Prepared remarks
Thank you for standing by. And welcome to First Western Financial's Second Quarter 2020 Earnings Conference Call. Currently, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. To ask a question during the session, you will need to press *1 on your telephone. To remove yourself from the queue, you may press *1 again. I would now like to hand the call over to Lisa Fortuna, Investor Relations. Please go ahead.
Thank you, and good morning, everyone. Thanks for joining us today for First Western Financial's Second Quarter 2020 Earnings Call. Joining us from First Western's management team are Scott C. Wylie, Chairman and Chief Executive Officer; Julie A. 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 would like to remind you that this conference call contains forward-looking statements with respect to 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 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 would like to turn the call over to Scott.
Thanks, Lisa, and good morning, everybody. We executed well in the second quarter and saw positive trends in many areas, including deposit cost, deposit growth, net interest margin expansion, managed expenses, and stable asset quality. This resulted in another quarter of solid profitability. We continue to maintain prudent risk management and conservative new loan production practices. Supported by the banking talent added over the last several years, and good economic activity across our markets, we achieved healthy loan production that was diversified across markets, industries, and loan categories. As a result of our financial performance and the balance sheet management strategies, we further strengthened our tangible book value per share this quarter. Moving to slide 4, we generated net income of $6.7 million or $0.57 per diluted share in the second quarter, 129% and 119% higher respectively than the year-ago period. With our prudent balance sheet management, our tangible book value per share increased by 2.6% this quarter to $25.53. Now I will turn the call over to Julie for some additional discussion of our balance sheet and trust and investment management trends. Julie?
Thank you, Scott. Turning to slide 5, we will look at the trends in our loan portfolio. Our loans held for investment increased $23 million from the end of the prior quarter, marking the fifth consecutive quarterly increase. On a year-over-year basis, total loans increased 7%. We remain conservative and disciplined in our new loan production, and the higher productivity of the bankers added over the last several quarters is supporting a stable pace of loan originations. New loan production was $115 million in the second quarter, and was diversified across various markets and loan types. We focus on relationship-based lending. We continue to be disciplined with respect to pricing, which resulted in the average rate on new production of 6.37% in the quarter, which was 6 basis points higher on a quarter-over-quarter basis and higher than the average rate of loan payoff of 5.89% in the quarter. Now moving to slide 6, we will take a closer look at our deposit trends. Our total deposits increased from the end of the prior quarter, with growth in money market accounts, partially offset by a decrease in time deposit accounts. On a year-over-year basis, total deposits increased 12.6%. Average noninterest-bearing deposits increased $18 million or 5.1% in the quarter. Turning to trust and investment management on slide 7, we had a $41 million increase in our assets under management in the second quarter primarily attributed to improving market conditions. Investment agency AUM increased $91 million in the quarter and $122 million on a year-over-year basis, which is our highest fee category. As David will cover shortly, our trust and investment management fees have increased 5.1% from the second quarter of 2020. We have restructured that team for growth. Now I will turn the call over to David for further discussion of our financial results.
Thanks, Julie. Turning to slide 8, we will look at our gross revenue. Our gross revenue increased 1.8% from the prior quarter primarily due to an increase in net interest income, partially offset by a decrease in noninterest income. Our gross revenue has increased 16% from the second quarter of 2020. Now turning to slide 9, let's look at the trends in our net interest income and margin. Our net interest income increased 4.3% from the prior quarter due to an increase in net interest margin and an increase in day count. Our net interest margin increased 9 basis points from the prior quarter to 2.9%. This was primarily due to a decrease in cost of funds combined with an improved mix shift in average interest-earning assets. The yield on interest-earning assets increased 4 basis points driven by a favorable shift toward higher-yielding loans while the cost of funds declined 4 basis points due to an improved funding mix and lower rates on time deposits. Our net interest income increased 21.7% from the second quarter of 2020 due to a 23 basis point increase in net interest margin and an increase in average interest-earning assets. Now turning to slide 10, our noninterest income decreased by $0.3 million from the prior quarter. This was primarily due to a decrease in net gain on sale of mortgage loans given lower origination volume due to higher mortgage rates, a decrease in risk management and insurance fees, partially offset by an increase in bank fees. Now turning to slide 11 and our expenses. Our noninterest expense increased by $1.0 million from the prior quarter. The increase was due to an increase in technology and information systems, data processing, and marketing. The increase was primarily attributable to a $0.4 million nonrecurring charge related to the write-off of certain previously capitalized technology assets, which negatively impacted diluted EPS by $0.03. Our efficiency ratio was 74.03% compared to 73.11% last quarter and 78.83% in the second quarter of 2020. Going forward, we expect quarterly noninterest expense to be between $20 million and $21 million, and we will continue to exercise disciplined expense control. Now turning to slide 12, we will look at our asset quality. As Scott indicated earlier, we saw stable trends in the loan portfolio in the second quarter with relatively flat nonaccrual loans and NPAs. Additionally, we had no loan charge-offs for the second consecutive quarter. Our allowance coverage was 75 basis points of total loans, as improved trends during the quarter drove a release of provision of $0.5 million. Now I will turn it back to Scott.
Thanks, David. Turning to slide 13, I will wrap up with some comments about our outlook. Based on our second quarter performance and what we are seeing in our markets, we are encouraged and expect further improvement in our financial performance during the second half of the year. Overall, we continue to see relatively healthy economic conditions in our markets. We are seeing good opportunities to add both new clients and banking talent, due to the ongoing disruption from M&A activity in our markets. We have also recently added new leadership in Arizona where we are beginning to see good traction and opportunities for growth. Our loan and deposit pipelines remain strong and should result in improved balance sheet growth in the second half of the year, a key objective of ours. In addition to balance sheet growth, we also expect to see positive trends in our net interest margin, fee income, and more operating leverage resulting from continued revenue growth and ongoing expense discipline. We had a net margin expansion of 26 basis points in 2025, and another 19 basis points so far in 2026. While we remain disciplined on our expense control, we believe there will be opportunities to invest in our business by adding banking, trust, and investment management talent and new clients due to the disruption caused by the continued M&A in our markets. These investments in the business will drive future shareholder value. The ongoing disruption from M&A activity in our markets creates opportunities for us to add revenue growth talent. We will take advantage of these opportunities if and when they materialize, as well as opportunities to add new clients. Based on the trends we are seeing in the portfolio, and the feedback we are getting from our clients, the credit outlook appears stable and healthy. The positive trends we are seeing in a number of key areas are expected to continue, which we believe will result in steady improvement in our financial performance and further value being created for our shareholders in 2026. So with that, we are happy to take your questions. Operator, please open up the call.
Questions and answers
As a reminder, to ask a question, you will need to press *1 on your telephone. To remove yourself from the queue, you may press *1 again. Our first question comes from the line of Woody Lay of KBW. Your line is open, Woody.
Hi. This is Woody stepping in for Wood Lay. Thanks for taking my question.
Good morning, Woody. Wanted to start off with loans. I saw you guys noted and mentioned earlier that you have strong loan and deposit pipelines. I was wondering if you could give a little more color on where that growth is coming from and how you are thinking about overall loan growth for the second half of the year. Sure. Let me start with a short answer and then give a little more detailed one, if that is okay. The short answer is we have seen a really nice balance in where our loan production is coming from. On the loan page of the deck, you can see there that we saw our usual $100 million a quarter in payoffs and paydowns. In the production that we did, the $115 million-ish was better than that, but not enough to drive the growth that we expected to see. The longer answer is we are seeing some impact, as I had predicted in the prior two quarters, from market disruption. It is a real two-edged sword. One side is that clients are disrupted and bankers are disrupted, and there is opportunity there, which we are definitely taking advantage of. We will see more results from that. The other side is that we are seeing real price competition on loans. We have made the decision here to be disciplined in our pricing and in our terms. For example, we saw a proposed loan priced at 125 over Treasuries for a long-term fixed rate loan, and we are just not going to do that. That does not make sense to me. Others entering the market who want to defend their clients or be aggressive with pricing may do so, and that is understandable, but that does not mean we will chase that. We have seen a nice increase in NIM continue. The fact that we have had significant improvement in the first half of the year and last year is a telling story on how NIM improvement that we predicted nine months ago has continued. We did not think it would go this fast, but I think it has because we focused on NIM. David has some interesting analysis we can delve into about the trade-off of NIM and growth. The short answer is, if we grew $280 million in net growth by the end of the year and just kept our NIM flat from here, that would have the same income effect as growing zero in assets and having 10 basis points a quarter in improvements. Or, if you take the midpoint, $130 million in growth a quarter and a 5 basis point improvement per quarter in NIM. That has the leadership team thinking maybe we back off the pace of improvement in NIM in the second half and see a little more asset growth. We have talked to the front office about that. We had our two-day annual summit earlier this week and asked the 19 office heads that were here whether we are missing the market by a little or a lot. They said in some cases a lot, in some cases a little, and we think we can be a little more competitive and grow faster. That is how we are looking at it. Sorry that turned into such a long answer, but I think it is a great question.
That is super helpful. Really appreciate all of that color. Wanted to touch back on what you said earlier about taking advantage of the market disruption and ask what you guys are seeing on the hiring front and how you are expecting this to impact expenses moving forward.
Yeah. Another great question. We have added 12 new front office people into the profit centers so far this year, and eight new people into the product group areas. If you look at people that are actually just direct salespeople, we have added 10 of those, which are included in the 20 I just mentioned so far this year. One challenge with that kind of hiring is it sometimes takes time to get those people up to speed. On their first day they typically do not produce a lot of new activity. We have done a couple of things to try to accelerate that. The first thing we did is start a program in February to really try to activate a shift back to the offense and get out and call more. I set a personal goal to do 100 calls between February and the end of June, and Julie supported that and called at Westwood initiatives we had this year to try and drive growth. I ended up doing 168 calls and beat my 100-call goal. Company-wide, I think we ended up doing almost 4,000 planned calls. We raised the bar on what a call was defined as: it had to be planned, face-to-face, have a call plan around it and a follow-up in the CRM, and we had an 88% increase in calls year over year. Yesterday we had our board trust committee meeting and our trust department, which historically is less proactive in sales, put a slide in that showed trust officer calls were up 180% in the first half of the year. So there is definitely a culture shift in the organization, including on the P&L side, about getting out and making calls. If you would allow me, can Julie talk a little bit about the activation program we have for new hires?
Yeah. Several months ago, we implemented a program to help the new hires coming into the organization, most specifically those that are client facing, really get launched as quickly as possible to understand our product set, our culture, and our methodology for client service. That was implemented two months ago, and every new hire in those front office roles is going through this additional program to optimize their ability to get out, tell the First Western story, and serve clients well.
Great. That is all super helpful. Really appreciate that. Thanks for taking my questions, and I will step back.
Thank you. Our next question comes from the line of Matthew Clark of Piper Sandler. Your line is open, Matthew.
Hey. Good morning, everyone.
Morning.
Morning.
Morning, Matthew.
I just wanted to touch on the expense guide first. You gave the range, and in the last couple of years, from Q2 to Q3 you have seen a bump up in comp. I am just curious if that is still expected to be the case this coming quarter, and if there are some offsets to that.
Well, just to be clear for Q2, we had some one-time expenses in there related to technology and data processing, which totaled a little under $0.5 million. So the baseline for second quarter appears higher than what it actually is.
Looking forward, we have these new hires in production roles that we are working to activate as we discussed. So I think we are going to see higher expense, which is why we are guiding now to $20 to $21 million instead of $19 to $20 million. Our hope is that expenses are higher in Q3 because we have more incentive comp, driven by good growth, since we accrue for incentive comp based on performance metrics, primarily revenue growth and earnings growth. That would be a good problem to have. Absent that, David, do you have more to add? We do not anticipate additional core expense increases in Q3 beyond what we have already seen in Q2.
Matthew, there is no seasonal component that causes expenses to increase every year in Q3. There are many dynamics—hiring, incentive comp performance, or other items—likely causing some of the spikes you see year to year.
The other thing, Matthew, is if you look back to 2023, our expense increase over the last three years has earned about $3 in core revenue growth for each dollar in core expense growth, so it is pretty good operating leverage, which we expect to continue.
Good. And then on deposit costs, wondered what the spot rate at the end of June was, and then your thoughts on pricing and overall deposit costs going forward, assuming the Fed stays on hold and this higher-for-longer environment persists—what that is doing to your competition.
If I could start and then David can fill in. Q2 for us is almost always a down quarter; we typically see about 2% shrinkage in our core deposits in Q2, and we saw that in April this year. We focused on core deposit growth, which brought deposit growth back to positive in May and June, and we ended up 2% positive for the quarter. Notably, our average noninterest-bearing deposits were up about 5% quarter over quarter, so there were really good improvements in the mix, which has been a focus for us.
Specifically on the spot rate, Matthew, the spot rate of deposits at June 30 was 2.8%.
Okay. And your thoughts about deposit costs going forward—can you continue to chip away at those, or does this environment make it more difficult?
I think it makes it more difficult. The cost of deposit acquisition has certainly increased in our markets given the disruption we have seen, as many participants are trying to hold on to deposits. We have not necessarily seen pressure from our existing depositors to raise rates, but the cost of new acquisition has crept up a bit.
From a time deposit repricing standpoint, we have had some benefits over the past few quarters. Our time deposit portfolio is currently at 3.64% on a spot basis, so I do not know that there is a ton of opportunity left there. I think our biggest opportunity will be continuing to improve our deposit mix through noninterest-bearing deposit growth. From a core basis, we are not seeing a lot of opportunity to change rates, but changing the mix is definitely the focus.
Got it. Thank you.
Our next question comes from the line of Ross Haberman of RLH Investments. Your line is open.
Good morning, Scott. Nice quarter.
Good morning, Ross.
You seem to indicate that, if I am hearing you right, if rates stay the same, you could see some improving margin. Is that correct from what I am hearing from you?
That is certainly what we have seen the last several quarters and we do think that will continue, but I will caveat that this quarter the trade-off between growth and NIM improvement is on our mind. Our feeling is that given the disrupted markets, it probably drives more shareholder value from where we are today to be a little more flexible on NIM improvement to try and drive better growth in Q3 than what we have seen year to date—better asset growth.
If the Fed raised rates a quarter percent for argument's sake, how would that affect your margin expectations? A one-time rate increase.
Historically, we try to run a balance sheet that is neutral on interest rate risk. Right now we have shifted to be more neutral, although we are still slightly liability sensitive. David, do you want to speak to that?
We maintain a relatively neutral balance sheet profile, which has been a goal over the past few years. We do lean slightly liability sensitive. A 25-basis-point decrease by the Fed would benefit us a little, let's call it one to two basis points in NIM, but it is not that material.
Just one follow-up. Asset quality looked really good. You got rid of a lot of nonperformers that plagued you last year. Are they completely gone now?
Yes. The problem credits we had from prior periods are largely resolved. We have seen a return to essentially zero net losses per quarter. A few quarters back there were very small amounts like 0.01 or 0.02, but it has been basically zero most quarters recently and historically. NPAs were flat quarter over quarter with a slight improvement to about 50 basis points, and from what I know today, assuming no surprises, we expect some improvement in Q3. Our underwriting standards—requiring multiple sources of repayment, personal guarantees, and hard collateral—continue to protect us against losses in a normal economic environment.
Nothing in the criticized or substandard categories causing you to lose sleep?
Nothing causing us to lose sleep. Both classified and criticized loans were slightly down in the quarter from last quarter.
Loans were slightly down in the quarter from last quarter.
Thanks, guys. Nice quarter. Have a nice week.
Thanks, Ross.
I would now like to turn the conference back to Scott C. Wylie for closing remarks.
Okay. Great. The key themes this quarter are largely unchanged. If you compare First Western to other $2 billion to $25 billion banks nationwide, we are in great markets with a top-decile mix of affluent markets and a strong niche. We are in the top three of all those banks in terms of wealth management fees as a percent of revenues. We have great bankers. Historically, our organic annual asset growth rate is well above peers; we are about double the median for that group and well into the top quartile, all with very high asset quality. We are continuing to see earnings normalize here. We typically do not talk about our internal plan on these calls, but I will tell you we are performing well against plan on an earnings basis and we think the opportunity to continue to see the gains we have seen so far year-over-year will continue through year end. So with that, thanks to everybody for dialing in. Have a great day.
This concludes today's conference call. Thank you for participating. You may now disconnect.