First Western Financial, Inc. (NASDAQ:MYFW) Q4 2022 Earnings Call Transcript

First Western Financial, Inc. (NASDAQ:MYFW) Q4 2022 Earnings Call Transcript January 27, 2023

First Western Financial, Inc. misses on earnings expectations. Reported EPS is $0.58 EPS, expectations were $0.65.

Operator: Thank you for standing by and welcome to First Western Financial Fourth Quarter 2022 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. . As a reminder today’s call is being recorded. I would now like to turn the conference over to the host Mr. Tony Rossi of Financial Profiles. Sir, you may begin.

Tony Rossi: Thank you, Valerie. Good morning, everyone, and thank you for joining us today for First Western Financial’s fourth quarter 2022 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 will use a slide presentation as part of our discussion this morning. If you have not done so already, please visit the Events and Presentations page of First Western’s Investor Relations website to download a copy of the presentation. Before we begin, I’d like to remind you that this conference call contains forward-looking statements with respect to the future performance and financial condition of First Western Financial that involve risks and uncertainties.

Various factors could cause actual results to be materially different from any future results expressed or implied by such forward-looking statements. These factors are discussed in the company’s SEC filings, which are available on the company’s website. I would also direct you to read the disclaimers in our earnings release and investor presentation. The company disclaims any obligation to update any forward-looking statements made during the call. Additionally, management may refer to non-GAAP measures, which are intended to supplement, but not substitute for the most directly comparable GAAP measures. The press release available on the website contains the financial and other quantitative information to be discussed today as well as the reconciliation of the GAAP to non-GAAP measures.

And with that, I’d like to turn the call over to Scott. Scott?

Scott Wylie: Thanks, Tony, and good morning, everybody. We had a number of objectives that we wanted to accomplish in the fourth quarter. We wanted to increase our focus on deposit gathering in order to improve our liquidity and reduce our loan to deposit ratio. We wanted to continue to generate solid loan growth while tightening underwriting and pricing criteria given the potential for weakening and economic conditions. And we wanted to continue to effectively manage our expense levels. I’m pleased to report that we were able to accomplish all these objectives and continue to generate strong financial performance, although earnings were lower than the prior quarter due to the increase in interest expense that we saw as a result of our strong growth in deposits and the competitive environment, putting pressure on deposit class.

Even with a tighter underwriting and pricing criteria, we still generated 21% annualized loan growth in the quarter with increases in each of our major portfolios. The strong loan growth that we continued to generate reflects our success and steadily growing our client base in Colorado, as well as the increase in contributions we’re getting from the teams that we built to increase our presence in Arizona, Wyoming and the Montana markets. With the strong business development capabilities that we’ve built, we’re able to generate a significant volume of high-quality lending opportunities, enabling us to continue generating strong loan growth while maintaining our prudent approach to risk management. Importantly, the growth rate we saw in total deposits was more than double our loan growth.

We are particularly effective in expanding deposit relationships with a few larger clients, which accounted for a significant portion of the deposit inflows we saw in the fourth quarter. And as with our loan production, our increased presence in some of our newer markets was also contributor to the strong deposit growth in the fourth quarter. As we mentioned on our last call, our near-term objective was to get our loan deposit ratio down near 100% and we were able to achieve that with our strong growth in deposits during the fourth quarter along with our improving liquidity by reducing our loan to deposit ratio. During the fourth quarter we also increased our total capital ratio by 53 basis points to 12.37%. Moving to Slide four, we generated net income of 5.5 million, or $0.56 per diluted share in the fourth quarter, or $0.58 a share with acquisition related expenses excluded.

Our strong profitability along with effective management investment portfolio has enabled us to continue to drive increases in both book value and tangible book value per share. In the fourth quarter, book value per share increased 2.5% from the prior quarter, while tangible book value increased 3%. During 2022, a year when most banks saw a significant declines, both metrics increased by more than 9% reflecting the strong value we’re creating for shareholders. Turning to Slide five, we’ll look at the trends in the loan portfolio. We had another strong quarter of loan growth, originating $182 million in loans. While this was down from the prior quarter, the average rate on new loan production increased by more than 100 basis points. So we’re still generating strong production without compromising on pricing.

Payoffs are also continuing to moderate. So more of our loan production is translating into net loan growth and our total loans held for investment increased 121 million for the end of the prior quarter. The growth was primarily driven by increases in our residential mortgage construction C&I portfolios, which offset a decline in our CRE portfolio, which is an area we’re limiting new production as part of our overall approach to risk management ahead of a potential recession. As with the prior quarter, most of what we’re adding the one to four family residential portfolio or jumbo arms that provide attractive risk adjusted yields. Moving to Slide 6, we’ll take a closer look at our deposit trends. The success we had in deposit gathering resulted in 44% annualized growth in total deposits during the fourth quarter.

We had a decline in non-interest-bearing deposits, which was largely attributable to some clients designed to move a portion of their excess liquidity into interest-bearing accounts to capitalize on the higher rates now being offered. We also made a decision to add some time deposits in order to lock in longer term fixed rate funding that we believe will enable us to more effectively manage our deposit costs going forward. Turning to Slide 7, Trust and Investment Management, our total assets under management increased by 189 million from the end of the prior quarter, which was primarily due to an increase in market values during the fourth quarter of 2022. Now I’ll turn the call over to Julie for further discussion of our financial results.

Julie?

Julie Courkamp: Thank you, Scott. Turning to Slide eight, we’ll look at our gross revenue. Our total gross revenue was relatively consistent with the prior quarter as an increase in non-interest income offset most of the decrease we saw in net interest income. On a year-over-year basis, our gross revenue increased 23.8% from the fourth quarter of 2021, largely due to higher net interest income, resulting from both organic and acquisitive growth on our balance sheet. Turning to Slide nine, we’ll look at the trends and net interest income and margin. Our net interest income decreased 4.6% from the prior quarter, due to the increase in interest expense resulting from our strong growth in total deposits, and an increase in our average cost of deposits.

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With our strong growth in deposits, we reduced our level of FHLB advances. And we continue to make adjustments to our level of wholesale borrowings going forward based on the trends we’re seeing in loan production and deposit flows. Excluding the impact of PPP fees, and accretion on acquired loans, our net interest margin decreased 47 basis points to 3.31. The net decline in our net interest margin was due to an increase in our average cost of funds resulting from the higher rate environment and very competitive environment for deposit gathering. Given the competitive environment for deposit pricing, we believe it is likely that we will continue to see some pressure on our net interest margin in the first quarter. As we exited the year, due to the changes in the composition of the balance sheet, we have moved to a more neutral position in terms of interest rate sensitivity.

And we have indicated in the past, we do not make bets in future direction of interest rates. Changes in our interest rate sensitivity are a function of the trends we see in loan production and deposit flows at any given point in time, with our primary focus being on generating growth in net interest income. Over the past few years as the growth in our commercial banking platform resulted in more commercial deposit relationships and an increase in non-interest-bearing deposits, we became more acid sensitive and saw significant expansion in our net interest margin. Now we are seeing a shift back to a more neutral position, which will serve us well in protecting our net interest margin when the Fed eventually starts to lower interest rates. Turning to Slide 10, our non-interest income increased 3.4% from the prior quarter, primarily due to higher bank fees and risk management and insurance fees.

The higher bank fees was partially attributed to an increase in prepayment penalty fees, while the increase in risk management and insurance fees primarily reflects a seasonal bump that we typically see in the fourth quarter. The growth in these areas offset minor declines in trust and investment management fees, and net gain on mortgage loans, both of which are starting to stabilize relative to the larger declines we experienced earlier in 2022. The volume of locks on mortgage loans originated for sale declined 32% from the prior quarter, approximately 95% of the originations were purchased loans, and we are seeing very little demand for refinancing given the rise in mortgage rates. Turning to Slide 11, in our expenses. Our non-interest expense increased 3.3% from the prior quarter, primarily due to an increase in data processing costs resulting from non-recurring implementation charges relating to enhancements we have made to our trust and investment management platform.

During 2022, we made significant investments and built new banking talent and technology that will contribute to our future growth and revenue and improvement in efficiencies. Following these investments, we expect the growth rate of non-interest expense to moderate in 2023, with most of the growth coming from annual salary increases. And for the first quarter of 2023, we expect non-interest expense to be in the range of 20 million to 21 million. Turning now to Slide 12, we’ll look at our asset quality. On a broad basis, the loan portfolio continues to perform very well with another quarter of minimal losses, although we did see an increase in non-performing loans in the fourth quarter. The increase in non-performing loans is primarily attributed to one commercial loan.

As we have indicated in the past, our underwriting criteria requires multiple sources of repayment. In this particular case, we have the assets of the business, a commercial property, and a personal guarantee from a high-net-worth client. As a result, we believe the loan is well secured, and there was no specific reserve required. We recorded provision for loan losses of 1.2 million, which was driven by the growth and changes in the mix of the loan portfolio. This puts our HFL to adjusted total loans at 78 basis points, which was relatively consistent with the end of the prior quarter, and reflective of our strong credit quality and the low level of losses that we have experienced in the portfolio. On January 1, we adopted the CECIL standard for allowance for credit losses.

Our preliminary estimate is that our ACL to total loans ratio will be in the range of 75 to 90 basis points and a 30 to 45 basis point coverage on off balance sheet commitments. Now I will turn the call back to Scott.

Scott Wylie: Thanks, Julie. Turning to Slide 13. I’ll wrap up with some comments about our outlook and priorities for 2023. What appears that the macroeconomic environment will be challenging this year, we believe we’re well positioned to effectively manage through an economic downturn while continuing to generate profitable growth, particularly when economic conditions improve. With our conservatively underwritten, well diversified loan portfolio and the strength of clients that we serve, we expect to maintain strong asset quality as we have during prior periods of economic stress. In each of the past three years, we further tightened our already conservative underwriting criteria. As a result of the credits we’ve added to the portfolio over that time have a substantial cushion in their debt coverage ratios and loan to values to absorb any deterioration that occurs in cash flows or collateral values.

We also have little or no exposure to the areas that are most likely to be impacted by a recession, such as office CRE, retail CRE, SBA or subprime consumer. We feel very comfortable with this small amount of office CRE that we have in the portfolio. These properties aren’t in major metropolitan areas where the work-from-home trend has been most pronounced. They largely consist of smaller properties in high-end suburban areas with tenants in more recession-resistant industries like medical practices. In terms of new business development, we’re going to continue to place an increased focus on core deposit gathering to fund our loan production. Our relationship anchors are focused on developing full relationships with both loans and deposits from clients, we expect this to result in better alignment between loan and deposit growth going forward.

While we continue to be conservative and highly selective in our new loan production until economic conditions improve. We expect to be able to continue generating solid loan growth as new teams that we’ve added in Arizona, Wyoming and Montana continue to gain traction and increase our market share. One of our priorities for 2023 is increasing our business development in the trust and investment management area. We’ve made some adjustments in how this business operates which will free up our business development officers to spend more time meeting with potential new clients. We’re also going to be adding a few new business development officers in various markets. We believe these efforts will not only help drive a higher level of growth in assets under management and fee income, but also contributed to balance sheet growth given our consistent success and expanding relationships with wealth management clients to include loans and deposits as well.

Our investment area will not have a meaning and full impact on our overall expense level as we’re reallocating resources from other parts of the business. And as Julie mentioned, now that our near-term investment in talent technologies support our long-term growth are largely completed, we expect to keep our expense growth rate well below our revenue growth rate this year resulting in increased operating leverage. We believe our increasing operating leverage a result of further earnings growth in 2023 with the second half of the year likely being stronger than the first half. It’s now been about 4.5 years since our initial public offering, and I think we have successfully delivered on the strategy we outlined at that time for enhancing the value of our franchise.

While navigating through a multiyear pandemic, we’ve generated strong organic growth by taking market share in our existing markets and expanding markets and complemented that with disciplined, well-priced and well-executed acquisitions. The balance sheet growth we generated has resulted in greater operating leverage and higher level of earnings and improved profitability. With our strong execution since the IPO, we’ve created significant value for the shareholders of tangible book value per share increasing by nearly 140%. We built a strong, high-performing culture and a very talented team that delivers exceptional client service and effectively communicates our value proposition to consistently bring in new relationships. With a strong team we’ve built, the attractive markets that we operate in and the highly productive business development capabilities we’ve developed, we believe we’re well positioned to deliver another strong year in 2023 and create additional value for our shareholders.

With that, we’re happy to take your questions.

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Q&A Session

Operator: Thank you. . Our first question comes from Brett Rabatin of Hovde. Your line is open.

Brett Rabatin: I wanted to talk about, first, the growth in deposits linked quarter. And I think, Scott, you mentioned some fairly sizable clients adding funds to the deposit mix. Can you talk maybe about the larger deposits this quarter and then the efforts to continue growing that? Would we expect that to continue in terms of the acceleration of the linked-quarter beta.

Scott Wylie: Yes. So we talked a little bit about this. I think in the last two calls. Historically, we’ve seen that we’ve been able to operate the bank in a kind of a 90% to 95% loan-to-deposit ratio. And we’ve always kind of wondered — we know where the next loan is coming from. We always kind of wonder where the next deposit is coming from. And I think what we’ve seen over the years is that our clients have liquidity and they’re willing to bring it here. If we want it, we don’t need to carry a bunch excess liquidity on our balance sheet that we’re not making money with. So I think that’s exactly what we saw in the fourth quarter. We told our relationship bankers, hey, we’re not going to operate this thing with 108% loan-to-deposit ratio where we were in Q3.

And we went out and increased our loans or deposits at a rate that was double our loan growth rate in Q4. So I do think that we really had nice success with that. And as we said in the prepared comments, a lot of that came from existing clients, which is exactly what we’ve seen over the prior 18 years here. And then my prior private banking operations. So yes, I do think that will continue into 2023. The comment you made towards the end of your question though, I just want to draw some attention to that. If you look at kind of quarter-by-quarter last year at our deposit beta. We did a pretty nice job, I think, as an organization in holding our deposit beta down in the first half of the year. And as we talked about last quarter, it’s really been an unprecedented environment.

I mean, in the 30-something years I’ve been doing this, we’ve certainly never seen deposit or Fed fund rates go up as fast as quickly buy as much as quickly as what we saw through the middle and latter parts of this year. And I feel like the relationship-based focus that we have here has really served us well. Of course, that came back in Q4 in an interesting way where we really saw a big spike in our cost of funds to the point where our net interest margin really came down, which we said we thought was going to happen in the last call and sure enough, it did. I think we guided in our comments that we’re going to see continued pressure in Q1 of 2023. But you look at where our NIM is. For example, in Q4 at 332 when you compare that to historic NIMs at First Western or compared to other high fee banks like us, and 332 is a very strong number.