Earnings Call Transcript - CBAN Q3 2022

Operator, Operator

Hello and welcome to today's Colony Bank third quarter 2022 Earnings Conference Call. My name is Jordan and I will be coordinating your call today. I will now hand it over to Andy Borrmann, Chief Financial Officer, to begin. Andy, please go ahead.

Andy Borrmann, CFO

Thanks, Jordan. Good morning, everybody. Thanks for joining us this morning. I'm going to make a quick opening statement of some disclosures to keep the lawyers happy. Certain statements we make on this call could be construed 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, the COVID pandemic, variations of the company's asset, businesses, cash flows, financial condition, prospects and other results of operations. With that, Heath, I'll turn it over to you.

Heath Fountain, CEO

Thanks, Andy. And thanks, everyone for being on the call today. We appreciate your continued interest in Colony. We're pleased to report an improvement in earnings in the third quarter compared to the second quarter. Particularly, I want to highlight the quality of our earnings as more of our earnings and earnings growth is coming from our traditional banking and recurring revenue businesses as compared to our transactional businesses. Our core banking business makes up about 93% of our earnings this quarter and about 90% of the earnings year-to-date, and that's up from about 75% in the previous two years. Loan growth this quarter, as you see, remained strong. Our loans increased over 9% from last quarter, so a 37% annualized growth rate. This is really the second consecutive quarter we've seen this accelerated loan growth, and our pipeline remains strong. We expect to see this continued accelerated growth for the next quarter or so. Due to that accelerated growth, we provided $1.3 million for loan losses during the quarter despite continued improvements in asset quality trends, but felt the need to make sure we provided to keep up with the loan growth. The loan growth continues to move the needle on our loan-to-deposit ratio, moving up from 62% last quarter to 66% this quarter, and that's up from 56% at the end of last year, so significant progress there. That's something we've talked about a lot for a long time. The key to achieving our profitability goals is to get that loan-to-deposit ratio up to more of an 80% to 90% range. That loan growth led to an improvement in both our margin, which went from 3.15% to 3.25%, but even more importantly, to an increase in the gross dollars of net interest income up 9% from last quarter. We were really pleased also to post deposit growth of 3% in the quarter in a pretty tough deposit environment. We've been working hard on the deposit side to ensure we're able to fund the loan growth and our really solid core customer base at Colony has allowed us to raise deposits both through selective specials and targeted customer acquisition strategies, just trying to do our best to target the increases versus increasing rates too much across our whole deposit base. Mortgage origination was slightly down from last quarter, but I still think a pretty strong level considering the rate environment that we're in. With the higher rate environment, we're also seeing more portfolio and ARM products being used. Given the inventory shortage, we're doing more construction to perm. This quarter, we only had sold loans of about 70% of what our production was. That, of course, decreases our upfront income on our mortgage group, but I still think they're doing a really good job of originating throughout this tough interest rate environment. In our government-guaranteed business, what we call our SBSL, small business specialty lending, we were down a little bit over last quarter. We've got a good pipeline there and feel like we'll end the year strong on that front. As we look at our earnings this quarter and the progress we're making, I'd like to point you to a slide we put in our Investor Day to Slide 12 that is the path to high performance. We discussed that we expect to get to a 120 ROA by the end of 2024. This quarter we're at 75 basis points. We wanted to walk you through some of the things that are drags on our ROA and also areas where we think we have opportunities and where we're making progress. A big factor is we have a large provision expense due to the outsized loan growth. It is wise to take advantage of the opportunity to grow quality loans in this environment, but it causes us to increase our provision above normal levels. That's about 11 basis points hitting our ROA versus if we were growing in the middle of our long-term range at about 10% loan growth. Our new business lines and start-up markets run about $800,000 in net expense per quarter, contributing another 9 basis points to our ROA. Progress is being made on both of those items. Each 5 percentage points we move our loan-to-deposit ratio, we think conservatively earns us about 9 basis points of ROA. So that's another area where we've made significant progress. Recall that we've moved that ratio from the 60s to the 70s, then to the 50s with the pandemic, and now we're back up into the mid-60s. Another area in 2020 and '21, mortgage and SBA, which are a big part of our business, added about 19 basis points to our ROA; this year it's only 7%, and last quarter, it was only 5%. Those lines of business have great teams doing a great job through this environment, and we think those will stabilize at a more normal level as rates and markets stabilize. With these factors, we are very confident we have a clear path to achieve our profitability goals in the intermediate term. We're positioned to achieve the near-term loan growth we want. We have the team members who can manage this growth; we're not necessarily reliant on hiring more bankers, though we're always on the lookout for talent. We're confident in our trajectory and proud of our team's efforts, especially given the tough operating environment with rapid rate changes. A few other highlights from the quarter: we moved $190 million of securities to held-to-maturity as we monitor the potential negative impact to our AOCI due to declining values in a rising rate environment. Our Board declared a dividend rate that has remained steady at $0.1075. Given the current equity market and the lack of interest in valuations for banks, we believe this may also affect us due to tangible book value declines in securities. Our Board authorized a stock buyback plan of $12 million, which is about 5% of shares outstanding at current market prices. We think this is a great opportunity at current pricing levels for long-term investments. We’re glad to see that support, and we believe in our position at Colony. Those are all my prepared remarks. At this time, I'll call on Jordan to open up the lines for questions, and we'd be happy to answer any questions that you guys have today.

Operator, Operator

Our first question comes from Christopher Marinac of Janney Montgomery Scott.

Christopher Marinac, Analyst

I wanted to ask Andy and Heath about the loan growth we saw by market. It seems to be strength not just in Atlanta, but in the other markets like Middle Georgia, Coastal Georgia and now Birmingham. How should that play out the next couple of quarters? Just kind of curious on pipelines and kind of the split between the various markets.

Heath Fountain, CEO

Yes. So we, too, are pleased that we're seeing that across the footprint. Obviously, we think we have capacity across the footprint. Certainly, in the Birmingham market where it's newer, we're really just starting to gain momentum there in Birmingham and Huntsville. I think definitely because we're coming off a low base percentage number, you'll see some outsized growth there. But we expect to see growth across the footprint. We have strong pipelines across the footprint, and we think we're seeing opportunity to look at really good credits across the footprint, even as we continue, just due to potential macro concerns, to tighten up credit boxes. We still see strong growth. I would expect to see it across the footprint, with opportunities in the Atlanta area and Birmingham potentially a little stronger than some of the other areas. But you should see it fairly spread out.

Christopher Marinac, Analyst

Great. And over time, can Birmingham become as big as, say, Middle Georgia, Coastal Georgia? I know that's probably a couple of years away, Heath, but just curious if that is a possibility in that big picture.

Heath Fountain, CEO

Yes, absolutely. We think there's a great opportunity there. We really try to focus on new markets where there's outsized share by the larger regional banks, and we think we compete very well against those. We certainly have that opportunity in those markets.

Andy Borrmann, CFO

And Chris, I would just add to that. The folks that we've hired over there have the capacity that our corporate bankers here in Atlanta possess. Realistically, four or five of those individuals could produce a significant portfolio over the next three years.

Christopher Marinac, Analyst

Great. And then last question, Andy, regarding the securities that were moved into HTM, was there any difference between those securities and the ones that remained available for sale?

Andy Borrmann, CFO

So Chris, the way we've approached it is very similar to what we've done the last couple of quarters where we moved incrementally along this front. We're trying to maintain maximum flexibility with the available-for-sale portfolio. We still have available-for-sale bonds in just about every category and sector we’re invested in. This way, if rates turn around and go the other way, and for example, taxables become more expensive than tax frees, we have the opportunity to take advantage of that if and when we need to.

Operator, Operator

Our next question comes from Dave Bishop of Hovde Group.

Dave Bishop, Analyst

Yes. Heath, Andy, just curious, you noted the margin expansion here. But noted that, on my calculations, overall loan yields, average loan yields pulled in. Just curious, about that dynamic here. It sounds like you still got the pedal to the metal from a growth perspective, but do you think you'll reach a point, just in terms of the growth, where it sort of outstrips the near-term funding capability? Or does that really compel you to ratchet up deposit costs? Just curious how you sort of balance the growth versus the funding equation here over the near term.

Andy Borrmann, CFO

Yes. So David, that's one of the operational daily questions we have. We have been ratcheting up our loan yields as we go. You could say maybe we haven't been ratcheting them up quite as much as our peers in the last 60, 90, or 120 days. But when we see the opportunity for good deals, we're willing to be very competitive. We think there's a better interest rate environment to be competitive and secure the right deals, given the fact that our loan-to-deposit ratio is still in the 65% range. We're trying to ensure that our funding is as organic as possible. We haven't changed strategies from what we said in the second quarter: wholesale funding will be secondary. If we can secure it organically, we'll do that. If not, we'll rely on wholesale for the time being. When loan growth slows down, we'll let the dust settle and all will shake out, hopefully with more organic funding. We have changed the way we incentivize deposit gathering in the last 90 days, and we'll continue with that incentive for the foreseeable future.

Dave Bishop, Analyst

Got it. And noted good expense control amid some of the choppiness in the second quarter. As you look out at the operating expense outlook, do you think this is a good run rate over the near term? Or should we model in some modest expense or inflationary expense increases into 2023? Just curious how we should think about operating expenses.

Andy Borrmann, CFO

Yes. I think our biggest line item is personnel expense. I expect that will be a pressure on everybody. So I don't want to suggest we'll be excluded from that. I do anticipate some personnel expense pressure. However, we believe we have the team we need for the next short to intermediate term cycle of Colony Bank. If we have opportunities to bring on strong people, we will. This is a relationship business, and we have hired people we believe in. We've invested in them and will continue investing in good folks. Overall, on the non-personnel side, I'd like to think we're in a good ballpark for at least the next three to six months, and we'll assess after that.

Dave Bishop, Analyst

Got it. And then one final question here. You obviously noted the good growth you broke out by geographic region. Just curious if you could provide any color in terms of what loan segments are growing this quarter versus last quarter?

Heath Fountain, CEO

We're generally seeing loan growth across the board, similar to our portfolio. We have a significant amount of commercial real estate and residential mortgage as well. We continue to see growth in all categories. We continue to tighten our credit box, particularly in commercial and the CRE category like retail and office. Despite tightening credit metrics, we're seeing good opportunities in those areas. Overall, we feel good about the broad loan growth, especially in heavy commercial real estate, given our portfolio emphasis.

Andy Borrmann, CFO

I'd add to that by noting that during the quarter and as we move forward, you've seen some peers back off from certain categories. Heath has previously described it well: there are always opportunities to engage with the right people, and we will bank with the right customers. We're adjusting prices on certain categories to reflect the fact that some areas are at higher risk than previously. Our focus is not only on credit quality but also on pricing adequately for the risk we're assuming.

Operator, Operator

Our next question comes from Kevin Fitzsimmons of D.A. Davidson. Kevin, the line is yours.

Kevin Fitzsimmons, Analyst

I guess we've talked a little bit about margin and a little about loan growth. But taking a step back, the margin didn't seem to expand as much as I would have expected or what many banks have seen. However, you guys have also achieved stronger loan growth, and you're signaling you're going to keep doing that, while a lot of banks are either signaling they are tapping on the brakes or seeing pipelines lined up. I guess it's a trade-off, right, in terms of how you get to NII growth? Maybe the margin percentage isn't expanding as rapidly because you're comfortable growing the loan book here. Is that the right way to think about this trade-off and how you guys are viewing it?

Heath Fountain, CEO

Yes. I think, Kevin, as I stated earlier, more important to us than margin expansion is the growth in dollars of net interest income. A bank like ours, designed to operate with an 80% to 90% loan-to-deposit ratio, needs to achieve that loan growth. We also need to be aware of the credit environment and our credit metrics, which will continue to tighten, but that loan growth is essential for attaining our profitability metrics. When we have the opportunity to bank the right customers, we aim to secure those deals without losing on rate. We're actively moving rates up and continuing to see them rise. Additionally, we've hired new bankers, ensuring we achieve profitability from those new hires. It’s critical to manage our balance sheet appropriately to bring in the right deals. Overall, our approach has been systematic, and I'm proud of our team's growth and achievements.

Andy Borrmann, CFO

Yes, Kevin, I would echo that. This scenario allows us to consider customers we may not have considered previously because they were associated with larger banks that may now be slowing down. So while the margin might not expand in large leaps, it could gradually grow over time.

Kevin Fitzsimmons, Analyst

So Andy, would you think the margin doesn't expand in leaps and bounds like we're seeing from other banks, but it could potentially creep higher for a longer period while other banks may peak sooner?

Andy Borrmann, CFO

Yes, Kevin, I hope that's the case. We're looking far into the future now. Short term, if our loan growth continues at the current pace, we'll need to finance that growth with more expensive sources. However, we're hopeful we can replace that money over time with the incentives we're implementing for deposits. This could lead to a gradual margin increase that outlasts some of our peers.

Kevin Fitzsimmons, Analyst

And you mentioned the buyback. Should we expect that to be implemented in short order, or is it more of a safety measure in case of further market disruptions?

Heath Fountain, CEO

Yes, I think we don't plan to be aggressive. However, it's hard to predict the market environment. We wanted that tool available within our capital management framework, which we haven't had in the past. It'll depend largely on the market opportunities we encounter.

Kevin Fitzsimmons, Analyst

Great. And one last question: with D Copeland stepping in as President, what has he been focusing on, and what changes is he implementing?

Heath Fountain, CEO

Yes, sure. He is not on the call, but he is off to a solid start. D’s initial focus is on ensuring that our ancillary lines and initiatives are integrated effectively and that we achieve our profitability objectives on those. Some more commercial lending efforts have performed well in the last few quarters. D has built relationships across the company during the past year in an advisory capacity, therefore, this transition hasn't been disruptive. He's contributing great ideas and positive changes.

Operator, Operator

We have a follow-up question from Dave Bishop of Hovde Group.

Dave Bishop, Analyst

Heath, regarding the 10 basis points ROA drag from some of the new lines of business, such as Indirect lending, Marine, RV, and obviously the new markets: you've allocated a considerable amount of expense dollars in hiring new lenders there. From a growth perspective, is there a timeline for when you expect that drag to become a positive?

Andy Borrmann, CFO

So Dave, I think the timeline for those business lines will vary. Our internal goal is to have that $800,000 drag eliminated sometime late in 2023. If we succeed in lending in Alabama and insurance proves to be modestly profitable, that may accelerate the timeline. Currently, our goal is still late '23.

Dave Bishop, Analyst

Got it. And there's a segment regarding homebuilder finance. Based on your conversations with builders, how are they coping with project flow and inventory? Are they managing well from a credit perspective?

Heath Fountain, CEO

Yes. In Augusta, Savannah, and Middle Georgia, there is indeed a lack of inventory. Builders have been conservative in managing their live inventory and development. They continue to sell more quickly than usual but not at the previous aggressive pace. There's a notable mismatch between housing supply and demand. Despite rate challenges from buyers, we expect a good outlook without seeing significant price reductions; builders are still selling at profitable levels.

Dave Bishop, Analyst

Got it. And one final question. Do you have the cost of deposits at quarter-end or margin details available?

Andy Borrmann, CFO

Give me one second. The cost of funds at quarter-end was slightly up. I think, off the top of my head, we were about 50 to 55 basis points cost of funds by the end of the quarter. Yes, the margin was a little bit higher than the 3.25% we just reported.

Operator, Operator

We have no further questions on the phone line. So I'll hand back for any closing remarks.

Heath Fountain, CEO

Thank you, Jordan. Appreciate it. Thanks, everyone, for being on the call today. We appreciate your support of Colony, and we look forward to speaking with you again soon. Thanks.