Good morning, ladies and gentlemen and welcome to the Colony Bank Second Quarter 2023 Conference Call. At this time, all lines are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. [Operator Instructions] This call is being recorded on Thursday, July 27, 2023.

I would now like to turn the conference over to Mr. Derek Shelnutt, Chief Financial Officer. Please go ahead..

Thanks Helena. Before we get started, I would like to go to our standard disclosures. Certain statements we make on this call could be constituted as forward-looking statements within the meaning of the Securities Act of 1933 and the Securities Exchange Act of 1934.

Current and prospective investors are cautioned that any such forward-looking statements are not guarantees of future performance but involve known and unknown risks and uncertainties.

Factors that could cause these differences include, but are not limited to, pandemic variations of the company's assets, businesses, cash flows, financial conditions, prospects and other results of operations.

I would also like to add that during our call today, we will reference both our earnings release and our quarterly investor presentation, both of which were filed yesterday, so please have those available to reference. And with that, I will turn the call over to our Chief Executive Officer, Heath Fountain..

Thanks Derek, and I want to thank everyone for being on the call today. We're pleased with our results in the second quarter during some really unusual times.

First and foremost, I want to thank all our Colony team members who have really had a pivot as our priorities have changed over the last few quarters and really proud of how the team has been able to do that, and that gives me a lot of confidence in how we're going to be able to execute on our strategic objectives as we move forward.

We were able to increase earnings and grow core deposits in a time where the economic environment presents many challenges. I'm going to briefly highlight some of our accomplishments and initiatives during the quarter, and then I'm going to hand it over to Derek, who will provide more detail on our earnings and balance sheet.

And then D Copeland, our President, who will provide an update on our banking and complementary lines of business.

During the quarter, we saw an increase in overall deposits with strong growth in our core deposits as we focused on building customer relationships and ensuring strong liquidity following the bank failures that happened at the end of the first quarter. Our outlook on our deposit pipeline remains positive with a lot of opportunity ahead of us.

From an earnings perspective, earnings increased quarter-over-quarter as a result of increased non-interest income, driven primarily by strong mortgage demand in the busy home buying season. Our government guaranteed lending pipeline remains steady and our Marine/RV lending has increased, which will drive profitability in that line of business.

We look forward to being able to increase non-interest income as we move throughout the rest of this year. This quarter, we did have one-time severance expenses related to production initiatives as we continue to evaluate and adjust costs based on our growth outlook.

We expect the outcome of this initiative to reduce our salary and benefit expenses going forward and we remain dedicated to our long-term investment in areas we believe will provide the most value for our customers and other stakeholders in the future.

We don't expect these staffing changes to adjust our ability to grow, and we expect them to still be able to enhance our operations in the future. We are committed to enhancing the profitability of mortgage in our other complementary lines of business and we saw those areas improved this quarter. And D will provide a more update on that.

Loan growth slowed this quarter and it's about 9%. It's higher than what we expected, but lower than what we have been seeing in the last few quarters. We continue to see lower demand in this interest rate environment and expect our growth to slow further throughout the rest of the year.

Margin pressure continues as we experienced a quarter-over-quarter decline in margin. Our overall cost of funds is still outpacing the growth in yield of our earning assets. We remain cognizant of that pressure on our funding costs.

And we've implemented some hedging and other strategies during the quarter to release some of that pressure and Derek will give you more detail on those. Non-interest expenses were up a little under $300,000 this quarter.

However, one-time severance expenses were $200,000 more than last quarter and variable compensation expenses from our non-interest income lines of business increased $0.5 million. Of course, those increases were offset by increases in noninterest income for those lines of business.

We're particularly proud of how we've improved non-interest income and lowered our recurring noninterest expense base.

Given our many fee income businesses, we like to measure our efficiency as our net non-interest expense to average assets, and on an operating basis, we've improved that from 1.96% in this quarter a year ago to 1.58% this quarter, and we expect to continue to improve our efficiency as measured by this ratio.

Asset quality is still strong, even though we saw a slight increase in non-performing loans for the quarter, primarily a little bit in our residential and a lot in our SBA portfolio. Non-performing CRE loans remain at very low levels and we haven't seen anything in these areas that give us a lot of concern in these portfolios.

We did also this quarter buyback 41,000 shares under our authorized stock repurchase plan. We continue prudent capital management and are committed to building capital levels.

However, given the market reaction to some of the events in the banking industry, we felt like a limited amount of buybacks at attractive pricing levels were a prudent use of capital. Given the continued pressure on margin, we are projecting that it will take us longer to achieve our short-term objective of getting to the 1% ROA.

We had initially hoped to be there by the end of this year, but given the continued rate increases [Technical Difficulty]. Now, we'll turn it on to Derek, who'll go through financials in more detail..

Thanks Heath. To start [Technical Difficulty] footprint. Our deposit growth was primarily in interest bearing accounts and we are still seeing some shifting from DDA to interest bearing MMA, or money market accounts, and CDs. However, we did manage to grow non-interest bearing deposits by about $3 million quarter-over-quarter.

And then taking a look at our uninsured and adjusted uninsured deposits, they remained relatively flat quarter-over-quarter, and that's indicated on slide 21 in the investor presentation.

In terms of liquidity, we continue to maintain a strong position with access to various sources of liquidity, and that's outlined on slide 15 in the investor presentation. During the quarter, cash increased over $72 million to a total of $155 million, which represents roughly 5% of assets.

We did not have any outstanding overnight borrowings at the end of the quarter, nor have we used the banks -- the Feds Bank Term Funding Program. Total FHLB advances declined $10 million during the quarter, which reduced our overall level of debt funding. Moving onto take a look at our AOCI.

We went from about $60 million at the end of the previous quarter to just under $63 million at the end of this quarter, which is a little bit of an increase that's primarily driven by the move in interest rates that we've seen over that time period. Slide 25 gives an overview of our investment portfolio composition.

We aren't seeing any credit concerns in the investment portfolio at this time. Over half of our portfolio is agency or government guaranteed with the biggest portion of the portfolio being high quality municipal securities. We haven't seen any rating downgrades or credit issues with our munis that would cause any concerns at this point.

And our private label mortgage-backed securities and our corporate, which includes some bank sub debt are still performing well from a credit perspective. From an earnings perspective, we saw an increase of EPS from $0.29 last quarter to $0.30 this quarter.

On an operating basis, EPS was up to $0.33 this quarter compared to $0.31 in the previous quarter. Non-interest income was up about $1.3 million from the prior quarter, with most of that increase coming from our mortgage division.

Earning asset yields increased 20 basis points to 4.43%, but interest bearing liabilities increased by 57 basis points, which led to margin decline of 30 basis points to 2.7% for the quarter.

Provision expense was $200,000 for the quarter and under CECL, expected credit losses on unfunded commitments are recognized when the commitment is made and those expected losses, they sit on the balance sheet as a liability.

And so, our loan commitment activity quarter-over-quarter has slowed in that balance on those unfunded loan commitments has decreased. And as some of those are funded, it kind of shifted over to funded loans. And so, what we've seen also is some kind of re-class from what was provisioned in the previous time periods for those unfunded commitments.

And as those loans are funded, that kind of moves over to the allowance account. So that's a -- we didn't have to re-provision for those funded loans that had already been provisioned for. We did see an increase in nonperforming assets of about $4.1 million in the quarter.

Of this, $2.3 million was related to the repurchase of the guarantee portion of non-performing SBA loans, which will be ultimately repaid by the SBA. And then I'd like to take a moment to talk more about the margin and what we're seeing and kind of what we expect going forward.

The decline in margin was primarily due to the increase in the cost of our interest bearing liabilities exceeding the increase that we're seeing in our earning asset yields. The increase in interest bearing liabilities is primarily deposit cost and it's driven by higher rates in the market with stronger competition for deposits.

So, what we've done is on the funding side, we have extended a portion of our FHLB advances out longer to take advantage of the curve and that should help with some of the short-term sensitivity that we're seeing in funding costs. And then also, we've hedged a portion of our short-term borrowings by entering into some interest rate swaps.

These swaps were near the end of the quarter, so we expect that benefit starting in the third quarter, and we should see savings on that interest expense of approximately $500,000 a year due to the initial positive carry on those swaps. At the end of the quarter, our cost of interest bearing deposits was close to 1.88%.

But we've seen that increase starting to slow down from earlier in the quarter. Competition for deposits remained elevated, but there is some slowing down in our markets that we're starting to see.

We feel like this is going to help provide some stability and ultimately kind of slow that outpacing difference between our liabilities and our earning assets. Our current assumptions indicate we should see margin at this level or maybe slightly lower over the next couple of quarters, and then start to move up from there.

Continued deposit mix changes may drive the margin down some more, but we expect those mix changes to be less or slow down from what we've seen in the first half of the year.

On non-interest expenses, non-interest expenses were up about $267,000 from the first quarter, variable commission based compensation expenses for our non-interest income lines of business increased about $0.5 million in the second quarter. But to T's point earlier, that was offset by the increase in non-interest income.

We did have net severance expenses in the quarter of $635,000, which was up a little over $200,000 from the previous quarter. These severance expenses were related to a reduction in force that occurred during the second quarter.

This initiative led to the reduction of 23 full-time employees and is expected to have an annual cost savings of about $2.5 million going forward. Net non-interest expense to assets was 165 -- 1.65% in the second quarter, which is down 21 basis points from 1.86% in the first quarter. On an operating basis, the second quarter net NIE was 1.58%.

Our expected run rate on non-interest expenses going forward is around or slightly under $20 million per quarter and we continued our disciplined approach to expenses and manage that alongside our commitment to invest in areas that add value over the long-term. And with that, I think I hand it over to D to talk more about those business lines..

Thanks Derek. On the commercial side of the bank, as Heath mentioned, we did grow loans about 9% at an annualized rate. That is lower than we had been, but probably a little higher than we would see on the forecast going forward. That slowdown in growth is expected to continue throughout the remainder of the year.

Page 14 in our earnings release details our loan growth by each of the markets. So, feel free to look at that. We still have solid asset quality, particularly in the commercial real estate portfolio, where the level of non-performing assets loans are still very low.

Slide 22 in the investor presentation gives a breakdown of our loan portfolio, and slide 24 gives further details on our office portfolio, which we believe is very conservative. We feel comfortable with our office portfolio, and we aren't seeing any signs of credit concerns there.

It is of note that we do not have any high rise office buildings and the majority of buyers are one or one or 2 story buildings. So, we feel good about that portfolio. Deposits, as mentioned, quarter-over-quarter grew 4.4%, 77% of that growth was in core deposits. As Derek mentioned, our non-interest bearing deposits were slightly up for the quarter.

On slide 19, you can see our growth in deposits. Our referrals and our deposit pipeline are both strong. So, we expect to see continued growth in deposits and in new customer relationships. I'll talk a little bit about the complementary lines of business. Production in our SBSL group increased in the second quarter.

As you can see, indicated in slide eight of the presentation. So, we're pleased with that performance in the rate environment, and they continue to remain profitable.

I think one thing to note is in that production, we do see a larger portion of that production being in construction, which ends up being a positive as we're able to -- for the future as those are completed, and we're able to sell the guaranteed portion in the future.

Mortgage, slide nine shows our mortgage production for the quarter, which was up about $44 million from the first quarter. Mortgage was profitable in the second quarter. And as we always like to see, we had more secondary market mix relative to the previous quarters, which was a positive.

On slide seven, it provides details on some of the start-up lines of business. First, I'll touch on Alabama. We still have a lot of opportunity in our Alabama market. Our team is doing well over there. We had 8% growth, and we -- from a loan standpoint, we are just over $44 million there. We continue to move towards profitability as we grow those loans.

The pipeline is still strong. And -- but I did want to touch base that as part of our efficiency efforts, we have decided to pull back in Alabama on the lending team and focus primarily on Birmingham as opposed to burning him and Huntsville.

By doing this, it will allow us to be profitable more quickly in Alabama, but still provides us great growth opportunities in this environment and in the future. RV and Marine, was a very solid quarter. For the RV and Marine Group as we entered into the spring of the buying season, loans grew $15 million for the quarter.

There's still a lot of demand in this space. Page 14 in the earnings release shows a breakdown of volumes for Marine and RV. Marine/RV, we are glad to say turn profitable at the end of the quarter and we expect to see this profitability on a go-forward basis. The other one I'll touch on would be merchant services.

We can continue to see improvement in merchant services. We see a lot of referral -- internal referrals from the group. Our processing volume continues to grow every month.

We expect to see that continue, and we would expect to see that be profitable during the second half of the year and then continuing to grow as a solid profitability in that business line. With that, I'll turn it back over to Heath..

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

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

Good morning, gentlemen..

Good morning, Dave..

A question just in regards to deposit flows this quarter and Heath and Derek, obviously, you saw the margin took it on the chin again. But it looks like there's a pretty significant back end flow of non-interest bearing deposits. Your average is sitting, I think, right around $500 million for the quarter, but you ended up a few million dollars.

Is anything happening in maybe the back end of the quarter that drove that success in new account wins? And should that -- I would think that would act as maybe a tailwind to the margin in the third quarter and next..

Yeah. Dave, one thing to note, and I'll let Derek or D further comments. But we do historically see that quarter, the second quarter as a quarter where we have a lot of tax outflows in terms of tax payments. And so, we saw a lot of that early in the quarter.

And so, rebuilding of that, I think, both from just our calling efforts, but also just customers rebuilding balances during the quarter. I don't know if there's anything further thing, gentlemen add to that..

Yeah. I mean that's pretty much a good look on kind of what we saw as far as flows in the quarter. I think we're still going to continue to see some mix changes from interest bearing to non-interest. So, it depends on what this -- where this rate environment ends up.

But most of what we saw during the quarter was those tax outflows at the beginning and then some of that rebuilding towards the end..

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

And I assume that sort of stat was -- and it was parked as end of period cash, that was a little bit elevated, maybe how we should think that being deployed here into loans, I would assume or maybe paydown [indiscernible]. Just curious how you're thinking of using the excess cash..

Yeah. I think, and Derek can comment more on this. But we clearly are at higher level of liquidity. I think we don't have any real concerns about liquidity. And so, as you saw, we paid down some home loan bank advances during the quarter.

I think during -- earlier in the quarter, following the bank failures and the liquidity runs that were happening in the industry, we were certainly probably focused on liquidity first and profitability of the customer relationship second.

And so, I think we are a lot more willing to let deposits walk out if the rates don't meet our hurdles at this point than we were earlier. So, we have been able to move deposit pricing down on CDs, our rate specials and things that go there during the quarter. And I think we would look to just see where best to deploy that.

I think as we've mentioned in the call, the expectations are to have that loan demand continues to go down, both from our rate hurdles causing customers to not want to need that and just in the demand from the customer. So, it can be a combination of all those things, Dave..

Got it. And then, I guess, structurally just from the loan portfolio, you tend to skew a little bit longer dated with the CRE portfolio.

Maybe your view of just loan re-pricing potential in terms of embedded yield pickup in the CRE portfolio over the next year or two or so, assuming the Fed stops raising rates here and deposit costs sort of stabilize, I would think you'd still see some tailwind to the earning asset yields in some of these CRE loans re-priced up into a higher yielding market..

Yeah. I mean, we certainly have seen and will continue to see tick ups there. Our total portfolio weighted average life of our loan portfolio is just under four years with just under three-year duration. So, we should see that more and more as we go forward to continue getting momentum from the loan portfolio.

So, it's just taking longer than the deposit side. So, as liability prices stabilize and don't move up as much, we should see earning assets start to outpace that. At some point, we think in the next couple of quarters and definitely into next year..

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

Yeah. So, we're seeing, obviously, each quarter a little better. I think our weighted average this quarter was about 7.5% of our weighted average rate of production for the quarter. So, we're continuing to see that move up. And of course, it's higher at the end of the quarter than it was at the beginning.

And so, I think we continue to see that move up and our pricing where we are today would be higher than that..

Got it. And then, Heath, I thought I heard you say you guys remain comfortable with expense expectations running at around $20 million.

Is that starting in the third quarter? I think previous guidance was by the fourth quarter, but I hear you maybe move it up until the -- starting this quarter?.

Yeah. So, the -- we had our expense reductions took place towards the end of the first quarter -- I mean, in the second quarter. So, we didn't have a full run rate of some of the expense reduction activities, which we should have in Q3 and forward.

I will say the only caveat to that would be -- if we continue to experience really good mortgage and SPSL production. We have variable compensation to place into that that could be the kicker to move it up, and we'd be happy if that were the case, but we should be right around that $20 million mark as we go-forward..

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

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

Hey, thanks. Good morning. Just want to go back to the swap that Heath and Derek mentioned.

Can you just walk us through the mechanics of that? And I guess my scenario I'm trying to explain is, if interest rates were to modestly fall, how does that play out for you?.

Yeah. Sure. So, we entered into two different swaps of different terms. And so, there's initial positive carry on those. It's about 100 basis points blended between the two. So, a modest fall in rates would still keep us in good position with those swaps.

It would take significant declines in interest rates for these swaps to kind of reverse, if you will, from their initial positive carry. And if that will happen, there will be other changes on the balance sheet that would kind of offset some of that.

So that's where we are on the swaps, and we see that as a benefit on those interest expense going forward..

Gotcha. Okay. And obviously, in the short-term, it benefits you a lot, as you just said so. And then I had a question for D about sort of the gain on sale in the SBA channel overall.

Did those possibly get better as we look prospectively the next year?.

Yes. It's been all over the place in the first half of the year, anywhere from 8 to a little bit over 10. It's been moving a good bit. I think as folks continue to have reductions in loan originations, I think there's an opportunity to do that. But I think it just depends on how much liquidity is in the market.

But I would say, at the end of the second quarter, we were seeing some of the best gain on sale numbers that we've seen for the first half of the year where a lot of those were touching just above 10%..

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

I just kind of wanted to get that on paper as we sort of start to pause the -- hopefully pause the cost of funds changes?.

Yeah. I mean, we have historically had very good long 10-ish-year relationships in our deposit portfolio. We see continued growth in deposit accounts. We think that we have done a good job, at the same time we certainly had to adjust rates up.

And we're starting to see, I think, rates at a level where we will be getting a lot closer to competitive rates on the deposit side just with our core ongoing business as this has lasted as the rates have kept going up. So, we feel good about it.

I think this past quarter, we were very focused on ensuring that if the marketplace liquidity was tightening up as the bank failures last quarter indicated, we wanted to try to get out in front of that.

And so that drove, I think, our deposit costs up a little more than maybe they would have been in an environment where everybody wasn't going out searching for liquidity. Like I said, we've seen that pull back. And so, we're focused on taking care of our current customers and growing at the same time, but we've had great stability in our deposit base.

And I think you see that on our slide where we indicate our average balances, our total number of counts. But certainly, the heightened environment has that in the customer base. Our average balances are lower than -- are low.

But even then, we got a lot of customers that have decided to make the move of excess cash over the interest bearing, which makes sense in this environment..

Gotcha. Okay. Great. Thank you for all that background. And just a last question for whomever, is just about the office portfolio.

Do you have anything that's kind of coming due or maturing in the next 24 months and kind of related as to sort of what has to happen for any sort of downgrades just within your risk rate system on those loans?.

We really don't have a lot that's coming due. The other part is a large chunk of ours, as you'll see in the owner occupied, so it's really -- that's a big piece of it as well, and they're really small in nature.

So, I would just say from our standpoint, our office portfolio is small, the units themselves are small and there are not any really big projects in there that have a lot of risk in them..

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

Thanks Chris..

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

End of Q&A:.

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

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