First Western Financial, Inc. — Q2 2019 Form 10-Q
Reporting period: Three and six months ended June 30, 2019; balance-sheet comparisons are to December 31, 2018. Amounts are in millions unless stated otherwise. First Western is a Colorado-based financial holding company providing private banking, trust and investment management, and residential mortgage services, principally across Colorado, Arizona, Wyoming and California.
Financial performance
| Metric | Q2 2019 | Q2 2018 | First half 2019 | First half 2018 |
|---|---|---|---|---|
| Net interest income | $7.96 | $7.58 | $15.93 | $14.94 |
| Non-interest income | $8.59 | $6.89 | $15.56 | $14.18 |
| Non-interest expense | $14.66 | $13.08 | $27.26 | $26.37 |
| Income before taxes | $1.97 | $1.39 | $4.12 | $2.94 |
| Net income | $1.40 | $1.05 | $3.03 | $2.23 |
| Net income available to common shareholders | $1.40 | $0.49 | $3.03 | $1.11 |
| Diluted EPS | $0.18 | $0.08 | $0.39 | $0.19 |
Q2 net interest margin was 3.10%, down from 3.29%; first-half margin was 3.06%, down from 3.27%. Net interest spread was 2.67% in Q2 and 2.64% for the first half, compared with 2.96% and 2.97%, respectively, in 2018. Higher loan balances and yields supported interest income, while higher deposit costs compressed margin. Q2 net interest income after the credit-loss recovery was $8.04 million; the first half included a $0.12 million provision.
- June 30 balance sheet: Total assets $1.190 billion, up 9.8% from year-end; loans held for investment $938.0 million, up 5.1%; mortgage loans held for sale $36.3 million, up 144.5%.
- Funding and liquidity: Deposits were $1.005 billion, up 7.2%; cash and cash equivalents were $92.8 million, up $19.4 million. FHLB borrowings were $36.1 million and subordinated notes $6.6 million; total borrowings were $42.6 million, nearly double year-end. The Bank reported $332.7 million of additional FHLB borrowing capacity.
- Capital: Shareholders’ equity was $122.2 million. The Bank was categorized as well capitalized; CET1, Tier 1 and total risk-based capital ratios were 10.65%, 10.65% and 11.53%, respectively.
- Cash flows, first half: Operating activities used $17.6 million and investing activities used $51.4 million; financing activities provided $88.4 million. Cash increased $19.4 million to $92.8 million. Mortgage-loan originations and sales materially affected operating cash flow.
Material changes versus comparable periods
- Q2 income before taxes rose 41.9% year over year; first-half income before taxes rose 40.1%. Common-shareholder income comparisons also reflect preferred dividends in 2018 and none in 2019.
- Mortgage gains were a major source of revenue growth: $3.26 million in Q2, up 140%; $4.72 million for the first half, up 80.8%. Mortgage originations were $155.5 million in Q2 and $228.3 million in the first half.
- Interest expense increased as funding costs rose amid higher market rates, deposit competition and a shift in deposit mix. Average interest-bearing deposit costs increased to 1.61% in Q2 from 0.96% and to 1.57% for the first half from 0.87%.
- Trust and investment management fees were nearly flat in Q2 but declined 2.9% for the first half. Bank fees declined 40.8% for the first half.
- Assets under management were $5.97 billion at June 30, up 10.2% year over year; first-half growth included $715 million of net market gains.
- Non-performing assets declined to $13.5 million from $19.7 million at year-end; non-performing loans were 1.36% of loans versus 2.13%. The allowance for loan losses was $7.6 million, or 0.81% of loans. No loan charge-offs were reported in the first half.
Outlook, risks and unusual items
- A $1.57 million non-cash goodwill impairment charge was recorded in Q2 for Capital Management, reducing diluted EPS by approximately $0.15. Management cited slower-than-forecast revenue growth, lower market penetration and slower AUM growth in that unit.
- On July 19, 2019, after quarter-end, the company agreed to sell its Los Angeles-based fixed-income portfolio management team for $0.5 million cash plus contingent consideration tied to asset-based revenues over three to five years. Closing was expected in Q3 2019. Management said the transaction should improve cost structure and redirect resources toward Wealth Management and Mortgage.
- The Board authorized repurchases of up to 300,000 common shares over one year; no shares had been repurchased as of June 30.
- The company’s rate-sensitivity model indicated a liability-sensitive balance sheet. A hypothetical 200-basis-point rate increase was estimated to reduce net interest income by 2.30%; actual outcomes depend on rates, deposit behavior, prepayments and balance-sheet actions.
- Key risks include geographic and real-estate concentration, credit quality and allowance adequacy, deposit retention and funding costs, interest-rate changes, mortgage-market conditions, investment-management client and AUM retention, cybersecurity and third-party technology, and regulatory requirements. Management reported no material change to previously disclosed risk factors and no legal proceedings expected to materially affect the financial statements.
- CECL implementation was in progress; the company could not estimate its financial impact and was awaiting the outcome of a proposed delay for smaller reporting companies. The Bank met regulatory capital requirements and lending-facility covenants.
Important facts for investors to verify
- Whether the fixed-income team sale closed as expected, and the amount and timing of contingent consideration and any resulting cost savings.
- Whether the mortgage segment’s strong gains and origination growth persist, and how sensitive results are to rates and secondary-market conditions.
- Whether deposit growth can continue without further increases in funding costs and pressure on net interest margin.
- Performance and credit status of the remaining TDRs and non-performing loans, the adequacy of the allowance, and the extent of real-estate collateral exposure.
- CECL’s eventual implementation date and estimated impact, and any use of the authorized share-repurchase program.