Colony Bankcorp, Inc. (NASDAQ:CBAN) Q3 2023 Earnings Call Transcript

Colony Bankcorp, Inc. (NASDAQ:CBAN) Q3 2023 Earnings Call Transcript October 26, 2023

Operator: Good morning, ladies and gentlemen, and welcome to Colony Bank Third 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. [Operator Instructions] This call is being recorded today, October 26, 2023. I would now like to turn the conference over to Derek Shelnutt, Chief Financial Officer. Please go ahead.

Derek Shelnutt: Thanks, Sergio. 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 uncertainty. 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 operation. 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.

Heath Fountain: Thanks, Derek. I want to thank everyone for being on the call today and for your interest in Colony. We’re pleased with our results for the third quarter as we continue to navigate a challenging and changing economic environment. Our earnings increased over last quarter as we begin to see the results of many strategic initiatives we’ve been working on over the past several quarters and will continue to work on in the quarters to come. I’m going to share an overview of the activity from the quarter, and then hand it over to Derek, who’s going to go into more detail on the results. Our net interest income for the quarter increased as we continue to diligently navigate the way we price loans and manage our customer relationships on the deposit side.

We also saw a full impact of some earlier strategies such as the hedging we put in place in Q2, which has positively benefited our interest expense. We’re glad to share that our noninterest incomes increased quarter-over-quarter and it represents about 33% of our total revenue. We’ve seen increases in our newer complementary lines of business as well as increases in deposit-related charges and fees. We remain focused on growing our complementary lines of business and feel it’s important to diversify our noninterest income sources, especially with those that are less sensitive to the rate in economic environments. There’s certainly been some slowdown in our mortgage division driven by the current rate environment and we continue to make changes there to our staffing and product mix, and in order to achieve breakeven there.

We’re really proud of our noninterest expense efforts, our noninterest expenses declined $0.5 million from last quarter. Teams worked really hard over the past several quarters to reduce expenses in order to be more complementary to the moderate growth projections and we’re seeing the impact of those efforts. And, even though, we’re mindful of the expenses and we do look at that alongside our long-term strategies and we’ve been able even with the expense initiatives to continue to invest in technology and infrastructure that will benefit our customers now and in the future. This past quarter we went live with a new data warehouse and API technology that will allow us to better manage and use our data. It will also allow us to integrate other platforms and fintech products with our core.

We think this is a big step forward in our long-term innovation strategy and it’s going to have positive impacts on how we serve our customers, how we market our products and enhance our operations and profitability. We also continue to look for opportunities to add to our team through strategic hires, where it will enhance long-term strategy even while we have seen decreases in our overall staffing levels. Asset quality remains strong. We saw a decrease in non-performing loans from the prior quarter. Our provision was up this quarter and our net charge also up primarily due to a few SBA loans from our SBSL division, where the portion of the loan that’s non-government guaranteed was charged-off. We mentioned this last quarter that we were seeing some weakness there and, of course, our SBA portfolio is primarily variable rate loans and so they’ve seen the most increases quickly in their payments.

This is an area where we may see some small charge-offs going forward, but really it was a small number of loans impacted and our team’s doing a good job of managing those. Our loan growth slowed from the previous quarter to an annualized rate of about 6%, a lot of the growth came from consumer, particularly Marine/RV during this season, the summer buying season. We expect that our loan portfolio growth for this and our overall portfolio to continue to slow for the next few quarters. Our total deposits were down a little from last quarter and, historically, we’ve seen a slight dip in the third quarter. Our deposit base is very diversified. We have a slide on that in the investor presentation. But we do see some seasonality from municipalities as they spend down during the year and from our rural customer base and agriculture as we see the activity there.

And we would generally expect both of those segments to increase in the fourth quarter as agricultural producers sell crops and as municipalities see property tax payments come in. Our total deposits are still up for the whole year, despite being down for the quarter. They’re up about 4% for the whole year. Our margin was flat quarter-over-quarter actually increased 1 basis point. The repricing deposits has slowed, but the environment remains competitive and we will continue to see our overall cost of funds increase. While we stayed flat, our modeling shows we could see still a potential for another 5 to 10 basis points of margin compression over the next quarter or two. So, with that, I’m going to turn it over to Derek to go over the financials in a little more detail.

Derek Shelnutt: Thanks, Heath. I’ll begin with our earnings for the quarter. Net income increased about $502,000 quarter-over-quarter. And when we compared to the prior quarter, we saw net interest income increased $440,000, noninterest income increased $766,000 and noninterest expense declined by $551,000. Interest income increased during the quarter as we remain focused on loan pricing relative to our funding costs. While growth in some areas has slowed, we did see growth in consumer loans, especially in our Marine/RV division through the summer buying season. And as Heath mentioned, we do expect that Marine/RV Lending to slow as we move into the end of the year and out of that traditional buying season. And then, we’ve also had some repricing on loans as they renew, which has also helped a little.

Interest expense on deposits also increased during the quarter as competition on deposit pricing still remains strong. And we also continue to see some mix and rate changes on existing deposits. Where we saw improvement on the interest expense side is with our FHLB borrowing. Average balances for the quarter were down compared with last quarter. And we also had a full quarter of the hedging strategy we put into place at the end of Q2, which has helped us both from the initial positive carry on the swaps and the hedge against the increase in borrowing rates that we’ve seen recently. We did see an increase in the end of quarter FHLB balances, which I will discuss here in a minute when I talk about deposits and funding. With noninterest income, the increase in noninterest income during the quarter is a product of several different components.

On Slide 16 and 17 in the investor presentation, we show a representation of how the mix has changed over the recent years and recent quarters. From deposit relationship related income, the net increase in service charges and interchange fees was about $244,000 for the quarter. The noninterest income component from our SBSL division increased about $163,000 during the quarter. Mortgage division income did decrease by $284,000 as we see slowing in that industry due to the rate environment. The Colony Insurance division saw a revenue increase of $66,000 and noninterest income from Colony Wealth Advisors increased $26,000 and Merchant Services income increased $10,000 during the quarter. All other noninterest income increased about $564,000 and some of that was one-time items.

So, for the next quarter and going forward, we don’t expect quite that same level of increase and really we kind of see this noninterest income remaining flat or even slightly down in some areas. With noninterest expense, we’ve been focused on operation or efficiency and managing expenses throughout the year. The decline in noninterest expenses quarter-over-quarter as a result of those efforts. Our net NIE to assets was 1.96% in the fourth quarter of 2022 and we’ve seen that number decline with our third quarter this year being at 1.42% on an operating basis, so a lot of improvement there. Total noninterest expenses for the quarter were $20,881,000 and $20,661,000, excluding some final severance expenses from our reduction in force portion initiative.

We still feel comfortable with our expected run rate around $20.25 million [ph] and remain focused on managing expenses to align with our strategy in the current environment. Provision expense totaled $1 million for the quarter. Net loan charge-offs were $898,000, which is up from $200,000 in the prior quarter. On last quarter’s call, we mentioned the possibility of seeing some charge-offs from SBA loans and these charge-offs were on the non-government guaranteed portion of a limited number of loans and that totaled a net of $714,000. Non-performing loans decreased quarter-over-quarter by about 17% and we still feel good about the overall credit quality in the portfolio. Total loans increased about $25.1 million, which is less than the previous quarter as we continue to see slowdown and overall growth there.

As we previously mentioned, a lot of the growth came from the consumer loans and the Marine/RV division. We expect overall loan growth to continue to slow over the next few quarters. Total deposits decreased $36 million during the quarter. This is related to the seasonality of a small portion of our deposits, particularly the municipal and government deposits, as well as some agricultural type deposits, as Heath mentioned earlier. And, historically, looking back, especially, pre-COVID, we see a small dip in the third quarter as these muni-deposits and ag-deposits kind of run off. But then, see increases in the fourth quarter as property tax payments come in and as crops are sold by some of our rural agricultural type deposits. Our FHLB borrowings increased $30 million during the quarter, and this was really towards the end of the quarter.

A real estate investment banker sitting in a plush office, reviewing financials and papers.

This was a short-term advance, and we expect this to be repaid as we see those municipal funds come in during the fourth quarter. Taking a look at the margin, we’ve seen some stability that has kept our increases and liability costs more aligned with our earning asset increases. This led to margin essentially being flat quarter-over-quarter. I don’t think we’re necessarily out of the woods yet, and we remain disciplined on pricing any new loans or renewals, renewals relative to our current funding costs and the expectation of any increases in those cost of funds going forward. There’s still many factors that could cause margin to decline a little more before we see it start to increase. Overall, liquidity remains robust, and we outlined the various sources of liquidity on Slide 15 in the presentation.

We have over $1.3 billion in total liquidity and liquidity sources available. 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 funds line. With investments, we haven’t seen a lot of activity in the securities portfolio throughout the year. We deployed the cash flow elsewhere on the balance sheet and primarily to fund our loan growth. We continue to evaluate the portfolio and market conditions to assess the possibility of some restructuring there in the securities portfolio and then redeploying some of those proceeds. These funds could be redeployed to achieve a better position from both an earnings and ALM perspective. And some of the important factors that we consider a look at as part of just evaluating any type of restructure in a securities portfolio, really the market conditions are earned back under a couple of years.

No loss then, it’s greater than a portion of our quarterly earnings as to not erode capital, and then understanding the best use of those proceeds. One last comment about taxes for the quarter, there was low increase in our tax rate from the prior quarters. We’ve been close to 18% to 19% EPR and that moved up to around 22% for Q3. This is a result of increased TEFRA disallowance related to our tax free municipals, which is driven by an increase in our overall cost of funds. So going forward, we expect a range of about 20% to 22% on that as we see that increased slightly just related to that that TEFRA disallowance. And now, I will turn it over to D to discuss our banking and business lines.

Dallis Copeland: Thanks, Derek. First, I want to touch on a few things on the banking side of the house. Heath and Derek mentioned, we are seeing loan growth slowed. We expect that to continue over the next several quarters. We really are seeing very little volume at all on the commercial real estate side, really that’s more of a result of the pricing in today’s market to maintain – to make sure that we can maintain the proper margin, as well as there’s just a generally slowing demand with the increase in borrowing costs in the marketplace. We have not really changed any of our underwriting standards there. We’ve made pretty consistent throughout the cycle. So, I guess, my point there would end up being it’s not a credit driven slowdown, it’s really more of an environment and pricing slowdown.

The loan growth we are seeing is coming from RV and Marine, as Heath and Derek, both mentioned. And as well, the funding up of consumer residential construction loans as those houses are continuing to be built. We have implemented a number of efforts to see our fee income increase, some on the consumer side, as well as some fees on the treasury side as well for the business customers. We did see some of that benefit this quarter, but we would expect to see a greater benefit during the first – fourth quarter and going forward. So, I think that should be a positive for us going forward. We are having success in winning new business on the treasury side. We’ve actually reduced the overall team through part of our expense initiatives, but we have been able to add back a couple of strong producers that have come from larger and more regional banks that have strong relationships and are giving us opportunities to get in front of some really good significant customers.

Our bankers are also focused on deepening the relationships and this has helped us as you have seen and I’ll talk a little bit more on that on Slide 7, but it’s helped us drive more revenue with merchant service business and also with our insurance businesses. And, in addition to that our branches have made a lot of progress in the referral and sales activity, which we are very proud of. Our bankers are also focused on staying in touch with our loan customers. We’re reviewing the business performance of all of our major relationships and proactively addressing any witnesses that we see, but as Heath stated earlier, we still feel confident about where we stand from the overall credit on our loan portfolio. As you can see on Slide 7, we have continued to focus on getting our start-up lines profitable, RV/Marine with the growth there has reached profitability this quarter.

Our merchant team is very close and is continuing to make progress there monthly as we have great additions to new customers on a daily and weekly basis so that trajectory looks good going forward. In addition, the Alabama team is making great progress on the environment, where the growth has been more limited. Profitability there is either going to be driven through increasing loans deposits, of course, or as we continue to manage expenses diligently for the overall company. If you look at the height of that investment, we have improved $500,000 on a quarterly improvement or $2 million on an annualized basis from the height of our investment in these start-ups. We expect to see continued progress to the performance on all of these business loans.

I do want to take a minute and touch on mortgage and SBSL. First, from an operational perspective on mortgage, we continue to focus on breakeven during this environment. As Derek touched on earlier, we did have a small loss for the quarter, but we are actively adjusting staffing levels to be in line with current demand. We’ve also changed several of our product offerings and removed a few as we continually evaluate what works in today’s environment with the elevated interest rates for both our customers and for the bank. Pricing is important. Our focus mainly today is on the secondary market and the prices – making sure we are pricing loans that can be sold to the secondary market. We’re pretty much eliminated the portfolio products and the construction firm product at this point with the exception of very strong customer relationships where we need to take care of those long-term Colony customers.

We think mortgage is important to our long-term success as a community bank, so we are committed to it. We are just very actively managing it in today’s environment to make sure there’s not an overall drag on performance. Our SBSL division, we’re working on building and implementing a system for the smaller $1 7[a] loans. I hope is that that should be in place during the fourth quarter and we’ll be able to see some positives in the fourth quarter, but really starting into the first quarter of next year we will see some good revenue generation from that. We have seen slowing from the larger loan demand, as you can imagine, with the floating rates that go with the SBSL portfolio, it has slowed demand. So that is part of our moving focus to those smaller 7[a] loans as well.

We did see, as we stated earlier, a decrease in classified and criticized loans from the prior quarter in SBSL, and we had a decrease in non-performing loans from the prior quarter as well. And as we talked about earlier from the charge-off standpoint in SBSL, it was from a few smaller loans that we had talked about last quarter. So, I think the good improvement there from a quarter-over-quarter of what we are seeing coming negatively into the pipeline. So I’ll stop there and hand it back over to Heath.

Heath Fountain: Thanks, D. I appreciate those comments. That really wraps up our prepared remarks. And with that, we’ll call on Sergio to open the lineup for questions.

Operator: Thank you. Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions] Your first question comes from Feddie Strickland from Janney Montgomery Scott. Please go ahead.

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Q&A Session

Feddie Strickland: Hey, good morning, gentlemen.

Heath Fountain: Good morning.

Derek Shelnutt: Good morning, Feddie.

Feddie Strickland: Just wanted to start with the incremental cost of raising new deposits today. What are new deposits coming on at and how much variation do you see among different parts of your footprint?

Heath Fountain: Yeah, that’s a good question. I think it’s changed over the course of the quarter. I think the beginning of the quarter, we were seeing a little bit less pressure on deposits and a little less competitive compared to the prior quarter. But as we got towards the end of the quarter, and I would say into the environment we’re in today, it’s moved probably from needing to be in the high-4s to bring in new business to in the low-5s to bring in new business on the deposit side. So we have seen that move up a little bit towards the end of the quarter, but that’s sort of the area we’re at to bring in new money.

Feddie Strickland: Understood. And along those same lines as we appear to be near the end of the hiking cycle potentially, how are you thinking about cycle-to-date total deposit betas? I think I pegged that around 29% today. Could we see that rise into the mid-30s just as there’s a little bit of catchable on deposits or do you think you’re more or less near the peak on deposit costs?

Heath Fountain: No, I think we’re going to see that continue to rise. I mean, the unknown there, right, is what we may or may not see the Fed continuing to do. Assuming, we level out into this higher for longer, somewhere around now, I think that we could see rates stabilize, but if we get increases, we’re going to see that continue to move up some. So it’s pretty hard to predict. But, I guess, as we look at the beta, when we look towards the end of the quarter, we’re up to the high-30s cycle-to-date. And so, I think, we will see that creep up a little more, if rates stabilize, just the catch up of getting rates to where they need to be.

Feddie Strickland: That makes sense. Switching gears, Heath, I know you talked about expense initiatives, some technology investments to hires, and you had some good information on the deck and it seems like there’s some near-term expenses should stay flat or maybe come down a little bit, we’ll just see. But can you talk about longer-term over the course of 2024, what we should expect in terms of an expense growth rate for the year? Should we look at something low-single-digits, mid-single-digits, just trying to think about net-net how much we see expenses potentially rise over the course of the year?

Heath Fountain: Yeah. Sure. And so, obviously, expense management is really on our radar, the biggest piece there being the headcount piece of that and we’ve seen good progress there. As we go into next year in our budgeting and our discussions, we’ve talked a lot about, we got to manage the inflation costs on our current team that we have in place relative to overall expenses and find ways to continue to improve that and manage that. I think, you’ll see you know expenses flatten out, and then we’ll look to continue to maintain a – when they start going back up, because they will at some point, right? You’ll see a low-single-digit type increases, except if we have the opportunity to generate revenue, and so we’re really focused on that net, noninterest expense to average assets, which Derek mentioned that we drove down from.