Colony Bankcorp Inc Q2 FY2023 Earnings Call

Good morning, ladies and gentlemen and welcome to the Colony Bank Second Quarter 2023 Conference Call. At this time, all lines are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. This call is being recorded on Thursday, July 27, 2023. I would now like to turn the conference over to Mr. Derek Shelnutt, Chief Financial Officer. Please go ahead.

Thanks Helena. Before we get started, I would like to go to 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, pandemic variations of the company's assets, businesses, cash flows, financial conditions, 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 to reference. And with that, I will turn the call over to our Chief Executive Officer, Heath Fountain.

Thanks Derek, and I want to thank everyone for being on the call today. We're pleased with our results in the second quarter during some really unusual times. First and foremost, I want to thank all our Colony team members who have really had to pivot as our priorities have changed over the last few quarters and I am really proud of how the team has been able to do that, and that gives me a lot of confidence in how we're going to be able to execute on our strategic objectives as we move forward. We were able to increase earnings and grow core deposits in a time where the economic environment presents many challenges. I'm going to briefly highlight some of our accomplishments and initiatives during the quarter, and then I'll hand it over to Derek, who will provide more detail on our earnings and balance sheet. Then D Copeland, our President, will provide an update on our banking and complementary lines of business. During the quarter, we saw an increase in overall deposits with strong growth in our core deposits as we focused on building customer relationships and ensuring strong liquidity following the bank failures that happened at the end of the first quarter. Our outlook on our deposit pipeline remains positive with a lot of opportunity ahead of us. From an earnings perspective, earnings increased quarter-over-quarter as a result of increased non-interest income, driven primarily by strong mortgage demand in the busy home buying season. Our government-guaranteed lending pipeline remains steady and our Marine/RV lending has increased, which will drive profitability in that line of business. We look forward to being able to increase non-interest income as we move throughout the rest of this year. This quarter, we did have one-time severance expenses related to production initiatives as we continue to evaluate and adjust costs based on our growth outlook. We expect the outcome of this initiative to reduce our salary and benefit expenses going forward and we remain dedicated to our long-term investment in areas we believe will provide the most value for our customers and other stakeholders in the future. We don't expect these staffing changes to affect our ability to grow, and we expect them to still enhance our operations in the future. We are committed to enhancing the profitability of mortgage and our other complementary lines of business, and we saw those areas improve this quarter. Loan growth slowed this quarter and it's about 9%. It's higher than what we expected, but lower than what we have been seeing in the last few quarters. We continue to see lower demand in this interest rate environment and expect our growth to slow further throughout the rest of the year. Margin pressure continues as we experienced a quarter-over-quarter decline in margin. Our overall cost of funds is still outpacing the growth in yield of our earning assets. We remain cognizant of that pressure on our funding costs. We've implemented some hedging and other strategies during the quarter to alleviate some of that pressure and Derek will give you more detail on those. Non-interest expenses were up a little under $300,000 this quarter. However, one-time severance expenses were $200,000 more than last quarter and variable compensation expenses from our non-interest income lines of business increased by $0.5 million. Of course, those increases were offset by increases in non-interest income for those lines of business. We're particularly proud of how we've improved non-interest income and lowered our recurring non-interest expense base. Given our many fee income businesses, we like to measure our efficiency as our net non-interest expense to average assets, and on an operating basis, we've improved that from 1.96% in this quarter a year ago to 1.58% this quarter, and we expect to continue to improve our efficiency as measured by this ratio. Asset quality is still strong, even though we saw a slight increase in non-performing loans for the quarter, primarily a little bit in our residential and a lot in our SBA portfolio. Non-performing CRE loans remain at very low levels and we haven't seen anything in these areas that give us a lot of concern in these portfolios. We did also buy back 41,000 shares under our authorized stock repurchase plan this quarter. We continue prudent capital management and are committed to building capital levels. However, given the market reaction to some of the events in the banking industry, we felt that a limited amount of buybacks at attractive pricing levels were a prudent use of capital. Given the continued pressure on margin, we are projecting that it will take us longer to achieve our short-term objective of getting to the 1% ROA. We had initially hoped to be there by the end of this year, but given the continued rate increases, we may need more time. Now, we'll turn it over to Derek, who'll go through financials in more detail.

Thanks Heath. To start, our deposit growth was primarily in interest-bearing accounts and we are still seeing some shifting from DDA to interest-bearing money market accounts and CDs. However, we did manage to grow non-interest-bearing deposits by about $3 million quarter-over-quarter. And then taking a look at our uninsured and adjusted uninsured deposits, they remained relatively flat quarter-over-quarter, and that's indicated on slide 21 in the investor presentation. In terms of liquidity, we continue to maintain a strong position with access to various sources of liquidity, and that's outlined on slide 15 in the investor presentation. During the quarter, cash increased over $72 million to a total of $155 million, which represents roughly 5% of assets. We did not have any outstanding overnight borrowings at the end of the quarter, nor have we used the Fed's Bank Term Funding Program. Total FHLB advances declined $10 million during the quarter, which reduced our overall level of debt funding. Moving on to take a look at our AOCI, we went from about $60 million at the end of the previous quarter to just under $63 million at the end of this quarter, which is a little bit of an increase that's primarily driven by the move in interest rates that we've seen over that time period. Slide 25 gives an overview of our investment portfolio composition. We aren't seeing any credit concerns in the investment portfolio at this time. Over half of our portfolio is agency or government guaranteed with the biggest portion of the portfolio being high-quality municipal securities. We haven't seen any rating downgrades or credit issues with our munis that would cause any concerns at this point. Our private label mortgage-backed securities and our corporate, which includes some bank sub debt, are still performing well from a credit perspective. From an earnings perspective, we saw an increase of EPS from $0.29 last quarter to $0.30 this quarter. On an operating basis, EPS was up to $0.33 this quarter compared to $0.31 in the previous quarter. Non-interest income was up about $1.3 million from the prior quarter, with most of that increase coming from our mortgage division. Earning asset yields increased by 20 basis points to 4.43%, but interest-bearing liabilities increased by 57 basis points, which led to a margin decline of 30 basis points to 2.7% for the quarter. Provision expense was $200,000 for the quarter and under CECL, expected credit losses on unfunded commitments are recognized when the commitment is made and those expected losses are recognized on the balance sheet as a liability. Our loan commitment activity quarter-over-quarter has slowed and that balance of those unfunded loan commitments has decreased. As those loans are funded, it kind of shifts over to funded loans. We didn't have to re-provision for those funded loans that had already been provisioned for. We did see an increase in non-performing assets of about $4.1 million in the quarter. Of this, $2.3 million was related to the repurchase of the guaranteed portion of non-performing SBA loans, which will be ultimately repaid by the SBA. I'd like to take a moment to talk more about the margin and what we're seeing and what we expect going forward. The decline in margin was primarily due to the increase in the cost of our interest-bearing liabilities exceeding the increase that we are seeing in our earning asset yields. The increase in interest-bearing liabilities is primarily deposit cost and it's driven by higher rates in the market with stronger competition for deposits. On the funding side, we have extended a portion of our FHLB advances out longer to take advantage of the curve, which should help with some of the short-term sensitivity that we're seeing in funding costs. We've hedged a portion of our short-term borrowings by entering into some interest rate swaps. These swaps were near the end of the quarter, so we expect that benefit starting in the third quarter, and we should see savings on that interest expense of approximately $500,000 a year due to the initial positive carry on those swaps. At the end of the quarter, our cost of interest-bearing deposits was close to 1.88%. We've seen that increase starting to slow down from earlier in the quarter. Competition for deposits remained elevated, but there is some slowing down in our markets that we are starting to see. This will help provide some stability and ultimately slow the outpacing difference between our liabilities and our earning assets. Our current assumptions indicate we should see margin at this level or maybe slightly lower over the next couple of quarters, and then start to move up from there. Continued deposit mix changes may drive the margin down some more, but we expect those mix changes to be less or slow down from what we've seen in the first half of the year. Non-interest expenses were up about $267,000 from the first quarter; variable commission-based compensation expenses for our non-interest income lines of business increased about $0.5 million in the second quarter. However, that was offset by the increase in non-interest income. We had net severance expenses in the quarter of $635,000, which was up a little over $200,000 from the previous quarter. These severance expenses were related to a reduction in force that occurred during the second quarter. This initiative led to the reduction of 23 full-time employees and is expected to have an annual cost savings of about $2.5 million going forward. Our net non-interest expense to assets was 1.65% in the second quarter, which is down 21 basis points from 1.86% in the first quarter. On an operating basis, the second quarter net NIE was 1.58%. Our expected run rate on non-interest expenses going forward is around or slightly under $20 million per quarter and we continue our disciplined approach to expenses and manage that alongside our commitment to invest in areas that add value over the long term. And with that, I hand it over to D to talk more about those business lines.

Thanks Derek. On the commercial side of the bank, as Heath mentioned, we did grow loans about 9% at an annualized rate. That is lower than we had been seeing, but probably a little higher than we would see on the forecast going forward. That slowdown in growth is expected to continue throughout the remainder of the year. Page 14 in our earnings release details our loan growth by each of the markets, so feel free to look at that. We still have solid asset quality, particularly in the commercial real estate portfolio, where the level of non-performing loans is still very low. Slide 22 in the investor presentation gives a breakdown of our loan portfolio, and slide 24 gives further details on our office portfolio, which we believe is very conservative. We feel comfortable with our office portfolio and we aren't seeing any signs of credit concerns there. It's of note that we do not have any high-rise office buildings and the majority of our buyers are in one or two-story buildings. We feel good about that portfolio. Deposits, as mentioned, quarter-over-quarter grew 4.4%, with 77% of that growth in core deposits. As Derek mentioned, our non-interest-bearing deposits were slightly up for the quarter. On slide 19, you can see our growth in deposits. Our referrals and our deposit pipeline are both strong, so we expect to see continued growth in deposits and in new customer relationships. I'll talk a little bit about the complementary lines of business. Production in our SBSL group increased in the second quarter, as indicated on slide eight of the presentation. We're pleased with that performance in the rate environment, and they continue to remain profitable. One thing to note is in that production, we see a larger portion of that production being in construction, which is positive as we are able to sell the guaranteed portion in the future. Mortgage, as shown on slide nine, saw production for the quarter up about $44 million from the first quarter. The mortgage line was profitable in the second quarter and as we always like to see, we had a higher mix of secondary market relative to previous quarters, which was a positive. On slide seven, details on some of the start-up lines of business. First, I'll touch on Alabama. We still have a lot of opportunity in our Alabama market. Our team is performing well there, with 8% growth as we just crossed over $44 million from a loan standpoint. We are continuing to move towards profitability as we grow those loans. The pipeline remains strong, and we have decided to pull back in Alabama on the lending team and focus primarily on Birmingham as opposed to branching out to Huntsville. This will allow us to be profitable more quickly in Alabama while still providing us great growth opportunities in this environment and in the future. The RV and Marine division had a very solid quarter as we entered into the spring buying season, with loans growing by $15 million for the quarter. There is still a lot of demand in this space. Page 14 in the earnings release shows a breakdown of volumes for Marine and RV. We are glad to report that the Marine/RV division turned profitable at the end of the quarter and we expect to see this profitability on a go-forward basis. Another area of improvement is in merchant services. We continue to see improvement, as we receive a lot of internal referrals. Our processing volume continues to grow every month, and we would expect to see that be profitable during the second half of the year and continue to grow as a solid profit line. With that, I'll turn it back over to Heath.

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

Thank you. We will now begin the question-and-answer session. And we have a question from David Bishop from Hovde Group. Please go ahead.

Good morning, gentlemen.

Good morning, Dave.

A question just in regards to deposit flows this quarter and Heath and Derek, obviously, you saw the margin take a hit again. But it looks like there's a pretty significant back-end flow of non-interest-bearing deposits. Your average is sitting, I think, right around $500 million for the quarter, but you ended up a few million dollars. Is anything happening in maybe the back end of the quarter that drove that success in new account wins? And should that act as maybe a tailwind to the margin in the third quarter and next?

Yeah. Dave, one thing to note, and I'll let Derek or D provide further comments. We do historically see the second quarter as the quarter where we have a lot of tax outflows in terms of tax payments. We saw a lot of that early in the quarter. So, rebuilding that, I think, both from just our calling efforts, but also customers rebuilding balances during the quarter. I don't know if there’s anything further that gentlemen would add to that.

Yeah. I mean that's a good look at what we saw as far as flows in the quarter. I think we're still going to continue to see some mix changes from interest-bearing to non-interest, so it depends on where the rate environment ends up. Most of what we saw during the quarter was those tax outflows at the beginning and then some rebuilding towards the end.

Yeah, which would have been consistent with exactly the way it flowed in 2022, last year.

I assume that statistic was related to the elevated end-of-period cash. I'm curious about how you plan to use the excess cash, whether it will be deployed into loans or used to pay down some debt.

Yeah. I think, and Derek can comment more on this. We're clearly at a higher level of liquidity. I don't have any real concerns about liquidity. As you saw, we paid down some home loan bank advances during the quarter. Earlier in the quarter, following the bank failures and the liquidity runs that were happening in the industry, we were certainly focused on liquidity first and profitability of the customer relationship second. I think we are much more willing to let deposits walk out if the rates don't meet our hurdles at this point than we were earlier. We have been able to lower deposit pricing on CDs, our rate specials, and things that go there during the quarter. We would look to see where best to deploy that. As we've mentioned in the call, the expectations are to have loan demand continue to go down, both from our rate hurdles causing customers to not want to borrow and demand from customers. It can be a combination of all those things, Dave.

Got it. And then, I guess, structurally just from the loan portfolio, you tend to skew a little bit longer dated with the CRE portfolio. Maybe your view of just loan re-pricing potential in terms of embedded yield pickup in the CRE portfolio over the next year or two or so, assuming the Fed stops raising rates here and deposit costs stabilize? I would think you'd still see some tailwind to the earning asset yields in some of these CRE loans re-priced up into a higher yielding market.

Yeah. I mean, we certainly have seen and will continue to see increases there. Our total portfolio's weighted average life of our loan portfolio is just under four years with just under three-year duration. We should see that more and more as we go forward. So, it's just taking longer than the deposit side. As liability prices stabilize and don't move up as much, we should see earning assets start to outpace that at some point, we think in the next couple of quarters and definitely into next year.

Curious what you're seeing in terms of new loan origination yields that you're able to onboard this quarter?

Yeah. So, we're seeing, obviously, each quarter a little better. I think our weighted average this quarter was about 7.5% of our weighted average rate of production for the quarter. We're continuing to see that move up. Of course, it's higher at the end of the quarter than it was at the beginning. I think we continue to see that move up, and our pricing where we are today would be higher than that.

Got it. And then, Heath, I thought I heard you say you guys remain comfortable with expense expectations running at around $20 million. Is that starting in the third quarter? I think the previous guidance was by the fourth quarter, but I hear you maybe moving it up until starting this quarter?

We implemented expense reductions towards the end of the first quarter and into the second quarter. We haven't fully realized the impact of these reductions yet, but we expect to see their full effect in the third quarter and beyond. However, if we continue to see strong production in mortgage and SPSL, the variable compensation associated with that could increase expenses, which we would welcome. Overall, we anticipate being around the $20 million range going forward.

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

Thank you. Our next question comes from Christopher Marinac from Janney Montgomery Scott. Please go ahead.

Hey, thanks. Good morning. Just want to go back to the swap that Heath and Derek mentioned. Can you just walk us through the mechanics of that? If interest rates were to modestly fall, how does that play out for you?

Yeah. Sure. So, we entered into two different swaps of different terms. There is initial positive carry on those, about 100 basis points blended between the two. A modest fall in rates would keep us in a good position with those swaps. It would take significant declines in interest rates for these swaps to kind of reverse, if you will, from their initial positive carry. If that happens, there will be other changes on the balance sheet that would kind of offset some of that. So that is where we are on the swaps, and we see that as a benefit on those interest expenses going forward.

Gotcha. Okay. Obviously, in the short term, it benefits you a lot, as you just said. And then I had a question for D about the gain on sale in the SBA channel overall. Did those possibly get better as we look prospectively into the next year?

Yes. It's been all over the place in the first half of the year, anywhere from 8 to a little bit over 10. It's been moving a good bit. I think as folks continue to have reductions in loan originations, there's an opportunity to do that. But it just depends on how much liquidity is in the market. I would say, at the end of the second quarter, we were seeing some of the best gain on sale numbers that we've seen for the first half of the year, with a lot of those touching just above 10%.

Gotcha. Okay. Great. That's helpful. Thank you for that. And then for Heath or really, Derek, just can you give us a reminder about the deposit tenure that you have with your customers? I feel like you've got a really long relationship.

Yeah. We have historically had very good long relationships in our deposit portfolio, around ten years. We see continued growth in deposit accounts. We have done a good job, and at the same time, we've certainly had to adjust rates up. We're starting to see rates at a level where we will be getting much closer to competitive rates on the deposit side. This past quarter, we were very focused on ensuring that the marketplace liquidity tightened up as the bank failures last quarter indicated. We wanted to get out in front of that. That drove, I think, our deposit costs up a little more than they would have been in an environment where everyone wasn't seeking liquidity. We've seen that pull back, and we're focused on taking care of our current customers while also aiming to grow, but our deposit base has shown great stability. You can see that on our slides where we indicate our average balances and total number of accounts. Even then, we have many customers that have decided to move excess cash over to interest-bearing accounts, which makes sense in this environment.

Gotcha. Okay. Great. Thank you for all that background. Just a last question for whomever, is just about the office portfolio. Do you have anything that's kind of coming due or maturing in the next 24 months? And what has to happen for any sort of downgrades within your risk rate system on those loans?

We really don't have a lot that's coming due. The other part is a large chunk of ours are owner-occupied, so that's a big piece of it as well, and they're small in nature. I would say from our standpoint, our office portfolio is small, and there aren't really any big projects in there that carry substantial risk.

Great. Thank you for all of our questions this morning. We appreciate it.

Thanks Chris.

Thank you. There are no further questions at this time. Please proceed with closing remarks.

Well, thanks again to everybody for your support of Colony Bankcorp. We appreciate you being on the call today, and we look forward to talking to you soon. Thanks.

Thank you. Ladies and gentlemen, this concludes your conference. Please disconnect your lines.