Ladies and gentlemen, thank you for standing by, and welcome to the First Western Financial Q4 2020 Earnings Conference Call. [Operator Instructions] Please be advised, today's call is being recorded. [Operator Instructions] I would now like to hand our conference over to your speaker today, Mr. Tony Rossi of Financial Profiles.

Thank you, Ryan. Good morning, everyone, and thank you for joining us today for First Western Financial's Fourth Quarter 2020 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. 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, including the impact of the COVID-19 pandemic. 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. And with that, I'd like to turn the call over to Scott. Scott?

Okay. Thanks, Tony. Good morning, everyone. Our fourth quarter performance capped an extraordinary year for First Western. We were extremely well positioned to manage through the unprecedented environment created by the COVID-19 pandemic. Our well diversified, conservatively underwritten loan portfolio has experienced very little stress from the pandemic. We capitalized on the PPP program to add new commercial customers and the refi boom caused by the reduction in interest rates enabled us to generate significant profits in our mortgage business that contributed to tremendous internal capital generation and growth in our tangible book value this year. The one drawback is that a huge increase in mortgage activity during the second and third quarter makes for difficult sequential quarterly revenue and earnings comparisons. But aside from the volatility in that one business, which still had very strong fourth quarter from a historical perspective, we continue to see very positive trends in the areas we're focusing on to build a sustainable path to higher earnings and returns in the future. When looking over our year-to-year comparison, the progress we made in 2020 is exceptionally clear. During the fourth quarter, our revenue increased 44.2% over the prior year. And with the operating leverage we're realizing as we continue to scale, this revenue growth resulted in 88.6% increase in both net income and earnings per share. Our strong financial performance, combined with the completion of our sale of the LA fixed income team, resulted in a tangible book value per share increasing 25% year-over-year. The primary contributor to this improved performance is the success we're having in growing our balance sheet as our commercial banking initiative continues to produce new relationships, high-quality loans and low-cost deposits. Excluding runoff of PPP loans, our held for investment loans increased 6% from the third quarter, while our…

Thank you, Scott. Turning to Slide 9. We've provided an update on our participation in the PPP program and how it impacts various metrics in the fourth quarter. Through the end of the year, we had $54.8 million of loans receive approval for forgiveness from the SBA. This left $142.9 million in PPP loans remaining on our balance sheet. Despite the acceleration of fees upon loan forgiveness, the PPP loans still had a negative impact on our net interest margin of 12 basis points in the fourth quarter. We are participating in the new PPP program, and as of January 25, we had received applications for $73.7 million in round 2 PPP loans. Turning to Slide 10. We look at our gross revenue. While we had a very strong quarter of revenue growth with increases coming in both net interest income and noninterest income, the significant growth we have seen in our balance sheet this year pushed net interest income up to 57.5% of our total revenue this quarter, which is above our historical mix. And we are very pleased that we are able to generate this level of revenue growth while keeping our expenses relatively stable. Turning to Slide 11. We'll look at the trends in net interest income and margins. Our net interest income increased by approximately $500,000 or 4.2% from the prior quarter. The growth was due to an increase in average loan balances, resulting from our organic loan growth. On a reported basis, our net interest margin was unchanged from the prior quarter at 3.07%. However, when the impact of PPP loans and purchase accounting adjustments were excluded, our net interest margin decreased by 13 basis points from the prior quarter. This is primarily due to a decline in average loan yields. Given our continued excess…

All right. Thanks, Julie. Turning to Slide 18, I want to provide some comments about our outlook and priorities for 2021. As a starting point, I wanted to address our capital position. Due to our strong performance in 2020, we had a tremendous amount of internal capital generation. Our tangible common equity increased by more than $26 million last year. For a company of our size that essentially equates to significant capital raise, but with no dilutive impact to existing shareholders. As a result, we're very well positioned to continue supporting organic and acquisitive growth without needing to raise external capital. From an organic standpoint, primary driver of our continued growth will be further expansion of our commercial banking platform. Since increasing our push into commercial banking, our reputation is a well-differentiated commercial bank that can compete and win against larger banks, has grown throughout our markets. This is creating more opportunities to attract talent to the bank. And one of our priorities this year is to steadily add bankers that have proven ability to bring in full commercial bank relationships. We'll also continue to build expertise to help us attract -- target attractive niche markets. We're getting good traction with the banking products and services that we've specifically developed from medical and dental practices. And as we see similar opportunities in other vertical markets, we'll look to replicate this same model. We'll also be active participants in the new PPP program. Last year's program turned out to be a huge accelerator of our commercial bank initiative and resulted in significant expansion of our commercial client roster. We'll again look to use the PPP program to attract new commercial clients that we can cross-sell and expand into more profitable relationships over time Turning to our mortgage business. We clearly won't…

[Operator Instructions] So the first question comes from the line of Brett Rabatin from Hovde Group.

I wanted to first make sure I understood the mortgage in the fourth quarter and then the guidance for '21. How much of the capacity constraint, how much of that kind of impacted what you did in 4Q? And then just thinking about the guidance for '21, doing 80% of what you did in '20. Can you talk about the revenue side on that, is that from an assumption perspective, what you're assuming on gain on sale margins versus 2020?

Well, let me start with a general response. And then, Julie, if you could come back and touch on the margin question, that would be great. When we saw the dramatic increase in volume in Q2 and Q3, we felt like we needed to rebuild our mortgage support for the higher volumes that we were seeing. And so we did a deep dive into that and decided to hire a secondary market specialist and create a capital markets desk in our treasury function that was outside of the mortgage team. And then we decided to strengthen the operations team, we hired a new operations executive for First Western with deep mortgage experience and then move the mortgage operations team under him. And both of those happened in the middle of the year. And then, as we saw these volumes continue into Q3 and even Q4, we're building the infrastructure to support the higher volumes. So I think the progress we've made during the year in addressing that, in a conservative way, in a cautious way, obviously, we want to get ahead of ourselves on the expense side, will give us the stronger support we need to hire more MLOs and push more purchase money volume into the process in 2021. So that's kind of what happened, how we reacted to it in our strategy going forward. In terms of our expectations for 2021, as we look at the granular detail of what our MLOs are seeing and what the industry is expecting for the year. As I said, we are seeing strong inflows into this market and saw strong housing markets for purchase money. And so we do expect to be able to generate more purchase volume in 2021. Do you want to address the margin questions?

Yes. So on the revenue recognition perspective, we booked the revenues on a pull-through adjusted basis, and that is at the time of the lock. So that's why you're seeing that decline. As the locks are coming down, seasonality is having a big impact on that as well. That's why you're seeing the revenue kind of follow the lock volume and not necessarily the origination volume. Originations is when we're funding it. So you can see that in the fourth quarter, we were able to make really good progress on reducing the backlog, improving processing speed. A lot of that will come through already in the fourth quarter and some in the first quarter, and we've seen really nice improvement in our lock volume and our pipeline for the first quarter already. So I think that, from a overall perspective, we feel like the processing constraints are kind of going to be through by the first quarter.

Okay. That's great color. And then the other thing I wanted to make sure I understood was the anticipation of margin pressure. You still have the PPP fees coming, obviously, and I assume mostly in 1Q versus maybe some -- and some still in 2Q. But would seem like that would have a positive impact on the margin in 1Q. I just want to make sure I understood the commentary about anticipating margin pressure. Is that on a core basis? Or does that exclude PPP? And then maybe you mentioned also the highest origination yields, just kind of curious how much more decline you might expect in loan yields this year?

Well, if you can get the noise out, which is really difficult here over the last 3 quarters, I think our margins have actually held up quite well. And I would tell you we expect that to continue. Now we're not expecting to be able to cut deposit rates significantly going forward unless -- well, assuming flat rates here. And we are seeing improvements in loan yields, which is a deliberate effort that we're making that we've talked about in the last 2 quarters. So I do think that we're going to be able to drive core NIM, at least at the levels it maybe slight improvements from here, we'll see. But we're not expecting continued declines at this point from what we know today. Now on top of that, though, you got the PPP noise. And I think what we're seeing is, Julie talked in her slides about the progress we've seen with the first round of PPP loans, those seem to be a little bit on hold right now from the SBA and not being processed. So I'm not sure that, that will clear out in the first quarter. And of course, now you're going to have additional noise from a second round of PPP, and we talked about our volumes there. I mean that's going to be another $75 million or so in PPP low spread noise that we'll have to adjust out in 2021. But it has increased noninterest and net interest income, even though it creates margin pressure.

Okay. I must have misheard the comment earlier on the margin. And then maybe if I can just sneak in one last one. I'm just curious a lot of banks are expecting or hoping for increased M&A activity this year. Just maybe any general comments on the M&A game and how optimistic you might be? And if you are seeing any increase in conversations?

Well, in acquisitions, we do have a corporate development department that's actively looking at bank acquisitions and RIA acquisitions. We've done a fair amount of fee business acquisitions over the years, and that's something we're very actively focused on and works nicely for us. We can expand our footprint by going de novo, as we did in Broomfield, for example, or in Vail. We can buy a bank and add the fee business or we can buy the fee business and add the bank to it and any of those have been successful expansion strategies for us historically and things we're certainly looking at actively in 2021.

And our next question comes from the line of Brady Gailey from KBW.

So I want to start just with the reserve, as you know, an adjusted 98 basis points. I know you guys are not yet CECL compliant. But I mean, that does screen as below peer levels. So as we look towards the next year or 2, should we think about that reserve slowly going higher? Or do you think you'll maintain this roughly 1% level?

Unfortunately, I don't think we have a great answer for you on that. What we saw in 2020 was all of our credit metrics improved significantly. And in spite of that, we decided to take our allowance up from roughly 80 basis points to roughly 100. And we just haven't done the work yet on what CECL implementation is going to be in a couple of years and what that would mean to us. And so for our internal look, we're assuming that 100 basis points or 98 basis points, about where we want to be on the allowance, knowing what we know today. But I would tell you, we're not seeing any credit metrics internally, whether that's losses or problem loans or NPAs or NPLs or past dues, I mean, none of that is trending in a direction that would make us think about increasing our allowance. And yet, as I say, we increased it about 25% as a percentage of a rapidly growing loan book this year.

Okay. And then, Scott, looking at loan growth, you guys have had a lot of success growing loans this year, even in the fourth quarter, annualized that's over 20% loan growth, when you back out the PPP and the held for sale. So just great robust on that, how are you thinking about loan growth as we enter into 2021?

It's a little bit hard to hear you, Brady. I heard everything up until how are we thinking about? And then I didn't get like the most important word in that sentence.

Yes. I was just asking about loan growth expectations for 2021.

Yes. So I think we're expecting to see loan growth in line with what we saw in 2020, again, ex-PPP noise.

And our next question comes from the line of Matthew Clark from Piper Sandler.

On the loan yields, I think you mentioned that you had the highest weighted average rate on new loans this quarter. Could you just give us that specific percentage?

The December average rate was 3.95% for new production there.

And is that sustainable, do you think? Or is there something about the mix in December that might have elevated it?

It's driven by the mix that was in December with a little bit of a heavier commercial loan production in that month. But overall, that is what we've been driving for is that kind of mix and the increase in the yield on the loan book is really something that we've focused on in the last several quarters. So I think that our expectation is that, that's maybe a little higher, but in line with where we would like to see it come in.

Okay. And then just on the mortgage gain on sale, I heard you on the down 20% for the year. But in terms of the cadence and how we should see that gain on sale revenue come through the year, I assume you'll see a step-up here. Is there some portion of the capacity constraints that you guys face in the fourth quarter that wasn't locked, that's going to come through here in the first quarter, so we might see a decent pop in the first quarter despite seasonality?

So I think Q1 is traditionally lower for us seasonality wise, so more in line with the Q4 of 2020 than what we have seen in the second and third quarter. Second and third quarter is always our higher home buying season for Colorado market, at least, which is primarily where mortgage loan originations come from. So for Q1, I would expect a little bit of a bump from Q4, but not too material from where we were. I think where we're going to see most of the revenues come in and higher levels would be in the second and third quarters.

Okay. And then on the PPP balances this past quarter, can you -- do you have the average just offhand? I guess I can back into it, but if you have it, I'd take it.

Average -- so we had 390 loans that were Forgiven. Total loans in dollars is $64.5 through the 25th of January, is that what you're asking?

No, just -- I can back into it with the 12 basis point impact to the margin. I was just trying to get the average PPP outstanding balance in the fourth quarter.

So most of our forgiveness come into like November, December, probably late November. So I would say halfway through the quarter be pretty reasonable guess.

[Operator Instructions] We have one more question currently in queue from the line of Ross Haberman from RLH Investments.

I've seen a lot of banks decide to sell their PPP loans and don't want to deal with all the forgiveness and the cost involved with that. Have you looked at that? And what do you think about that option?

We haven't. Especially now with our automated loan processing for the PPP loans, it doesn't really make economic sense. We make money off of those as we hold them. And to the question earlier, obviously, it does hurt your NIM. But at the end of the day, the capital required for that is none because of the accounting treatment, the regulatory accounting treatment. So I mean, we're making money off of those and benefiting the shareholders with them. Obviously, if we keep them, we are able to build relationships better with those borrowers and then book the fees as they get forgiven. So I think that's something we have analyzed, but it doesn't make a lot of sense for us, given our ability to digitize all that.

And just one follow-up question. The new branches you purchased in the last quarter or 2, are they fully assimilated? And are they generating from the type of income and revenue and profitability that you thought? Or is there more to come? You haven't realized all the synergies and/or the revenue enhancements yet? And if so, when will it sort of begin to kick in more so?

So Good question. We closed, as you know, well, as you may recall, in the middle of Q2. We setup the 4 locations that we acquired that we would close 3 of them, but you can't do that for 90 days because of the regulatory notice purchases. So 90 days later, in the middle of Q3, we closed those 3 locations and retain one, our new loan tree location. And we, I think, had a lot more success retaining and growing that business than we had anticipated. The additional folks that we brought over from that acquisition have proven to be really valuable new associates for us, good partners. And so I would tell you, I think we've probably outperformed our projections there, and we thought it was going to be highly accretive and it's proving to be, I think, a real win-win for the shareholders.

And we do have a question in queue from the line of Matthew Clark with Piper Sandler.

Just want to follow-up on the margin outlook. I think early in the call, you were suggesting there might be some modest core NIM pressure ex-PPP, but then it sounded like maybe holding the line. I mean, if you look at your incremental loan yield at 3.95% and funding it at 45 basis points and you consider the liquidity, maybe earning, I don't know, 90 basis points, it suggests your core NIM should migrate back to the low 3.30s. And I just wanted to make sure we were on the same page or whether or not there's something I'm not thinking about?

Well, you're right, it depends how that excess liquidity plays out and how successful we are in growing the loan book. I mean I gave you my view of it. We could ask Julie for a rebuttal?

I would say it totally depends on that, yes. But I think it would be safe to say -- so I think our core NIM at 3%, a little bit ahead of 3& maybe. Give us a little room, but that's where I would guide you.

All right. If there are any other questions, we'll do the financial section again. That was particularly fun today.

At this time, I'm showing no further questions and would like to turn the call back to management for any closing remarks.

All right. Well, thanks, everybody, for dialing in. We do appreciate your support and your interest, and hope you have a great weekend. Thank you.

Ladies and gentlemen, this does conclude your conference call for today. You may now disconnect.