First Western Financial Inc Q2 FY2024 Earnings Call

Good day, everyone, and thank you for standing by. Welcome to First Western Financial Second Quarter 2024 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 will hand the call over to Tony Rossi of Financial Profiles.

Thank you, Carmen. Good morning, everyone, and thank you for joining us today for First Western Financial's second quarter 2024 earnings call. Joining us from First Western's management team are Scott Wylie, Chairman and Chief Executive Officer; Julie Courkamp, Chief Operating Officer; and David Weber, Chief Financial 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. During the second quarter, we continued to prioritize prudent risk management and a conservative approach to new loan production, which resulted in our balance sheet remaining relatively flat during the quarter. At the same time, we continued to execute well on our strategic priorities and had positive trends in a number of key areas. We maintained disciplined expense control, which resulted in non-interest expense declining from the prior quarter. We added new deposit relationships in our largest non-interest income generating businesses. Wealth management and mortgage banking continued to perform well and made strong contributions to our revenue. Notably, our performance grew stronger as we moved through the quarter and in June, we had increases in both loans and deposits and we saw an increase in our net interest margin. In terms of asset quality, we made progress on resolving our largest non-performing assets and foreclosed on two of the properties we had as collateral during the quarter. We experienced a decline in past due loans while having net recoveries in the quarter. As we indicated in the past, when we see a loan move from non-performing status due to specific issues with a borrower, it rarely results in a meaningful level of loss due to the strong collateral we typically require, which often includes multiple forms of repayment and personal guarantees. On Slide 4, we generated net income of $1.1 million, or about $0.11 per diluted share in the first quarter and pre-tax pre-provision net income of $3.7 million. On a pre-tax pre-provision net income basis, our financial performance was consistent with both the prior quarter and the same period last year. With our prudent balance sheet management, we had a further increase in tangible book value per share this quarter. Now I'll turn the call over to Julie for additional discussion of our balance sheet and investment management trends. Julie?

Thank you, Scott. Turning to Slide 5, we'll look at the trends in our loan portfolio. Our loans held for investment decreased by $20 million from the end of the prior quarter, but as Scott mentioned, our loans held for investment increased during the month of June. We continue to be conservative and highly selective in our new loan production, but we did see a higher level of loan production in the second quarter with total loan production increasing to $50 million up from $31 million in the prior quarter. Most of our new loan production comes in the areas of commercial loans and residential mortgages where we are also getting deposit relationships. Our level of payoffs was relatively consistent with the prior quarter and higher than our level of loan originations, which resulted in the decline in total loans. We continue to maintain our pricing criteria, resulting in the average rate on new production being 8.35% in the quarter, which is higher than the average rate of our payoffs, resulting in the turnover in our loan portfolio being accretive to our average yield on loans. Moving to Slide 6, we will take a closer look at our deposit trends. Our total deposits declined during the quarter as we saw outflows primarily driven by seasonal tax payments, operating account fluctuations, and clients using liquidity for further strategic investments. However, on an average basis, our deposits are up $39 million compared to the second period of 2023 due to our deposit gathering efforts over the past year. We had success in new business development and added $22 million in new deposit relationships during the second quarter. We had the largest growth in time deposits during the quarter, primarily related to clients moving money into time deposits from lower yielding deposit accounts to take advantage of the higher for longer interest rate environment that we are in. Turning to Trust and Investment Management on Slide 7, we had a $129 million decrease in our assets under management in the second quarter, driven by asset withdrawals and custody accounts that minimally impact trust and investment management fees. However, we have seen an increase in AUM of 8% over the past year. Now I'll turn the call over to David for further discussion of our financials.

Thanks, Julie. Turning to Slide 8, we'll look at our gross revenue. Our gross revenue decreased 2% from the prior quarter but was up from the average of our prior three quarters. We saw positive trends in NIM and mortgage fee income this quarter. Now turning to Slide 9, we will look at the trends in net interest income and margin. Our net interest income decreased 1.9% from the prior quarter, primarily due to lower levels of interest bearing cash. We continue to see more stability in our NIM, which increased 1 basis point from the prior quarter to 2.35%. As Scott indicated earlier, we saw an increase in our NIM during June, and we expect to see continued expansion in our net interest margin over the second half of the year. We are seeing an increase in our average yield on interest earning assets primarily due to new loans coming on the books at higher rates than the loans that are paying off. We added some overnight borrowings to offset the deposit outflows that occurred during the quarter. We plan to reduce these borrowings as deposit balances build back up again. Now turning to Slide 10, our non-interest income decreased 4.2% from the prior quarter but was up 29.6% from the average of the last three quarters of 2023. Our largest sources of non-interest income, trust and investment management fees and net gains on mortgage loans, continue to make strong contributions, but they were offset by a decrease in bank fees. Our net gain on mortgage loans increased from the prior quarter due to a higher level of production resulting from the addition of MLOs earlier in the year, as well as an increase in home buying activity in our markets. Now turning to Slide 11 and our expenses. Our non-interest expense decreased to $19 million, primarily due to a lower level of professional service fees as we continue to make progress on the resolution of our non-performing loans. Our efficiency ratio is trending in the right direction. For the next few quarters, we expect non-interest expense to be relatively consistent, with the main variable being the level of incentive compensation, which will depend on our financial performance. Now turning to Slide 12, we'll look at our asset quality. Our non-performing assets increased slightly to $49.3 million. The increase was due to the foreclosure on two properties held as collateral, which more than offset the resulting decrease in non-performing loans due to a participated balance. We continue to make progress on our large workout relationship as we had previously discussed. Additionally, we had a decline in past due loans and had a small amount of net recoveries in the quarter. With the decline we had in loans and the provision recorded in the quarter, our level of allowance to adjusted loans increased 12 basis points to 1.12% at June 30. Now I'll turn it back to Scott.

Thanks, David. Turning to Slide 13, I'll wrap up with some comments about our outlook. While economic conditions remain uncertain, we will continue to prioritize prudent risk management and a conservative approach to new loan production. In addition, we continue to make progress on resolving the credits that were placed on non-performing status over the past few quarters. Notably, our past due loans have continued to decline over the past two consecutive quarters. We will continue to focus on maintaining disciplined expense control and developing new deposit relationships. We are benefiting from the strength of the franchise we've built, and as we open new positions in the organization, we are seeing good opportunities to upgrade our banking talent. These new additions, along with strong execution across our entire organization on our business development initiatives, are positively impacting our pipelines in all areas of the business, including loans, deposits, mortgage banking, and investment management. We are also in the process of reorganizing our investment management business to improve its performance and business development capabilities. Based on the positive trends we are seeing, including the expansion in the net interest margin, we expect to generate a higher level of profitability in the second half of the year. We continue to maintain a very strong balance sheet, and with the increases we are seeing in our capital ratios and improvement in our asset quality, we have the ability to consider additional options for capital use. This led to the authorization of the stock repurchase agreement that we announced in June. We did not repurchase any shares during the second quarter, but we do have a 10b5-1 plan in place now, and we believe that repurchasing our shares will be in the best interest of the shareholders. With that, we are happy to open the call to take your questions. Carmen, please open up the call.

Thank you. One moment for our first question, please. And it comes from the line of Woody Lay with KBW. Please proceed.

Hey. Thanks for taking my questions. I wanted to start with credit. As expected, there was some movement from NPL to OREO. Could you just remind us where NPA exposure stands to that one larger relationship and any updated thoughts on timing around the potential resolution?

Yes. We have just under $30 million of NPL on that one credit plus a specific reserve of $8.2 million, of which $2.4 million of that was put on in Q2. Regarding the timing of the other property sales, we had said that this was going to play out over the course of 2024, which it is. The process is well underway, but it is nevertheless complex. We started out with seven properties that we've talked about. We now have four remaining; two of them are in OREO and are being listed and sold during the second half of the year, I hope. There's another property that's scheduled to be auctioned off in the first half of August, and that's on track and something we've anticipated all along. The timing of the sale of the last property is uncertain right now.

Got it. So have your thoughts on the potential loss content changed at all given the increased provision? Or was this just sort of a move out of abundance of caution?

Well, one of the properties – one of the seven properties had a new issue that popped up in Q2 with a clouded title and litigation, which led us to book a zero value for that property and our expectation that we don't want to take further risk on that. We will not have a recovery from that. So that was really what drove the specific reserve increase on that relationship.

All right. Thanks for the color there. Maybe shifting over to the net interest margin. It sounds like there was a little bit of improvement throughout the quarter. Could you just talk through your expectations on the NIM for the back half of the year?

Sure. I'll give it a try and Julie and David, if you want to add extra color, please go ahead. On the two sides of driving NIM on loans and deposits: Starting with loans, we are seeing a fair amount of competition on loan pricing, and we still think that there could be a rate cut in the second half of the year. We believe that our net interest margin will improve slowly. However, it appears that our return to a more normal NIM is going to take some time, which is in line with what we've previously discussed. The loans that we booked in Q2 came on our books at an average rate of 8.3%. Is that the correct number, David?

8.35%.

8.35%. So we are getting a nice yield on the new loans that we're booking. Although, we're hearing stories from our frontline about people out there doing five-year fixed rate commercial real estate loans that start in the 6% range. So, there are definitely things that we are not going to pursue on the loan side. On the deposit side, the cost of funds for the quarter was around 3.47%. The cost of deposits technically was 3.47; the spot rate for June 30 was 3.46. So it's not really a significant improvement obviously, but it is an improvement. If you look back over several quarters, you'll notice a very good trend line in terms of slowing NIM compression and then improvement, which is consistent with our guidance from Q1. Did I miss anything important there, David or Julie?

No, no. All fine.

All right. Thanks for taking my questions.

Thank you. One moment for our next question. And it is from the line of Matthew Clark with Piper Sandler. Please proceed.

Hi. This is Adam Crow on for Matthew Clark. I guess my first question, I was wondering if you happen to have the NIM spot rate for June?

David, do you want to go through that?

Yes. We saw a slight improvement in NIM in June, 236 versus 235 for the quarter.

And then switching to expenses; those came down this quarter, and I know you guys are focused on continued investments in talent and technology, so I was just wondering how we should think about the expense run rate going forward?

We have discussed our expenses being in the $19 million range each quarter this year. I believe that's about where we landed in Q2. We have had success bringing on production new hires largely by replacing open positions and gaining efficiencies on the back office and middle office sides. We have hired 14 additional front office producers in the first half of the year, particularly in Jackson, Boulder, and Fort Collins. We have also added five new mortgage loan officers (MLOs) so far this year. I feel we've done a commendable job controlling expenses while adding production capability that should pay off in the second half of the year.

Got it. That's super helpful. I guess my last question is; it looks like there was some ongoing deposit remix this quarter and I was wondering if there was an update on the flows you're seeing on the deposit side and expectations going forward, particularly with non-interest bearing and if you're seeing a kind of stabilization in your deposit base?

Yes. As we previewed, we usually see deposit declines in Q2, and we did see some outflows of non-interest bearing deposits in Q2 as you pointed out in your question. However, with the new production leaders that we've added in several of these markets, we expect to see an increase in operating company deposits, which should help offset some of the outflow, and we're expecting stable to improving deposit levels over the course of the second half of the year.

Got it. Thanks for taking my questions.

Yes. Were the Piper questions from Adam?

Yes.

Thank you, Adam.

Thank you. One moment for our next question. And it is from the line of Bill Dezellem with Tieton Capital Management. Please proceed.

Thank you. I'd like to circle back to your recent comment about hiring 14 new producers this year. Would you please go into a bit more detail about those? What's the net new number and are all of those 14 producers or is some of them support around producers?

If you look at our number of production people from last year, we're up 24% year-to-date versus our total last year. So these are net new producers. Some of them are vacancies that we've had for years. We promoted our Boulder Market President to be a Regional President, and he has been effective in that role. He's been doing double duty as the Boulder Market President. We were able to attract a strong Boulder Market President who's one of those 14 just as an example, who is a longtime leader in the market at another bank.

And Scott, you'd mentioned that some of these positions have been open for a long time. Is it a coincidence that a number of these long-term open positions are now being filled? Is it a combination of working on these filling these positions for a long time? Or is there something loosening in the market with competitors that's making it easier to hire or those prospective candidates being more interested in making a move?

That's a great question, and I'm not 100% sure of the answer. I do believe there is turmoil in our markets that we haven't seen over the past couple of years; that is creating the opportunity to bring new people in. Anecdotally, it seems to bear out with each of the 14 stories. I can tell you we had our semi-annual summit with all of our managers, and there was a very positive tone with those folks, particularly the front office. I would say there is significant turmoil in the market, creating opportunities to upgrade our talent, and people seem to agree. I didn't get any pushback on that. I'd love to be six months from now talking about additional talent we've been able to attract to build our organic growth story in 2025.

Great. That's really helpful.

Julie seems to have something to add.

I think First Western has a differentiated story to tell. More and more, our name is getting out there with talent and clients as a place that has high-quality relationships. This applies to both clients and associates.

Great. Thank you. Relative to mortgage, you've seen a nice uptick there and the commentary in the market indicates some stagnation. Given you aren't national, is the mortgage business a rebound for you?

Yes. I'd say this is more than just a slight rebound. We had a really nice turnaround, moving us from months of significant losses to positive earnings over the last four months. This isn't investment from thin air; it involves a concerted effort by us to support our mortgage team and build our mortgage team. We've added five new MLOs in the first half of the year, which are bringing additional production. This should accelerate in the second half of the year. Additionally, we have opened two new MLO loan production offices recently, one in Northern Colorado and another in Southeast Wyoming, which will aid in building their production. It's a combination of better rates, improved activity, good work by the mortgage team under Julie's leadership, and hiring new MLOs.

Which we're continuing to do, and that was one reason for office openings and to attract more MLOs.

Relative to your pipeline of new MLOs, do you anticipate being able to hire an equal number or more in the second half?

It's hard to forecast but our goals are to achieve the same level of new hires in the second half of the year. We'll see how that plays out.

Great. Let's jump back to the 14 new producers on the non-mortgage side. Do you think you can repeat that in the second half?

I don't know the answer to that. We've tasked our senior leaders to look for the top talent and let them know we're open for business. A lot of banks are being cautious right now, and there's a lot of turmoil in our markets. New acquirers will come to town and be approved in the next few months, creating opportunities with clients and top talent. I want our team focused on that, and if we bring more new people here, that would be terrific.

Great. Thank you both for the time.

Thank you, Bill.

Thank you. Our next question comes from the line of Ross Haberman with RLH Investments. Please proceed.

Good morning, all.

Hi, Ross.

Just a couple of quick questions. I got on a bit late, so I'm sorry if you mentioned this. The additions to your non-performers, these two pieces of collateral that you took back, did you say you think you're pretty well secured against those?

Yes, the short answer is yes. The two pieces of collateral are the same properties we've been discussing. Having them as collateral is advantageous because we control it and can sell it.

I got it. Anything else in the criticized or delinquent that you're concerned about today, or are those the main items?

That's a great question. We've talked about this in our prepared remarks and in the deck. The topline number of NPL or NPA is not a number we're pleased with, but it's mainly driven by the one credit we've been discussing. If one of them is written off, any news on that one would be positive because it would indicate a recovery. Currently, we are down to one credit which is a workout project proceeding as anticipated. With a bit of luck, we'll resolve that by year-end, or it may extend slightly into next year. However, many of the other credit metrics we track are showing positive trends.

Could you tell me how much expense was incurred regarding all these non-performing assets in terms of the non-interest expense for the quarter?

I don't know the total of that, but maybe Julie or David do. It's a non-zero number regarding time and effort. I believe that came down in Q2, and I think it will continue to come down as we move forward. If you look at criticized and classified loans in the second quarter, they were below the prior three quarter ends, trending downward. Total criticized and classified amount was about $80 million as of March 31 and about $60 million as of June 30. The underlying trends are strong, and as we’ve mentioned, we've seen significant declines in past dues over the last couple of quarters.

Yes. Between our legal fees and other workout costs related to those efforts, it was about $300,000 for the quarter.

Okay. Got it.

I believe that was down from Q1.

Absolutely.

Okay.

That doesn't include the opportunity cost of removing those non-interest earning assets from the books and deploying those into interest-earning ones. That is a not insignificant number to consider. We are actively working to offload these assets due to inherent costs.

That revelation from Julie was a surprise when she pointed out the potential EPS uptick if those NPAs were turned into interest-bearing assets.

You had some new lending offices in Bozeman and Arizona. How are they faring?

The Bozeman office is making excellent progress. That market continues to offer tremendous opportunity. Our Market President there was here recently for the meetings I mentioned and has a very positive outlook. In Arizona, we’ve retooled the staff over the last 12 to 18 months. Both locations are now fully staffed with strong people as part of our new production hiring mentioned. The feedback from our internal teams, including Regional and Market Presidents, is positive regarding the outlook. Arizona has been profitable for quite some time, but we want to see it perform even better. I often remind our leaders that if we had the same market share in Arizona as we do in our largest market, Fort Collins, we'd be $4 billion bigger. So there is tremendous opportunity in Arizona, and I feel we're building a strong team to capitalize on that.

And just one last question. Any large expenditures expected in the next quarter or two, besides the workout expenses for the non-performing assets?

I don't believe the answer is yes; however, we are due for a significant rebuild of our tech platform. This will ultimately save us money throughout the process. We are changing the way our tech platform is hosted and modernizing it in the cloud while using Fintech solutions. This involves rebuilding the foundational elements, which is about 80% complete.

Yes, the foundational build is ongoing.

We're implementing the middleware now and will begin rolling out additional features in Q4 and early next year. Future calls will shed more light on the efficiency gains we expect to see, which will be beneficial both internally for our associates and externally for our clients. Additionally, we anticipate overall cost savings.

Thank you.

Thank you, Ross.

As I don't see any further questions in the queue, I will conclude the Q&A session and pass the call back to Scott for final comments.

Thank you, Carmen. Thanks to everyone for joining today. To conclude, some headline numbers are challenging. We're not satisfied with the EPS, efficiency ratio, or asset quality. However, the year is progressing largely as we expected and indicated earlier and aligns with our previous guidance. Additionally, many positive underlying trends are emerging for the second half of the year, as we noted in Q2, June, and early July. These include disciplined expense management, developing new deposit relationships, improving fee income, asset quality enhancements, a better NIM outlook, the onboarding of new producers, a favorable efficiency ratio trend, and larger pipelines throughout the organization. Thus, we believe there is a positive story moving forward. Thank you all for your interest and support for First Western. Have a great day.

Thank you all for participating in today's conference. You may now disconnect.