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

First Western Financial, Inc. (NASDAQ:MYFW) Q4 2023 Earnings Call Transcript January 26, 2024

First Western Financial, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Thank you for standing by and welcome to the First Western Financial Q4 2023 Earnings Conference Call. At this time, all participants are on a listen-only mode. After the speakers’ presentations, there will be a question-and-answer session. [Operator Instructions] Please be advised that today’s call is being recorded. At this time, I’m going to turn the call over to your host, Tony Rossi with Financial Profiles. Please go ahead.

Tony Rossi: Thank you, Valerie. Good morning, everyone, and thank you for joining us today for First Western Financial’s fourth quarter 2023 earnings call. Joining us from First Western’s management team are Scott Wylie, Chairman and Chief Executive Officer; Julie Courkamp, Chief Operating Officer; and David Weber, 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.

Various factors could cause actual results to be materially different for many 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.

With that, I’d like to turn the call over to Scott.

Scott Wylie: Thanks, Tony. And good morning, everybody. As we enter our 20th year in business and our sixth as a public company, we believe we’re well positioned for solid revenue and earnings gains in spite of the environmental challenges of 2023. During the fourth quarter, we continued to execute on our strategic priorities, which included maintaining disciplined expense control, while focusing on new deposit relationships in order to increase our liquidity and put us in a better position to fund new loan production once loan demand increases as economic conditions improve. With our increased focus on deposit gathering, we had an 18% annualized growth in total deposits with increases in both non-interest bearing and interest bearing deposits and further lowered our loan to deposit ratio to achieve our year-end target of 100% as we remain conservative in new loan production, which kept our total loans relatively flat during the quarter.

As part of this effort, we made the strategic decision to add some short-term higher cost deposits. While this had a near-term impact on our net interest margin, we believed it was in the best interest — best long-term interest is, it enables us to have the funding to add new client relationships that we believe we can expand over time and be highly profitable for the company. Given the short-term nature of the deposits, we’ll be able to replace them with lower cost funding sources as market conditions normalize and interest rates decrease. Our provision for credit loss has increased largely due to reserve on individually analyzed loans we established for the relationship that we put on non-accrual in the prior quarter. This provision resulted in a lower level of net interest income for the quarter, but we still had $4.1 million in pre-tax, pre-provision net income.

As we’re going through the workout process for the relationships in non-performing status, we’ve received updated appraisals on the properties we have as collateral, which have all remained consistent with previous valuations, and in some cases have increased. However, in a couple cases, we also have as collateral receivables and business valuations that we now believe might not be fully collectible. So we established a reserve on individually analyzed loans to reflect the possibility that we may not fully collect on those receivables. Consistent with what we said last quarter, we expect it will take a few quarters for these loans to be resolved and with the sale of multiple properties we have as collateral, all being on different timelines.

The experience we have consistently through the history of First Western is that, the strong underwriting criteria and collateral we have is ultimately resulted in minimal or no losses on these loans. As I indicated earlier, we continue to execute on our key strategic priorities, one of which was disciplined expense control. At the beginning of 2023, we indicated we expected noninterest expense to be in the range of $20 million to $21 million per quarter in 2023. We finished the year with non-interest expense well below this level at just over 18 million. This reflects our focus on improving efficiencies throughout the organization and reducing costs without impacting our business development capabilities or the level of service that we provide to our clients.

We’re continuing to look at all areas for opportunities to operate more efficiently, which not only reduces expenses, but also offsets our investment in other areas, such as our technology platform that we believe will help enhance the long-term value of our franchise. Moving to Slide 4, We generated net income of $0.3 million or $0.03 per diluted share in the fourth quarter. We also saw a small decline in our tangible book value per share during the quarter, which was due to an unfavorable shift in AOCI, resulting from a cash flow hedge on certain FHLB borrowings that decreased in value as the interest rates declined. Nevertheless, our tangible book value has increased 143% since our pre-IPO levels of June 2018, as shown in the layer slide.

Now I’ll turn the call over to Julie for some additional discussion of our balance sheet and trust and investment management trends. Julie?

Julie Courkamp: Thank you, Scott. Turning to Slide 5, we’ll look at the trends in our loan portfolio. Our total loans increased $12 million from the end of the prior quarter. The increase is driven by growth in our residential mortgage and CRE portfolios, which was partially offset by small declines in our other portfolios. We continue to be conservative and highly selective our new loan production, focusing primarily on clients that also bring a full relationship, inclusive of deposits and investment management to the bank. This resulted in new loan production being about half of what it was in the prior quarter, which, as Scott mentioned earlier, helped us to bring our loan to deposit ratio in line with our year-end target of 100% and much closer to our historic target of 90% to 95%, which is a key near-term objective for the company.

And with the discipline we are maintaining in our pricing criteria, the average rate on new production increased 35 basis points from the prior quarter to 8.27% and was 8.43% in the month of December. Moving to Slide 6, we’ll take a closer look at our deposit trends. Our total deposits increased by $109 million during the quarter with increases in both non-interest bearing and interest bearing deposits. We continue to have success in new business development and added 118 million in new deposit relationships during the fourth quarter. Non-interest bearing deposits increased $6.3 million during the fourth quarter, reversing 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.

And as Scott mentioned earlier, we made a strategic decision to add some short-term higher-cost deposits, which also contributed to the deposit growth in the quarter, but will be replaced with lower-cost funding as market conditions normalize and interest rates decrease. Turning to trust and investment management on Slide 7. We had a $357 million increase in our assets under management in the fourth quarter, primarily due to market performance. We also had a $303 million in inflows from new and existing clients during the quarter. However, this was offset by account closures and withdrawals. The $646 million increase in AUM year-over-year was achieved in spite of a 10% fee increase we began implementing mid-year. Now, I’ll turn the call over to David for further discussion of our financial results.

David?

David Weber: Thank you, Julie. Good morning, everyone. Turning to Slide 8, we’ll look at our gross revenue. Our gross revenue declined 2.7% from the prior quarter, primarily due to an increase in deposit costs that reduced our net interest income. This was the smallest decline that we have seen over these past five quarters as the environmental headwinds have abated. Turning to Slide 9, we’ll look at the trends in our net interest income and margin. Our net interest income decreased 2.6% due to a decline in our net interest margin. Our net interest margin decreased 9 basis points to 2.37%, driven by an increase in interest-bearing deposit costs, offset partially by an increase in yields on average earning assets. As Scott indicated, we made a strategic decision to add some short-term higher-cost deposits to increase our near-term liquidity, which negatively impacted NIM in the fourth quarter.

As market conditions normalize and interest rates decline, we will replace these deposits with lower-cost funding that will be beneficial to our NIM. Now turning to Slide 10, our non-interest income remained flat compared to the prior quarter. Net gain on mortgage loans was slightly lower, which reflects both the seasonal impact of lower mortgage demand in the fourth quarter, as well as the higher rate environment. We had a slight decline in trust and investment management fees compared to the prior quarter. However, fees increased 8% year-over-year. These declines were partially offset by an increase in risk management and insurance fees, which are seasonally higher in the fourth quarter each year. Now turning to Slide 11 and our expenses.

Our noninterest expense was relatively consistent with the prior quarter, as we continue to focus on disciplined expense control. A decline in our salaries and benefits expense in the fourth quarter, partially driven by the one-time acquisition-related compensation expense that was recognized in the prior quarter was offset by small increases in most other line items. It is a challenging environment to forecast in. However, if we generate mid-teens revenue growth in 2024, we expect our non-interest expense to range from $19.5 million to $20.5 million per quarter. If we generate single-digit revenue growth in 2024, we expect our non-interest expense to range from $18.5 million to $19.5 million per quarter. Now turning to Slide 12, we’ll look at our asset quality.

On a broad basis, the loan portfolio continues to perform well as we had another quarter of minimal losses. This continues our 10-year history of near 0% credit losses. We had a slight increase in non-performing loans, which was attributable to two credits placed on non-performing status in the quarter. We recorded a provision for credit losses of $3.9 million, which related to the reserve on individually analyzed loans that Scott discussed earlier, as well as reserves established for the two new credits that were placed on non-performing status. The provision recorded this quarter, combined with the modest level of loan growth, increased our level of allowance to adjusted loans by 18 basis points to 1.1% at December 31st. Now, I’ll turn it back to Scott.

Scott?

Scott Wylie: Thanks, David. Turning to Slide 13, we provided an update on our strong track record of value creation for shareholders. This slide shows our trend in tangible book value per share since our IPO in 2018 and the factors that have contributed to our consistent ability to drive growth in tangible book value per share as we’ve executed well on the plan that we communicated at the time of our IPO. Following our fourth quarter performance, we’ve increased our tangible book value per share by 143% since our IPO, which includes the 56% decrease we had due to the adoption of CISL at the beginning of 2023. And the fourth quarter included a negative impact due to the unfavorable shift in AOCI resulting from the cash flow hedge on certain FHLB borrowings we mentioned earlier.

We’re very proud of this track record of value creation and believe that we’re well positioned to continue creating additional value for our shareholders in the future. Turning to Slide 14, I’ll wrap up with some comments about our outlook and priorities for 2024. There remains a high degree of uncertainty regarding the economic conditions we’ll see in 2024, but we believe we’re well positioned to perform well in any economic scenario that emerges this year. A strong balance sheet and conservative underwriting criteria should enable us to effectively manage through an economic downturn as we have throughout our history. I’d like to reemphasize a point I made earlier. While we may see an increase in problem loans and non-accrual loans in economic downturn, historically this has not resulted in a meaningful level of loss due to the strong collateral we require in our underwriting.

And we would also expect to continue to have a level of net charge-offs that’s well below the level experienced by the broader banking industry in a material economic downturn or recession. Should the Fed manage to keep us out of a recession and affect a soft landing for the economy, our business development capabilities and unique value proposition will enable us to take advantage of strengthening economic conditions and an increase in loan demand. At this point, with economic conditions remaining uncertain at the start of the year, we’ll continue to prioritize prudent risk management and conservative underwriting criteria, which should result in a modest level of near-term loan growth. But we have the ability to be nimble and quickly respond to changing market conditions.

And should economic conditions improve and loan demand increase, we would expect to see a higher level of loan growth at that point. As we look to our markets, we believe the competitive environment has become more favorable for us as many banks have had to pull back from loan production due to capital constraints, funding challenges, and/or credit concerns. We’re able to maintain our disciplined pricing criteria and still add new relationships with fewer banks being as aggressive in pricing and structure in order to win business as we’ve seen in recent quarters. As we’ve indicated, deposit gathering is going to remain a top priority with an increased focus on targeting deposit rich industries like nonprofits and homeowner associations. We have a good deal of expertise in both of those areas throughout the company that we’re now leveraging to a greater extent to add new clients that are good sources of low-cost deposits.

Most importantly, our focus will remain on our core business and our core clients. These type of clients provide good opportunities to expand relationships over time as they typically want and need the various products and services that we provide and they typically result in very low levels of credit losses. This is what we built our franchise on and there are — still lots of room to grow by focusing on these types of clients. While 2024 will be a difficult year to forecast, we do see a number of catalysts that should contribute to earnings growth this year. Our core revenue sources of loan yields, deposit costs, fees, [indiscernible] fees and mortgages have survived the strains of 2023 and seem likely to have upside in 2024. We have good momentum in business development that should lead to continued growth in our client roster and balance sheet.

We have a liability-sensitive balance sheet and a good deal of deposits indexed to Fed funds. So when we see expansion in our — we should see expansion in our net income — net interest margin as market conditions normalize and interest rates decline. We’ll also continue to be disciplined in our expense management, while we continue to get the benefit from leveraging past investments in technology, talent, and office expansion. In the past year or so, we’ve also made many process improvements throughout the organization that should lead to enhanced efficiencies as we continue to add scale. We believe these catalysts should result in a higher level of earnings this year, even with a modest level of balance sheet growth. And as always, we’ll continue to operate the company with a long-term perspective.

The strength of the franchise and the balance sheet we’ve already built, we believe we can continue to capitalize on the attractive markets that we operate in to consistently add new clients, realize more operating leverage as we increase scale, generate profitable growth, and further enhance the value of our franchise. In the future, as we grow earnings and create value for shareholders, the improved currency we’ll have from higher stock price will enable us to execute on additional M&A transactions that we believe will enhance shareholder value just as our past transactions have done. With that, we’re happy to take your questions. So, Valerie, go ahead and open up the call, please.

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Q&A Session

Operator: Thank you. [Operator Instructions] Our first question comes from the line of Brett Rabatin of Hovde Group. Your line is open.

Brett Rabatin: Hey, good morning, everyone.

Scott Wylie: Good morning, Brett.

Brett Rabatin: I wanted Just to start off on credit and you talked a little bit about the $3.9 million that you added this quarter. Can you talk a little bit about kind of what led to those moving to non-accrual and just anything you’re seeing in any particular industries?

Scott Wylie: Are you asking about the credit or are you asking about the credit trends across the platform?

Brett Rabatin: I’m just asking about those two loans that I think are $3.9 million, just what led to those…

Scott Wylie: Okay. Yes, sure. So one was a relatively small commercial loan, and the other was a construction loan that has substantial equity in it. And recent valuation collateral showed it was well in excess of the loan. Both of those were downgraded for very specific reasons related to the borrowers. They aren’t indicative of broader trends that we’re seeing in the portfolio. This is reflective of what we’ve seen throughout our history, which is, sometimes loans go into non-performing status and they rarely result in a meaningful level of loss due to our underwriting standards and our strong collateral and the multiple sources of repayment that we require.

Brett Rabatin: Okay. And then on the four loans that you moved to non-accrual last quarter that are related for $42 million. How much of the $3.9 million provision was specifically related to those? And then any color on how much of that relationship, I know, there’s a commercial loan — a commercial — owner-occupied commercial estate loan, a residential mortgage, and I think a personal line of credit, how much would be not covered by real estate?

Scott Wylie: I think a starting point on that has to be that, that relationship is currently the subject of ongoing litigation, which is out in the public realm through the courts. And because of that, we shouldn’t provide any additional detail. I think, specifically on the question of the reserve this quarter we put up, it was substantially related to that relationship. And we think that the provision that we recorded is prudent and conservative based on everything we know as of now. We do continue to believe we have adequate collateral, and I mentioned that we’ve been working on updated appraisals, and all the appraisals have held up, including some that have increased significantly in a couple of cases.

Brett Rabatin: Okay. Yes, a little litigation, that’s somewhat unusual. And then maybe just for clarity on the margin and kind of the pace from here, you referenced that you use some shorter term funding sources this quarter. Can you maybe talk about just how you see the margin progressing in 2024? And then just if the Fed’s cutting 2025, 100 basis points, what rate cuts would mean to the margin, as you see it?

Scott Wylie: Yes, let me take a stab at that, David, and then if you want to jump in and provide more — if you want more, just ask. But, as I look at NIM as a starting point and look for, kind of trend and a bottoming out, I would tell you our last three months were apples to apples, 2.50% October, 2.35% November, 2.26% December. We were anticipating 2.33% for January and that seems to be about where we are. 2.35% in February and 2.43% in February and March are kind of our internal forecasts. Again, who knows, as we talked about several times in our comments. Overall, the bank is liability sensitive. We historically have tried to operate with a balanced — balance sheet from an [indiscernible] perspective, but right now we are significantly liability sensitive.

And so, our estimate in sort of unprecedented conditions that we’re in today is a 25 basis point decline, would produce something like a $1 million annualized earnings improvement, revenue and earnings improvement. So those would be kind of the two data points I would point to from what we think we know today. [indiscernible] David.

David Weber: Yes, that’s totally fair.

Scott Wylie: Give a good start.

David Weber: Yes.

Brett Rabatin: [Multiple Speakers] Okay. Yes, that’s really helpful. I’ve got other questions, but I’ll hop back into the queue. Thanks so much.

Scott Wylie: Yes, thank you.

Operator: Thank you. One moment please. Our next question comes from the line of Brady Gailey of KBW. Your line is open.

Brady Gailey: Thanks. Good morning, guys.

Scott Wylie: Good morning, Brady.

Brady Gailey: One more just on the reserve build. I mean, taking the reserve up 18 basis points in a quarter is pretty notable. It sounds like that’s driven by a specific reserve on this credit where litigation is involved, is that correct?

Scott Wylie: That is correct.

Brady Gailey: Okay. And I know you don’t want to talk much about it, just the facts on it, how big is that loan and what type of loan is that? Where the litigation is involved?

Scott Wylie: The relationship, which includes a number of loans, is a total of $53 million and we participated out $11 million of that. So on our books, it’s $42 million.

Brady Gailey: Okay. And the composition of those loans is what?