Colony Bankcorp Inc Q4 FY2022 Earnings Call

Hello, and welcome to today's Colony Bank Fourth Quarter 2022 Conference Call. My name is Harry, and I'll be coordinating your call today.

Thanks, Harry. Before we get started today, I would like to go through our standard disclosures. Certain statements we make on this call could be constituted 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, pandemics, variations of the company's assets, businesses, cash flows, financial condition, prospects and other results of operations. I would also like to add that during our call today, we will reference both our earnings release and our quarterly investor presentation, both of which were filed yesterday. Please have those available to reference. And with that, I will turn the call over to our Chief Executive Officer, Heath Fountain.

Thanks, D. I want to thank everyone for being on the call today. Before I get into the operating results, I want to cover a couple of other things that you read in the release. First, this week, we said goodbye to our longtime team member and director, Terry Hester, who passed away on Sunday. Terry started with Colony in 1978 and served with the company for over 42 years, spending much of his career as our CFO. He was also a director since 1990. Terry was a dedicated member of our team, and the Colony family was really part of his family, and he's going to be sorely missed by his family and our team. So our sympathies go out to all those who worked closely with him, and certainly to his family. Second, you saw that we also announced yesterday that Andy Borrmann, our CFO, is leaving the company to pursue other career opportunities. Andy joined us in 2021 through our merger with SouthCrest, and we appreciate all that he has contributed during his time here and wish him well in his future endeavors. We have started a search process for a replacement for Andy. In the meantime, I've been named Acting CFO of the Holding Company. Most of you know I spent over eight years as the CFO of Heritage Financial Group. We have a deep management bench, and I'm confident I can provide the support that our accounting and finance team needs to ensure we have a smooth transition. I will also serve as the primary investor relations contact for you during this transition. Additionally, our Chief Accounting Officer, Derek Shelnutt, who is on this call, has been named the Acting CFO of our Operating Subsidiary Colony Bank. Derek is a CPA with experience in public accounting and banking. He joined our team in 2020 and played a key role in the development of our accounting team. He has handled much of our accounting work related to M&A, ALCO, and all aspects of operations. I have a lot of confidence in him and his ability to lead us through this transition as well. So with those matters behind us, I'm going to get right into the quarter. Our earnings were up slightly from last quarter, reporting $0.31 versus $0.30 last quarter. I wanted to note that our earnings fully came from the banking division this quarter. Slide 13 in our presentation shows you a breakdown by segment, and banking made up all of it for the quarter. While the earnings are only slightly up for the quarter, we've made significant strides throughout the year regarding how much of our earnings is coming from our core banking. Of course, we had significant headwinds from an interest rate perspective on the mortgage banking side this quarter. As rates peaked over 7% at the end of the third quarter and into the fourth, like a lot of other banks with significant mortgage businesses, we saw a real shift from secondary market products into portfolio adjustable-rate products during the quarter. Our gain on sale was down about $0.5 million from last quarter and down nearly $1.9 million from the fourth quarter of last year. On slides 16 and 17 in our presentation, you can see how originations have been impacted. Our originations remained strong, but our sales were down significantly in the fourth quarter as we moved to portfolio products. Our strategy in mortgage right now is to keep our purchase-focused origination team together, give them products to offer to our customers, recruit new originators within our footprint, and be poised to take advantage of opportunities when rates settle out. There are many folks in the mortgage business right now affiliated with banks that are really stepping back, and I think we'll be primed when rates settle out a little bit. Our net interest margin was down slightly from 3.25% to 3.23%, but our net interest income in dollars was up over $0.5 million, primarily due to our loan growth. Our loan growth is outpacing our deposit growth, and we are having to fund some things at our marginal cost, which is putting some pressure on our cost of funds. However, we feel good about where our deposits are. We've maintained good discipline in deposit pricing and have been able to grow our deposits by 2.5% quarter-over-quarter, excluding any wholesale deposits. You are going to hear D discuss our deposit focus in a bit. It's a tough environment to predict interest rates. We may see our margin stabilize or compress slightly from this level, but we have opportunities to continue to add higher-earning assets at levels that may be slightly dilutive to NIM but will be accretive to ROA and ROE, and we plan to do that. Our loan growth, as you saw, has been strong, and D will discuss that as well. Our asset quality remained very good. Non-performers were flat, and criticized classified loans went down. With that strong asset quality, we were able to provision a little less this quarter despite the loan growth. We are moving to CECL next quarter, and we continue to model for that. As we disclosed last quarter, we anticipate a 15% to 25% increase in our reserve with that adoption. Core CECL was forward-looking, so how things will look forward now from three months from now is hard to determine. Just a reminder that, that could change. Going forward, I want to discuss our performance and where we're headed. We laid out our path to high performance in the presentation, specifically on slides nine through 11. I want to highlight three key points. First is achieving strong organic growth. We're executing well on the loan side, and I think in this environment, we're also executing well on the deposit side. Growing deposits in this environment is challenging, but we're doing it. Increasing non-interest income is the second of our three highlights. While mortgage being down has hurt us on the revenue side, I see real opportunity for that to return. Our SBSL team is performing strongly and we have opportunities to continue to grow in insurance, merchant, and treasury services as well. Lastly, we are focusing on internal opportunities. We believe M&A will be on the back burner for a while, and we are concentrating on internal growth. We're driving internal referrals, having recently implemented our CRM system to track that, focusing on the profitability of our new business lines and ensuring we capture efficiency from investments made in technology. We're also managing expenses. We've experienced significant growth and are limiting hiring to only strategic and market-specific positions. We will not be expanding into new markets in this environment and will focus on reducing controllable expenses, including business development and travel, as well as lowering our core provider costs. We are finalizing the renegotiation of our core agreement and expect some cost savings to start reflecting in the first quarter of this year. Since my arrival in 2018, we’ve averaged 18% annual growth in assets, increasing from $1.2 billion to just under $3 billion, adding multiple business lines such as mortgage, small business, specialty lending group, insurance, and merchant services. We’ve expanded into new markets and completed whole bank acquisitions. We began this growth phase at a time when the Colony platform was not ready for growth. We have been investing significantly in people, processes, and technology. We have the team largely in place now and have developed our systems to support this growth. However, given where we are with the amount of growth experienced and in light of potential economic slowdowns, we are shifting from external growth opportunities to internal opportunities to improve efficiency and profitability. As laid out last quarter, slide 12 discusses our plan to reach an ROA target of 1.2 by the end of 2024. I walked you through how we plan to achieve this. Excess growth is currently at a higher level, with some excess provision of about 6 basis points reported this quarter. New business lines need to improve from where they currently stand, generating about 6 basis points pre-tax this quarter. Mortgage and SBA, year-to-date have only contributed about 6 basis points of ROA. Besides other contributors, these lines will be profitable, and we expect them to reach around the 10 basis point range soon. Additionally, every 5% improvement in loan growth translates to about 7 basis points of ROA. When we tally up these metrics by the end of next year, we project achieving around 115 basis points ROA, excluding more profitable business lines and without considering our technological efficiencies or our expense management. This is our plan, and our team is committed to executing it effectively. I’d like to mention a couple more things before handing it over to D to discuss our production side. Our AOCI and unrealized loss in the securities portfolio have leveled off this quarter, which was positive after several quarters of rising rates that resulted in significant losses. We have added more disclosures on slides 31 to 35, providing a detailed breakdown of our investment portfolio. We want you to be aware that we do not have much credit exposure there; interest rates have driven our losses. We are beginning to see our yields slightly increase, and I'm hopeful that we've reached a peak in the duration of our portfolio. We're optimistic that as rates stabilize, we can recover much of our tangible book value. We are actively seeking opportunities to trim our holdings when rates drop, but we are looking to avoid losses if possible, especially if our deposit strategy is successful. Lastly, regarding the dividend, we are pleased to declare $0.11 for the quarter, which is vital for our retail investors, who make up about half our shareholder base. It reflects the confidence we have in our ability to continue improving our earnings. With those highlights covered, I'll turn it over to D to discuss the production side of the bank and our business lines.

Thanks, Heath. On the commercial side of the bank, we had another strong quarter of loan growth. As Heath mentioned earlier, we had 9.5% growth over last quarter, representing a 40% annualized growth rate. I would like to point you to a few slides in our presentation to add color on the loan portfolio growth. If you look at slide 30, it gives you a breakdown over the last several quarters of the loan-to-values with which we’ve been originating in commercial real estate (CRE). Our non-owner occupied CRE portfolio has very low loan-to-value ratios. Our customers are putting cash into these deals, and we feel confident about the loans we've originated. While we have the opportunity to grow loans, we have managed to maintain strong credit metrics as we move towards the end of the year and continue to tighten our credit standards based on the economic environment we anticipate. Additionally, as the Fed has increased rates, we've also moved our rates up gradually. Going into the end of the year, we've become more aggressive in increasing rates. As we raise rates, it will significantly reduce the loan growth from our originations in CRE this year. While we will see loan growth slowing, I believe we will still have elevated loan growth in the first and second quarters for two reasons. Firstly, we still have a strong pipeline despite these elevated pricing levels. Secondly, we are doing construction lending, and as those draws are made on those lines, it will continue to add to our loan growth in the first half of the year. Our expectation for the second half of the year is to return to our long-term goal of 8% to 12% loan growth while maintaining the credit discipline we've implemented along with the pricing strategy we've established. I'm proud to report that we had 2.5% deposit growth over the quarter, excluding wholesale deposits. In a top-rate environment, that’s a solid number. We have good markets for deposit growth and bankers ready to deliver this growth when needed. In 2023, we are making significant changes to our incentive plans for the commercial side, with the majority of their plans focused on deposit growth and referrals to other ancillary lines that Heath mentioned earlier, which I will elaborate on shortly. This shift in focus for Colony is beginning to show positive results, as evidenced by our strong numbers in the third quarter and this 2.5% growth in the fourth quarter. On the treasury side, we've spent the past year developing various treasury products and building a team to meet the needs of our commercial customers. In October, we added a sales manager with years of treasury experience, structuring our services to proactively meet our customers’ needs. Now, transitioning to our small business specialty lending (SBA) or government-guaranteed lending, as shown on slide 15, we have maintained consistent profitability throughout the year. We entered 2023 with a good pipeline, slightly elevated compared to the start of 2022. Regarding mortgage operations, while our volume figures remain flat, we reduced secondary market sales. Our main focus this year is to shift back towards secondary market sales, particularly as rates decrease, making these loans more appealing. We had the luxury of being able to portfolio loans and retaining that origination team, but this is more of an interim strategy until rates stabilize. If you look at slides 16 and 17, you will see our production figures year-over-year. Our production in 2023 and 2022 remained almost unchanged, but profitability was impacted by short-term secondary market sales this year. I'd also like to briefly touch on our new markets and business lines. In Alabama, we have LPOs in Huntsville and Birmingham, which achieved over $20 million in growth at year-end. All these bankers were hired either mid-year or after. Their pipelines look promising. With changes in our incentive plans and a strategic focus for these teams, they are now less focused on CRE and more on operational businesses. Historically, Birmingham and Huntsville have been great sources for commercial and industrial loan origination and deposits. We expect to see profitability in the next quarter or two based on the loan growth. As for marine and RV lending, we recently started originating loans and booked our personal loans last week. While numbers are limited at this point, we believe this segment presents a tremendous opportunity for us in the coming years. It is an efficient way for us to generate loans while adding flexibility to our balance sheet, as we can either hold them or sell them in the secondary market. Importantly, this is not a significant short-term expense for us until we reach profitability. Lastly, I want to mention Ed Cannon, who recently joined our team in November as Chief Revenue Officer. I want to congratulate him on the early impact he has already made. He came to us from Capital City Bank, bringing a wealth of mortgage experience, which is invaluable in today's environment. His experience is already energizing our ancillary lines and focusing our team on achieving the revenue targets we've set while maintaining profitability in each area throughout 2023. With that, Heath, I will turn it back over to you. Thanks.

Thanks, D. That wraps up our prepared comments. I’d like to ask Harry to open up the line for questions.

Thanks very much. Our first question today is from David Bishop of Hovde Group. David, please go ahead.

Yes, good morning, Heath, and D. Appreciate you taking the question. D, you alluded to raising loan pricing, and I wanted to ask if you think you were potentially behind the curve compared to the competition in this regard? Does this give you a potential lift in loan yields and pricing as well as margin in the second half of the year? How should we think about this development regarding the margin?

Yes, David, that's a great question. I believe we could have raised loan prices more quickly given how fast rates moved up. Just to give you an idea, in the fourth quarter, our weighted average was slightly over 6%, compared to a little under 5% the quarter prior and just above 4% at the end of last year. Therefore, I believe there's an opportunity for our loan portfolio yield to continue increasing. The pressure on pricing from the deposit side makes it harder to predict confidently given the current banking environment, with some banks losing funding and becoming aggressive with their rates. However, I do see a clear opportunity for the loan yield to improve. D, do you have anything to add?

No, I agree. We've provided further pricing guidance and pricing sheets to our commercial bankers and are raising loan pricing accordingly as we move forward. Right now, I would say we are keeping pace with the market.

Got it. I was also curious about your current CRE concentration levels. Is that a limiting factor at all for your operations?

We are currently at the 100/300 concentration limits. We have some capital at the holding company that we could push down if necessary, but we prefer to maintain the current mix without adding significantly more CRE to our balance sheet.

Additionally, I want to highlight that part of our objective is to shift our focus on profitability towards operating businesses. These businesses are likely to bring in deposits, enabling us to refer additional treasury and merchant services, which considerably enhance fee income—essentially adding value to our ROA.

Got it. One final question: as you look into your operating expenses, can you provide guidance on the anticipated growth rate? Should we expect a decline from high double digits to low to mid or high single digits?

That's a good question. We have invested significantly in growth, and it's now crucial for us to derive returns from those investments. We are focusing on various projects to reduce operating expenses and maintaining a hiring freeze—except for essential market hires. You may see a slight increase in our operating rate from the fourth quarter levels due to actions taken in Q4. However, as we progress into the second and third quarters, we expect to start reducing our current operating rate. Furthermore, as mortgage revenue rebounds and other business lines return to profitability, we will be able to absorb this lower run rate.

Our next question today comes from Feddie Strickland of Janney. Feddie, your line is now open.

Hey, good morning. I apologize if I missed this during the opening remarks, but I was curious about what drove the rise in FTE headcount in the fourth quarter. Is there a timeline for these new hires to generate earnings if they are producers?

Yes, there are two primary drivers for the FTE growth. First, the fourth quarter was the first time since the aftermath of COVID that we've been able to restore our retail staffing to the levels necessary to efficiently serve our customers in our branch network. Many of those positions are lower-tier pay, which account for a significant portion of the rise. Additionally, we made several mortgage hires throughout the year to seize production opportunities, including a notable team we brought onboard in Birmingham in Q4. Typically, these types of hires come with a three-month guaranteed salary. As of January, all our new mortgage producers have exited their guarantee period, transitioning to a commission-based compensation model. Furthermore, we also had some additions in our Alabama team during Q3 and Q4.

Got it. Should we think about this retail investment as primarily an investment in deposit gathering, particularly in rural areas? I understand that these positions are intended to fill vacancies, but could having more retail employees make it easier to maintain those deposits?

Yes, the rural parts of our footprint have a great deposit-gathering franchise, so I agree with your assessment. We are implementing a staffing model to align with transaction volumes, allowing us to adjust staffing levels based on transactional demands. This investment in retail staff is aimed at gathering additional deposits while also refocusing them towards ancillary revenue lines, including insurance and merchant services. So, in that respect, your thinking is spot on.

Understood, thank you for clarifying. On the topic of deposits, do you find that municipal deposits in smaller cities are requesting rate increases? Have you noticed any significant shifts in this area in the past ten months?

We do maintain municipal relationships across our footprint, though they don't represent a large proportion of our deposits. To give you an idea, we had approximately $290 million in municipal deposits at the end of Q2, which increased to about $320 million by the end of Q4. Our municipal deposits tend not to fluctuate as significantly as those of other banks. While there is an opportunity for us to approach more municipalities with our improved product offerings, we haven't experienced a lot of pressure for increased rates, as most of our municipal relationships primarily involve operational accounts.

Thanks for answering my questions. I’ll step back in the queue.

Thank you. We have a follow-up question from the line of David Bishop. David, your line is now open.

Yes, Heath, regarding the improvement in ROA and the expected decline in loan growth, should we assume that this implies a decrease in provisioning levels, assuming credit metrics remain stable despite potential economic uncertainties? Can you provide any directional guidance on provisions if growth decelerates later?

Yes, I believe that lower loan growth will have an impact on provisions. Currently, we expect a quarter or two of loan growth that trends lower than we have experienced in the past few quarters, yet above our long-term target of 8% to 12%. By the end of next year, holding to those growth expectations, we project an 80% loan-to-deposit ratio. Provisioning levels will likely trend lower with reduced loan growth, as long as we maintain our credit metrics. The one caveat to this is the incoming CECL model which will consider new forward-looking economic factors not currently factored into our provisions. However, I do see provisions decreasing as loan growth slows, assuming our credit remains solid.

Great, thank you for that clarification. Lastly, can you remind me about the CECL impact? I believe it's neutral regarding regulatory capital, but negative in terms of tangible common equity. What's the expected range for the reserve increase at the moment?

That’s correct. As we disclosed last quarter, we anticipate a reserve increase ranging from 15% to 25%. We will update this in our 10-Q this quarter.

Thank you. It appears we have no further questions being registered at this time. So I'd like to hand it back to Heath for any closing remarks.

Thanks, Harry, and thanks to everyone for being on the call today. We appreciate your support of Colony Bancorp, and we welcome you to reach out to us if you have further questions. Thank you.

Thank you everyone. This concludes today's call. You may now disconnect your lines.