Q3 2016 Shareholder Update
The timing of this quarterly shareholder update is interesting – with big changes in our national political, economic and financial markets coinciding with a number of positive developments at First Western. I focused my last update on FW’s terrific progress – this update will describe more of our current situation and our plans to take advantage of these new opportunities.
To encourage you to read the details below, here are the main takeaways:
- These are interesting, seemingly very positive, times for long suffering bank investors.
- Our capital raise has made great progress – thank you to the participants. We have to close it out shortly and I hope those on the fence will choose to participate – I explain why.
- We have always been very focused on shareholder value creation at First Western, but it has been very difficult with the headwinds of that past eight years. While we avoided a big dilutive capital raise, we can create much more value going forward if we do the right things. I describe our focus in today’s changing environment.
- To succeed in that focus, I highlight some of the strategic initiatives we are contemplating for 2017.
A New World for Banks?
It has been a remarkable week for the US this week in political, economic and financial terms. While Election Day brought surprises that many of us didn’t expect (or in some cases, like), for financial institutions, there is new hope like we haven’t seen in years. The early market indications for bank stocks are very positive – the KRX index of small to mid-size regional banks, which is a good indicator for FW if we were public – was up 17% in the first week post-election. This is the strongest one week rally in these stocks in many years.
While it will take time to understand, and validate, this new optimism for our sector, here are some possible reasons for this positive reaction:
- Bullet Dodged – A democratic White House and Senate likely “would have meant policy tacking further to the Left and a possible re-acceleration of uber-regulation”. That risk was exacerbated by the recent Wells Fargo fake account scandal – our big bank friends keep finding new ways to fuel the public’s disdain and mistrust for our industry.
- Deregulation – Trump has spoken many times of repealing Dodd Frank. While that seems unlikely to me, reversing the eight year trend of regulatory constriction seems likely to finally reverse. While that will be nice for big banks, for banks our size this could be a game changer – very positive.
- Economic growth – The stock and bond markets are indicating that odds of accelerated economic growth have improved – good for banks and good for FW. “Mr. Trump’s background… likely means good things for the CRE industry (which constitutes a substantial portion of bank balance sheets).”
- Tax Relief – Corporate tax cuts, if they happen, should disproportionately benefit FW – we are full tax payers as we don’t have the scale or maturity to use many of the tax shelters used by larger and older financial institutions to lower marginal tax rates.
- Rising rates – Interest rates climbed last week and futures jumped based on the expectations of higher economic growth, tax cuts and infrastructure spending. “Presumably, this means more debt issuance, which would drive yields higher.” Short term rates depend on the Fed’s view of the inflation risk, which seems more likely today than it did pre-election. This are positives for FW because we manage for an asset sensitive balance sheet – revenues and earnings should benefit as rates rise.
FW Capital Raise
Thanks to those who participated in the current FW capital raise that I described in the Q2 update and the Board approved in August. Since we launched that offering, we have raised about $12mm in new common stock and $6mm in subordinated debt, through new subscriptions, and conversion of the Preferred D and debentures into common. As I noted last quarter, this is our first offering of common stock in six years, and we greatly appreciate your consideration and participation.
We hope to increase the current shareholder participation before selling shares to new investors so if you didn’t participate, I hope you’ll reconsider. While we could have priced this at a low price to drive participation (coercive pricing is typical in rights offers), we felt that a price reflecting the value we believe that we have created and are creating was more beneficial to all our shareholders.
As you may recall, we are offering current shareholders the right to invest about 9% of their current holdings, which in my mind is very beneficial to current holders. I have asked the Board to extend the time to conclude this offering – with multiple current high priorities at FW, this has not been a big enough focus for me.
While we have always been very focused on shareholder value, the drivers of value have shifted over these dozen years since we opened our doors at First Western. While our early focus on revenue growth, expansion and proving the model was successful, during the Great Recession and the long slow recovery, the focus shifted to persevering and protecting as the industry consolidated and has been heavily reregulated. Today our value creation is driven by earnings growth, specifically EPS growth. For First Western, that EPS growth has some natural benefits but also some particular challenges:
- Operating leverage – We have demonstrated FW’s operating leverage – organic growth increases contribution margins in our already high margin mature offices. However, growing these offices requires more capital. And of course more shares outstanding requires continued earnings growth to grow EPS.
- New Locations, Services – More offices, as they mature, provide strong contribution support to overall earnings growth and help leverage our core fixed costs. New services generate additional revenues in both our current and new locations, but typically require a ramp up period and capital support.
- Regulatory Capital– On top of all the Dodd Frank expectations for higher capital ratios, the Federal Reserve adoption of Basel III requirements for all US banks began to phase in starting in 2015 and ratchets up capital requirements for all banks. FW applied for and received an exemption because of our business model that is only available to certain institutions with under $1b in consolidated assets. We are now just below that threshold and need additional capital to meet the twin challenges of growth – capital for the growth plus capital for the higher capital ratios required under Basel III.
- Potential IPO timing – We believe FW shareholders will benefit from a public offering, providing the opportunity for public valuation, liquidity and currency for additional acquisitions. Investment bankers advise us that any IPO valuation is dependent on our earnings growth outlook, so we are trying to continue our recent success in growth and expansion to support that story, all requiring more capital. Potential IPO caveat: note that any potential IPO is subject to many variables, including performance, timing, market access and other factors, some of which are beyond our control.
For those reasons and the additional ones detailed in the last update, your participation in the current offering is encouraged. With the improved bank investment climate noted above, hopefully the investment story is even more compelling.
This is the time of the year we do our 2017 planning and budgeting. Given the imperatives described above, you can probably guess what our priorities are – to best position FW for the opportunities ahead. Here are some of the things we have been working on, which I would expect to accelerate in 2017:
- Revenue growth – We have had good success with organic growth. I highlighted our balance sheet growth in the last update, which has continued, although our ability to continue that growth will depend on our ability to raise capital at a fair value.
- Revenue mix – We have recruited a new product group President, Joe Maslowski, to strengthen our fee generating product teams and continue our industry leading fee growth story. This is already an area of great strength for First Western with a fee income to total revenue ratio nearly double that of our high fee peer banks around the US.
- Expense control – FW has effectively limited expense growth. While net revenues grew YTD through September by 14% over 2015, compensation expenses, our largest controllable expense by far, grew just 7%.
- Earnings growth – Over the same period, operating earnings grew 35%, reflecting continued operating leverage improvements as noted above.
- Cautious expansion – We accomplished this while continuing to add new services and new locations. Our Jackson Hole office is reaching critical mass, and our new Aspen office, now in our permanent home just behind the Jerome, may be the quickest new office ever to produce a positive contribution. Our new mortgage and third party administrator initiatives launched last and this year, respectively, are both contributing nicely as well.
- Managing growth initiatives – With our recent success in growth and expansion, we are building our organization to ensure that our teams feel well supported. We have reorganized and created a smaller executive team, adjusting for the very flat and decentralized organization I used to get us through challenges of the Great Recession and subsequent re-regulation. We are strengthening our Human Capital function, it is by far our biggest cost and our key differentiator. We also are re-visioning our culture and co-creating new operating principles for a growth enabled culture, a critical step to keep our entrepreneurial spirit fresh and meaningful to our associates and therefore to our clients.
As noted above, we have seen quite a rally in comparable bank stocks post-election. In addition, the market is once again looking favorably at our type of high fee, niche WM institution. FW’s closest comparisons have sold (CNY and PBNK recently sold for 18.5x forward earnings) or traded at attractive multiples (growth peers like CBSH, FRC, SIVB, FFIN and FHB are trading now in mid-November at 20x forward earnings). Investors will focus on these important comparable valuations.
We continue to be focused on growing revenues and earnings with a path to an attractive valuation and options for liquidity in 2017. There are a number of things that need to happen for this to all work out by next year, some internal and many external, but so far our progress has continued to be good. With the earnings improvement trends from 2015 and now 2016, FW is set up for the opportunity of attractive valuations and liquidity to come.
We continue our pre-IPO preparations, with our first PCAOB audit completed and various FDICIA and SOX initiatives currently underway. While there is much work to be done, with these earnings trends and forward price market multiples, there is certainly good potential for FW.
If you would like more information or have any questions, please just give me a call at 303-531-8101 or email me at Scott.Wylie@myfw.com. Thanks once again for all your support.
1 Quotes in this update are from a Sandler O’Neill post-election Industry Note – email me if you would like a complete copy.