First Western Financial, Inc. — Q2 2018 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2018. Financial statements are unaudited; dollar amounts below are in millions unless stated otherwise.
Business context and reporting period
First Western is a Denver-based financial holding company providing private banking, trust and investment management, mortgage, and institutional asset management services, principally in Colorado, Arizona, Wyoming, and California. It reported $5.4 billion of assets under management at June 30, 2018. Results include three segments: Wealth Management, Capital Management, and Mortgage.
Financial performance and condition
- Q2 results: Net interest income was $7.58 million, with no provision for credit losses. Non-interest income was $6.89 million and non-interest expense was $13.08 million. Pretax income was $1.39 million; net income was $1.05 million, or $0.08 per diluted common share. After preferred dividends, income available to common shareholders was $0.49 million.
- First-half results: Net interest income was $14.94 million, after a $0.19 million recovery of credit losses. Non-interest income was $14.18 million and non-interest expense was $26.37 million. Pretax income was $2.94 million; net income was $2.23 million, or $0.19 per diluted common share. Income available to common shareholders was $1.11 million.
- Margins and revenue: Net interest margin was 3.29% for Q2 and 3.27% for the first half, versus 3.10% and 3.01%, respectively, in 2017. Net interest spread was 2.96% and 2.97%, compared with 2.88% and 2.79%. Q2 total income before non-interest expense was $14.47 million; first-half total was $29.31 million.
- Balance sheet at June 30: Total assets were $1.047 billion, up 7.9% from year-end 2017. Net loans were $835.5 million; mortgage loans held for sale were $35.1 million; deposits were $843.7 million; total borrowings were $89.0 million; and shareholders’ equity was $105.0 million.
- Liquidity and funding: Cash and cash equivalents rose to $58.5 million from $9.5 million at year-end. Deposits increased 3.4% to $843.7 million, while borrowings increased 112.0% to $89.0 million, mainly reflecting higher FHLB advances. The Bank had $202.4 million of additional FHLB borrowing capacity and unused federal funds lines; the filing reports covenant compliance.
- Cash flow: First-half operating cash flow was negative $8.65 million, investing cash flow negative $17.65 million, and financing cash flow positive $75.27 million. Mortgage loan originations and sales were substantial; the company attributed the operating cash outflow principally to mortgage loan activity.
- Credit and capital: The allowance for loan losses was $7.1 million, or 0.84% of loans held for investment, with no first-half net charge-offs. Non-performing assets were $3.71 million (0.35% of assets), down from $4.88 million at year-end. The Bank was classified as well capitalized; its CET1 ratio was 10.17%, versus 7.04% on a consolidated basis.
Material changes versus prior comparable periods
- Q2 pretax income rose 126.3% year over year to $1.39 million; first-half pretax income increased 104.9% to $2.94 million. Net income available to common shareholders turned positive in both periods, from losses in 2017.
- Growth in average loans and higher loan yields drove higher net interest income. Average loan balances increased $123.9 million in Q2 and $114.6 million in the first half versus 2017; average loan yields also increased.
- Mortgage gains increased to $1.36 million in Q2 and $2.61 million in the first half, attributed to higher origination volume following the September 2017 EMC asset purchase. The gain-on-sale margin declined year over year, which management attributed to competitive pricing.
- Non-interest expense rose 6.5% in Q2 and 12.0% in the first half, particularly due to salaries and benefits and costs associated with EMC. Deposit interest expense also increased amid rising rates and higher average interest-bearing balances.
- Assets under management ended at $5.416 billion, up from $5.110 billion a year earlier. Management cited market gains and contributions, partly offset by closed accounts and withdrawals.
Outlook, commentary, risks, contingencies, and unusual items
- No specific earnings or revenue guidance is provided. Management described operational streamlining to improve profitability, including a 16-employee reduction (6.1% of headcount); related salary expense and severance were $0.7 million and $0.2 million, respectively, for the first half.
- Capital Management and Mortgage remained loss-making: first-half pretax losses were $0.83 million and $0.39 million, respectively. Management said it was pursuing operational changes to reduce redundancy and improve profitability in both segments.
- After quarter-end, the company completed an IPO of 2,271,250 shares at $19 per share, with estimated net proceeds of approximately $32.3 million. It subsequently redeemed all preferred stock for $25.4 million and the 2020 subordinated notes for $6.9 million, using IPO proceeds; remaining subordinated notes were approximately $6.6 million. The company said remaining proceeds would support organic growth and general corporate purposes, including regulatory capital.
- Post-IPO trading triggered issuance of 128,978 additional “Make Whole” shares under investor rights. Verify the final share count and dilution in subsequent filings.
- Key exposures include geographic concentration, real-estate collateral (71.9% of the loan portfolio), commercial credit, interest-rate changes, deposit retention and funding costs, securities valuation, and wealth-client and investment-activity attrition. Securities had $2.4 million of gross unrealized losses, which management attributed primarily to market conditions and did not consider other-than-temporary impairment.
- One $1.2 million residential loan was 90 days past due but still accruing; a $1.8 million commercial and industrial TDR remained on non-accrual status, with a $1.04 million specific allowance. Management stated that pending litigation was not expected to have a material effect.
- Interest-rate simulations indicated that a 300-basis-point increase could raise modeled net interest income 6.65% while reducing modeled fair value of equity 7.25%; actual outcomes may differ. The company also disclosed $19.3 million of future operating lease obligations and is evaluating the expected balance-sheet impact of lease accounting adoption in 2019. CECL adoption is planned for 2020; the impact was still under evaluation.
- Management concluded disclosure controls were effective and reported no material change in internal control over financial reporting during the quarter. The cover page’s response to whether required reports had been filed during the prior 12 months is marked “No”; investors should clarify the circumstances.
Important facts for investors to verify
- Whether loan growth, mortgage origination gains, and higher interest margins are sustainable as deposit costs rise and mortgage gain-on-sale margins compress.
- Post-IPO capitalization and dilution, including preferred-stock and debt redemptions, the remaining subordinated debt, and Make Whole shares.
- Credit quality trends, especially the past-due accruing loan, the non-accrual TDR, real-estate concentration, and adequacy of the allowance.
- Whether Capital Management and Mortgage can reduce losses, and whether client attrition or withdrawals affect fee income and assets under management.
- The explanation for the cover-page “No” filing-compliance response and the eventual impact of lease and CECL accounting changes.