Colony Bankcorp Inc Q1 FY2024 Earnings Call

Welcome to Colony Bank's First Quarter 2024 Conference Call. It is now my pleasure to turn the conference over to Colony's Chief Financial Officer, Mr. Derek Shelnutt.

Thanks, Abby. 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.

Thanks, Derek, and I want to thank all of you for being on the call today and for your support of Colony. We're pleased with our improved operating results in the first quarter as well as the progress that we made over the last several quarters. We've managed to build on our core customer relationships, strengthen our complementary lines of business, and align expenses with our current growth outlook, all while continuing to innovate and enhance our customer experience. I first want to thank and congratulate our team members on a great quarter. It's their commitment to achieve our internal mission to build a sustainable, high-performing independent bank that's driving our improved earnings. In the first quarter, operating net income increased nearly $400,000, and a lot of that is driven by continued improvement in our noninterest income lines of business. Noninterest income increased almost $1 million on an operating basis. Last quarter, we mentioned that we expect to see a few more basis points of margin decline, and we did see 1 basis point during the first quarter, which was slightly better than our expectations. We saw some stability and a slowing in the rise of our cost of funds during the quarter. However, as you all know, as we've entered into the second quarter, we've seen the rate environment heat back up. The 5- and 10-year treasury have increased over 40 basis points since the end of the quarter. And you've also seen the likelihood of rate cuts this year continue to diminish. That's driving more competition for deposits in the marketplace, and we will see that put continued pressure on our funding costs. Given that, while we're closer to the end of margin contraction, we could see margin decline another 3 to 5 basis points from here if this environment stays where it is now before we start to see that recover and expand, we believe, in the second half of the year. Derek's going to discuss the next items in more detail. But during the first quarter, we did make some strategic balance sheet adjustments, including the sale of securities and some loans as well as the paydown of broker deposits and borrowings. These adjustments are part of our ongoing balance sheet management, and we likely will see similar transactions, particularly the security sales, going forward when we believe they are appropriate and helpful to future earnings. We're glad to see our complementary lines of business continue to progress. The performance of those lines is highlighted. There is seasonality to our marine RV entire merchant service lines of business. So, when you look at Q1 last year, we saw a lot of improvement over Q1 this year. Even though they're down a little bit from Q4. We do expect marine RV to be profitable going forward, emerging to reach profitability in the next quarter or so. The biggest driver in the increase in our noninterest income was from gains on sale of SBA loans. During the first quarter, our SBSL, our small business specialty lending group, hit the high mark over the last year or so. We continue to see success with our small dollar lending program and expect to see those do well over the next several quarters. For mortgage, the first quarter is typically a slower quarter for mortgage in any kind of environment. And of course, we still see a challenging interest rate environment for mortgage. However, we did see our mortgage come pretty close to breakeven in the first quarter and certainly an improvement over where we were in the first quarter of 2023. We did see loans decline during the first quarter, primarily as a result of the sale of portfolio mortgage loans and some criticized loans that paid off during the quarter. However, if you look at our average balance of loans, we were down only about $3 million quarter-over-quarter in average balance. And our current loan levels today and our pipeline indicate we should expect some modest loan growth for the rest of this year, which is what we've been forecasting in the last few quarters. Total deposits did go down quarter-over-quarter, but that was primarily due to the payoff of broker deposits. We are glad to report that our core customer deposits increased by about $12 million over the last quarter, and we remain focused on building core deposits and deepening our customer relationships. Expense discipline remains a priority. And although noninterest expense increased slightly from the prior quarter. It was offset by increased noninterest income. So our net noninterest expense to average assets, which given our business lines is really how we think best to judge our operating efficiency. That number was 1.38% on an operating basis in the first quarter, which is exactly the same as it was last quarter and a significant improvement from 1.78% in the first quarter of 2023. We feel good about our overall credit quality. Nonperforming loans decreased quarter-over-quarter in addition to the decrease in net charge-offs over the prior quarter. The charge-offs we have seen are primarily related to the unguaranteed portion of our SBA loans. We expect to see some of those small dollar loans to have that as well, and we started to see that. However, those loans do have a great premium that we sell those for. And so we think it's a great revenue source for our SBS sales team and overall a very profitable product. Innovation. As I mentioned earlier, despite the focus on expense control. We've continued with innovation. It's an important part of our growth strategy and our ability to better serve our customers effectively and efficiently. Our teams got a number of innovation initiatives that they're working on, that will give us a better customer experience and boost our customer service standards of being collaborative, prompt, and simple, and we're looking forward to seeing some of that roll out through the rest of the year. And with that, I'm going to turn it back over to Derek, who's going to go over the numbers in some more detail.

Thanks, Heath. I'll start off with our earnings for the quarter. On a GAAP basis, net income decreased around $265,000, but excluding the loss on security sales, operating net income increased about $376,000. Interest income increased from the prior quarter but was slightly outpaced by the increase in interest expense, which led to a decline in net interest income of about $220,000. This led to a slight margin decrease of 1 basis point from 2.70% in the prior quarter to 2.69% this quarter. The margin decline was a little less than our expectations, as Heath mentioned earlier, and we still do expect to see some margin decline in the 3 to 5 basis point range before we start seeing any expansion. We have been seeing some slowdown in the increase of our cost of interest-bearing liabilities. That was 2.58% in the first quarter, up 8 basis points from the fourth quarter. To compare, the increase from the third quarter of '23 to the fourth quarter of '23 was 24 basis points from 2.26% to 2.50%. If interest rates stay where they are for a while, we'll continue to see our cost of funds increase, but we expect it to be at a slower pace than what we saw throughout 2023. On an operating basis, noninterest income increased $973,000 during the first quarter. This was primarily a result of an increase in SBA gain and related fee income of $535,000, and is related to the increased gains from the newer small dollar loan product. Net service charge and fee income was slightly down due to fewer days during the quarter, and revenue from both wealth and insurance showed some small increases from the prior quarter. Our BOLI income did increase quarter-over-quarter, but was a result of a one-time claim payout in the first quarter. Noninterest expense totaled $20.4 million, and most of that increase was in employee compensation and benefits. The first quarter is when we see annual salary increases go into effect. We typically see more payroll taxes at the beginning of the year and 401(k) match resets. On last quarter's call, we mentioned that we would likely see an increase in expenses in the first quarter and that we were still targeting that 1.40% net NIE to assets. Operating net NIE to assets was 1.38% in the first quarter, and we see it being around that 1.40% range for the next few quarters. Total noninterest expense of around $20 million is what we're expecting on a go-forward basis, but it could be slightly higher based on activity. We would anticipate that to be offset with noninterest income. Provision expense totaled $1 million for the quarter. Net charge-offs were slightly down quarter-over-quarter. Total nonperforming loans decreased $3.8 million, from $10.2 million last quarter to $6.4 million this quarter. Of the $665,000 of net charge-offs, $535,000 of that was from the unguaranteed portion of SBA loans in our SPSL division. The small dollar express loans, which are 85% guaranteed, had slightly higher losses, but they also have higher premiums when sold. We've recently tightened our underwriting a little on these and are still seeing good volume. So we think they're going to be a good product long term. Total loans held for investment decreased $24.5 million from the prior quarter. However, as Heath mentioned earlier, our quarterly average is down only about $3 million. Overall loan demand has slowed, but the driver for this quarter was primarily the sale of $8 million of portfolio mortgages for an $84,000 gain, and payoffs close to $10 million in loans that no longer matched our credit standards. Based on our current pipeline, we still expect modest loan growth this year. And on the last call, we said that we expected to see that pick up in the latter half of the year, and that's still what we're anticipating. Total deposits declined $22 million and was due to the payoff of $34.5 million of broker deposits. We grew customer core deposits by $12.5 million, and that still remains a primary focus area for us. Additionally, we paid down FHLB borrowings by $20 million during the quarter and in doing so, further reduced our reliance on higher cost funding. We did not have any outstanding overnight borrowings and still maintain a strong liquidity position. The overall value of our investments portfolio increased and led to an increase in OCI of about $1.3 million quarter-over-quarter. We did sell investment securities for a $555,000 loss during the quarter, and a few details about that are highlighted in the investor presentation. The fair value of those securities was around $8.6 million with a book yield of 2.05%. Our conservative estimates put that earn back at about 2 years, but could be shorter if deployed into loans. It's likely that we will do some more restructuring going forward, and those transactions would probably be of a somewhat similar size. The portfolio mortgage sales, paydowns on wholesale funding, and investment in security sales are all part of our prudent balance sheet management strategy. We feel that continuing to optimize our funding mix alongside restructuring underperforming assets puts us in a better position for overall margin improvement. Mortgage is still seeing stable production relative to the higher rate environment. The first quarter pretax profit was around breakeven and a big improvement over the first quarter of last year. In our SPSL division, the smaller express loans are doing well and offsetting some of the slowdown we've seen for the larger SBA loans. We continue to see improvement in our start-up complementary lines of business. The breakdown of income on a pretax basis is outlined in the presentation. Marine and RV lending is seasonal, and we're just getting into the prime season now. However, we see considerable improvement compared to the first quarter of 2023. Heading into the 2024 season, we've almost tripled the number of dealers in our network compared to the end of March last year. We've recently implemented auto decisioning software, which is aligned with our underwriting guidelines and enables us to quickly respond to dealers in our network. Merchant Services has made great progress compared to the first quarter of last year. The total number of customers is up 46% since last March. The total number of quarterly transactions were up 92% in the first quarter of '24 compared to the first quarter of '23. The total quarterly volume is up 75% compared to the first quarter of '23. Volume continues to increase, and we have the capacities to significantly grow revenue with our current resources without adding a lot of additional expense. We also see this as a great lead product in developing full customer relationships with potential customers. Colony wealth advisors continues to add revenue and increase assets under management, and we see a lot of opportunity ahead. For Colony Insurance, we recently expanded our product offerings by adding a life insurance specialist to the team. We feel adding life insurance to our list of products allows us to better serve our customers and generate additional revenue. That concludes my overview, and now I'll turn it back over to Heath for any final comments before we take questions.

Thanks, Derek. That does wrap up our comments. And with that, I'll call on Abbie to open up the line for questions.

Your first question comes from the line of David Bishop from the Hefty Group.

Yes, just curious, a very strong quarter from the small business segment, probably double what it was last first quarter. Did that sort of drain the pipeline? Should we expect sort of a dramatic falloff from here? Or do you think that $2 million or approximate that's a pretty good broad rate going forward? I'm just curious how we should think about overall fee income in the second quarter and beyond as you sort of rebuild the pipeline.

Yes. So we do expect that it might not be quite this strong, but we do expect it to be stronger than previous year's volumes in the SBSL Group with the addition of this. There's, I think, a lot of opportunity there. Of course, other fee income as we look out for the year, Q1 is always light in our customer-related fees, whether it be our deposit account fees, our interchange, all that. So second quarter, we would expect some of those things to pick back up normally. And despite mortgage challenges that are out there, we would certainly expect the second quarter to be stronger than the first quarter from our mortgage side. So we should see a good fee income going forward.

Okay. And then I know earlier in the reporting season, I think some peers were hearing some issues maybe in the RV and marine segment, I guess, related to inventory build. Are you seeing any sort of blips or issues there related to RV and Marine lending?

No. We have seen a little bit of charge-offs there. Nothing significant. Of course, we're new into that business. So it's not quite as seasoned as maybe some other portfolios. But our outlook for that is good. We're just kind of gearing up into the Marine portion of the season generally this time of year. So while our mix is roughly half, by the end of the year, we'll start to see a pickup in Marine during the spring buying season and then the RV would generally pick back up in the fall. So it's probably a little early to make any projections on the RV side, but the Marine side looks strong and the demand looks good there and there's available inventory, which had been challenging in the past. So, don't feel like the inventory on the Marine side is an issue with too much or too little.

Got it. And then I appreciate the NIM outlook there. Does the securities restructure have any sort of impact there in terms of investment yields? Just curious how we should think about that moving forward? And should we continue to expect some runoff in the brokered deposit funding stores?

Yes. So I think with the security sales, the size that we did this quarter is probably not going to have a huge impact on the margin overall. But I think continuing to see these types of transactions as they make sense are going to overall help speed up some of the improvement that we expect there. I mean, especially if we see continuing loan demand and can reprice those underperforming assets into loans. So I think that's going to be positive going forward for earnings. And then we've been managing to pay down broker deposits, and I think we'll continue to do that as we have that availability. So we should see it come down a little bit, but we're well below, when you compare to our peers, our level of broker deposits. So we feel pretty comfortable there and then we have the optionality to get some if we need it, but I think our focus has been paying that down as much as we can.

I want to add that while the quarter has ended, we've observed a significant increase in rates recently. From listening to various earnings calls, it seems that larger banks are making efforts to reduce deposit costs. However, we are still facing strong competition for deposits from regional and community banks. We aim to increase customer deposits as cost-effectively as possible, but as loan growth resumes, we might need to rely on brokered deposits temporarily, similar to our past practices. We'll then work on generating deposits from our customers, focusing on shorter terms and minimizing costs.

Got it. And then last question, I'll hop back in the queue. It looks like maybe 3 or 4 loans on the commercial real estate side slid into the classified. Any commentary just on the puts and takes and what you're seeing on sort of the criticized and classified front?

Yes. What we're really seeing on the criticized classified end is that it's coming out of the SBA lending group. Those have seen the biggest amount of rate change since they're mostly variable rate loans. And so we're just continuing to see some of that weakness that we've talked about in the last couple of quarters. So we don't see material challenges from that. As you've seen, our reserves remain strong. We haven't had to provision a lot for those, but we got to pull them in and work for them.

Your next question comes from the line of Christopher Marinac from Janney Montgomery and Scott.

I wanted to ask more about the office portfolio. Is there any part of that that is criticized? And can you just give us an update on kind of what you're seeing on that debt service coverage for those particular loans?

Yes, Chris, and we outlined a slide on our office portfolio. I think you get a pretty granular view on that. We are not seeing challenges on the office side. Again, our office is different from most given our lack of exposure to major markets. So most of our office is in the 1, 2, 3 story categories. Again, we also break down the loan to value there, and we're not seeing any real challenges in that sector in the portfolio.

Okay. So criticized are low and the debt service coverage ratios are still above which the LTV would have indicated anyways?

Correct. And I guess I want to be clear, we may have a little bit, but we're not seeing any major trends in that direction or any kind of challenges where we're doing office properties refinancing with major changes in debt service coverage. So it's just really been a non-event for us.

Great. Thanks for the slide too, I follow that. That's very helpful. So on the margin, and Dave kind of asked this already too, but can we take the implied payback and kind of apply that to the next quarter and then build upon that? Would that be kind of fair? Because it sounds like there's still an evolution on the securities portfolio ahead.

Yes. I mean that's what we're doing. I think our intent really is probably, while rates remain elevated, to look at the portfolio, what I would call chip away at it. I think we discussed in the range of 10% to 20% of operating net income for the quarter is what we'd sort of be willing to do in terms of what we're willing to take loss because we want to continue to build capital. We want to continue to build tangible book value. But we want to start positioning ourselves for improvement on the other side of this. And obviously, even now. So we'll continue to chip away at that. What we're seeing there in the under 2 years is basically if we were to go buy a security or just pay off some borrowings, if we're able to get loans in the 7%-8% range, we'll be able to even pay those off faster. So they're going to be helpful, but just given the dollars we're talking about relative to the entire portfolio, it’s going to take a few quarters for those to start adding up to something meaningful.

That's helpful. My last question is about new hires in Savannah, Augusta, and Atlanta. What is the trend regarding the addition of full-time employees this year?

We are currently maintaining our team and starting discussions on rebuilding our talent pipeline. As a company, we are assessing our opportunities and resources, and creating a resource allocation plan to strategically place them where we can grow revenues effectively. We see significant opportunities in the current rate environment, particularly by adding treasury personnel on the commercial side, as they become profitable quickly compared to a low-rate environment. We have successfully hired some talent from larger regional banks. Additionally, as we anticipate an increase in loan demand, we are mindful that loan growth has been slow, partly due to our cautious approach to maintaining credit quality and appropriate pricing in a challenging market, but also due to customer demand. It may be later this year or early next year before we look to add commercial bankers. Our goal is to do this alongside margin expansion, allowing us to generate more income and work toward our financial objectives. We have enough capacity with our current bankers to support growth for now.

Your next question comes from David Bishop from the Hovde Group.

Okay. Just a quick follow-up. Heath, I know it may be too early to tell, but have you noticed any positive developments from the new addition in Northern Florida? Are there any signs of production or results in the pipeline, either from loans or deposits?

Yes, we are experiencing strong activity in the Florida market. I have recently visited the area and met with our team, including D. Copeland, who leads our operations there. We are seeing potential with our customers and expect to achieve growth in loans and deposits in that region. Moving forward, you will begin to notice this growth, and we will share our progress as we find success in Florida.

Got it. Derek, could you please repeat the operating expense guidance? I believe I heard it was between $21 million and $20 million.

Yes. We are still aiming for approximately $20 million per quarter, and it could be slightly higher if we see increased activity. However, if it exceeds that and we experience more activity, we expect it to be balanced out by additional noninterest income. So overall, we are forecasting a net noninterest expense to assets ratio of around 1.40 for the remainder of the year.

Remind me how you calculate again? Is that OpEx minus the fee income side?

Yes. It's the noninterest income minus noninterest expense divided by average assets.

And Dave, we believe that when we compare ourselves to other banks that lack some of the revenue-generating business lines we have, it's a better measure than the efficiency ratio. Many of those businesses may not perform well on the efficiency ratio side, but they are strong for return on assets and return on equity. Therefore, we prefer to analyze it this way and compare our peer group based on that net to average assets to create a fair comparison in those revenue businesses.

I appreciate the numbers on the merchant services. Do I understand that you expect that to approach breakeven or even achieve pretax profit by the second half of the year?

Yes. I think we'll definitely start turning profits into the second half of the year there. And most of that is all recurring revenue business. So we'll just continue to build. I think we got a lot of opportunity on that side to continue to grow it even faster than we have been growing it as we have successes within our customer base. So a lot of opportunity there.

And you often see deposit opportunities as well. I think you said before?

When we approach a first-time business customer, it's challenging to lead with our deposit products unless they are experiencing some issue. Moving into business deposits and treasury services is a lengthy process. However, we typically leave these initial meetings with their merchant statements because they are dissatisfied with their current service and believe they are paying excessive fees. This allows us to quickly return with an improved service offering and a better fee structure. It serves as a straightforward way to establish a new relationship, after which we can focus on developing their deposit needs. We recognize this as an increasingly effective entry point for new customers, enabling us to start offering them deposit and other services.

Got it. That's all I had. Appreciate the color.

There appears we have no further questions at this time. I will now turn the program back over to our presenters for any additional or closing remarks.

Well, I just want to say thanks again for your support of Colony Bancorp. We appreciate you all being on the call today and look forward to speaking with you again soon. Thank you.

This does conclude today's program. Thank you for your participation. You may disconnect at any time.