First Western Financial, Inc. (NASDAQ:MYFW) Q2 2023 Earnings Call Transcript

First Western Financial, Inc. (NASDAQ:MYFW) Q2 2023 Earnings Call Transcript July 28, 2023

Operator: Good day, and thank you for standing by. Welcome to the First Western Financial Second Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today’s conference is being recorded. I would now like to turn the call over to your speaker for today. Tony Rossi, please go ahead.

Tony Rossi: Thank you, Lisa. Good morning, everyone, and thank you for joining us today for First Western Financial second quarter 2023 earnings call. Joining us from First Western’s management team are Scott Wylie, Chairman and Chief Executive Officer; and Julie Courkamp, Chief Financial and Chief Operating Officer. We’ll use the slide presentation as part of our discussion this morning. If you’ve not done so already, please visit the Events & 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. Scott?

Scott Wylie: Thanks, Tony, and good morning, everybody. Our second quarter performance reflects the strength of the franchise we’ve built as we continue to see good stability in our deposit base and healthy asset quality despite the challenging operating environment. As we indicated, we would do on our last earnings call, we continue to prioritize prudent risk management. From a core earnings perspective, we continue to deliver solid financial performance and generate $3.9 million in pretax pre-provision income. However, we had three items that significantly impacted our reported results this quarter. The first was a $1.2 million pre-tax impairment to the carrying value of contingent consideration assets, which relates to the sale of our Los Angeles Fixed Income Portfolio Management Team that we completed in 2020.

The second was a $1.1 million pretax loss on loans accounted for under the fair value option. And third, we recorded a $2 million allowance on an individually analyzed loan, which we expect to be non-recurring. Collectively, these items reduced our diluted earnings by about $0.32 after tax this quarter. Our balance sheet trends reflect the strength and stability of our franchise and client base, as well as the conservative approach that we’ve taken in operating the company. In general, we continue to see a trend of declining balances among existing client accounts as the Fed tightening continues to pull deposits out of the system. In particular, our clients are using excess liquidity to invest in higher yielding options. This is also typical of Q2 due to tax client payments.

However, our total deposits were essentially unchanged from the end of the prior quarter. And during the month of June, we started to see DDAs increase. This is largely due to new client relationships that we’re adding through our business development efforts. While economic conditions remain healthy in our markets, we continue to see a lower level of loan demand due to higher rates and a concern about the potential recession. We also continue to remain conservative in our underwriting criteria and disciplined in our pricing. Despite these factors, our loan portfolio is still increased at a 4% annualized rate during the second quarter. Given the healthy economic conditions that we continue to see in our markets and our conservatively underwritten loan portfolio, our asset quality continues to remain strong.

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During the second quarter, our non-performing assets declined and we once again had immaterial levels of charge-offs. While asset quality remains strong, we increased our allowance coverage given our prudent approach to risk management. Moving to Slide 4, we generated net income of $1.5 million, or $0.16 per diluted share in the second quarter. On an adjusted basis, excluding the impact of the continued consideration asset adjustment, we had $0.25 in diluted earnings per share. Excluding the impact of all three non-recurring items, we had $0.48 in diluted earnings per share. And over the past year, due to our strong financial performance and the prudent balance sheet management, we’ve seen increases in both book value and tangible book value since the impact capital resulting from our adoption of CECL at the beginning of the year.

Turning to Slide 5, we’ll look at the trends in our loan portfolio. Our total loans increased $27 million from the end of the prior quarter. This increase was driven by our growth in the CRE portfolio and draws on existing construction lines, which offset slight declines in our other portfolios. The construction projects being funded are primarily multifamily properties to a very strong — experienced developers in areas with limited housing supply. We had $55 million in new loan production in the quarter, which reflects both the lower level of loan demand we’re seeing and our discipline in underwriting criteria and pricing. Given the lower level of loan demand, we’re seeing some banks and insurance companies being very aggressive on pricing to win deals, which has caused us to pass on a number of opportunities where the pricing just doesn’t make sense.

With our discipline on loan pricing, we continue to see higher rates on new loan production with the average rate of new loan production increasing by 23 basis points from the prior quarter. And it’s notable that we had $38 million in loan production in June, which represents the largest amount in any month so far this year. So we’re starting to see some positive trends more recently. Moving to Slide 6, we’ll take a closer look at our deposit trends. Our total deposits were relatively unchanged for the prior quarter. We continue to have success in new business development and added $37 million in new deposit relationships during the second quarter. The inflows on these new relationships helped us lessen the typical seasonal impact that we see in the second quarter from outflows related to tax payments.

The mix of deposits continues to reflect the trend of clients moving money out of non-interest bearing accounts into interest bearing accounts in order to get a higher yield on their excess liquidity. Our average deposits are up almost 12% annualized from Q2 of, excuse me, fourth quarter of 2022. Turning to trust and investment management on Slide 7, we had $122 million increase in assets under management in the second quarter, primarily due to market performance with nearly all of our product categories increasing quarter-over-quarter. The growth we’re seeing in AUM is being partially offset by some outflows as clients continue to take advantage of higher yield investment opportunities. With that, I’ll turn to call over to Julie for further discussion of our financial results.

Julie?

Julie Courkamp: Thanks, Scott. Turning to Slide 8, we’ll look at our gross revenue. Our gross revenue declined 5% from the prior quarter due to lower levels of both net interest income and non-interest income. On Slide 9, we’ll look at the trends in net interest income and margin. Our net interest income decreased 5.8% from the prior quarter due to an increase in interest expense resulting from higher average cost of deposits. Our net interest margin decreased 20 basis points to 2.73% driven by the increase in interest bearing deposit costs offset partially by the increase in yields on average earning assets. However, we saw average loan yields increase 15 basis points in the month of June, while average deposit costs were flat in the month.

We continue to maintain a higher level of borrowings as they continue to represent a lower cost of funds than other sources in the highly competitive deposit environment that we are seeing. These continue to be short-term borrowings that provide us the flexibility to quickly make adjustments on our liability mix, based on trends in deposit flows, and loan production that we see. Turning to Slide 10, our non-interest income decreased 32% from the prior quarter due to the non-core items that Scott mentioned earlier. Among our larger recurring sources of non-interest income, our trust and investment management fees were consistent with the prior quarter, while we had a decline in net gain on mortgage loans. Net gain on mortgage loans decreased to $800,000 as higher rates continue to impact loan demand.

Approximately 90% of the mortgage originations were for purchase loans in the second quarter. Turning now to Slide 11 and a look at our expenses. Our non-interest expense decreased 10% from the prior quarter due to the staffing realignment and reduction in headcount that we implemented in the first quarter, and again in April. As a result of these expense reductions and our disciplined expense control, our non-interest expense came in below our targeted range. We continue to manage expenses to better align with current revenues and have further reduced our expense guidance within a range of $18 million to $19 million for the remaining quarters in the year. Turning to Slide 12, we’ll take a look at our asset quality. On a broad basis, the loan portfolio continues to perform very well, as we had another quarter of minimal losses and our non-performing assets declined 18% due to the full repayment of two private loans.

We recorded a provision for credit losses of $1.8 million, which was driven by an allowance established for a commercial loan that we put on non-performing status during the fourth quarter of 2022. We are working to collect on the sources of repayment on this loan, including a personal guarantee. However, at this point, we felt it was prudent to establish an allowance. The provision recorded this quarter combined with a modest level of loan growth increased our level of allowance to adjust the total loans by 8 basis points to 0.89% at June 30th. Now I’ll turn this call back to Scott. Scott?

Scott Wylie: Thanks, Julie. Turning to Slide 13, I want to take a moment to review our strong track record of value creation for our shareholders. This slide shows our trend in tangible book value creation since our IPO in 2018. Our consistent ability to drive growth in tangible book value is attributable to a number of factors. We’ve executed well on a plan that we communicated at the time of our IPO, and generated strong organic growth as we’ve deepened our presence in Colorado and expanded our presence into attractive markets in other states, which has increased our scale and improved our operating leverage. We’ve been disciplined in our acquisition strategy, making sure the pricing made sense from an economic standpoint and that we’ve executed well on the integration, capturing all of the cost savings that we projected, which has made them nicely accretive to our names and to our tangible book value.

Our conservative underwriting criteria and the strength of our clients has resulted in extremely low levels of credit losses throughout our history, including the challenging economic conditions presented over the past few years by the pandemic and the ensuing period of high inflation and interest rates. And finally, our prudent asset liability management has served our shareholders well, most notably when we decided not to invest our excess liquidity that we built up during the pandemic into low yielding bonds, which enabled us to avoid the significant losses in investment portfolios and the resulting hits to capital that many banks have experienced as interest rates have risen. We’re very proud of this track record of value creation and believe that we’re well positioned to continue to create additional value for our shareholders in the future.

Turning to Slide 14, I wanted to wrap up with some comments about our near term outlook. While there’s a high degree of economic uncertainty, we’re going to continue to prioritize prudent risk management and maintain high levels of liquidity, capital and reserves, even if that impacts our level of profitability in the short-term. We believe it’s likely that loan growth will remain at a low level in the near future, although, we’ve maintained a high level of unfunded commitments throughout the year. This provides a potential catalyst for higher level of loan growth as borrowers increase utilization of existing credit lines. As we’ve mentioned in our past few earnings call, deposit gathering will continue to be a focus throughout the organization.

Given the current economic environment, we continue to see good opportunities to add new clients who are looking to move to a stronger finance institution. We will continue to prioritize prudent risk management, and will also remain committed to acting in the best long-term interest of our shareholders. Accordingly, as market conditions stabilize, we’ll continue to evaluate opportunities for capital utilization that can create additional value for shareholders. With that, we’re happy to take your questions. Lisa, please open up the call.

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Q&A Session

Operator: Thank you. [Operator Instructions] The first question for today will come from Brady Gailey of KBW. Your line is open.

Brady Gailey: Hey. Good morning, guys.

Scott Wylie: Good morning, Brady.

Brady Gailey: So the margin took another step down here, linked quarter, which you’re not alone that’s the industry has seen that. But from this 274 base, have we hit the bottom and an inflection point? Or do you think there could be some more NIMs slippage in the back half of this year?

Scott Wylie: Well, we previously said that we thought our margin would trough in the second quarter, and we still think that will be the case. But as you know, it’s a little bit difficult to predict the economic and competitive and financial outlook from where we are today. I think, we talked about in our prepared comments, positive trends with our DDAs in June and margin also increasing in June. So those seem like really positive indicators for the rest of the year. So our hope is that there’s an improvement in the margin. I think prudently, we could say flat to slight improvement Q3, and then we’re expecting continued improvement in Q4. We’re also assuming in our numbers that we won’t see a whole lot of increased short-term rate increases from the Fed, but assuming that we’re in a relatively stable environment from the Fed going forward here, we’re hopeful that Q2 is going to be our trough.

Brady Gailey: Okay. All right. That’s helpful. And then I heard your comment about a low level of loan growth kind of in the near term. And historically, First Western has been a pretty solid organic grower. But do you think that a more normalized level of growth will come next year in 2024 or do you think even next year it will remain at a pretty depressed level?

Scott Wylie: Yeah. I think that that really depends on the competitive environment and the economic outlook. We’re seeing loan demand, but we’re seeing some of the loans that we would like to do, the relationships we’d like to build being taken away from us by hundreds of basis points. They’re not beating us by 5 basis points or 10 basis points or 20 basis points. These are priced 200 basis points or 300 basis points under where we’re lending. So, I mean, that’s a difficult factor for us. And we’re just not going to do loans like that in this environment, doesn’t make any sense to us. I think also we have a situation here where our clients don’t need to do things. They don’t need to borrow the money to do things. They can wait.

And I think a lot of them are doing that. They’re saying things that made sense at 3%, 4%, 5%, that don’t make that sense at 7%, 8%, 9%, we can wait. And so I think we’re seeing demand down because of that. On the other hand, on the positive side, you know, we’re in economies that are doing well. Our markets are doing well and they’re growing. So I think, we’ll still see some benefit from that. And I think we’ll see some benefit from the unused credit lines that we have on the books that people are drawing down, the construction loans that we have on the books that people are drawing down. So I think we’re going to still see loan growth, probably in the mid-single digits, as we’ve said before for 2023. And then if the economy continues to be strong, maybe rates abate a little bit, maybe competition abates a little bit, we could see stronger growth in 2024.

Certainly the machine that has traditionally produced nice loan growth here is still in place. And I think we’re just hearing on the side of caution as an organization here.

Brady Gailey: All right. And then finally for me, the loan to deposit ratio took a modest step up. It’s now 106%. Is there a goal that you would like to get that down to? And any thoughts on how you could reduce that ratio?