Colony Bankcorp Inc Q1 FY2023 Earnings Call

Hello, and a warm welcome to Colony Bank First Quarter 2023 Conference Call. My name is Candice, and I'll be your coordinator for today's call. I would now like to hand the conference over to Derek Shelnutt to begin. Derek, please go ahead.

Thanks, Candice. 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, so please have those available for reference. And with that, I will turn the call over to our Chief Executive Officer, Heath Fountain.

Hi, everyone, thank you for joining the call today. We're happy to share strong results in what has been a very unusual quarter. After the failures of Silicon Valley and Signature Bank, our industry faced a significant test of liquidity and confidence, and I believe we passed that test, along with most of the banking industry. I want to thank our team for their hard work and dedication in supporting our customers during this uncertain period. The disruptions we experienced this quarter underscored the value of our core deposit franchises. We have not borrowed from the Fed's Bank Term Funding Program, and we had no overnight borrowings outstanding at the end of the quarter. During the call, we will highlight the strength of our deposit base and liquidity and share some new information about that. I will provide a brief overview of the quarter, followed by Derek, who will discuss our earnings and liquidity, and then 'D' Copeland will update us on our operating businesses. We observed good stability in our deposits this quarter, despite the market uncertainty, which we were pleased about. From an earnings standpoint, there was a decline quarter-over-quarter, but if we exclude one-time items, our operating earnings remained consistent with last quarter. It's worth noting that Q1 is the shortest quarter of the year, with fewer days for earning interest and fees, and it typically sees weaker mortgage origination. Nevertheless, we are pleased to report operating earnings in line with last quarter. Similar to previous quarters, all our earnings came from our banking division, highlighting the strength of our core banking business. We are committed to improving the profitability of our mortgage and other operating businesses, and 'D' will update you on our progress. Loans grew at an annualized rate of about 14% this quarter, but given the current economic outlook and reduced customer demand, we anticipate loan growth will remain flat or slightly increase for the rest of the year. Our margin did decline quarter-over-quarter as expected, due to rising deposit rates outpacing the growth in our earning asset yields. We expect this trend to continue, projecting our margin to be in the low 3s or high 2s for the remainder of 2023 based on current interest rate forecasts. Non-interest income remained relatively stable this quarter. This quarter is typically light for non-interest income due to fewer days and the seasonality of mortgages. Mortgage revenue was flat compared to last quarter, and insurance and other non-interest income offset decreases we saw in our government-guaranteed lending this quarter. We see numerous opportunities to grow non-interest income throughout the year, and we are excited about that. One area where we saw significant improvement this quarter was in operating expenses, which decreased by $662,000 from last quarter, and by about $1.3 million when excluding one-time severance and contract termination costs related to the SouthCrest acquisition. We were pleased to see that. Asset quality remains strong, with levels of criticized and classified assets consistent, as well as net charge-offs. Regarding capital management, we did not repurchase any shares this quarter. While we believe this is an attractive opportunity to buy back shares, considering the economic uncertainty and regulatory environment following recent bank failures, we feel it's a better time to build capital. Overall, a solid first quarter positions us well to meet our goals this year, including aiming for a 1% ROA run rate by year-end. Now, I'll turn it over to Derek Shelnutt, our Chief Accounting Officer, to discuss the financials in greater detail.

Thanks, Heath. First, I'd like to cover some information about liquidity and deposits. We've added a number of slides in our investor presentation to provide you with more information on our liquidity and our deposit base. Starting on slide 18, we lay out some additional information on our deposit accounts. We're growing our customer base in terms of total accounts, but we are seeing our customers shift their balances, as you might expect in a higher interest rate environment, from demand accounts to interest-bearing accounts. On slide 19, you can see that our deposits are spread throughout our footprint with the strongest deposit base being in our legacy South Georgia footprint. On slide 20, we've provided you with a breakdown of our business deposit customers by industry type. Given the concentrated nature of the deposits with some of the banks that have struggled with liquidity challenges recently, we thought it was important to highlight just how diversified our business customers are. On slide 21, we show you the trends in our uninsured deposits, and as you can see, we did see a decrease in uninsured deposits this quarter. We saw inflows to our ICS products and some general restructuring of accounts to maximize their coverage of FDIC insurance. Overall, we have a really low level of adjusted uninsured deposits, which would exclude our municipalities who have their deposits collateralized. We have sufficient off-balance sheet liquidity as highlighted on slide 15 to cover all of our adjusted uninsured deposits in a stress liquidity situation. I'd also like to address our AOCI, which is driven by unrealized losses in our securities portfolio. Our AOCI went from about $66 million last quarter to $60 million this quarter. Slides 25 through 27 give you a breakdown of our investment portfolio, and we don't have a lot of credit exposure in our portfolio; it's the interest rate changes that are driving those losses. We continue to see the yields creeping up, and we also see our average life and durations decreasing from their peaks back in the second quarter and third quarter of last year. There's significant opportunity to recover tangible book value as we see rates stabilize or come down from here. From an earnings perspective, as Heath mentioned earlier, EPS was down to $0.29 this quarter compared to $0.31 last quarter. On an operating basis, earnings per share was flat at $0.31 this quarter and last quarter. Our net interest income was down about $800,000 from last quarter, with a little more than half due to the shorter quarter. Our earning asset yield increased 25 basis points from last quarter to 4.23%. This was exceeded by the 51 basis point increase we saw in our interest-bearing liabilities. To give you an idea of what that looks like going forward, our cost of interest-bearing funds was around 1.66% at the end of the quarter compared to 1.47% for the whole quarter, and our cost of interest-bearing deposits was around 1.24% at the end of the quarter compared to 1.06% for the whole quarter. Our provision for loan losses for the quarter was $900,000, which is in line with last quarter and is driven primarily by our loan growth. We did adopt CECL during the first quarter and that resulted in a $1.2 million one-time charge to capital related primarily to the requirement in CECL to reserve for unfunded commitments. As Heath mentioned, our non-interest income was flat compared to last quarter. Mortgage income was stable compared to last quarter, and as 'D' will discuss in more detail later, we saw significant increases in our pipeline towards the end of the quarter as rates decreased and we entered the traditionally strong spring home-buying season. We are focused on driving down operating expenses and we want to drive our quarterly run rate of operating expenses down to $20 million per quarter by the end of the year. This quarter, excluding one-time charges, we were around $20.5 million. We shifted our team's focus internally given our outlook for lower growth, and we are making adjustments to leverage technology and ensure that our staffing levels remain appropriate for our current outlook. From a staffing perspective, we're down significantly in FTE this quarter, both in the banking division and in mortgage, and we'll continue to see those numbers come down both through attrition and reduction in force. We've already implemented some of those reductions in the second quarter, particularly in our mortgage back office. Our compensation expense quarter-over-quarter was flat when you exclude severance expenses. Of course, in the first quarter, some of those decreases in staffing were offset by our annual compensation increases that occur in the first quarter. On a go-forward basis, we should see that number come down as these FTE reductions take hold. Leveraging technology has always been part of our path to profitability; however, we thought we would grow into some of this by adding capacity, but given our current outlook for lower growth, we'll continue to make adjustments to our expense base, and we believe we see the opportunity for other expenses to continue to come down. Also during the quarter, we renewed our core contract or core system contract, resulting in about a $1 million annual savings, and we realized a portion of that in the first quarter. Now, I'd like to hand it over to 'D' to discuss our business plans.

Thanks, Derek. First, let me touch on loans. I'd like to talk a little bit about the loan growth on the commercial side of the bank. We had another great quarter of loan growth. As Heath mentioned, it grew about 14% on an annualized rate for the quarter. That's significantly lower than it was last year. We expect to continue to slow down this year, and we likely will see loans stay flat to slightly up for the remainder of the year. On page 12, you'll see a breakdown of the different loan growth by different markets. You'll see that we had strong loan growth in both the Alabama and the Atlanta markets. On slide 22, we have an additional breakdown of the overall loan portfolio. One area that has gotten a lot of attention this quarter from a lot of the other financial institutions and investors is our office sector, and I thought I'd give you a little bit of information on what our office portfolio looks like. Roughly 10% of our total loan portfolio is in the office sector, and if you look at ours, we do not really play in the high-rise offices that a lot of the other institutions do. Over half of our portfolio is single-story office buildings, and we have no offices over three stories. As you can see from the information provided, we have strong loan-to-value ratios in the sector, and only 9% of our portfolio is non-recourse. We feel good about this portion of our book, and probably one of the most telling statistics is that at the end of the quarter, we had zero past dues in the office sector. I'll switch now to deposits. Deposits did grow slightly at 1% quarter-over-quarter. If you exclude broker deposits, we were virtually flat for the quarter as well. If you look at slide 19, we give you a breakdown of the deposits by market. I think that's a very telling story for us; the majority of our markets are in that historic rural South Georgia portfolio, which is a very, very stable deposit base. We have a tremendous opportunity for deposit growth in the long-term in our higher growth markets, and we look forward to that opportunity. On the commercial side, our banker incentives have been moved this year, really at the beginning of the year prior to all of the events that took place and are heavily focused on the deposits for 2023. We have implemented and rolled out retail incentive plans that are also focused on deposits, and these incentive plans have been in place since the beginning of the year. Now, in treasury, we have added talent on the sales side very recently, and we hope that this pick-up can help us in acquiring deposits in the markets, and we feel we can be very competitive there. I'll switch now to a couple of our lines of business. First, I'll talk about small business specialty lending. We had a good quarter there, and just as a reminder, those are variable rate loans that are generally in the prime plus two type of loans. So in today's rate environment, they are good loans for us to be making as they will move as rates do. You can imagine that with those rates, there has been pressure on that business, but at the same time, we had good production as you can see on slide eight. This group has been consistently profitable. In addition to that, we are exploring other opportunities by adding small dollar lending and other specialty groups within the SBSL portfolio, and those loans would have yields in excess of what I just mentioned. On the mortgage side, we had a significant shift during the first quarter. We've moved more heavily back to the secondary market loans, which was most apparent in March. We did have some things in January and February that we closed out from year-end. As you look at it, we moved to profitability in March, and for the month of March, we were there. Slide nine shows the mortgage production that we had, but in addition to moving to profitability in March, we also took actions needs to be done. We reduced back office expenses in the first quarter and have already reduced additional expenses in April that will show up in the second quarter as well. We are seeing good locks and good production in April, now in excess of where we were in March, which is very positive as we turned to profitability. We expect mortgage to be profitable for the remainder of the year, assuming we stay in the rate environment that we are today. Let me touch on a couple of the other new markets and start-up business. If you look on slide seven, there's a lot of different information there. I think one key thing to note is that the losses in those businesses peaked in the fourth quarter and should continue to come down and turn to profitability over the remainder of this year in each of those businesses. I'll touch first on Alabama; we're making good progress with the team in Alabama. Our loans closed at about $41 million in Alabama, which is almost double where we were at the beginning of the first quarter. We still have a good pipeline and have done this with our team shifting over from CRE to more C&I focused lending and deposit generation as well. The Marine RV group is in its first quarter of full operation, closing with about $2 million in outstandings. We continue to see a positive ramp-up there, closing to about $5 million, with $3 million in production at the beginning of April. A positive aspect is we have put strong credit scores and returns on this business. Expenses should not increase significantly with the addition of this portfolio, and so as we add assets, we expect to gain more profitability. Lastly, I want to touch on merchant services. The merchant team is having good success; as our bankers have found, this is a great lead product for calling on business customers for deposits, and our referrals continue to grow every month. Our volumes are consistently increasing, which is really the main factor in growing to profitability. We continue to see a very good trajectory for this and expect to be at profitability during 2023 as well. With that, I'll turn it back over to you, Heath.

Thanks, D. That wraps up our prepared comments for today. And so with that, I'll call on Candice to open up the line for any questions we might have.

Thank you. Our first question comes from David Bishop of Hovde Group. Your line is now open. Please go ahead.

Yes. Good morning, gentlemen.

Good morning.

I am curious, Heath or D, I appreciate the disclosure on the start-ups. As you noted, it looks like the expense drag may have peaked. Do you see those potentially breaking even by the end of this year, maybe just where you see the overall sort of profitability or pre-tax profitability trending throughout the year?

Yes, we do expect those to be profitable by the end of the year on a run-rate basis. Alabama is pretty close given the loan growth there, so we should see that this quarter or next, and then the others towards the end of the year.

Yes, all of them should be profitable this year. And the types of loans, the C&I loans in those markets, are those similar to the ones you're making in your core markets?

Yes, if you’re talking about Atlanta and Alabama, I would say absolutely; they’re the exact same things that we do. It's a very similar type of customer. Some of them may be slightly larger in size than our smaller clients, but not by much. They are exactly the same type of customer we're banking in our other markets.

Got it. And then curious, it sounds like you've already addressed some of the back office, FTE headcount or such, at least mostly in the mortgage banking unit. Do you worry about that cutting into and impacting revenues, or do you think it's just some of the excess that's been eliminated and it won't impact production?

Yeah. Our expectation is that it won't impact production. We've worked hard to bring on excellent folks on the origination team and the back office team, but just as we expanded, we had excess capacity that was not going to be needed for a while, so we needed to ensure our expense base matched the production side. We have a very good outlook for production and the markets that we're in; much of our mortgage origination comes from Middle Georgia, Augusta, and Savannah, where housing activity is still very robust. The limited inventory presents a challenge, but it's an active and good market. So, with rates leveling out, we’ve seen a lot more activity there.

Got it. And then D, Heath, still it sounds like from the preamble that loan growth is expected to be relatively flat. Are you being cautious in construction? Is it safe to say you'll probably see some attrition there through the years as you move the concentration ratio down?

I think we will be selective on the CRE side. We may see some attrition, but in today's environment, there's not a lot of payoffs happening. We'll continue to get amortization, and most of these historic loans have been there for a while and would be refinancing at higher rates. So, I don't think we'll have a ton of attrition, but at the same time, we'll be more selective on the new loans that we generate in that portfolio.

On the construction side, we have the homebuilder finance business that operates similarly to mortgage, covering Augusta, Savannah, and Middle Georgia, extending a bit into South Atlanta. We're seeing those builders pull back, even though they have no problems turning inventory and selling. These builders, having gone through the cycle before, are keeping their housing starts to a minimum. So, we're observing a pullback in that sector as well.

Yes, having been through the crisis last time, are you seeing any signs of overbuilding in those markets? Is the inventory versus demand still well balanced?

We don't see any overbuilding happening. There remains a real shortage; these are markets experiencing net population growth with very low levels of inventory and quick turnover. There's no sign of deterioration at this point, and the key issue is lot inventory. A lot of builders are having to develop their own lots due to the lack of available land, which is a challenge as we move into today's environment.

Got it. I'll hop back into the queue. Thanks.

Thank you.

Thank you. Our next question comes from the line of Feddie Strickland of Janney Montgomery Scott. Your line is now open. Please go ahead.

Hi, good morning.

Good morning, Feddie.

Just wondering if you could talk about the balance between deposit costs and deposit retention. It sounds like you think the South Georgia deposits help you versus peers on that front, is that right?

A couple of things: it's the markets we’re in that have a lower level of competition than larger markets, and the average size of the depositor is smaller. When rates move up from an environment of earning nothing to 3% or 4%, that makes a big difference on $100,000, but less on $5,000. Given our consumer base and the large number of customers, that's helpful. It is a balance, and we are doing our best to manage that, paying fair deposit rates for our customers without excessively inflating our interest expense. As you can see from our deposit balances, I think we're achieving a good balance, and we don't see the need to drastically move rates up at this point, but obviously, as time goes on, deposit rates will continue to rise.

That makes sense. Thanks, Heath. Switching gears, can you remind us of the securities cash flows? I'm trying to peg AOCI unwind over the next 18 months to 24 months and figuring out what incremental tangible book you might get out of that.

I'm going to let Derek provide some numbers, but I'll just say that when we consider our valuation and the upside prospects for our stock, the amount of tangible book value rolling back in through time is significant. We believe there's a lot of opportunity for that, and as I noted and as you’ll see on our slides, the rates are moving up on that. We're observing the maturities, just rolling the curve. There is a good opportunity for us to recover tangible book value. Derek, do you want to provide some of the cash flow numbers?

Currently, with principal interest and maturities, we're around the $20 million mark per quarter, plus or minus. I think that's pretty stable, given this interest rate environment, unless rates move up or down significantly, which could extend or shorten our portfolio, especially on our pass-through investments.

Got it. Thanks, that's helpful.

I hope that’s helpful, Feddie?

No, that's super helpful. Thank you for that. Just one last question from me: thinking about the Bank Term Funding Program, I know you guys didn't tap it, and I know now rates have moved up to more or less where FHLB is; considering the pre-payment penalty, do you view it in the same realm as the discount window?

When it first rolled out and you had it available, the Federal Home Loan Bank was getting hit with advances, presumably from the larger regional banks that spread between FHLB and the Bank Term Funding Program was significant. At that time, concern was if you utilize that—would there be stigma from the public or from investors? Regulators clarified they didn't see it that way. Since things have settled out, the home loan bank differential, as you mentioned, isn't that large. The flexibility of repaying at any time without penalty is attractive, but right now, we're in an environment where one new story could impact public confidence negatively. No media outlet is looking to report positively on the banking industry. Therefore, we don’t feel it’s worth it now, especially given that differential. We see it as a backup and we have pledged some of our more significantly underwater securities to that to retain flexibility. This is an evolving situation as we watch others, but we don't want to be an outlier.

Got it. Makes sense to me. Thanks for taking my questions.

Thank you.

Our next question comes from the line of Kevin Fitzsimmons of D.A. Davidson. Your line is now open. Please go ahead.

Hi, good morning, gentlemen. This is actually Christian on for Kevin.

Good morning.

So, just on loan growth, I know you guys mentioned that this year might be flat or slightly up. Are there any certain areas you're experiencing slow-down in the loan pipeline?

Yes, I'll touch on that, Christian. Our pipeline still looks good. Some of it has been an intentional shift; a lot of our growth last year was in the CRE side, so we're reducing some appetite for the CRE side in today's environment. It’s really more about reducing that and ensuring we focus on businesses we can establish full relationships with—deposits, loans, and selling other ancillary lines of business with them. We might see a slight uptick in the homebuilder crowd for the next month or two due to building season, but the reality is we're slowing down on the CRE side.

Got it. Thank you. And then just on loan re-pricing, wondering if you can provide any color on how the new and replaced loan yields looked going into the quarter?

Yes, our weighted average put-on yield last quarter was a little over 6%, and this quarter, it's just a little under 7%. We’re seeing that move up nicely. We continue to get nice pickups in yield, and we believe that will continue to increase given where rates are now.

Great, thank you. And just one final question from me: as demand slows, how should we think about the provision going forward? I know this quarter was flat; I’m just wondering if you have additional color on that.

Yes, I think we will likely see provisions, even as loan growth slows. Provisions might not decrease as much due to the current CECL model, as this takes forward-looking forecasts into account. We would not be surprised to see slight increases in net charge-offs in this environment, but we don't anticipate anything major. However, we probably wouldn’t see provisions come down as much because of the economic uncertainty out there.

Great, thank you for your time.

Thank you.

We now have a follow-up question from David Bishop of Hovde Group. Your line is now open. Please go ahead.

Yes, thanks. A quick question drilling down on the increase in broker deposits. Could you provide some details on the tender in terms of duration and weighted average cost of those deposits?

Yes, I’ll let Derek address specifics, but I will say we have a low relative level of broker deposits. We looked during the quarter to ensure liquidity; given what was happening, we adjusted liquidity ratios to ensure they looked fine. We likely added brokered deposits beyond what we typically would, but we still have a lot of opportunities there and we are at a very low total brokered level. You're starting to see that market come in a bit; the differential is narrowing from what we can obtain in customer markets versus brokered markets, not as large as it was after the bank failures. Derek, would you like to talk about costs?

Yes, we've brought in broker deposits back into last year; some have rolled off at lower costs. The more recent broker deposits have been shorter-term, around a year or less, staggered out over different terms. The cost of new deposits has been higher than what has rolled off, which we expect overall costs to increase. The rates we're currently seeing for new broker deposits is roughly in the range of 5%.

Okay, got it. Thank you.

Thanks, Dave.

I've got no additional questions waiting at this time. I'll hand the conference back over to Heath Fountain for closing remarks.

I just want to thank everyone for being on the call today. We appreciate your support of Colony Bankcorp. Thank you, and have a great day.

Ladies and gentlemen, this concludes today's call. Thank you for joining. Have a great day ahead. You may now disconnect your line.