Earnings of First Western Financial, Inc. (NASDAQ:MYFW) will likely dip in 2021 because of the normalization of mortgage banking income. On the other hand, the management's expansion efforts will likely boost fee income and the loan portfolio size. Further, the provision expense will likely return to almost a normal level in 2021 as the credit risk is almost at a pre-pandemic level. Overall, I'm expecting the company to report earnings of $2.92 per share in 2021, down 5% from last year. The year-end target price suggests a decent upside from the current market price. Therefore, I'm adopting a bullish rating on First Western Financial.
Normalization of Mortgage Activity to Drag Earnings
The mortgage banking income grew by 177% year over year in 2020 to make up 30% of total revenues last year. The surge in mortgage banking revenue was attributable to interest rate cuts in the earlier part of 2020. I'm expecting the mortgage banking activity to return to a more normal level this year due to the following factors.
- Stable interest rates will likely dampen refinance activity.
- High home prices will likely reduce purchase activity (home price growth is depicted in the chart below).
The Mortgage Bankers Association expects mortgage banking volume to decline by 17% year over year in 2021.
On the other hand, I'm expecting fee income to continue to grow this year due to the management's efforts to boost commercial banking. As mentioned in the fourth quarter's investor presentation, First Western expanded its commercial banking team and added construction lending expertise in 2020. This expansion will likely drive deposit growth, which will boost bank fee income. Further, trust and investment management fees will likely receive a boost from team expansions.
Based on my outlook for mortgage banking activity and fee income, I'm expecting non-interest income to decline by 21% year over year in 2021.
Management's Aggressive Efforts to Drive Loan Growth
First Western's loan portfolio has grown strongly in the past through both organic means and acquisition activities. The company acquired Simmons Bank locations in Denver in the second quarter of last year, according to a press release. Further, the management expanded its commercial banking and construction lending teams last year. This expansion will likely continue to boost loan growth in 2021. Further, the management mentioned in the presentation that it intends to continue to focus on organic and acquisition-related growth this year.
On the other hand, the Paycheck Protection Program ("PPP") will likely have a net negative impact on the loan portfolio size. First Western had $142.9 million worth of PPP loans outstanding at the end of last year, representing 9.3% of total loans. I'm expecting these loans to get forgiven in the first half of 2021. The impact of the forgiveness will be partly offset by the second round of PPP, wherein First Western has received loan applications of around $73.7 million. As a result, PPP will likely reduce the loan portfolio by around $70 million or 4.5%.
Considering the management's aggressive growth policies and PPP, I'm expecting the loan portfolio to increase by 7% by the end of 2021 from the end of 2020. The average loan balance will likely be 22% higher in 2021 compared to 2020 because of the acquisition of Simmons Bank locations in the second quarter of last year.
Meanwhile, the deposit growth will likely also remain strong because of the team additions. As a result, I'm expecting the asset mix, and consequently the high liquidity, to be more or less maintained this year. The following table shows my estimates for loans, deposits, and other balance sheet items.
Margin Likely to Remain Under Pressure
The net interest margin ("NIM") will likely remain under pressure this year due to the following factors.
- Continued excess liquidity, as discussed above.
- Reinvestment of cash flows from maturing loans at lower rates.
- Subordinated debt issuance. As mentioned in the earnings release, the company raised $10 million at an initial interest rate of 4.25%. The issuance will likely increase the funding cost by two basis points, according to my calculations.
On the other hand, a material amount of time deposits will mature this year, which will ease the pressure on NIM. As mentioned in the 10-K filing for 2020, around $125 million worth of Certificates of Deposits ("CD") are scheduled to mature in 2021. If the company can replace the maturing CDs with deposits carrying rates that are 50 basis points lower, then the maturity can reduce the average deposit cost by five basis points.
Considering these factors, I'm expecting the NIM to decline by two basis points sequentially in each of the four quarters of this year. This means that the average NIM in 2021 will be seven basis points below the average NIM for 2020.
Expecting Earnings of $2.92 per Share
The normalization of mortgage banking income will likely drag earnings this year. On the other hand, strong growth in the loan portfolio will likely continue to boost the bottom line. Additionally, the provision expense will likely decline to a more normal level this year. As mentioned in the investor presentation, First Western had no loans with COVID-19 related payment modifications as of January 25, 2021. This indicates that the portfolio's credit risk is back to the pre-pandemic level.
Overall, I'm expecting the company to report earnings of $2.92 per share, down 5% from last year. The following table shows my income statement estimates.
Actual earnings may differ materially from estimates because of the risks and uncertainties related to the COVID-19 pandemic and the new variants. Further, the future corporate tax rate is currently uncertain. I have incorporated a higher effective tax rate for my 2021 estimates compared to 2020.
The December 2021 Target Price Suggests a Double-Digit Upside
I'm using the historical price-to-tangible book multiple ("P/TB") to value First Western. The stock has traded at an average P/TB ratio of 1.03 in the past, as shown below.
Multiplying the average P/TB multiple with the forecast tangible book value per share of $19.2 gives a target price of $19.9 for the end of 2021. This price target implies a 26.3% downside from the April 1 closing price. The following table shows the sensitivity of the target price to the P/TB ratio.
As First Western earns a large part of its total revenues from non-interest-based sources, the equity book value does not capture the full earnings potential. As a result, I'm augmenting my investment thesis with the price-to-earnings multiple ("P/E"). The stock has traded at an average P/E ratio of around 14.5x in the past, as shown below.
Multiplying the average P/E multiple with the forecast earnings per share of $2.92 gives a target price of $42.3 for the end of 2021. This price target implies a 56.9% upside from the April 1 closing price. The following table shows the sensitivity of the target price to the P/E ratio.
Equally weighting the target prices from the two valuation methods gives a combined target price of $31.1, which implies a 15.3% upside from the current market price. First Western does not currently pay a dividend.
Based on the decent price upside, I'm adopting a bullish rating on First Western Financial. I like the company because of its strong balance sheet growth history and outlook, and the low credit risk.
