tightened, while others are pulling back on CRE loans. If we see growth this year, I think that's why—we may find opportunities because clients slow down what they might have done otherwise, leading to the possibility of attractive acquisition opportunities as other banks are less aggressive than a year or so ago.

And sorry, just one final thing on those CREs, what kind of rates are you getting today on those types of new loans?

Our new production is averaging about mid-seven. For CRE, it might be around six, and C&I would be more like eight. So, it's a rough average, but that's what we've been seeing.

And we have a follow-up question from Brett Rabatin with Hovde. Your line is open.

Just two quick things. Hey Scott, in your prepared comments, it sounded to me like the message was that you're implementing things in the current environment for the long-term improvement and growth of the bank. But I got a sense that maybe profitability might continue to have some drag in the near term. Is that a fair assessment, or can you talk directionally about your comments on profitability?

Yes, I have said on these calls before that our path to success is probably not through cost-cutting, but rather through growing revenues. You look at the environment today and question how confident you feel about revenue growth, and it’s challenging to say we expect mid-teen growth because of the uncertain environment. We have looked at this and planned for the worst while hoping for the best. The strategy is to manage our liability costs. Additionally, we will grow loans cautiously, ensuring they meet our terms. If balance sheet growth does not yield significant net growth, we will manage our expenses to improve earnings. We're down 22 FTEs in Q1, that was intentional. We anticipate an adjustment in the non-interest expense down to about $19 million to $20 million per quarter. So, without any further disruptions in the industry, you can expect improved earnings. Potential improvements in mortgages and trust income, combined with a well-controlled expense base, should lead to nice growth in earnings.

Okay. That's helpful. And then you talked quite a bit about the $1.4 million of reduction, and it sounds like you're focused on improved efficiency with the production people while streamlining. Is there a concerted effort to increase outreach or engagement with clients, if business does become more available and how do you see the pullback in credit by other banks affecting your production?

You're right in assuming that. In our 19 locations, we have these market presidents with senior bankers on the bank trust and investment side. They're direct reports to the market president, which allows experienced bankers to spend less time in administrative roles and more time actively engaging with markets and clients. We aimed to ensure our top people are visible to clients and prospects. This reorganization we initiated last fall has been completed in Q1, and while it's uncertain if it will drive new business in Q2, I feel that it will foster overall growth this year and create a substantial change.

Hi. Thanks for the follow-up. Just want to clarify the margin commentary. 2.97% in March is above the first quarter margin, which was a bit confusing. Could you recap loan yields and the current state of the deposits and borrowings?

I think through March and early April, we had carried more on our balance sheet, which may have increased costs. There might be some variances in our loan fees between first and fourth quarters, making it a bit lumpy from that perspective. However, this provides an idea of where we are heading.

I wouldn't expect NIM in Q2 to be 2.97%. It will come down from what we know today, Matt. But...

We will see compression in the second quarter for sure.

Okay. Great. Thank you.

And I’m showing no further questions at this time. I would now like to turn the call back over to Scott Wylie for closing remarks.

Great. Thank you, everyone. Just at this significant time of disruption in the industry, I'd like to give a special thanks to our associates and clients for their efforts and the support we have received through this challenging time. First Western has demonstrated solid, steady progress in creating fundamental shareholder value in spite of significant headwinds. We have positioned our balance sheet and expense structure for continued headwinds. However, if cost of fund pressure stabilizes and asset yields improve while fee income picks up, and our expenses are well controlled, we believe our earnings outlook could improve nicely. With that, thank you everybody for their interest and support today. We appreciate your interest in First Western.

And this concludes today's conference call. Thank you for participating. You may now disconnect.