First Western Financial, Inc. (MYFW) Q3 2020 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by, and welcome to the First Western Financial Q3 2020 earnings conference call. [Operator Instructions] Please be advised, today's conference is being recorded. [Operator Instructions] I would now like to turn the conference over to your speaker, Tony Rossi, please go ahead.

Thank you, Sydney. Good morning everyone, and thank you for joining us today for First Western Financial's Third 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?

Okay. Thanks, Tony. And good morning, everybody. We're very pleased with our performance this quarter as we continue to deliver record earnings despite the ongoing impact of COVID-19 pandemic. We continue to execute on the vision that we that we communicated at the time of our IPO in 2018. We're a unique wealth manager built on a private bank platform that was emerging at that time from a period of capital constraint. And we said we would realize strong operating leverage as we grew our balance sheet through both organic growth and acquisition. Investments we've made in both banking talent and technology are having the positive impact we expected on new business development, resulting in the consistent addition of new clients as we take market share and drive growth in both net interest income and noninterest income. In the third quarter, our gross revenue increased 18% from the prior quarter, resulting in a $9.6 million in net income or $1.20 in earnings per share, both record levels of profitability for the company. We had another very strong quarter of mortgage activity, but outside that area, we're seeing positive contributions across the rest of our operations. Our established offices continue to gain scale and improved profitability for bringing in new clients and ramping up quickly in new markets such as Vail Valley and Broomfield. One of our goals entering this year has been to build the First Western brand, which we have supported with increased marketing and sales investment, and it's clearly paying dividends. Our marketing efforts are generating more leads. And with the compelling value proposition that we offer, we are having a great deal of success in converting those leads into new client relationships. Another goal this year, which we talked about on our earnings call in January, was the implementation of our commercial banking initiative that was designed to grow our commercial client base, shift our loan portfolio towards more C&I and commercial real estate loans, and add low-cost transaction deposits. The emergence of the COVID-19 pandemic slowed us down a bit, but over the last 2 quarters, we've seen really positive results from this initiative, particularly after the completion of our branch acquisition in May. One of the aspects of this transaction that we are particularly excited about was the opportunity in a number of experienced commercial bankers, including the former Colorado market president for Simmons, who's now heading up our commercial banking initiative. We're seeing very encouraging results so far. And the balance sheet growth that we saw in the fourth -- in the third quarter was largely due to the addition of new commercial relationships where we're getting both loans and deposits. From an offensive standpoint, the current environment has been very favorable for us in terms of growing our client roster and taking business away from larger competitors. At the same time from a defensive standpoint, in terms of managing through the impact of the pandemic, we continue to be well positioned and see good trends in asset quality. With a conservatively underwritten portfolio and very little exposure to industries that have been most impacted by the pandemic, we continue to project very low loss content in our portfolio. During the third quarter, our total active COVID loan modifications declined by 62% and at September 30 represented just 4% of our total loans. And our nonperforming loans declined by 14% from the end of the prior quarter. We continue to implement enhanced monitoring and portfolio reviews to ensure that we have a good understanding of how our borrowers are being impacted by the pandemic. For the most part, the information we're getting is very positive and indicates our clients have been able to make adjustments to adapt to the current environment and continue performing well. With that, let's move over to Slide 4, where we show a significant jump that we've seen this year in terms of our level of profitability. While clearly we're getting a bump this year from our mortgage activity, we're more focused on the balance sheet growth and the improving operating leverage that we've been able to generate. This underscores our success in creating a sustainable path to improving profitability and returns that will enable us to replace the earnings generated from mortgage activity when this refinancing boom inevitably runs its course. Turning to Slide 5. We'll look at the trends in the loan portfolio. Our total loans held for investment increased $83 million or 23.6% annualized from the end of the prior quarter. We had loan production of $142 million in the quarter, which was partially offset by $83 million in payoffs and paydowns. Most of the growth in the portfolio is due to the traction we're getting in our commercial banking initiative. The year-over-year trend shows the shift in our loan portfolio away from residential loans towards business related loans as a result of the branch acquisition, the relationships added through the PPP program, and the progress we're making with our commercial banking initiative. Compared to a year ago, mortgage loan -- residential mortgage loans have declined from 40% of total loans to 30% of total loans. Moving on Slide 6. We'll take a closer look at our deposit trends. Our total deposits increased $157 million or 44.4% annualized growth from the end of the prior quarter. The growth was almost entirely attributable to growth in commercial DDA relationships. The increase in DDA relationships has helped offset some of the runoff that we saw in PPP-related deposits as clients deployed those funds. As of September 30, we had just $29 million in PPP-related deposits remaining on our balance sheet. With the success we've had in adding commercial transaction accounts, we've seen significant improvement in our deposit mix, with noninterest-bearing deposits increasing to 30% of total deposits from 21% just a year ago. Turning to trust and investment management on Slide 7. Our total assets under management increased $379 million and returned above the $6 billion mark. The increase this quarter was primarily due to a combination of improved market conditions and additional contributions made to existing client accounts. Now I'll turn the call over to Julie for further discussion of our financial results. Julie?

Thanks, Scott. Good morning. Turning to Slide 8. We've provided an update on our participation in the PPP program and how it impacted various metrics in the third quarter. We had a net impact of $800,000 in the quarter relating to this program and have $2.1 million in fees remaining to be recognized. We have now started the process of assisting our clients in applying for forgiveness. And as of October 16, we had submitted $85.2 million to the -- of loans to the SBA for forgiveness and received approval on $2.1 million. We also have a total of $5.5 million in loans under $50,000 that have not yet been forgiven that will apply under the simplified process announced by the SBA. Turning to Slide 9. We'll look at our gross revenue. As Scott mentioned, we had a very strong quarter of revenue growth, with increases coming in both net interest income and noninterest income. On Slide 10, we look at the trends in net interest income and margin. Our net interest income increased $2.1 million or 19.7% from the prior quarter. The growth was due to an increase in average loan balances resulting from our organic loan growth. Our net interest margin declined 3 basis points to 3.07% primarily due to a declining yield in earning assets. This was primarily offset by an 11 basis point decline in our cost of deposits. However, when the impact of PPP loans and purchase accounting adjustments are excluded, our net interest margin increased by 1 basis point from the prior quarter. The significant deposit inflow we had in the quarter resulted in a buildup of liquidity, with our average cash and cash equivalents increasing by more than $100 million. Our net interest income should benefit from the redeployment of this excess liquidity into higher-yielding assets. However, we expect our net interest margin to remain flat in the near term. Our ability to deploy the excess liquidity further decreased deposit costs along with PPP forgiveness, should help to drive improvement in NIM in the longer term. Turning to Slide 11. Our noninterest income increased 16.9% from the prior quarter. The increase was primarily due to the record quarter of net gain on mortgage loans sold that we had. Aside from that impact, the general increase in economic activity and the addition of clients from the branch acquisition earlier this year are contributing to growth in our bank fees. On Slide 12, we've provided some additional detail on our mortgage operations. We had another record level of production in the quarter, with approximately $376 million of originations for sale and another $42 million originated for our own portfolio. Purchase demand was stronger during the quarter and increased to 41% of total originations, up from 27% last quarter. With the increased volume and improved mortgage sale margins, we continue to see a significant spike in the profitability of our mortgage operation. We generated $10.2 million in net income on revenue of $12.3 million in the second quarter. Turning to Slide 13 and our expenses. Our noninterest expense increased 31.5% from the prior quarter. The increase was primarily due to the deferred loan origination expense related to PPP loans that reduced our expense levels in the second quarter. The full quarter impact of the branches and personnel that were added in the branch acquisition, along with increase in incentive compensation and vendor costs due to the growth in the balance sheet, also contributed to the increase. With the balance sheet growth and mortgage activity generating a significant increase in revenue, we continue to see improvement in our efficiency ratio relative to the prior year. In the third quarter, our efficiency ratio was 53.4%, down from the 80% range that we have had during 2019. We also completed the branch consolidations from the Simmons transaction in August. Following these consolidations, we expect our quarterly run rate for noninterest expense to be in the range of $16.7 million to $16.9 million, excluding expenses or reductions relating to the sale of the LA fixed income team. Now turning to Slide 14, we'll look at our asset quality. We saw generally stable to improving trends across the portfolio in the third quarter. Our nonperforming assets decreased by $1.7 million and dropped to 53 basis points of total assets from 67 basis points at the end of the last quarter. Once again, we continue to see a very low level of losses in the portfolio and had minimal charge-offs this quarter. Turning to Slide 15. We recorded $1.5 million of provision expense in the third quarter, which primarily reflects the growth we had in the portfolio as well as the ongoing uncertainty presented by the COVID-19 pandemic. This increased our allowance to adjusted total loans to 1% when PPP loans and acquired loans are excluded. Turning to Slide 16. We have provided an update on our loan modifications. At September 30, we had 44 modified loans totaling $66.7 million, which represents a decline of 62% from the end of the prior quarter. Of this amount, only one loan, for $750,000, represents a second 90-day modification. We only had 2 new modification requests made during the third quarter. Given the lack of new modification requests and the trend of almost all borrowers being able to return to regular payment schedules following the expiration of their deferral period, we would expect our total modification to continue declining over the remainder of the year. Turning to Slide 17. We have some additional information on our loan modifications. We continue to remain in close contact with borrowers who have received a loan modification and received updated financial data on a regular basis. At this point, almost all of our remaining modifications are commercial loans. We continue to have very little exposure to the industries that have been most impacted by the pandemic, with our largest concentration of modified loans being in office properties in the commercial real estate portfolio. Now I will turn this call back over to Scott.

Okay. Thanks, Julie. Turning to Slide 18. I want to provide some comments about our near-term outlook. We expect the positive trends we're seeing to continue and drive strong earnings and further increases in our tangible book value. So far this year, we've added $2.23 to our tangible book value per share, which represents an increase of 17%. Outside of our operating performance, we have a couple of other items that will positively impact our tangible book value going forward. First, we'll continue to recognize fees we've earned through the PPP program. And second, as we announced last month, we've resolved the issues that prevented the closing of the sale of our LA fixed income team last year and have a new agreement in place. The sale should not have a significant impact on earnings, but it will have a positive impact on tangible common equity of $3 million to $3.3 million at the time of closing, which we expect before the end of the year. The collective impact of the PPP fees and the sale of the LA fixed income team will be another boost to our tangible book value. The significant increase in tangible book value per share we're generating illustrates our strong commitment to creating shareholder value. During a period of unprecedented stress on our economy, we've been able to strengthen our capital position without doing anything that's been diluted to shareholder value, either from an earnings or a tangible book value perspective. As a company with high insider ownership, you can be assured that our interests are highly aligned with shareholders, and we evaluate all decisions from the perspective of what will preserve and grow the long-term value of our franchise. Looking at other trends, we're remaining very diligent in staying in close contact with our borrowers through the duration of the pandemic. At this point, we aren't seeing anything that would point to any meaningful deterioration in asset quality. Starting in the fourth quarter, we'll also start to recognize the full impact of the synergies from the Q2 branch acquisition following the Q3 consolidation of those locations. We also expect our net interest income to benefit from the redeployment of this excess liquidity into higher-yielding assets. However, we expect net interest margin over the short-term to remain flat. And from a business development standpoint, we continue to have strong pipeline in both our residential mortgage and commercial banking areas. Going forward, we'd anticipate our commercial banking initiative to be a primary driver of additional balance sheet growth. In addition to the commercial bankers that we added from the branch acquisition, we're working on a number of other initiatives that will increase our ability to attract commercial clients to the bank. First, we're continuing to build expertise in niche industries. I mentioned earlier this year we hired a leader to develop commercial banking products and services, specifically for medical and dental practices. The pandemic slowed down the ramp-up of that initiative, but as things have opened back up, we're getting more traction in this area and see encouraging results. We intend to replicate this same model for other vertical markets as we move forward on this initiative. And following the processes we developed for participating in the PPP program, we're planning to remain active in SBA lending, which will expand the addressable market for our commercial banking team. And finally, we're actively participating in the main street lending program, which we believe will further add to our roster of commercial clients. The progress we're making this year on the commercial banking initiative has created a much more diversified business mix that should lead to consistently generating strong returns over the long term. And as we continue to gain scale through organic growth and additional strategic acquisitions, we believe that our model will solidify First Western as a high-performing financial institution and create significant value for our shareholders in the future. With that, we're happy to take your questions. Sydney, please go ahead and open up the call.

[Operator Instructions] Our first question comes from the line of Brady Gailey with KBW.

So loan growth was very robust in the quarter. I know you've done a lot, as you said, to add to the commercial banking team. Maybe just talk about expectations for loan growth going forward? I mean I'm guessing it's probably not going to be at this run rate, but what do you think would be an appropriate loan growth run rate for you guys over the next year or so?

Well, as you know, we've seen kind of 2 sides of loan growth at First Western. One is the gross loan growth, which has been strong, and then the net loan growth that comes after we see the payoff. So we've seen payoffs over the last 5 quarters in the $80 million range. Our production over the last 5 quarters or 4 quarters really more than the $140 million average range. So I think that with the infrastructure we have in place, we could expect that to continue at about that rate.

Okay, all right. And then when you guys talk about a flat net interest margin from here, maybe just talk about what base you're looking at? Is that the reported margin? Or is that excluding PPP or excluding accretable yield? What's the base that you're looking at when you say flat from here?

Sure. So I think our expectation is from our base level, so excluding PPP and accretion. We would expect it to kind of remain flat at that level.

So as PPP rolls off, we're going to see an increase in net interest margin...

Yes, net interest margin.

That's the reported, yes.

Yes, okay. All right. And then you've had such great growth this year, and you've made a lot of money from earnings. But if you look at the TCE ratio, that we've moved from 8.5% at year-end last year, down to about 6.3% TCE. So maybe just give us an update on your capital base, how you're thinking about it? And if you're -- if there's any upcoming plans related to your capital strategy?

Sure. Well, as you know, we raised a small amount of sub debt in the first quarter and certainly would look at some additional sub debt. Given where rates are today, I think that, that could be something attractive. The TCE gains that we booked this year were offset somewhat by the Simmons goodwill that we booked. And so in spite of that, the fact that we've earned 2 1/4 I think year-to-date in increased TCE bodes well for the future, I think, to the extent that we can continue to have the strong core earnings. And then we'll have to see what happens in mortgages in terms of this whole refi boom that we've seen. But I think our projections right now indicate that we can continue to grow our tangible book and TCE ratios at a pace that will support our balance sheet growth. And we're not anticipating a need for a common raise at this point.

Okay. And then finally with me, I mean as you're having more success on the commercial banking side from a growth perspective, as you said, mortgage loans have moved from about 40% of loans down to 30%. Should we expect to continue to see that mix shift happen further, so mortgage loans will continue to decline from the 30% level going forward?

I don't think so. I think that the mix that we're at now, at 40%, we were feeling like that was getting a little outsized. And I think at the -- in the range it is now that, that's more a comfortable range for us. So I wouldn't expect a further trend like that.

[Operator Instructions] Our next question comes from Ross Haberman with RLH Investments.

You've got a nice quarter again. Could you give us a sort of a sense of the general economic activity? How are things beginning to sort of unfold, I guess, or -- and the 2 new branches which you're talking about, Vail and the other one, at -- in this quarter, would you say they were marginal? And when do you think there'll be a net contributor to the bottom line?

Okay. Well, thank you for that 3-in-1 question, Ross.

Sorry.

Let's start with that -- no, no need to apologize. Let's start with the overall economic situation. We're very fortunate in our markets because I think we have a combination of a relatively high percentage of workforce that can work remotely and manage this pandemic without seeing a whole lot of economic disruption in their personal and financial lives. And so I think that, that's been a big factor for us in all the improvements that we've seen, continued improvements we've seen in basically every credit metric that we look at First Western. And we talked about that a little bit in the deck, in addition to the comments that we've made. I think the second factor that's really benefiting the economic situation in our markets, and particularly with respect to our business model, is this in-migration that we're seeing from the coast, not only into the front range and in Arizona, the urban markets, but in the resort markets we're seeing a very strong impact, too. And I think one of the interesting takeaways in our mortgage operation is in Q2. You saw a pretty extraordinary shift in our business mix where we were seeing a lot of refis. And so you wonder what goes -- what happens when all that goes away, as it always does? And I think Q3 is an interesting example. I mean it's really back almost to the mix that we had in Q3 of 2019, and yet our volumes are still almost 3x higher than they were a year ago. So I think the efforts we've made in mortgage and the investment we've made in mortgage, in infrastructure, and in additional MLOs and in the productivity of that team is really going to benefit our ability to produce just on the purchase side as we move back to a more traditional First Western mix of 75/25, something like that. So overall, I think the economic trends that we're seeing in our markets are complementary and benefiting our business model. With respect to your question about the new locations, I mean that's been a very interesting development for us this year. We thought that Vail would take a longer time to get traction than it has. It's taken off quite nicely. Frankly, I think that's benefited from this in migration that we've seen and all the activity in Vail. We've seen really a demand for residential housing up there that we haven't really seen in, I don't know, 20 years or something like that. And so being out in front of that and being part of that, with a team that's been in the Vail Valley for 20 years and been leading financial institutions up there, just really shows how nicely our business model plays out. Interesting in Broomfield, which is a suburban Denver location that's really about halfway between Denver and Boulder, and this is a market that we had targeted 1.5 years ago and we decided to try something new in that market, which is, essentially incubate the team that's opening in Broomfield in an existing location, which in this case was Boulder. And that has turned out to be a really nice success for us because we've built a nice business in Broomfield, and we haven't even finished our tenant improvement in our space in Broomfield yet. So the shop is up and running. The team's working nicely. We're building a nice revenue base for them, and they haven't even moved into their permanent space yet. So 2 really interesting success stories that we'll be able to build on with new locations, hopefully into 2021.

And just sorry, one final technical question. The gain on the sale this quarter from the LA asset management transaction, that $3 million to $3.3 million, is that a pretax or a post-tax number?

Yes. So Julie, you want to address the mechanics of that?

Sure. So that's going to just come out of our held-for-sale asset, which is effectively in our goodwill balances. So TCE just comes down by $3 million to $3.3 million. And that will occur in the fourth quarter when we close on that transaction.

So it doesn't run through the income statement, Ross. It runs through the balance sheet. And the big benefit there is additional TCE.

So it's an additional $3 million to $3.3 million added to the shareholders' equity without any tax implications, you're saying?

Correct.

Ladies and gentlemen, I'm not showing any further questions at this time. I would now like to turn the conference back to management for any closing remarks.

Sure. Thank you, Sydney. I just would like to thank everybody for joining us on the call today. We sure appreciate all the support. And look forward to speaking with you again next quarter, if not before. Thanks, everybody, stay safe.

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect. Everybody, have a good day.