First Western Financial, Inc. — Q3 2018 Form 10-Q
Reporting period: Three and nine months ended September 30, 2018; balance-sheet comparisons are to December 31, 2017. First Western is a Denver-based financial holding company providing private banking, trust and investment management, capital management, and residential mortgage services, principally across Colorado, Arizona, Wyoming and California.
Key financial results
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Total income before non-interest expense | $14.4 million | $13.8 million | $43.7 million | $38.8 million |
| Net interest income | $7.8 million | $7.4 million | $22.7 million | $20.3 million |
| Net income | $1.7 million | $1.0 million | $3.9 million | $2.0 million |
| Net income available to common shareholders | $1.4 million | $0.5 million | $2.5 million | $0.2 million |
| Diluted EPS | $0.19 | $0.08 | $0.40 | $0.04 |
| Net interest margin | 3.29% | 3.35% | 3.27% | 3.12% |
At September 30, total assets were $1.05 billion, up 8.4% from year-end 2017. Deposits were $878.6 million (+7.7%); loans held for investment were $856.2 million, with net loans of $850.2 million (+5.4%). Available-for-sale securities were $45.5 million, down from $53.7 million.
Cash and cash equivalents were $70.4 million, versus $9.5 million at year-end. For the nine months, operating cash flow was $8.6 million, investing cash flow was negative $27.2 million, and financing cash flow was positive $79.6 million; cash increased $60.9 million. The increase included $34.5 million of net common-stock issuance proceeds from the July IPO and $62.5 million of net deposit growth.
Total liabilities were $937.4 million and shareholders’ equity was $114.2 million. Borrowings totaled $51.2 million: $44.6 million of FHLB advances and $6.6 million of subordinated notes. The Bank reported regulatory capital ratios above applicable requirements and was classified as well capitalized; its total risk-based capital ratio was 11.31% and Tier 1 leverage ratio was 8.45%. Management reported $256.4 million of additional FHLB borrowing capacity.
Material changes and operating drivers
- Nine-month pre-tax income rose 66.0% to $5.2 million; net income increased 98.3%. Higher net interest income and non-interest income were principal contributors.
- Loan growth and higher loan yields supported net interest income. However, deposit interest expense rose as rates increased and average interest-bearing deposits grew; Q3 net interest margin declined year over year.
- Nine-month non-interest income increased 8.0%, led by mortgage gains, which rose 69.6% to $3.8 million. Mortgage originations increased following the September 2017 purchase of EMC Holdings; management cited competitive pricing as a factor in lower gain-on-sale margins.
- Nine-month non-interest expense increased 8.0% to $38.5 million, primarily due to salaries and benefits, including EMC-related costs and stock-based compensation. The effective tax rate fell to 24.1% from 36.5%, reflecting the 2017 federal tax law change.
- The July 2018 IPO raised $32.5 million net of issuance costs. The Company used IPO proceeds to redeem $25.0 million of preferred stock and, separately, $6.9 million of subordinated notes due 2020. Common shares outstanding were 7,968,420 at November 5, 2018.
- Assets under management were $5.626 billion, up from $5.180 billion a year earlier; the filing attributes growth mainly to contributions and market gains.
Outlook, risks and unusual items
- The filing provides no quantified earnings, revenue, margin or loan-growth guidance. Management says mortgage operations are undergoing changes intended to improve profitability; the Mortgage segment reported pre-tax losses of $0.3 million for Q3 and $0.7 million year to date.
- Asset quality weakened from year-end: non-performing assets increased to $19.0 million from $4.9 million, or 1.81% of assets versus 0.50%. The increase primarily reflected a $11.3 million non-accrual loan secured by cash, securities and other collateral, which was in workout and had no specific reserve at quarter-end. The filing also reports $5.3 million of loans 90 or more days past due and still accruing.
- The allowance for loan losses was $7.1 million, 0.83% of loans; the Company recorded a $0.2 million recovery of credit losses for the nine months. Management says it uses a dedicated problem-loan resolution team. Real estate collateral secured 72.7% of the loan portfolio.
- Unrealized losses on available-for-sale securities increased to $2.8 million from $1.6 million at year-end, primarily due to interest-rate and mortgage-prepayment market changes. Management did not consider the securities other-than-temporarily impaired and stated it could hold them until recovery.
- Management disclosed that the Company’s market capitalization was below book value ahead of its October 31 annual goodwill test. Goodwill was $24.8 million, including $8.8 million allocated to Capital Management; an impairment charge was possible but not certain. Management said any such impairment would not affect tangible book value or regulatory capital.
- Interest-rate modeling indicated a less asset-sensitive balance sheet than at year-end; under a 300-basis-point increase, modeled net interest income changed negative 0.28% and fair value of equity negative 12.20%. Results depend on assumptions including deposit betas, prepayments and timing of rate changes.
- Off-balance-sheet commitments included $276.3 million of unused credit lines and $23.6 million of standby letters of credit. Contractual future operating lease obligations were $19.1 million; the Company expected to recognize right-of-use assets and lease liabilities upon adoption of the new lease standard in 2019.
- Management stated that no pending legal proceedings were expected to have a material financial effect. Disclosure controls were concluded effective; the filing indicated the Company had not filed all required Exchange Act reports during the preceding 12 months.
Important facts for investors to verify
- Performance and recovery prospects of the $11.3 million non-accrual loan, the causes of the broader rise in non-performing assets, and adequacy of the allowance.
- Whether deposit pricing and funding costs continue to rise faster than asset yields, and the resulting effect on net interest margin.
- Results of the fourth-quarter 2018 goodwill impairment test, especially for Capital Management.
- Mortgage segment progress toward profitability and whether higher origination volume can offset competitive pressure on gain-on-sale margins.
- Use of IPO proceeds, capital and liquidity trends, and compliance with regulatory capital requirements.
- The significance of the filing’s “No” response regarding timely filing of required reports during the prior 12 months; the filing does not explain the reason in the supplied text.