First Western Financial, Inc. (MYFW) Q2 2019 Earnings Report, Transcript and Summary

Good day ladies and gentlemen, and welcome to the First Western Financial Second Quarter 2019 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. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference, Mr. Tony Rossi from Financial Profiles. Sr, you may begin.

Thank you, Dwell. Good morning everyone, and thank you for joining us today for First Western Financial Second Quarter 2019 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 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. The management team will discuss the first quarter results and then we'll open up the call for questions. 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 as supplement, but not substitute for the most directly comparable GAAP measures. This 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. Scott?

All right. Thanks, Tony and good morning everybody. I'll begin with Slide 3 and an overview of the second quarter. We're very pleased with the performance in the second quarter, which reflects the strength of private banking and wealth management platform that we've developed along with our continued execution on the embedded growth drivers in the business that we've talked about over the past year. From an operating perspective, we generate our strongest results since our IPO in 2018, which was attributed to our ability to continue to attract new clients, grow loans deposits and assets under management. This quarter's results also reflect the payoff of our commitment to the mortgage business despite the cyclical weakness that we saw in 2018. In the second quarter we generated our highest ever level of mortgage production and gain on loan sales. This resulted in record profitability in our mortgage business, which was a critical driver of our strong operating earnings growth. On a GAAP basis, we reported net income available to common shareholders of $1.4 or $0.18 cents in earnings per diluted share. This includes a goodwill impairment charge resulting from the sale of our Los Angeles based fixed income team, which I'll talk about more later in the call. Excluding this charge, we recorded adjusted EPS of $0.33 cents. This represents a 57% increase in EPS from the previous quarter and a 313% increase from the second quarter of 2018. We continue to generate goodwill -- to generate good balance sheet growth as our gross loans increased 3.5% annualized rate in the second quarter and we're 11.4% higher year-over-year. We continue to have a strong loan production but overall loan growth in the quarter was impacted by a significant increase in pay off and pay downs, which were almost twice as high as they were in the prior quarter. On the deposit side, we continue to see good inflows. Our total deposits rose at 11.1% annualized rate during the quarter and were with 19.1% higher year-over-year. Across the board, we saw positive trends in our key operating metrics. Our efficiency ratio continues to improve as we scale the business and drive revenue growth. We saw a nice expansion in our net interest margin as we redeployed the liquidity from the strong deposit growth we've had over the past few quarters. And we saw strong improvement in credit quality driven by significant reduction in substandard rated assets. Our strong operating performance is driving significant improvement in the value of franchise. Over the past year, tangible book value per share, has increased nearly 35%. Outside of our operating performance, we recently took a couple of strategic actions designed to enhance shareholder value. The first, was authorization of a stock repurchase program that allows us to repurchase up to 300,000 shares of our common stock. Another action we took recently was the sale of our Los Angeles based fixed income team, which I'll talk more about later. Given the decline in our stock price since the IPO, we believe that the market is not accurately valuing the company and the strong opportunities that we've continued as we continue to grow revenue and earnings in the future. Accordingly, we believe repurchasing our shares at these levels is an attractive long-term investment of the company and will provide us with another catalyst for creating shareholder value. Moving to Slide 4; we provide additional detail on our second quarter earnings. Our strong improvement in earnings was driven by higher revenue and well controlled expenses. Revenue grew more than 10% from the previous quarter while core expenses were relatively flat, resulting in continued improvement in our efficiency ratio. On an adjusted basis, excluding the goodwill impairment charge, our earnings per share were up 57% from the prior quarter and up 313% from the prior year. Turning to Slide 5; we look at trends In our loan portfolio. Our loan production could need to be strong in Q2 with $52.6 million in new loan originations during the second quarter. Compared to the second quarter of last year, our loan production was up 26%, which speaks to the increasing traction we have in our business development platform. We continue to see good diversification across our loan production. This quarter the strongest growth occurred in our residential mortgage portfolio and loan secured by cash, securities and other assets. With respect to residential mortgages, we saw a pickup in demand for both new purchases and refinancings. Given the seasonal strength, strong housing market here in Colorado and additional mortgage officers that we've had over the past year, we were well-positioned to capitalize on this increase in demand. Our average loans were up 16% annualized to the second quarter where our year-end -- into the period loans were up 3.5% annualized. And in the period loan growth was impacted by a significant increase in payoffs and pay downs, much of which occurred late in the quarter. We had $44.7 million in total payoffs and pay downs in the quarter up from $24.5 million last quarter. While the higher payoffs and pay downs represented a headwind for loan growth this quarter, quite a bit of a pay down activity was related to production in substandard loans. So we also saw a nice improvement in the overall quality of our portfolio. Continuing on to Slide 6; we'll take a closer look at deposits. Our period in total deposits topped $1 billion for the first time ever, which was an increase of about $27.1 million from the prior quarter. We saw the strongest growth in new deposit accounts, which was attributable to high -- new high network client relationships, particularly the Denver market. Unlike trust deposits, which have been a driver of much of our deposit growth in the prior two quarters, new accounts are lower cost deposits so this was a positive development in terms of our efforts to manage our cost of funds. Turning to trust in investor management on Slide 7; our assets under management increased this quarter by $187 million to $5.97 billion just under $6 billion. Positive performance in the U.S. equity market accounted for some of the improvement while new accounts contributed $162 million in the second quarter. The new assets being brought in through our business development efforts as far exceeded outflows from client departures this year. Through the first six months of the year, we added $214 million new client assets compared to $87 million lost due to closed accounts. The one variable that has served as a headwind to AUM growth this year has been withdrawals from existing accounts. We had $376 million withdrawals in the first six months of the year, which is quite a bit higher than the same period last year. This is a largely uncontrollable factor in our business as clients will invariably have needs for their cash. But as the increase in withdrawals we've seen this year's match some of the success we've seen in new acquisitions. Now, I'll turn the call over to Julie for further discussion of our financial results. Julie?

Thanks, Scott. I'll begin with Slide 8 and First Western's revenue trends. Gross revenue at $16.5 million was at 10.7% from the previous quarter, given in large part by the robust market activity that Scott discussed and the resulting increase in non-interest income. With a strong quarter of the income, our total revenue mix was split nearly 50-50 between spread income and fee income. Moving to Slide 9; we'll take a closer look at the net interest income and the margins. Our net interest income was consistent with the prior quarter, while our net interest margin improved by seven basis points during the quarter to 3.10%. Increase in NM was primarily due to higher average loan yields, which increased seven basis points to 4.53% and a favorable shift in our mix of earning assets as we reinvested some of that deposit inflows from last quarter into our loan portfolio. These factors more than offset a seven basis point increase in our process funds to 1.30%. Looking ahead, our balance sheet is fairly neutral in terms of asset-liability sensitivity at this point. As such in a declining interest rate scenario, we expect our NM to be relatively stable. However, we continue to have opportunities to improve the mix in our earning assets, which should have a positive impact on our margins. Moving to Slide 10; we'll take a look at non-interest income. Our total non-interest income increased 23.1% from the prior quarter. Due primarily to an increase in gain on mortgage loans sold. We sold $138.3 million in mortgage loans for a gain of $3.3 million in the second quarter. This is compared to $67.1 million sold for a gain of $1.5 million in the prior quarter. Relative to the first quarter of 2019, our volume of new purchase origination approximately doubled while refinancing increased 59%. As a result, our mix of mortgage production went up to 70% of new purchases compared to 65% from last quarter. Trust and investment management fees were up slightly from the prior quarter and total of nearly $4.7 million. Turning to Slide 11 and our expenses; total non-interest expense increased 16.3% from the prior quarter, primarily due to the $1.6 million goodwill impairment loss that Scott discussed earlier. Excluding that charged non-interest expense increased slightly, primarily due to higher legal fees related to the cell of the LA fixed income team and our 2019 proxy filing higher oddities related to internal controls and seasonal implementation as well as additional spend on marketing activities, corresponding with the full staffing of our marketing team in the first half of the year. We continue to realize good operating leverage as our revenues grow. This resulted in our efficiency ratio improving to 78.2% in the second quarter from 83.2% last quarter. With the practice Island completed and the bulk of the legal expenses relating to the sale of the fixed income team already incurred, we expect to see some decline of legal expense over the second half of the year. However, we continue to invest in marketing activities and business development personnel to further drive revenue growth. As a result, we expect our operating expenses to be flat to slightly higher and the third quarter and then reduced in the fourth quarter relative to the reduction in the capital management segment expenses. Moving on the Slide 12 in asset quality; our non-performing assets the client has $13.5 million, or 1.13% of total assets at the end of the second quarter. Down from $19.4 million or 1.69% of total assets for the previous quarter. The primary driver for the decline was paid down by non-performing loans. During the second quarter, we received approximately $6.3 million in pay downs on non-performing loans. We also receive approximately $8 million in pay downs on other substandard loans, which further improves the quality of our portfolio. We continue to experience very low levels of credit losses, and in fact, had net recoveries for the second quarter of $8000. As a result of the net recoveries and the decline in problem loans, we recorded our recovery, a provision for loan losses of $78,000 in the second quarter. I'll turn the call back over to Scott now.

Okay. Thanks, Julie. Continuing on Slide 13; I want to provide some more information on the agreement we reached seller at Los Angeles based fixed income team, which is a component of our capital management segment. This is a team we acquired 11 years ago and allowed to operate on a relative standalone basis. It pretty strong investment performance, but its impact on our business from a profit standpoint didn't meet our expectations so we continue to look for opportunities to optimize our cost structure and invest platform. We identified a very attractive option to sell this team to legal advisors and operate capital management to related companies. The agreement we reached will still provide bank clients with full access to the team through advisory and sub-advisory relationships so they'll be no impact on our clients and $300 billion and legacy client assets under management will transition to legal advisors. By selling the team we can free up capital and management resources that can be used to strengthen our core, wealth management and private banking business. We'll see a decline in assets under management about $300 million related to sale, but we don't expect there to be any meaningful ongoing impact to earning from their sale as the revenue decrease will approximately be in line with the expected expense reduction. If there is any impact on earnings, it should be a slightly positive one. The sale resulted in a revaluation of goodwill and resulted in a $1.6 million good goodwill impairment charge reported in the second quarter. Once the sales complete in the third quarter, we expect to recognize the positive impact for tangible common equity ranging from $3.3 million to 3.9 million. Moving on to Slide 14; I'll discuss our outlook for the remaining portion of 2019. This year is pretty much tracked in line with our expectations so far. Investors we meet in our business development platform are producing good results and we expect to continually attract new clients to the bank. This should lead the continue bouncy growth and fee income growth, resulting in a strong second half of the year. Our pipeline in the mortgage business remains very healthy, so we expect this business to continue to make strong contributions to our revenue and earnings over the remaining portion of the year. As we've previously communicated, the operating leverage within our model provides opportunity for continued earnings growth and we continue to deliver on that expectation. Our revenue of growth is exceeding our expense growth, and we expect to see continued improvement and operating efficiencies, even if we continue to make investments to further enhance our business development capabilities. One initiative we're particularly excited about is our interest into the Vail Valley Market. We recently hired a market president to focus on the Vail Valley. This market has similar demographics to a number of our most successful markets and we expect it will be a significant contributor to our continued growth in the coming years. Michael Glass, our new Vail Valley Market president has led two of the largest banking offices in Vail Valley and we believe he'll be very successful in marketing our unique value propositions of the broad network of high net worth clients he's worked with in the community over the past 20 years. Finally, we intend to be active in our new share repurchase program. Combined with a strong operating performance, we believe that we purchase programs that serve as a positive catalyst for the stock price and create value for shareholders. With that, we're happy to take your questions. After now Gerald please open up the calls.

[Operator Instructions] Our first question comes from Gordon McGuire with Stephen Zink. Your line is now open.

Good morning. Julie, maybe just to start your commentary about the name kind of being neutral, some more flattish if we get any fed moves in the coming quarters. I guess I was a little bit surprised that you wouldn't be a little bit more liability sensitive just given the deposit data you've seen the past few quarters. Can you kind of walk us through how you would expect maybe the assets and the liabilities to reprise to kind of target that kind of flattish impact?

Yes, I can. You know, it depends a little bit on how much of the federate test we think we can successfully pass along and we do think that we'll have some level of success there. We have about $230 million in deposits that we think are about 100% data. So we expect those to move. We have another $300 million in deposits that are subject to 100% data but may already you know, there's discretion and whether or not we move and how much we move those rates. So we feel like we'll be successful in that it's just we don't know exactly how much of it we'll be able to move. We'll definitely see some level of reduction in the deposit costs with the rate cut, but just to the degree that we think that they will drop will be dependent on how much they can pass through those discretionary accounts, which is a little bit difficult to say at this time. On the loan side of the house, we've got about 30% of our loan book but it is variable, 30% is at a fixed rate; so we feel like we're in a pretty good position there from the loan side.

That's pretty helpful. Scott, I think last quarter you had mentioned, trying to get the organization a little bit more focused on -- within the AUM and more focused on fees rather than just AUM. I'm wondering how much traction you're getting that with your people and just trying to think about with the margin continuing to compress this quarter, if there's any kind of line of sight into when we might get to see some stabilization in that.

Well, I can tell you in incentive plans that we have in place. They're all oriented towards revenue dollars and not AUM dollars. So I know there's plenty of focus on that around the organization and I think we've got them focused in place. I don't think we're seeing any margin compression in any of our lines of business. We've talked before about that the trick in our business is if you see more growth in a lower margin area, it looks like the fees would be declining. But you're not actually seeing declining fees, you're seeing a shift in the business. So we've also talked before about relatively small business like this, a small change can show up in the quarterly numbers in a larger way. I'm not concerned about fee pressure in our wealth business. We're not seeing that on the trust and investment management side. We did talk a little bit in the presentation today about the new business that we're gaining and that's largely a full fee business and so I think we're going to continue to see a good momentum in that second half of the year.

Okay. And then just on the mortgage. I think you characterize the pipeline and the activity there is still pretty healthy. I was wondering if there is any way you can size that up? Just given the strong quarter, I guess I'm a little skeptical that it's repeatable but I'd just like to hear any color on whether you think this is kind of a good run rate outside of any kind of seasonality.

Well, I can tell you we spent a lot of time and effort building a team there that can produce at a higher level than what they've produced historically. And I think we saw a good evidence of that in the second quarter that things are going to -- you know, we saw relatively low demand last year across the industry and certainly it impacted us and this year we're seeing stronger demand and that's -- we're benefiting from that. I think the markets that we're in continue to have a very strong housing market. There's a lot of immigration, we're seeing very active real estate markets. So we think that this should continue as long as the cycle continues, whether it's going to continue at the same level we saw in Q2 or not or if it'll be a little higher or a little lower, but we're not expecting a dramatic change in Q3. We'll slowdown in Q4 and Q1, we've talked about our initiatives in Arizona to try to offset that season.

Got it, good. Sounds like there wasn't anything I guess unusual in the second quarter that maybe wasn't repeatable. That's good. Maybe last thing for me. Just do you have what the fee and expense impacts for the Los Angeles team sale would be? Just trying to think about how it fits in my model.

Would you like to answer that?

Yes. The revenues on that business that we will be selling off. So a little bit tricky. We have 300 million of AUM that will decline but there's more AUM that is being serviced by that L.A. team that is reported at the bank level because there's a sub advisory relationship. So the total revenues are about 500,000 but there's about 530,000 recurring expenses that go with it as well. So that's why we're talking neutral impact to the earnings out the deal calls for us to have an earn out included in that. So that will all be baked into the final closing entries that we expect to do upon closing of the deal.

All right, thank you. It's all I had and congrats on a good quarter.

Thanks, Gordon.

Thank you. [Operator Instructions]. Our next question comes from Ross Haberman with our RLH Investments. Your line is now open.

Good morning, Scott. Scott, how've you been? Quick question on the efficiency ratio. The 78%. I think in the final slide, you said there was room for improvement there. Could you be a little more specific? And do you have a goal over the next -- I don't know, two or three years, what you can get that 78% number down to? Please.

Thank you for that question. We have said since the IPO that we believe that we did get our financial metrics in line with our peers and we know that high fee banks tend to have higher efficiency ratios and higher operating costs than a typical community bank. So you know it would be wonderful to have a bank where the efficiency ratio is at 50 or 60% but I don't think that's realistic in a high fee bank like First Western. And the fact that the high fee banks that we compare ourselves to, we are at the top of the range in terms of fees. We're almost 52% in non-interest income in Q2. So I don't think we're ever going to get there, but for the medium term, we've talked about getting to 70% efficiency ratio. Which I think is achievable, and is something we're working towards. And I think the fact that we're done in almost 10% in efficiency ratio since our IPO a year ago is showing really strong progress towards that goal.

Could you get there within? I don't know, two years or would that be an optimistic projection? Specifically, I guess, if you open up any additional branches.

Yes. Well, that's a good question. I mean, it just depends on whether our growth is all organic, or whether we're expanding or whether we're able to do some acquisitions course. In the history of First Western, we've now done 10 acquisitions and those things can be nice support to creating critical mass for a low-efficiency ratio but first, we got to get the stock price in line and continue to sell improved operating performance and that's really our focus for the short-term.

And just one clerical numbers question. If I'm using the gain for next quarter that you expect to book upon the sale, let's just use $3.5 million that would add, if my math is right, roughly about $0.45 to your tangible book. All things being equal next quarter, is that about right?

So it's not a gain on sale, it's a reduction in goodwill. We've got on the books prior to the second quarter; we had a point $8.8 million of goodwill on the books relating to our capital management segment, of which we wrote off $1.6 million. Our estimated valuation of the deal is about in the range of, you know, pretty much $3.6 million to $3.8 million for the value of the bill with the deal. So upon closure that would come out of our goodwill that remains on the book.

So but again, that would raise your tangible book, if my math is right 40 somewhat cents?

That's right.

Correct. Thanks, guys, the best of luck.

Thank you. And our next question comes from Woody Lay with KBW. Your line is open.

I wanted to touch on pay downs real fast, so they were elevated on the sub-standard portfolio, but I was wondering sort of how they were on the healthy portfolio outside of that?

Good morning, Woody. Julie, can you speak to that?

So we, as you noted that and we've talked about on the call here have kind of reduced our sub-standard if you will loan by $13 million. So the rest of it was in a portfolio which was a little elevated from where we were in the first quarter. But not outside the range of what we've seen over the course of kind of a having flow over quarters over the last 12 to 24 months.

Got it. That's helpful. And then last form me; it's great to hear you all want to be active on the buybacks front. Could you just give us some color on where you sort of feel comfortable taking your TCE range down to as you are active with 5x?

I couldn't hear the heart of the question. The target range for the what? What's that Woody?

Sort of where you all feel comfortable taking the TCE range down to you are active with 5X.

Yes. So just generally on that, we do have 10b5 plan in place so we do want to have the ability to be consistently in the market, to the extent that the opportunity presents itself in terms of target ratios. Julie, you want to speak to the target TCE ratio?

So and I think we've been pretty consistent in how we've run capital at the bank and still comfortable with where our growth is and what our earnings projections are against what we have announced as our full buyback program over the next 12 months. So I think we'll likely be lower in TCE on our capital ratios that we would typically run this pretty efficiently and feel pretty comfortable with where they're at.

All right, that's helpful. Thank you.

Thank you. I'm not showing any further questions at this time. I would now like to turn the call back over to management for any closing remarks.

Okay. I'll just like to thank everybody for taking the time to dial in this morning. We sure appreciate your interest in First Western and your support. We look forward to speaking with you all again next quarter.

Ladies and gentlemen, thank you for participating in today's conference. This thus concludes today's program and you may all disconnect. Everyone have a wonderful day.