Second Quarter 2016 Shareholder Update
We started this year with big plans for revenue and earnings growth that would position FW for some streamlining of our capital structure in 2016 and a potential public offering of common shares in 2017 (see caveat, below). This Q2 update will walk you through the operating improvements, financial performance and outlook, capital plan and discuss some possible implications.
To encourage you to read the longer version below, here are the main takeaways:
- First Western is uniquely positioned, and is an attractive and differentiated investment story.
- We continue to grow and expand, in spite of being somewhat capital constrained in recent years. Our expected revenue and earnings ramp is on schedule, with earnings 2% ahead of plan YTD.
- We have the requisite approvals for our 2016 capital plans – a series of important initiatives to lower our cost of capital, simplify our capital stack, and set our IPO up for more success.
- WE ANTICIPATE A PREEMPTIVE RIGHTS OFFERING OF COMMON STOCK TO ACCREDITED INVESTORS IN Q3, OUR FIRST IN SIX YEARS, AND ENCOURAGE YOU TO CONSIDER PARTICIPATING.
- Current trends position FW well for an attractive valuation in a possible 2017 public offering, subject to continued performance and market conditions.
You have surely heard us describe FW’s mission “to be the best private bank for the Western wealth management (WM) client.” A prospective client, or for that matter an equity analyst or new investor, evaluating First Western today sees:
- A unique, focused Western private bank and trust company positioned in a dozen affluent high growth markets including Denver, Boulder, Aspen, Jackson Hole, and Scottsdale;
- A fully integrated firm (no silos) delivering through local teams in CO, AZ, WY and CA supported by a centralized team of product experts;
- Just under a $1 billion bank ($1 billion triggers FDICIA and small bank holding company issues) with $5 billion in trust and investment assets, growing at rates well above peers;
- With 59% of revenues in highly desirable fee income, our non-interest income ratio is nearly double the median of FW’s national high fee bank peers;
- Consistently strong investment management performance – for example, two of our three First Western mutual funds have now been rated by Morningstar, and both are rated 5 Stars;
- Strong risk management with excellent asset quality; and
- An experienced and long tenured management team.
We believe this highly differentiated story, solid financial performance and lack of true peers in a highly desirable niche and geography, will drive strong investor interest and a premium to peer banks.
We expected continued improvements over last year’s revenue and earnings growth, and FW is performing well:
- Revenue growth – Net revenues are up 17% year to date to over $28.5mm through June.
- Revenue run rate – Continuing our organic revenue growth and operating leverage gains, we achieved a record $66mm annualized revenue run rate in June.
- Earnings growth – We had a very strong second quarter, earning $1.9 million pre-tax in Q2, with pre-tax earnings year-to-date of $2.7 million, and $3.6 million at the Bank.
- Operating earnings – Up year over year by 35% to $3.2mm, and 2% ahead of Plan through June.
- Organic growth – On a consolidated basis, our assets are up 25% year over year through June to $914mm.
- Loans – Have grown $113mm, 20%, including mortgages carried on our books, to over $710mm.
- Deposits – Are up $236mm, or a remarkable 45%, since last June.
- Expansion – We added a new location in Aspen, plus mortgage offices in old town Ft Collins and in North Scottsdale over the past 12 months.
- Expense control – Expenses are favorable to Plan year to date by 5%.
- Fee/Revenue Ratio – This key ratio is now over 59%, our highest ratio ever and well above almost every one of our high fee bank peers.
- $5.0 billion in trust and investment management assets – Up 5% so far this year.
With the very positive earnings momentum from 2015 and now the first half of 2016, we are expecting continued good news in 2016, which YTD is certainly what we are seeing.
2016 Capital Plan
I have previously noted that one of our more significant successes over the past few years is that we avoided having to do a big dilutive stock offering during the Great Recession and subsequent massive re-regulation of our industry. That was not the case with the publicly held Colorado banks or for most early stage and/or higher growth banks around the country.
We did enter our current growth cycle with a relatively complex capital stack. While we have been “well capitalized” throughout our history, for us to continue to grow and expand, we must raise more common equity. With Dodd Frank, regulators have had growing common equity expectations for all banks, and the 2015 Basel III rule changes require bank holding companies with over $1b in consolidated assets to hold even higher capital levels.
As a result of all of these factors, we can either limit our growth to our existing capital until a potential IPO, which would significantly slow our asset growth trajectory, or take steps now to increase capital and continue our revenue and earnings growth progress to improve our potential public company valuation. 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.
Therefore we are planning the following steps in the latter half of 2016 to increase capital ratios, lower our cost of capital, and simplify our capital stack:
- Complete a common equity raise at a target level of $10mm in 2016;
- Improve operating earnings – as noted above, already underway and working;
- Better integrate FWCM, improving our growth and earnings outlook there;
- Provide incentives for early conversion for Preferred Series D holders into common stock;
- Complete a subordinated debt raise to redeem current sub debt and increase Tier 2 capital; and
- Redeem some or all of our outstanding preferred stock Series A to C.
By replacing our 9% dividend preferred with common and attractively priced sub debt, there is a great opportunity to simplify our capital stack, lower our after tax cost of capital, and increase cash available to common shareholders.
To avoid dilution by new shareholders and still support the planned pre-IPO revenue and earnings growth at First Western, we are planning a pro rata offering of common stock to accredited shareholders later this year. Our preliminary analysis shows that if we offer each shareholder about 9% of their current total share value, that would add enough common equity to the mix of balance sheet actions listed above to complete the capital plan. Thus a shareholder that now has $200,000 in common stock value would have the right to purchase $18,000, probably with some kind of oversubscription right as well.
In addition, for those accredited shareholders that would like to have the interest income from a First Western debt instrument, we are exploring offering eligible shareholders the ability to purchase a pro rata portion of the subordinated debt offering as well. These notes are expected to pay interest in the 7% range, so they do have an attractive coupon. We are currently drafting a private placement memo and expect to have details to share with you in the latter part of August.
As I have noted in the prior updates, our valuation looking forward is trending positive. In addition, the market is once again looking favorably at our type of high fee, niche WM institution. FWFI’s closest comparisons have sold (CNY and PBNK recently sold for 18.5x forward earnings) or traded at attractive multiples (FRC now is over 22x LTM and 17x NTM P/E). Investors will focus on these important comparable valuations. Other, more mature high fee banks like UMB, TMP, BPFH and FFWM, albeit with lower fee income to revenue ratios than FWFI, trade at forward multiples in the mid-teens.
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 improvements trends from 2015 and now 2016, FWFI 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 FWFI.
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.