Colony Bankcorp Inc Q4 FY2023 Earnings Call

Good morning, ladies and gentlemen, and welcome to Colony Bank Fourth 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, January 25th, 2024. I would now like to turn the conference over to Derek Shelnutt, Chief Financial Officer. Please, go ahead.

Thanks, Julie. Before we get started, 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 to reference. And with that, I will turn the call over to our Chief Executive Officer, Heath Fountain.

Thank you, Derek, and thanks to everyone for being on the call today. I want to congratulate Derek on his promotion to CFO, which we announced this Tuesday. Derek has been the CFO of Colony Bank and the Chief Accounting Officer for the company, and he has done an excellent job over the past year during this transition. I wanted to take a moment to recognize him and wish him well in this new role. I will go over some highlights from the quarter and the year, and then pass it back to Derek for more details. Since the start of the rate hikes, especially in 2023, we have altered our business operations. This year, we've focused more on efficiency, building core customer relationships, enhancing our complementary lines of business, and managing expenses to align with the current environment and opportunities. Our team has made significant progress adapting to these changes, and we believe this success will improve our performance in the future when we see margin expansion again. In the fourth quarter, our earnings were slightly lower than in the third quarter, mainly due to increased funding costs and additional provision expenses. We indicated last quarter that we expected the margin to decline by another 5 to 10 basis points in Q4, and it did decline by about 8 basis points. However, we are seeing easing pressure on deposit costs, and the rate of increase on the deposit side is slowing. Our interest income increased for the quarter, but interest expenses outpaced that, leading to a slight decrease in net interest income. We continue to see assets repricing to higher rates, and the rate of funding costs is slowing, so we anticipate these trends will move in the right direction. We forecast margins to be flat or slightly down next quarter before we start experiencing expansion later in 2024. Our provision expenses were higher in the fourth quarter, with charge-offs similar to what we experienced in the third quarter, alongside a slight increase in classified and criticized loans. We previously mentioned that we might see additional charge-offs related to our SBSL, particularly with the guaranteed loans, as rising floating rates put pressure on those borrowers. Our team is doing an excellent job managing these situations. We remain confident in our overall credit quality, and the slight increases we've observed appear to be isolated incidents. We have not encountered widespread issues that would suggest larger credit concerns. The levels of criticized and classified loans are still very low overall. We have provided more information on these loans in Slide 29 of our presentation for greater detail. Noninterest income was down in the fourth quarter, primarily due to the seasonal changes in our mortgage business, along with challenges in the mortgage environment. Service charges have increased due to our focused efforts to enhance those, and our SBSL division revenue also saw an increase. Noninterest expenses declined during the quarter, and we are proud of how we've addressed these costs; however, we don't expect them to stay at this level going forward. As we approach next year, we will implement annual compensation increases, and Derek will discuss our expectations for noninterest expenses. With the shifts in the rate environment we noticed in the fourth quarter, the fair value of our AFS securities portfolio improved, resulting in an 18% boost in our OCI, which we welcome. Total deposits for the quarter decreased compared to the previous quarter, primarily due to the payoff and reduction of broker deposits. However, on a core deposit basis, our customer deposits rose both quarter-over-quarter and year-over-year. We also announced our entry into Northwest Florida this quarter with Kyle Phelps joining us as our regional market executive. We're excited to have Kyle on board and look forward to building customer relationships in those markets, especially Tallahassee and the Florida Panhandle, where we have many customers due to our proximity to South Georgia. In Slide 9, we show a trend of overall improvement in our startup and complementary lines. The fourth quarter tends to be slower, especially with the seasonality of our Marine/RV business, but we are pleased with the progress we've made. We will continue to focus on these lines of business in 2024 to ensure ongoing improvement, increase our noninterest income, and better meet our customers' needs. We are also pleased to announce a quarterly dividend increase to $0.1125 per share. This dividend is very important to our long-term shareholders, especially individual shareholders and the communities we serve, many of whom are significant bank customers. This marks the eighth consecutive year of dividend increases, outlining our confidence in our earnings. Looking ahead to 2024, we expect some loan growth, but likely under 5% for the year, reflecting both customer demand and our lending appetite. In addition to lending, we will concentrate on three primary internal areas. First, we will focus on deposits, aiming to retain and grow current relationships while developing new ones through our calling and marketing efforts, with most of our incentives tied to deposit growth. Second, we will enhance noninterest income, particularly working to improve our mortgage revenue as the rate market stabilizes and growing revenue in other complementary business lines. We will also optimize our customer data to better integrate our internal processes. Third, we will emphasize efficiency, maintaining the discipline in expenses established in 2023 and seeking further opportunities to serve our customers more efficiently. We adhere to our internal service standards, which are collaborative, pronged, and simple. When we can enhance the customer experience and achieve those standards, we will continue to pursue those improvements. Now, I'll turn it over to Derek to delve into the financials in more detail.

Thank you, Heath. I'll start with our earnings for the quarter. Net income decreased $206,000 quarter-over-quarter. When compared to the prior quarter, we saw net interest income decreased approximately $744,000, noninterest income decreased $414,000, but we also saw noninterest expense decline by about $1.3 million. Interest income increased from the previous quarter as we continue to see assets repriced to higher rates and experienced modest loan growth. Loan growth did slow to an annualized 4% compared to 6% in the prior quarter. As we mentioned last quarter, we did see a slowdown in our RV and Marine lending division during the off-season. Interest expense outpaced the increase in interest income during the quarter. But as Heath mentioned, we're starting to see that slow down. The increase in the fourth quarter, quarter-over-quarter, was lower than previous quarters in 2023. Net interest income declined in the fourth quarter and led to an additional margin compression of 8 basis points, which was in line with our forecast that we mentioned on last quarter's call. Although we've seen a lot of reduction in the overall pressure of funding costs, we still see competition for deposits. You can see the slowdown in those deposit costs on Slide 21 in the investor presentation. From here, going forward, we're likely to see margin drop maybe another 3 to 5 basis points before we start seeing any margin expansion. While we're optimistic that we will see margins starting to go up at some point, we think that will be likely in the second half of 2024. The timing, and by how much that increase is will largely depend on external factors such as timing and magnitude of any Fed cuts this year. Noninterest income decreased $414,000, which was primarily due to a decrease in mortgage-related income of over $500,000. Typically, we see mortgage income drop off this time of year, and the overall mortgage environment is still really tough. Net service charge and fee income increased around 18% quarter-over-quarter, which is about $395,000. SBA gain and related income from our SBA sale division increased $347,000 from the prior quarter. Commission from our insurance division also increased quarter-over-quarter. Other noninterest income was down, but if you remember from our last quarterly call, we mentioned we had a few one-time items in the third quarter that we didn't expect to see again. The fourth quarter other noninterest income was in line or maybe even slightly up from earlier quarters of the year. As Heath mentioned, we've seen improvement in our newer lines of business and expect that trend to continue as we move through 2024. Noninterest expenses totaled just under $19.6 million for the quarter, which was a decrease from the third quarter. We're still committed to operational efficiency and expense discipline. In 2023, we improved our net NIE to average assets from 1.96% in the fourth quarter of 2022 to 1.35% in the fourth quarter of 2023. This was the result of a lot of hard work and effort from all of our team members. Going forward, our expectation is to be in the 1.40s on that net NIE, and project our quarterly noninterest expenses to be around $20 million, which is a little bit higher than this past quarter. As Heath mentioned, in the first quarter of 2024, we'll have annual compensation increases go into effect, and then we'll likely see some other expenses trend up slightly as we see activity pick up as we move out of the slower winter months. Provision expense totaled $1.5 million for the quarter. On last quarter's call, we mentioned the potential for some more charge-offs and this quarter, net charge-offs were $692,000, which was similar to the previous quarter. We did see a slight increase in total nonperforming loans quarter-over-quarter, but NPLs still remain low relative to the whole portfolio. Our classified and criticized loans increased, and we've broken that down for you on Slide 29 in the investor deck. The increases are related to a small number of loans across different loan types. Right now, we aren't seeing any issues with any specific loan types or anything that really gives us a lot of calls for concern. Criticized and classified loans still remain at a relatively low level compared to overall loans. Total loans increased to about $18.5 million or around 4%, which is less than the previous quarter. We still continue to see that slowdown. Again, we expect to see modest loan growth in 2024. Any pickup we do see there will likely occur in the latter half of the year. Total deposits were down $46.5 million, and it was the result of the paydown of broker deposits. During the quarter, we reduced broker deposits by around $55.1 million and grew our core customer deposits by $8.6 million. In addition to the broker deposits, we also paid down FHLB advances by $10 million as part of reducing our reliance on the more expensive wholesale funding. Slide 17 outlines our liquidity at the end of the quarter, and we're still in a great position there with access to over $1.3 billion in liquidity. We do realize the bank term funding program is likely going away this quarter. We haven't used it at all, and so it really won't have an impact on our overall access to liquidity. We didn't have any discount window or other Federal Reserve borrowings at the end of the quarter and did not have any outstanding borrowings from any of our Fed fund lines. An area where we saw improvement was in the fair value of our investment portfolio with rates moving down as the market adjusts to potential Fed rate cuts. We've seen the fair value of the AFS portfolio increase over $16 million from the previous quarter, which translates to a $12 million improvement in our AOCI. This increase in the fair value of the portfolio creates a little more room for us to potentially look harder at restructuring a small portion of the portfolio. Again, this is something that we're continually looking at and any losses would be limited to a portion of our quarterly earnings. The mortgage environment is still challenging, and we continue to evaluate and make adjustments to our products and pricing. Our focus has been on breakeven for our mortgage division, and we did end up breaking even in the fourth quarter with just a slight amount of profit there. We still believe mortgage is an important part of our long-term strategy, and we are hopeful to see improvement again once the environment gets a little better. In our SBSL division, the pipeline for the small express loans is strong and we see this as a good opportunity going forward. The premiums on the express loans are typically a little higher, and we expect that volume to increase throughout 2024. We're still seeing slowing demand for the larger loans. So more volume in these express loans is a good way to replace some of that slowing demand for larger loans. We did have a few more charge-offs related to SBA loans this past quarter, which Heath mentioned earlier. However, NPLs decreased for the SBSL division quarter-over-quarter. Heath mentioned earlier, the improvement in our startup lines, again, that's outlined on Slide 12. There's a lot of opportunity that we see for these lines to continue to improve over the next year. Some of these new lines became profitable in 2023, and we expect the remaining ones to be profitable sometime in 2024. And now I'll turn it back over to Heath for any final comments before we take questions.

Thanks, Derek. That wraps up all of our comments we had. So with that, I'll ask Julie to open the line for any questions.

Thank you. One moment please for your first question. Your first question comes from David Bishop from Hovde. Please go ahead.

Hi. Good morning, gentlemen.

Hi, David.

Good morning.

Hey, Derek, just curious, I appreciate the guidance in terms of the net interest margin. Just curious how sensitive the margin is to the forward curve and the expectations in terms of the Fed? I think you were thinking maybe three rate cuts. Just curious, maybe, how we should think about sensitivity of the margin to potential Fed rate cuts?

I will make a comment and then turn it over to Derek. We don't have a clear idea of what the Fed will decide. Our guidance suggests no change in rates, but lower rates could improve our margin if the cuts are minor. However, we believe it will take a quarter or two after the cuts to see an effect, as we are still dealing with rising deposit costs, which, although increasing at a slower pace, are still a concern. It will take time to address the CDs and some of the marginal funding costs we are facing. Additionally, the lower loan demand is complicating matters, as it is contributing to ongoing compression, in contrast to earlier in the year when we experienced higher loan growth. So, some of this depends on that. Derek, do you have any further comments?

Yes. And just to kind of touch on what Heath said about the deposits. I think there will probably be some lag there for a majority of our deposits. We do have kind of pricing and different price points across our deposit base. We have some shorter-term wholesale funding, which we would see more of an impact earlier on. But some of our other deposit CDs and money market accounts, we have some that are priced higher that we would see some benefit. Also, we still have some that are priced low that we might see some increases in. I think there'll be some benefit to margin if we do see rates decline. But to Heath's point, it may take a quarter or two just as we kind of see some of that lag on some of the deposit cost side.

And from a loan repricing, just remind us maybe over the next year or so, how much is maybe the near-term fixed to reprice and what the repricing at into new origination deals?

Yes. From a new origination perspective, we're observing originations in the eighth. The new yield we're seeing is promising; however, our challenge lies in the fact that we would prefer our loans to reprice more quickly. Derek, would you like to discuss the repricing?

Yes, yes. We don't have as much repricing this year as we'd like to have. I think we will see some benefits there. We'll see some modest loan growth which will help with that some. But right now, we're seeing pricing in the eighth, as Heath mentioned. That will be some benefit. We are seeing a continual increase in our loan yields as we kind of move through the quarters, and we expect to see that ongoing this year as well.

Got it. And then you mentioned the nice uptick in deposit service charge increases. Just curious what's driving that? Is this sort of a nice or new run rate moving forward, for those fees, do you think?

Yes, we implemented some new service charge fees in the last quarter, actually starting at the end of Q3. We have received about a full quarter's worth of that income. The level we observed in the fourth quarter seems to be a solid benchmark for our expectations going forward. However, there might be a slight decline as some customers may opt out of certain fees. Overall, the increase we've seen appears appropriate and should remain in place for several more quarters.

It's a mixture of fees on the consumer side of kind of getting more in line with our peers and also a concerted effort on the Treasury side to go generate business and to price those products appropriately as well that you can do a little better in a higher rate environment.

Got it. I have a couple more questions. The downgrades on the classified and criticized accounts seem quite detailed in terms of dollar balance. I'm curious about what caused those downgrades. Was it due to a decline in borrowing financials at the end of the year or the potential for repricing that might impact debt service covenants? I’m just interested in what led to those downgrades.

Yes, it's pretty much across the board. I think we certainly this time of year, start to get financials in for our folks that are later filers, and we get those analyzed. It's definitely more, I think, on a prospective basis, us analyzing financial statements and having concerns about repricing and other trends in their business. I would say it's a lot rate-driven from the majority of it.

Got it and one final question. You noted the uptick in SBSL charge-offs. Just curious on a dollar basis or what percent of the current quarter and last quarter were related to that segment? Thanks.

So last quarter, a majority of those net charge-offs were related to SBSL, but that was a smaller portion this quarter. I would say probably about 60% to 70% this quarter related to SBSL. That was one of the leading impacts really on our net charge-offs for both quarters.

Your next question comes from Chris Marinac from Janney Montgomery Scott. Please go ahead.

Thank you, good morning. I appreciate you hosting us today. I wanted to inquire about the improvement in AOCI. The information you provided in the slide deck concerning the different categories appears to be pretax. I'm trying to compare the overall change in AOCI with those three categories because it seems like there was an offset beyond taxes. I would like to understand that better. Is there potential for further recovery in AOCI in the future?

Yes, Chris. In addition to our investments, we do have a small amount of interest rate swaps that would offset that. I think it was just a few hundred thousand dollars during the quarter. Quarter-over-quarter, that move was about a million because we had a gain in those swaps of about 700 last quarter and then a loss this quarter of 300, so you have about a million move there. That's obviously a fraction of the improvement we saw on the security side. We continue to see the terms on these securities come in. They're rolling down the curve. The biggest move to that would be if we continue to see rates come down.

Got it. That makes sense. Thank you for that. I appreciate that. Then when we look at the loan yield that you have seen increased loan yields over many quarters, is there additional loan yield bumps that can happen even as the portfolio turns or just sort of natural rate increases go through? I'm just kind of curious if there's more loan yield that's available in this next 12, 18 months?

Yes. I think there is, and that's kind of what we're forecasting in our budget for the year. We do have loans that will be repricing. We'll have new loans coming on at higher rates. We expect the pickup across the next year, but I think it will be similar to what we've seen over the past couple of quarters.

Yes. I'll just add, Chris. Our total loan yield, I think, is 565 for the quarter. We're putting loans on in the 8s or in some cases in the high 7s. Our total duration of our loan portfolio is just over 2.5 years. We have several hundred million dollars of loans repricing each year. Obviously, we're working hard to push the yields up on these renewals. Not having net growth will limit some of that, but there's still significant opportunity to move our loan yields up. I think in the last few quarters, it slowed down some of that yield increase because we've been coming off of such a low base, but there's still an opportunity each quarter to get some nice increases on our loan portfolio.

And Heath, the mix between fixed and variable, do you see that kind of still being relatively the same in the next year or so?

Well, actually, from a production standpoint, we are seeing continued more production on the variable side the last couple of quarters. From an overall standpoint, we're still at a high percentage, still a higher percentage on the fixed side, but we are chipping away at that.

Great. That's helpful. And then last question for me is, there's a slide, I think it's number 12 about the sort of data and analytics that you're now harvesting. I'm sure it's still early for what you want to do with that. But what do you envision that data does for you this next year or two? I mean do you kind of cross-sell the same customer just more business at a better profit margin? Do you see that data kind of helping you get net new customers? I'm just sort of curious how you think through kind of where that's going to take you.

Yes, that's a great question. We are at an early stage. Over the past year to year and a half, we have built our data infrastructure, and it is now in place. The next step is to utilize this data effectively to prioritize areas where it can drive significant revenue growth. We currently serve nearly 100,000 customers, and our aim is to leverage this data to identify marketing opportunities for our bankers. This will help us understand where our customers' other business lies and how we can direct them towards wealth management, insurance, and merchant services. Our revenue growth has primarily come from diligent calling efforts, and we hope to use our data to enhance that marketing and outreach. This will be a central focus for us in the coming years. We recognize the value of offering multiple lines of business to increase revenue per customer and optimize our customer base, particularly in our smaller branches. Boosting revenue from additional services enhances the effectiveness of our low-cost deposit network, even though there are higher expenses involved. We expect to see sustained improvement in noninterest income from this initiative over the long term, and we believe we are just beginning to tap into its potential.

Great. That's really good color. Thank you both for the time and background this morning.

Thank you, Chris.

Your next question comes from David Bishop from Hovde. Please go ahead.

Yes. I have a couple of follow-up questions. Heath, you mentioned the addition of Kyle this quarter to boost efforts in Northern Florida. I noticed the lagging pretax profitability in the Alabama OPL. Could that possibly enhance some of your ongoing efforts, considering the close geographic proximity? Also, regarding the Marine/RV lending, are those loans being developed for a portfolio, or do you typically accumulate them for bulk sale every few quarters? Thanks.

Yes. Regarding Florida, our aim was to initiate that effort without incurring additional costs. You can see that some areas are showing improved profitability. We’ve had reductions in other areas that help balance out the increased expenses there, and we don't anticipate this being a significant burden overall. As for the Marine/RV segment, we haven't made any sales yet, but our intention is to build that portfolio and eventually begin periodic loan sales. We believe there's potential to generate revenue from this area, which hasn't been evident in our operations so far, as we have retained everything up to this point.

Got it. And then, Derek, I think if I heard you, obviously, you've been leaning on expenses here, but we should expect some sort of inflationary pressure into the first quarter and then into 2024 as FICA takes hold and annual compensation rates take effect. Did I hear you correct?

That's right. Where we've landed on our forecast is around that $20 million quarter mark, which is going to be higher than this past quarter. Again, it just goes back to some of those increases that we know are coming in this first quarter, and that will cause that to go up a little bit.

Great. Appreciate all the call this morning.

Thank you.

Presenters, there are no further questions at this time. Please proceed with your closing remarks.

All right. We appreciate everybody being on the call today. Thanks, again, for your support of Colony Bancorp, and that concludes our call.

Ladies and gentlemen, this concludes your conference call for today. We thank you for joining, and you may now disconnect your lines. Thank you.