Colony Bankcorp Inc Q2 FY2022 Earnings Call

Good afternoon. Thank you for attending today's Colony Bankcorp conference call. My name is Tamia, and I will be your moderator for today. It is now my pleasure to pass the call over to our host, Andy Borrmann, CFO of Colony Bankcorp. Please proceed.

Thanks, Tamia. First of all, thank you to everyone who's on the call, and thank you for recognizing the relatively quick turnaround today from the earnings release to the call. So we appreciate you joining us. To get started this afternoon, keep the leaders happy. I'm just going to make a quick opening statement. Certain statements we make on this call could be construed as forward-looking statements within the meaning of the Securities Act of 1933 and the Securities Exchange Act of 1934. Current and prospective investors are cautioned that any such forward-looking statements are not guarantees of future performance, but involve known and unknown risks and uncertainties. Factors that could cause these differences include, but are not limited to, the COVID pandemic, variations of the company's assets, businesses, cash flows, financial condition, prospects, and other results of operations. With that, Heath, I'll turn it over to you.

Thank you, Andy, and thanks, everyone, again for being on the call. And like Andy said, I know it's a quick turnaround time. Appreciate you all working with us on that logistical issue. But let me just walk through, I think it was a really solid quarter for us, but it was certainly noisy. So I would like to walk through some of the moving pieces that we've laid out for you for the quarter and give you a little color on some of those. During the quarter, we took a $1.35 million charge to personnel expense for our previously announced efficiency initiative, and that initiative was largely completed during the quarter. We also had some charges that are related to the rapid increase in interest rates that we saw this quarter. So we took a $751,000 charge to interest expense due to the write-down of acquired FHLB advances that came from the SouthCrest acquisition. Those were called during the quarter, and then $316,000 hit to noninterest expense due to the write-down of servicing assets on our government-guaranteed loan portfolio. So we had those things that we wanted to highlight during the quarter. We also had a great loan growth quarter. We added nearly $100 million in loans. That's nearly a 30% annualized growth rate. So it was good to see us getting that traction after running a little bit behind where we were hoping to be earlier in the year. And that increase in loans led to us providing $1.1 million to our loan loss reserve. So despite improving credit metrics and the credit outlook remaining stable, we felt the need to put $1.1 million in to cover the loan growth we experienced during the quarter. And of course, that's ahead of where we were expecting to need to put in the allowance due to the growth. And I think certainly, our analysts that follow us were projecting lighter numbers than that as well. So when you take those items into account, I think we had a really good quarter. I'd like to note a couple of other things for the quarter. For the last couple of years, our mortgage and government guaranteed lending, or what we call our small business specialty lending, our SBSL group, helped drive our results as we work on improving our core bank earnings. And this quarter, with a challenging environment for mortgage and for government guaranteed lending, we really saw the core bank performing well and driving the majority of the net income. And so it was good to see that in the core bank. This is also the first quarter where we saw very little PPP income. In the previous quarter, it was about $0.5 million, and we did not have that this quarter. So with all that taken into account, again, like I said, it's a bit noisy, but I think you can see why we're happy with the quarter and positive about our earnings outlook. In addition to the operating results that we've detailed, we were also able, during the quarter, to complete a $40 million subordinated debt offering. So, really, in the first half of this year, I'm proud of what we've done there to shore up our capital base with the $60 million capital raise in Q1, plus it really puts us in a great place from a capital perspective to work through any economic uncertainties out there. So proud of what we accomplished this quarter, proud of our team. That's really all the prepared comments I have. So at this time, Tamia, if you'd like to open up the lines for questions, please do so.

The first question comes from Kevin Fitzsimmons with D.A. Davidson.

Apologies if I haven't made it through the whole release or deck yet, so if you've already covered this in the release. But just wondering if you could talk about the margin. I know there was that $751,000 probably created some noise in it, but it just looks like it went up 2 basis points linked quarter. If you can help us think about the trajectory of the margin going forward in the third quarter and beyond, assuming what the market is anticipating the Fed is going to do? How do you guys position?

Sure, Kevin. Thanks for the question. Yes, that $750,000 does put a little bit of a wrench in that math, clearly. The way we pencil out the math, it looks to be about a 32 basis points impact. So I would say our margin ended up being mid-3.40s, 3.45-ish to 3.47, depending on how you probably annualize that. But realistically, I think that's a good starting point for the NIM going into the third quarter. We continue to expect to get some benefit going forward, both from the interest rate environment and the asset mix change. As we look at the loans we've been putting on the books, we have seen pricing from the beginning of the second quarter, end of the first quarter, and the beginning of the second quarter to the end of the second quarter and this month improve pretty meaningfully, as you can imagine. And so we do expect some benefit there going into the third quarter still from the second quarter level.

Is it fair to say that the third quarter might be the biggest quarter of expansion and then it could slow down after that as deposit betas increase?

Yes. I think that's a fair position; that would probably be our baseline assumption. We try not to make too many interest rate assumptions, Kevin, just given the volatility in that market, obviously, here recently. But I think that's our baseline expectation.

Okay, great. I have just one question. I know credit looks good right now and that applies to everyone. With such strong loan growth, I'm curious if you considered increasing the allowance more given that there may still be risks out there. Or are you limited by the model in doing that?

Yes. Kevin, that's a good question. And one thing to remember for us, we're not CECL yet. And so we should be working through an incurred loss model. For us, with credit metrics improving, we did move some of our other factors around, but we're seeing good trends. We have made some underwriting adjustments and are still seeing continued loan growth even with those underwriting adjustments. So we feel good about what we're putting on. With that being said, we didn't really feel the need to add more than to cover the growth during the quarter.

So those underwriting adjustments, is that like you're just tightening up? Or are you looking at certain classes of loans and really tapping on the brakes in terms of your interest in them?

Yes. I think it's important for us and how we operate, maybe versus some of the larger banks, that we stay nimble. We try to make slight adjustments as we go, versus some of our larger competitors where we get the advantage sometimes to see where they move bigger swings in and out of certain classes. We have looked at our concentrations and where we are just ensuring that the stuff we put on in areas where we may be concentrated is sound. We're just being careful, I would say, in certain categories. So not really slamming on the brakes anywhere, but looking around to make sure that we're being prudent in what we have, especially in areas where we might be concentrated.

The next question comes from David Bishop with Hovde Group.

Following up on Kevin's question regarding the office side, I apologize for not having deeply explored the presentation. On the other hand, what are you observing regarding the funding aspect of deposit growth this quarter? Additionally, I assume the 30% loan rate is probably not sustainable. How are we planning to support the loan growth for the second half of the year?

Yes, it’s certainly challenging at the moment. We anticipated our loan growth to increase from the first quarter, but 30% annualized is not a typical scenario for us. We are managing a few aspects here. Deposit growth has been nearly flat, and if we exclude the subordinated debt, we’ve seen a slight decrease, but it's mostly stable since we haven't raised pricing significantly. We believe we are close to needing to reconsider deposit pricing to stimulate growth in those balances again. You can expect us, along with others in a similar situation, to manage some wholesale funding and possibly a small broker position over the next 6 to 9 months while we navigate this period of loan growth. I’m not certain how long this will last, but at least through the third quarter. As we begin to boost deposit growth, ideally through more competitive pricing, we aim to reduce those wholesale positions. We are actively working on various strategies to support this expected loan growth. Currently, our pipelines for the third quarter appear quite strong. We are noticing early signs of what might be a minor slowdown in the fourth quarter based on anecdotal information we’ve received, but for now, the third quarter looks promising.

Got it. And then, secondarily, I guess back to the loan discussion. Just curious what segments drove that growth this quarter? And curious about the breakdown in terms of the various markets and the hires. Just curious how big you think the Huntsville and Birmingham markets are for loan growth.

Yes. No. And I think just from a breakdown geographically where that loan growth came from, it was fairly spread out across our footprint. I think roughly one-third or a little more than one-third came from the Atlanta market and then spread throughout our footprint pretty well after that. We have not yet brought lenders on in the quarter in Birmingham and Huntsville but really haven't seen the benefit of that yet. That was later in the quarter. We had strong pipelines there, and we think we'll see really strong growth there, but don't have that on the books yet. So that wasn't really a part of this quarter. As far as what we saw in terms of the lending breakdown, really, it was very largely similar to the portfolio as a whole. We continue to see commercial real estate growth. Obviously, one of our concentrations that we have is trying to manage that commercial real estate, particularly any non-owner-occupied pieces of that. And those are the areas where we're being a little more cautious in terms of making sure that we stick to our underwriting, and in some cases or sectors, tighten up the underwriting, especially in the areas like non-owner-occupied real estate related to retail where consumer spending and things like that can cause a slowdown.

And was your last part of that question around the potential size of Birmingham and Huntsville?

In total.

Yes. I mean, in Huntsville right now, we have 1 commercial banker, and in Birmingham, we would have 3. Those markets have a lot of upside potential. Today, when you think about our portfolio, we've got Atlanta, and then we would have Savannah and several other markets in Georgia like Columbus, Warner Robins, and all being larger markets. Certainly, we would expect, over a longer period of time, just with Birmingham and Huntsville to start to move up in the chain and the markets there where Savannah and Atlanta are currently showing. That's going to take a while if you think about it. We would look at lenders if we have an opportunity to get good lenders, but we don't need that to achieve good solid growth.

Next question is from Christopher Marinac with Janney Montgomery.

Heath and Andy, just want to go through the securities portfolio. Anything changed there in terms of credit risk within those securities? And I guess maybe just a sense of how some of those will mature and pay off over time?

No, Chris. We really didn't have any change there. We haven't had any downgrades in our municipal or credit portfolios that I'm aware of. Realistically, as you and I have discussed over the years, we tend to be 5- to 10-year window investors in most products, occasionally a bit longer. We do have a small portion of our treasury portfolio that we plan to sell if rates reach a level that makes it sensible to exit without incurring losses. However, at the moment, most of our maturities are no earlier than early 2024, and our duration in that portfolio is approximately 6.

Got it. From a high level, do you see the liquidity on the balance sheet as part of the strategic plan you put in place two or three years ago? What is the timeframe for transitioning the balance sheet to have a much greater proportion of loans compared to where we are today?

Yes. As I mentioned earlier, we will be managing some wholesale funding for the next 6 to 9 months. It's difficult to predict loan growth for 2023; I feel optimistic about the third quarter, but it becomes less clear afterward. If we can meet our targets of 8% to 12%, we should reach a 70% loan-to-deposit ratio in the second half of 2023, which seems like a reasonable expectation. In the first half of 2024, we should begin to transition from securities to loans without relying as much on wholesale funding.

Got it. And then, Heath, could you give us an update on the merchant business and how you see that playing out next year, presuming that next year is a big transition year for both product teams?

Yes. We're excited about the merchant team. They really got on board in December and pretty much took several months to kind of get our infrastructure in place, get our processing agreement and team in place. So we're really probably only a couple of months into them getting out and actually being able to produce. I don't have numbers I would project to you right now, but I would say that we have a significant upside opportunity on the merchant team and what we can do there. From that standpoint, I think there's a good opportunity to use that as a lead product to go after deposit customers on the commercial side. I think, realistically, we might see some slowdown in lending at some point and the ability for our commercial bankers to focus on deposits and for us to use that. We also have a tremendous opportunity. We just put a treasury team in place over the last few quarters, and the ability to grow our commercial deposits that way is really strong and also to produce some fee income. So we've got some areas where we can anticipate some nice fee income increases.

Great. And then I guess the last one for me is just how Middle Georgia continues to add more to the portfolio. I know it's not as big as Atlanta. But as you think about another 12 to 18 months, what proportion of the company do you see Middle Georgia being that's still on a growth trajectory like we've seen year-to-date?

Yes. We have some good things happening in Middle Georgia. That's a vibrant economy. The Warner Robins area with the Air Force Base and everything going on there. We added a lender in Macon, and we're seeing growth there, and we're putting a more significant office in place there, probably in 12 months or so. We would love to add bankers to the team in that market. That Middle Georgia market is like many of our markets where there's a large market share held by larger banks. In that market in particular, you have Renasant and Cadence going through the State Bank and then going through that cycle. I think there's significant opportunity there for that to be a market that moves up in size pretty well.

There are no further questions in the queue, so I will pass it back over to the management team for any closing remarks.

Thanks, Tamia, and thank you all for being on the call today. Thank you for your support of Colony. We appreciate it. Another thank you to our team for everything this quarter. And again, we appreciate the opportunity to talk to you. We look forward to speaking with you all again soon. Thank you.

This concludes the Colony Bankcorp conference call. Thank you for your participation. You may now disconnect your lines.