Earnings Labs

First Western Financial, Inc. (MYFW)

Q2 2020 Earnings Call· Fri, Jul 24, 2020

$27.85

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Transcript

Operator

Operator

Good day, ladies and gentlemen, and welcome to the First Western Financial Q2 2020 Earnings Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to turn the conference over to your host, Mr. Tony Rossi, Financial Profiles.

Tony Rossi

Analyst

Thank you, Katrina. Good morning, everyone, and thank you for joining us today for First Western Financial's Second Quarter 2020 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. 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, including the impact of the COVID-19 pandemic. Various factors could cause actual results to be materially different from any future results expressed or implied by such forward-looking statements. These factors are discussed in the company's SEC filings, which are available on the company's website. I would also direct you to read the disclaimers in our earnings release and investor presentation. The company disclaims any obligation to update any forward-looking statements made during the call. Additionally, management may refer to non-GAAP measures, which are intended to supplement but not substitute for the most directly comparable GAAP measures. The press release available on the website contains the financial and other quantitative information to be discussed today as well as the reconciliation of the GAAP to non-GAAP measures. And with that, I'd like to turn the call over to Scott. Scott?

Scott Wylie

Analyst

All right. Thanks, Tony, and good morning, everybody. Before we get into the discussion of our second quarter results, I'd like to take a moment to thank all our colleagues at First Western for their extraordinary efforts during this challenging time. Throughout this crisis, we've been able to maintain exceptional customer service levels and continue the strong momentum we have in our business development efforts. It's a testament to the culture that we built here at First Western, and I'm extremely proud of the way our team consistently finds ways to overcome obstacles and deliver for all our stakeholders. And now turning to our results. In our IPO 2 years ago, we said that we thought we were at an earnings inflection point where the operating leverage built into our business model could produce strong earnings gains, which played out in 2019 and has accelerated year-to-date in 2020. In the second quarter, we generated net income of $8.7 million or $1.10 in earnings per share, which represents a record level of profits for the company. It was an exceptional quarter and one that reflects the inherent advantages that we have in managing through the impact of COVID-19 pandemic. From a defensive standpoint, unlike a lot of banks our size, we don't do much small business lending, where it appears the pandemic is having the greatest impact. And we have minimal exposure to more stressed industries, such as hotels and restaurants. We also underwrite our loans with conservative criteria that requires low LTVs, high debt service coverage ratios and personal guarantees in many cases. Our client base consists of a lot of knowledge-based companies and workers, meaning they've been able to shift to a work-at-home environment without much disruption to their business. Accordingly, we continue to see relatively normal levels of…

Julie Courkamp

Analyst

Thank you, Scott. Turning to Slide 9. We have summarized our participation in the PPP program and included its impact on various lines, line items and metrics in the second quarter. We originated $191.7 million of loans and added 281 new relationships through this process. We have earned a total of $5.7 million in fees from the SBA and are amortizing both the loan fees and the loan origination expense over the 24-month expected life of these loans. Should these loans be forgiven at an earlier time, then we will accelerate the recognition of the associated fees and expense. In addition to the impact on our loan balances, we estimate that at June 30, we had $62.4 million in PPP-related deposit balances. We also had $204.3 million in borrowings from the PPP liquidity facility that were used to fund the PPP loan. These loans contributed approximately $600,000 of net interest income this quarter. Backing out the impact of the interest income and interest expense associated with the PPP program, our net interest margin would have improved to 3.22% in the second quarter. We had $2.9 million of deferred loan origination expense related to PPP loans, which served to reduce our salaries and benefits expense this quarter. As I mentioned earlier, this expense will be recognized over the 24-month expected life of the loans or on an accelerated basis, if the loans are forgiven. The net income remaining to be recognized is $2.4 million related to PPP fees from the SBA less origination expense. Turning over to Slide 10. We'll look at our gross revenue. As Scott mentioned, we had an exceptional quarter of revenue growth, with increases coming in both net interest income and noninterest income. Turning to Slide 11. We'll look at the details behind that revenue growth and…

Scott Wylie

Analyst

All right. Thanks, Julie. Turning to Slide 19. I wanted to provide some comments about our near-term outlook. While the ongoing pandemic creates a great deal of uncertainty, we believe we're well positioned to see a continuation of our strong performance in the second half of the year. Our asset quality remains strong, and we have a healthy loan pipeline that should continue to drive organic loan growth in the next couple of quarters. Mortgage demand remains strong which should lead to another good quarter of mortgage production and gain on sale income in the third quarter. As Julie mentioned, we expect to see some expansion in our net interest margin, and our AUM is trending higher as the market recovers from the depths of the pandemic. So we should see positive trends in trust and investment management income as well. We are on track to start realizing the final synergies from the branch acquisition, and the combination of all these factors should result in a strong level of earnings in the second half of the year, further increases in our tangible book value per share and additional value being created for our shareholders. With that, we're happy to take your questions. Katrina, can you open up the call, please?

Operator

Operator

[Operator Instructions] We do have a question from Brady Gailey of KBW.

Brady Gailey

Analyst

So when you look at loan growth, even excluding the Simmons deal and the PPP, it's still a big number for you guys, $66 million. Maybe just expand a little bit on where that came from? And maybe just a little more color on how you're thinking about kind of core loan growth for the balance of the year and then into next year?

Scott Wylie

Analyst

Yes. It's interesting, Brady. In the Great Recession, 10 or 12 years ago, it really felt like our clients went and hit under a rock for 2 or 3 years, and we really saw a very cautious approach to getting through the recession. Here, we're seeing something really different where people have just shifted their location where they're doing their work, and they continue to do things. A lot of them feel like this is a time of opportunity from that last long recovery, and they feel like they can and should keep going and doing things. So we've seen continued demand. In fact, I would say we've seen accelerated demand, which has led to these good balance sheet growth numbers that we saw. I think your comment is right on in terms of -- to understand this financial performance, you need to break out the organic growth and the impact of PPP and the Simmons branch acquisition. The interesting thing about the organic and the Simmons pieces will, of course, continue on. But PPP, maybe that $200 million all goes away in forgiveness in the second half of the year. But we've seen all these new client opportunities and new clients that have come in through PPP that I think are going to continue to create organic growth opportunities for us in the second half of the year.

Brady Gailey

Analyst

Okay. Great. Next I'd like to ask about the provision. I mean it ticked up here in the second quarter. The reserves now on an adjusted basis, 93 basis points. How do you think about how the provision will trend from here? I mean, I know with you guys not being a CECL adopter yet, it's different than most. But should we expect the provision to continue to remain elevated in the back half of the year similar to what we saw in 2Q?

Scott Wylie

Analyst

Well, Julie, let me take a stab at that, and then you can provide some more color, please. We haven't seen really any signs of credit deterioration, both when you look at across the portfolio or at the micro level. And this is in spite of increased monitoring and tighter interaction between the lenders and our clients. So we haven't had a reason to put more into the reserve other than our general concern that Julie mentioned in her comments about the deteriorated economic conditions. So we increased for that, and then we put in a significant reserve related to the COVID modifications. Again, not because we see a concern, but just to be conservative on that. I would think that we're going to look to continue to build the reserve in the second half of the year. But we really have to wait and see how the credit trends, the economic trends and the COVID deferral trends unfold. [indiscernible] you would add to that, Julie?

Julie Courkamp

Analyst

I think you've covered most of it. We're just very closely monitoring the economic trends in all of our major markets. We're doing deep dives that Scott mentioned in his remarks, on the credit portfolio and in specifics at COVID mods and/or the higher-impact areas from COVID-19, so that's all going to be driving our future allowance levels, and we'll kind of assess that as things change and/or as we get more information in that area.

Brady Gailey

Analyst

Okay. My next question is on capital. With all the growth we saw from the acquisition and from PPP, I mean, your TCE ratio is a little thin at 6.3%. Is that -- any thoughts just on your capital base? And is raising some form of noncommon capital something you guys would consider at this point?

Scott Wylie

Analyst

Do you want to speak to this one, Julie?

Julie Courkamp

Analyst

Sure. So with the branch acquisition, we had anticipated that capital levels would reduce. We added additional assets corresponding with that closure as well as just the growth that you've been noting, Brady, in the balance sheet. So we also expect that the additional earnings coming from that acquisition, along with the strength in the earnings of the bank will be building our capital levels in the second half of the year. We've completed that sub-debt raise in the first quarter of $8 million, and we injected capital into the bank relating to that and the branch acquisition. I think we've consistently said that we thought we had enough capital -- adequate capital to get through 2020. And if we continue to see growth in the balance sheet at the current levels, depending on the impact of the recession and all the other unknowns, I think that we believe this is still true. So anything else you want to add in?

Scott Wylie

Analyst

Well, I think also, when we look at the capital ratios, we're backing out the PPP loans because we're not required to hold capital for them. We funded 100% of them through the small -- the PP...

Julie Courkamp

Analyst

PPPLF.

Scott Wylie

Analyst

PPPLF. Thank you. Yes. I wasn't sure how many Ps were in that one. And so for balance sheet purposes, that's not additional leverage we have to cover.

Brady Gailey

Analyst

All right. And then finally from me. I saw the SEC settlement for $200,000. Anything to be concerned about there or any other impact there outside of the financial impact?

Scott Wylie

Analyst

We don't think so. This was an issue that we discovered in 2017, we assessed the client impact and determined there wasn't any net client impact on the accounts. And then subsequent to that, we've replaced the leadership and the compliance team that was there at the time. The SEC did a routine examination in late 2019 and saw that and raised it as an issue, and it was concluded with the settlement here a couple of weeks ago.

Operator

Operator

[Operator Instructions] Next question, we have Gordon McGuire from Stephens.

Gordon McGuire

Analyst

Congratulations on the quarter. Julie, I may have missed your comment. Did you give spot deposit rates for end of June?

Julie Courkamp

Analyst

It did not give spot deposit rates, but I can. The spot deposit rate was 30 basis points or 32 basis points, excluding PPP deposits. So if you're trying to compare that to what our March spot deposit rate was, it was at 0.48%, 48 basis points.

Gordon McGuire

Analyst

And can you help us think about the cadence of the deposit costs? I guess, beyond the third quarter, how far do you think you can bring them lower?

Julie Courkamp

Analyst

Well, I think from a current balance sheet perspective, again, excluding PPP deposits that our June spot rate is a pretty good indicator, but that was still trending down, as you can see from the numbers I just gave you from the beginning of the quarter. So I think we should still see a slight decline in our cost of deposits in the third quarter just as that levels out quarter-over-quarter.

Gordon McGuire

Analyst

Okay. And do you have what yield the acquired loan portfolio came over? I'm curious if there's any kind of benefit or yield differential that I need to think about for the next quarter?

Julie Courkamp

Analyst

Sure. So when we look at our kind of core, excluding purchased, loan yields in the second quarter, those were about 3.38%. The acquisition acquired loans had an average rate of 4.09%, so a little bit higher than our core book. And then excluding PPP loans, they were at 4.45%. So I think it will give us a little bit of a boost in -- on that, the yield on loans, excuse me.

Gordon McGuire

Analyst

And then did I get it right, $15.3 million to $15.7 million expenses post consolidation?

Julie Courkamp

Analyst

Yes, you did.

Gordon McGuire

Analyst

What does that assume for mortgage and commission levels?

Julie Courkamp

Analyst

Well, our mortgage commissions are held within our revenue line of net gain on mortgage sales that comes out of there. And it does have a little bit of growth in the mortgage area for operations, salaried individuals, but not significant.

Operator

Operator

Next question, we have Ross Haberman from RLH Investments.

Ross Haberman

Analyst

Could you talk about the margin on the sale of loans? What are you seeing there? Any trends? Is it coming down what it was compared to, say, 3 or 6 months ago and change?

Scott Wylie

Analyst

Sure. So this is a great question. We talked in the Q1 release about the disconnect that happened from mid-March until early April between the mortgage market -- the secondary market sales pricing and the asset-backed -- the mortgage-backed market that we use for hedging. So our loan position in the mortgages that we had in March on the books disconnected from the hedge position that we were short, that was, as we talked about then, caused by the 150 emergency rate cut that the Fed did in mid-March, and then significant purchases that the Fed made. And so we had a $4 million loss in Q1 that -- in just mortgages. We think we recovered about $2 million of that. It's complicated between the different pricing, but I think we recovered about $2 million of that $4 million in Q2. So it's interesting. If you look at our earnings story, and if that disconnect had not happened at the end of March, then we'd have $4 million more in pretax earnings in Q1, perhaps $2 million less in pretax earnings in Q2. Having said that, we have seen margins recover to normal levels and, in fact, improved. We've been able to improve our margins in Q2 on the mortgages sold.

Ross Haberman

Analyst

And just are you keeping any of those loans? Or are you selling all of them basically?

Scott Wylie

Analyst

We've been consistently working to keep mortgages that are a good fit for us from a client standpoint, and then we'll sell the great majority of them. Do you have the data, Julie, in Q2?

Julie Courkamp

Analyst

In quarter 2, we originated for sale $344 million and $37 million for the portfolio.

Ross Haberman

Analyst

And just one final question. That West Coast money management business that you were going to sell a quarter or 2 ago, what's the status of that today and going forward?

Scott Wylie

Analyst

Yes. So that's the fixed income portion of First Western Capital management, and we have not completed that transaction yet. We are looking to find a better home for them, and we'll continue to work on that.

Operator

Operator

Next question, we have Kevin Swanson from Hovde Group.

Kevin Swanson

Analyst

Within the acquired portfolio, do you anticipate any runoff there or derisking of that portfolio?

Scott Wylie

Analyst

So from May 15 to June 30, we actually saw some growth in both the loan and deposit side of that acquisition. So initial runoff hasn't really been a problem so far. The next challenge will be when we close 2 of the 3 branches. We have been able to retain the key client service people from the legacy Simmons team and, in fact, put them into positions where we think they're going to be really productive for First Western. So I would say on the loan side, we expect to have really good retention and, in fact, good growth from that team going forward. On the deposit side, I think there's likely to be some runoff of small deposits because of Simmons, they had more of a retail deposit composition than what First Western has. And I think just moving the locations, there'll be some breakage there, but I don't expect it to be material in terms of overall numbers or profitability.

Kevin Swanson

Analyst

Great. And then across the industry, it seems like mortgage has performed quite well, but the result this quarter for you guys is something else entirely. Is there anything maybe broadly, or even specifically, you can kind of point to that was so successful this quarter? Or just -- was it kind of a combination of a bunch of moving parts? Just curious on how you kind of think that business performed and what you think the strengths were.

Scott Wylie

Analyst

Well, when we bought that 2.5 years ago now, we thought that there was an opportunity to strengthen their infrastructure and make it so that they could be -- handle more volume. And we talked about at a time making some considerable efforts in that area, which, obviously, paid off big time in the first half of this year. As I said a minute ago, I think it's a little misleading because of this hedge disconnect. I mean, the first quarter was very strong for us, just didn't show up because we had a $4 million loss embedded in the gains in the first quarter. And the second quarter is a little bit overstated in the same way because there's a $2 million recovery that we wouldn't expect to get in a normal environment. And at the time, and I talked about this in the Q1 earnings call too, that our mortgage team was saying this is a once in a lifetime disruption in the market that they've never seen anything like it. And so I think that we're going to see a more normal performance going forward here. We think that the volumes are likely to continue at strong levels, perhaps not at the current level because of the refinancing portion of it. But we have very strong teams now. We continue to add strong MLOs. So I think that the core production for new money purchases is going to continue to be a strong business for us. I was talking to our Jackson Hole team this morning for a periodic review I do with them. And they're talking in these resort markets about all the folks moving to town out of the big urban markets, and we see that in each of our resort markets, we see it here in Denver, and we see it in our other front range in Arizona markets. All that feeds into the mortgage business as well as supporting the underlying organic growth of the company.

Operator

Operator

This concludes our question-and-answer session. I would now like to turn the call back to management for any closing remarks.

Scott Wylie

Analyst

Okay. Well, thank you, everybody, for dialing in. As I said at the beginning of the call today, we had, in our initial public offering, said that we thought there was a real earnings inflection coming, and it's great to see that playing out here into 2020. We've made a number of investments over the past 12 months. We just talked about the mortgage one. The PPP cross-sales opportunity is going to be very strong in the second half of the year. We've added several new offices that are expenses for us that are just maturing now into being contributors. That includes the new Broomfield office, the new Loan Tree office, Vail, Aspen and now our new RiNo, River North, Denver office. I think that with all that, we continue to see opportunity to upgrade our products and services and the skills of our team. We're launching a big First Western Way Sales Training next week to retrain all of our people in a specific sales methodology that we use here. We just got, earlier this week, our new Net Promoter Score from our clients, which continues to be in the mid-80s, which is an extraordinary score for a financial institution, and we've launched a new Trust Where You Bank campaign highlighting the difference between a community-oriented bank like First Western and some of our giant competitors that we compete with day in and day out. So we're optimistic that we can continue with strong results like we posted this quarter and year-to-date. And I sure appreciate the interest and support of all of you. Thanks, and have a great day.

Operator

Operator

Ladies and gentlemen, this concludes today's conference. Thank you for your participation, and have a wonderful day. You may all disconnect.