First Western Financial, Inc.
Q4 2018 Earnings Call Transcript

Published: 25 Jan 2019

[Operator:]

Good day, ladies and gentlemen, and thank you for standing by. We welcome you to the First Western Financial Fourth Quarter 2018 Earnings Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this conference call may be recorded. I would now like to turn the conference over to Investor Relations for First Western Financial, Tony Rossi. Please go ahead, sir.

[Tony Rossi:]

Thank you, George. Good morning, everyone and thank you for joining us today for First Western Financial’s fourth quarter 2018 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. The management team will discuss the fourth quarter results and then we'll open up the call for questions. 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 no 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:]

All right. Thanks, Tony, and good morning, everyone. I'm going to start this off on slide three with overview of the fourth quarter. Our team continued to execute on the drivers of earnings growth that we'd identified at the time of the IPO last summer, and finished 2018 with a strong quarter that we believe provides excellent momentum heading into 2019. In the fourth quarter, we reported net income available to common shareholders of $1.7 million, up more than 20% from the previous quarter and $0.22 in earnings per diluted share, a 15.8% increase from the prior quarter, which did gain traction with our business development efforts and produced strong balance sheet growth during the fourth quarter as well. Our gross loans increased at 17.1% annualized rate, while total loans grew at 26.9% annualized rate. We also continue to carefully manage our cost structure and generate more operating leverage. Our non-interesting income expense declined 4.3% for the previous quarter, which helped improve our efficiency ratio to 80.6% in the fourth quarter, down from 83% in the prior quarter. We also saw a number of positive operating trends, most notably were the stable net interest margin, despite rising deposit costs, and we also saw continuation of our strong credit quality. Continuing on slide four, we provide more detail on earnings performance. The execution on our embedded growth drivers led to significant improvement in our profitability over the last three quarters of 2018. During the fourth quarter, we realized the full benefit of our lower capital costs. And with no preferred dividend payment this quarter, we had more income from the bottom-line for our common shareholders, which drove the increase in earnings relative to the prior quarter. Moving on to slide five, we'll take a closer look at the trends in our loan portfolio. With very strong quarter of loan production in Q4, particularly in our Denver office, we had $102 million in total loan production fourth quarter, which was substantial increased from the $32 million we produced in the prior quarter. Importantly, our growth was well-diversified with increases in our residential mortgage, C&I and CRE portfolios. Our business development efforts were particularly focused on commercial lending. So, we're pleased with the double-digit percentage growth generated in both C&I and owner occupied CRE loan books during the quarter. Consistent with broader industry trends, we saw relatively high levels of loan paydowns and payoffs in the fourth quarter. We had $67 million in net runoffs in the portfolio of the fourth quarter, up from $21 million in the prior quarter. Despite the high payout levels, we were still able to produce our period-end gross loans sold -- still able to increase by $37 million, which represents more than 17% annualized growth. Shifting to deposits on slide six. Our total deposits were $937.8 million at the end of the fourth quarter, an increase of nearly $59 million from the prior quarter. Some of this growth is attributable to increased trust cash from our client investment portfolios, and within the deposit carries the strongest growth in our money market accounts in the time deposits. Turning to trust and investment management on slide seven. Our assets under management decreased in Q4 by $391 million to $5.24 billion. This was due primarily to considerable equity market declines in December. It was partially offset by $158 million in new relationship assets added during the quarter. We expect our investment platform to continue to play a vital role in our efforts to bring in new clients. While we don't want to minimize the concerns embedded in the recent equity market weakness, in the wealth management business, when markets are volatile, it creates an opportunity to show value to potential clients and demonstrate the need for professional advice. Our experienced investment professionals have demonstrated ability to outperform their benchmarks while employing less risk in various market cycles. A great example of this is our First Western Fixed Income Mutual Fund, which recently received a five-star overall Morningstar rating. This recognition is test for our ability to deliver superior risk-adjusted returns. And having a five-star rate is fun, it’ll be valuable to our efforts to attract new clients and build our wealth managemtn business. Now, I'd like to turn the call over to Julie Courkamp for further discussion over our financial results. Julie?

[Julie Courkamp:]

Thank you, Scott. I'll begin with slide eight, and I’ll look at our revenue trends. Our gross revenue of $14.3 million was relatively stable compared to the prior quarter. The loan growth we generated in the quarter helped increase net interest income by 1.4%. This was offset by lower non-interest income in the quarter, which was primarily due to lower residential mortgage production. The decline in mortgage production was consistent with broader industry trends with the demand for new home loans and the refinancing of loans easing as interest rates rose steadily in 2018. The fourth quarter, given winter weather, also a seasonally soft in Colorado where a significant portion of our revenues are generated. Moving to slide nine, we'll look at our net interest income and margins. Our net interest income increased 1.4% from the prior quarter due to our higher average loan balances. We continue to see higher deposit costs, which is partially attributable to the growth we have had in our trust deposits, which had a higher deposit beta. As a result, we had a 13 basis-point increase in our cost of funds from 93 basis points to 106 basis points. However, this was offset by upward repricing in our loan portfolio as interest rates continued to climb. This drove an 11 basis-point increase in our average yield on interest earning assets from 4.2% to 4.31% in the quarter. This all resulted in our net interest margin remaining unchanged at 3.29%. We anticipate our net interest margin will be flat for the full-year 2019 as we continue -- expect to continue to offset or replace higher deposit costs with lower cost deposits and increasing loan yields. Turning now to slide 10, we'll look at non-interest income. Our total non-interest income declined 4.3%, primarily due to lower gain on mortgage sold. Despite the drop in AUM, our trust and investment management fees were relatively flat as the decline in the equity markets was most pronounced late in the quarter, and the majority of our accounts are calculated based on the daily average balance of the portfolios or are on a fixed fee basis. Looking ahead to 2019, we expect our gain on mortgage loans sold to be lower in the first quarter due to seasonality support trending higher as we move into the stronger quarters for the housing market. Turning to slide 11 and our expenses. Total non-interest expense declined 4.3% from the prior quarter. This was largely due to a decrease in incentive compensation, primarily related to lower production. The lower cost combined with stable revenue, pushed our efficiency ratio down for a third consecutive quarter. We’ve continued to make adjustments to our staffing levels in the mortgage business to better align our costs with the current level of demand. We expect to see the full impact of those adjustments in the first quarter. However, it's likely, that will be offset by a normalization of bonus accruals, tracking with our expected growth in 2019. And we anticipate our operating expense run rate will move a little higher in the fourth quarter. We also expect to generate revenues at a pace above our expense growth rate and that we will continue to drive improvements in our efficiency ratio in 2019. Later in the year, we expect to benefit from a decline in amortization expense. Beginning in June, an additional $430,000 per year in amortization expense related to our capital management segment will end. Moving to slide 12 and I’ll look at our asset quality. Nonperforming assets totaled $19.7 million or 1.82% of total assets at the close of the fourth quarter, up slightly from $19 million or 1.81% of total assets at September 30th. The increase in nonperforming assets was primarily related to the addition of a TDR still accruing, which is partially offset by two credits that are now performing following administrative delays in renewing the credits during the previous quarter. Our loss experience continues to be extremely low as we recorded an immaterial amount of net charge-off in the quarter. We also recorded a provision of loan loss of $349,000 for the fourth quarter, which is primarily related to the growth in our loan portfolio in that quarter. With that said, I'll turn the call back to you, Scott.

[Scott Wylie:]

All right. Thanks, Julie. On slide 13, I want to provide a quick update on the earnings drivers that we talked about at the time of our IPO. As you know, we used summer IPO proceeds to lower our capital costs by redeeming $6.9 million of sub debt and $25.4 million in preferred stock. Fourth quarter marked our first quarter that had no preferred stock dividend, providing additional boost to our bottom line. With our capital constraints removed, we've now transitioned to a more sustained effort to grow our balance sheet. We're successfully winning new business and growing our loan book as evidenced by particularly strong loan production during the fourth quarter. Throughout 2018, we made adjustments in our staffing level to eliminate redundancies and streamline our cost structure. As a result, we've seen a reduction in our noninterest expense levels and steady improvement in our efficiency ratio. More importantly, we've been able to do this without impacting our business development capabilities. This is evidenced by strong revenue growth we’re seeing in our profit centers, which became more profitable -- become more profitable as they gain scale. In 2018, we produced revenue gains of 53% in Aspen, 42% in Denver, 41% in Scottsdale, 24% in Cherry Creek, and 20% in our Jackson Hole office. One particular note on new client win in the quarter demonstrates how we use our entire platform to provide value for clients and also generate more profitable relationships. At quarter-end, this client is a business with $13.4 million in commitments, over $700,000 in deposits, and they provide us access -- exclusive access to their wealthy and influential client base. The collective impact of these catalyst drove strong earnings growth this quarter and throughout the second half of the year, and should continue to drive improvements going forward. Turning to slide 14, I want to spend a few minutes talking about our outlook. Each of states we operate, Colorado, Wyoming, Arizona, and California, unemployment rates are low, economic activity is very healthy, and that should continue to provide lots of opportunities for us to win new business. We've made significant investments in our business development platform over the past two years, and we expect to continue to increase our productivity and ability to grow revenue. Following the additions we've made last year, we entered 2019 with the full executive team in place which should positively impact our leadership and continuity this year. We've hired 10 new business development officers over the course of ‘17 and ‘18. And now, all our full service officers have a business development officer on their teams. We found it generally takes about a year for these BDOs to get up to speed and produce consistently. So with that time now under their belt, we expect to see a higher level of productivity going into 2019. Similarly, we have a full-year of mortgage loan originators and are also working within our existing offices, and our mortgage business is being better integrated into our overall operations, which should continue to produce more cross-selling opportunities. One key takeaway from last year is that the profit centers where we have the leadership and business development officers in place, they produced excellent results. Those offices where we didn't have a full staff, didn't perform as well. Now, we’ve filled these vacancies, we believe all the profit centers are well-positioned from a talent and staffing standpoint. We're also excited about expanding our presence in the Arizona market. We think Arizona can offset some of the slowing in mortgage activity that we experience seasonally in Colorado, as well as being a little different in terms of its own seasonality cycle during the year. We're going to continue to be diligent on our expense management. And with further increases in revenue, we should expect -- we expect to see continued improvement in our operating efficiencies. Finally, we think our unique model positions us well to capitalize on the dislocation taking place in the Colorado banking market in the wake of prominent local bank selling to out of state acquirers. In the fourth quarter, we launched a coordinative marketing and advertising campaign, highlighting the local aspect of First Western's market position. We're emphasizing that First Western is now only one of two remaining publicly held banks in Colorado. We're just starting to see some potential opportunities emerge to attract clients from these acquired banks and hired some experienced talent. We anticipate this will be a trend that gains momentum as the integration with those banks occur, and we expect to be the beneficiary of the disruption. We're optimistic about our opportunities to deliver a strong year for our shareholders with the second half of the year likely being stronger than the first half of the year. We have the team, the infrastructure and strategy in place to continue to build our client base, grow our earnings power and enhance the value of our franchise. So, with that, we're happy to take your questions. George, can you go ahead and open up the call, please?

[Operator:]

Thank you. [Operator Instructions] And our first question comes from the line of Brady Gailey with KBW. Your lines now open.

[Brady Gailey:]

Good morning, guys. Maybe we can just start with mortgage. I know 4Q is a seasonally weak quarter, but your mortgage fees were down a little more than I was expecting. And I know that business had been running kind of breakeven, there probably was a loss in 4Q. But, maybe just an update on the mortgage. I heard Julie say that in 1Q, you expect mortgage fees to be down again. But, as we get into the seasonally strong quarters of 2019, 2Q and 3Q, maybe just talk about your expectations for the mortgage business?

[Scott Wylie:]

Okay. Well, I think there's a couple of factors here that we certainly saw in ‘18 and we expect that continue to be factors in 2019. We’ve had generally upward trends in mortgage rates, which seem to have slowed or reversed themselves here over the last month or two. We've seen rate pressures in terms of margins, and then we’ve seen volume pressures in the fourth quarter coming from the competitive landscape and the slowdown in new home sales and purchase transactions. So, all of those things kind of working against us in the fourth quarter, and not just, like you said, it's in the industry. Talking to the producers, they're saying that they're seeing good activity now in January. And so, hopefully, we're going to see some earlier seasonality benefits than what you typically see, wait until spring. There is no reason that we know of that as long as rates continue to be lower than they were trending last year, and competitive environment certainly hasn't changed. I think it's going get worse from where it is, we're optimistic about what we can do from a market standpoint. I think it's important to know also we're not being passive and crossing our fingers and hoping things turn around. I mean, we believe that this is a cyclical industry, and we’ve seen this cycle before over the years. And I think we're seeing the shakeout and we're going to see the strong players survive. Also, we believe this is a strategically important business for First Western. So, we've been pretty proactive. We've talked about this at the last call in terms of managing that business, integrating it better, making sure we're taking advantage of the strategic opportunity that we think that could deliver. And to the extent that we are seeing volumes and margins improve, we feel comfortable with that. To the extent we don't, we're going to be proactive in managing as we have been.

[Brady Gailey:]

All right. And the outlook for roughly flat net interest margin for 2019, is that -- I'm guessing that assumes no additional rate hikes. And maybe just talk about your sensitivity to rate hikes, like if we did see one or two additional hikes, I'm guessing the margin might see some upward expansion.

[Scott Wylie:]

Well, I can tell you as we've done our business planning for 2019, we've had a chance to look at all three ways, because originally we were assuming a couple of rate hikes, when we started back in October and then we were down to 1, and now we're down to zero in our own internal models. And you're absolutely right, I think if we saw some short-term rate hikes, we think that that helps us improve margins; if we operate our models internally with no rate hikes for 2019, then we end up with the flat net interest margin for 2019. I think it bears seeing also, when you see the kind of growth that we saw in Q4 of 27% in deposits, if you take a longer view on this, we're not going to be able to grow our balance sheet if we can't grow deposits. But, when you bring in new deposit clients, sometimes they are more expensive, and there were couple of factors Julie talked about in her financial portion on this are significant. We have some higher beta deposits like our trust deposits that are pretty much tied to money market mutual fund rates. So, when you see those being shoot up as they have in the latter half of 2018, that's going to have an impact on those cost of funds for us. Also, when you bring in new clients, in our world, frequently, it's more expensive; and as those clients bases stabilize, the costs moderate. You also saw an effort in 2018 to try and guide more C&I and owner occupied CRE business that turned out nicely in Q4, showing some progress on the loan side. Of course that also has a deposit impact. We have a big new win in January of a commercial account as bringing a whole bunch of operating accounts and cash management accounts from a large local competitor. And again, those won’t turn up as lower cost deposits until later in the year because the cost of transition is typically expensive at that time. But I think that there's going to be some pressure on the margin here in the short-term that will look better later in the year as these things all play out.

[Brady Gailey:]

All right. And then, just lastly for me on the topic of organic loan growth. Do you think that kind of this mid to high-teens level is a good expectation for loan growth for you guys in 2019?

[Scott Wylie:]

We do. We think we produced growth in that range in 2017. We saw that again in the latter half of 2018. I do think it's interesting. And one of the risks of having to report every quarter is in a institution our size, there is some volatility to it. And so, when you see pretty high production quarter, $100 million but then also a high payout quarter in the $60 million range, it just shows you how the numbers from one quarter and the next quarter end just really aren't that predictable for us. But if you look at the underlying trends and you sort of smooth out the short term, the numbers seem very positive. In markets where the economies are strong, the business sentiment is really strong, people are moving here, people are moving their businesses here, it’s true in Arizona; it’s true in Jackson Hole and these resorts communities that we're in. So, I think the underlying economic factors are going to help us continue to grow the balance sheet. And then, you look at the competitive landscape which I spoke about a little bit in the presentation where we see Citywide last year, this year -- in 2017, Citywide and 2018 CoBiz and Guaranty Bank being required by state banks are also I think very positive factors for continuing balance sheet as well as new client acquisitions.

[Brady Gailey:]

Great. Thanks, guys.

[Scott Wylie:]

Thank you.

[Operator:]

Thank you. [Operator Instructions] And our next question comes from the line of Matt Olney with Stephens. Your line is now open.

[Matt Olney:]

Thank you. Good morning, guys.

[Scott Wylie:]

Good morning, Matt.

[Matt Olney:]

I want to start with the operating expenses. I believe in the prepared remarks there was a comment about the expenses in the first quarter moving back up from the fourth quarter level. Did I hear that correctly? And any of the commentary you can help explain kind of what happened in the fourth quarter, and then why would it move back up in 2000 -- or in the first quarter?

[Julie Courkamp:]

Sure. I can start with that one. As I have mentioned that had a decline, just primarily between Q3 to Q4 the decline in the accrual for bonuses and incentive compensation, which won't reoccur obviously in the first quarter. We expect it to return to levels that are much more consistent with kind of where we were in maybe the second and third quarters. However, we were able to reduce some additional incentives in the mortgage business that will partially offset that. So, I think we're, our expectation is that the first quarter expense level will be up from the fourth quarter.

[Matt Olney:]

Got it. Okay. Thank you for that, Julie. And then, on the deposit front, I wanted to focus on the non-interest bearing deposits had some pretty considerable outflows I guess over the last two quarters. Is there anything we should keep in mind on that as far as seasonality or any kind of -- anything usual or is that -- do you think that pressure will just continue in 2019?

[Scott Wylie:]

We believe there's an opportunity to grow our non-interest bearing deposits. We have a very competitive treasury management platform. And so, we think that's an area where we should focus and can get some good results. In the latter half of last year, we updated some of the technology underlying that to make sure it's current, lead [ph] our fees there. And then starting January, we brought in a new Director Treasury Management that has a strong sales background and a strong treasury management background that's going to be leading that product group centrally and pushing more focus on commercial accounts through our profit centers. So, that's an area where we think there's an opportunity. We've been working on laying the groundwork there to grow that and then we've made a significant personnel addition near that that we think can have a nice impact. We also have a data service that we use that can help us target commercial clients of other institutions. And again, looking at the turmoil in the market here, the out of state acquisitions, we think there's a really great opportunity for our deal team to be out talking to local businesses that want to do business with a local financial institution. So, I think all of that should drive some gains in non-interest bearing deposits in 2019.

[Matt Olney:]

And then, I want to make sure -- I appreciate the outlook for the core margin. It sounds like you expect the core margin to be relatively flattish in 2019. I think, Scott, you mentioned maybe a little bit near-term softness to the first half of the year and recovery to back half of the year. Did I hear that correctly? And what was driving that?

[Scott Wylie:]

Well, I think you did hear that correctly. That's a fair summary of what we're anticipating. And again, I think the drivers have a lot to do with -- when you see the kind of deposit growth that we produced in the latter half of 2018, the incremental costs in the short-term, the fact that we've seen a high increase in money market mutual [ph] funds that affect the cost of some of our deposits that are tied to those rates. We know there are factors that are now on December 31st in the numbers for the ending point that become the numbers for the starting point 2019. So, as we look at the mix of business, as it stabilizes and grows into 2019, we think that that changes and overall wind up with a NIM for 2019 in the same range where we were in the latter half of 2018. Julie, probably you want to add to that?

[Julie Courkamp:]

Just that we have seen nice growth in our loan production and the rates on those loans have been good. And on our trust cash, while it is higher on the deposit side, we're also getting fee income, so that helps offset some of that cost with some revenue, so.

[Matt Olney:]

Okay, got it. And then, on that fee income and specifically on trust and investment management, I want to make sure -- I appreciate just how those fees are captured. Are those accrued or are those built based off end of period end of the month level, or is it just kind of during the quarter? I just want to make sure that the market hit that we saw in the fourth quarter, was that totally captured in your fees in 4Q or could we see little more of that pressure in the first quarter?

[Julie Courkamp:]

So, our fees are primarily charged on a daily average balance of the AUM balances. So, what -- as the markets move, our fee revenues will move as well. So, most of the Q4 is baked in, and as we continue to see improvement in the markets, then our fees will follow that trend.

[Matt Olney:]

Okay. Thank you for that, Julie. And then, lastly for me on the credit front. I think last quarter, we talked about a larger credit that hit the books and looking for resolution on that. Any update you could talk about on that credit and when we should expect some resolutions?

[Scott Wylie:]

Sure. Last quarter, we talked about three credits that meet up the vast majority of the NPLs that we talked about on that call. So, there was the one today $11.3 million credit that we talked about that’s largely secured by cash and investment management securities here at First Western. That continues to perform; it's doing fine. We're leaving it as a non-accrual NPL until it performs for a consistent period of time. I'm hopeful that that comes out sometime in the first half of 2019. I think, if Julie answered that question instead of me, she’d probably tell you that we'd be looking into Q3 for that. But no reason I think that that won't -- that we know of today that that won’t come out of NPLs sometime say midyear 2019. The other two loans we talked about last quarter were administrative renewal problems and those were completed actually before our call. So, those are gone from the NPL list. What came on, Julie mentioned, was this TDR. And that was our loan that's been on longstanding client of First Western and has performed consistently. They had some business challenges a couple of years ago. And we put them on a shorter lead, and they’ve done a fine job of performing with that. And I would say that credit has, from my perspective, improved considerably over the last couple of years. But, we renewed it in the fourth quarter of 2018, and at that time felt that should be classified as a TDR. So, even though it’s performing and I would say improving in the underlying trends, it does show up as a new NPL in Q4. Again, not an area of concern. We've tested all these for impairment, and they are fine from an impairment standpoint. So, flat NPLs from last quarter, and expect to see those numbers improve in 2019.

[Matt Olney:]

And Scott, what was the amount of that last one that you mentioned that's on TDR now?

[Scott Wylie:]

I think it's down to $4.7 million today. I don't know today -- that was a 12/31 number, I believe. Yes.

[Matt Olney:]

Sure, okay. Okay, guys. Thank you for all the color. I appreciate it.

[Scott Wylie:]

All right. I think that brings us -- are there any other questions, George?

[Operator:]

I see no further questions at this time. I would like to turn the call back over to the management team for any closing remarks.

[Scott Wylie:]

Okay, great. Well, thanks everybody for dialing in. We sure appreciate your interest and support and plan to set up individual calls as need be. Have a great day.

[Operator:]

Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program. You may all disconnect. Everyone, have a great day.