Colony Bankcorp, Inc.

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 -and-answer session. If at any time during this call you require immediate assistance, please press star zero for the operator. This call is being recorded on Thursday, July 27, 2023. I would now like to turn the conference over to Mr. Derek Schnald, Chief Financial Officer. Please go ahead.

Thanks, Eleanor. 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 prospective investors are cautioned that any such forward-looking statements are not guarantees of future performance but involve known and unknown risk 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 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 to pivot and their priorities have changed over the last few quarters. I'm 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 want to hand it over to Derek, who will provide more detail on our earnings and balance sheet, and then to Dee 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 reduction 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 improve this quarter, and D will provide a more update on that. Long growth slowed this quarter to 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 experience the -over-quarter decline in margin. Our overall cost of funds is still outpacing the growth and 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 relieve 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 half a million dollars. Of course, those increases were offset by increases in non-interest income for those lines of business. We're particularly proud of how we've improved non-interest income and lowered our recurring non-interest 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 .96% in this quarter a year ago to .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 buy back 41,000 shares under our authorized stock repurchase plan. We continue to 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 the limited amounts 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 a 1% ROA. We had initially hoped to be there by the end of this year, but given the continued rate increases, we

now project that it will be during 2024, assuming current road forecasts hold out. Lastly, if you're all aware, last month we announced that Derek Jelma, the same CFO at the Collin Bank, Derek has expressed the background of banking and he's quickly moved up the ladder in our organization over the last few years. We're excited about getting to move Derek into this role and we look forward to seeing him continue to recruit his active role in the organization. So now we'll turn it over to Derek and let him go through the financials in more detail. Thank you. To start, I talked about our deposit growth in the second quarter. Slide 19

of our investor presentation provides detail on our growth in the deposits in the second quarter. Total deposits increased a little over $111 million. And while a portion of that growth was on broker deposits, $86 million of that was our customer deposit and it was spread throughout our footprint. Our deposit growth was primarily in interest bearing accounts and we are still seeing some shifting from DDA to interest bearing, you know, 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 take a look at our uninsured and adjusted uninsured deposits. They remained relatively flat quarter over quarter and that's indicated on slides. 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 Fed's bank term funding program. Total FHLB advances declined $10 million during the quarter, which reduced our overall level of debt funding. We're moving on to 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 our portfolio is agency or government guaranteed, with the biggest portion of the portfolio being high quality municipal securities. We haven't seen any ratings downgrades or credit issues with our munis that will cause any concerns at this point. 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 29 cents last quarter to 30 cents this quarter. On an operating basis, EPS was up to 33 cents this quarter compared to 31 cents 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 about 57 basis points, which led to margin decline of 30 basis points to .77% for the quarter. Provision expense was $200,000 for the quarter, and under Cecil, 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, and that balance on those unfunded loan commitments has decreased. And as some of those are funded, they kind of shift over to funded loans. And so what we've seen also is some kind of reclass 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 re- we didn't have to reprovision for those funded loans that had already been provisioned for. We did see an increase in non-performing assets of about $4.1 million in the quarter. Of this, 2.3 was related to the repurchase of the guaranteed 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 is 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 is 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 remains 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, you know, 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 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 half a million dollars in the second quarter, but T's point earlier, that was offset by the increase in non-interest income. We did have one-time 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 annual cost savings of about $2.5 million going forward. Net non-interest expense to assets was .65% in the second quarter, which is down 21 basis points from .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 managed that alongside our commitment to invest in areas that add value over the long term. And with that, I'd like to hand it over to Dee 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 the 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 asset loans is 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 two-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 -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. Talk a little bit about the complementary lines of business. Production in our SPSL group increased in the second quarter, as you can see indicated in slide 8 of the presentation. We're pleased with that performance in this 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 for the future as those are completed and we're able to sell the guaranteed portion in the future. Mortgage, slide 9 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 7, it provides details on some of the startup lines of business. First, I'll touch on Alabama. We still have a lot of opportunity in our Alabama market. Our team's doing well over there. We had 8% growth, and we, from a loan standpoint, we're just over $44 million there. We continue to move towards profitability as we grow those loans. The pipeline is still strong, but I did want to touch base it as part of our efficiency efforts. We have decided to pull back in Alabama on the lending team and focus primarily on burning ham as opposed to Birmingham 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 the loans for Marine and RV. Marine RV, we are glad to say turned 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 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 continue to grow as a solid profitability in that business line. With that, I'll turn it back over to Heath.

Thanks, Dee. That wraps up our comments. With that, I'll call on Hilda to open up the line for any questions that we have.

Thank you. We will now begin the question and answer session. If you have a question, please press star and then one using your touchtone phone. You will hear a three-tone prompt acknowledging your request. Questions will be taken in the order received. Should you wish to withdraw from the question queue, please press the star followed by the number two. If you are using a speaker phone, please lift the handset first before pressing any keys. One moment while we gather the questions. We have a question from David Bishop from Hoppy Group. Please go ahead.

Good morning, gentlemen. Good morning. A question just in regards to deposit flows this quarter. Heath and Derek obviously saw the margin and took it on the chin again. It looks like there was a pretty significant back end flow of noninterest bearing deposits. Your average was sitting right around 500 million for the quarter. You ended up a few million dollars. Anything happening in the back end of the quarter that drove that success and new account wins? 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 now that Derek or Dave had further comments, but we do historically see that quarter, you know, 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 saw a 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 any further things y'all want

to add to that. Yeah, I mean, that's pretty much a good look on what we saw as far as flows in the quarter. I think we're still going to continue to see some mixed changes from interest bearing to noninterest. So it depends on where this rate environment ends up. But, you know, 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 2020 last year.

And I assume that sort of stat was parked at end of period cash. You know, that was a little bit elevated. Maybe how we should think that being deployed here into loads, I would assume, or maybe pay down some of the costs. I'm 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 on a higher level of liquidity. I think, you know, 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, you know, earlier in the quarter following, you know, 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, you know, our rate specials and things were going there during the quarter. And I think, you know, we would look to just see where best to deploy that. I think, as we've mentioned in the call, you know, the expectations are to have that loan demand continues to go down both from, you know, our rate hurdles causing, you know, customers to not want to meet that and just from the demand from the customer. So it can be a combination of all those things.

Got it. And then I guess, you know, structurally just from the loan portfolio, you know, you tend to skew a little bit longer data with the CRE portfolio. Maybe your view of just loan repricing potential in terms of embedded, you know, yield pickup in the CRE portfolio over the next year or two or so, assuming the Fed stops, you know, raising rates here and deposit costs sort of stabilize. I would think you'd still see some tailwind to the earning asset yields as some of these CRE loans repriced 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. And so, you know, we should see that more and more, you know, as we go forward to continue to get 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, you know, in the next couple of quarters and definitely into next year.

I'm curious what you're seeing in terms of new loan origination yields, but 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 seven and a half 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. So I think we continue to see that move up and our pricing where we are today will be higher than that.

Got it. And then, Keith, I thought I heard you say you guys remain comfortable with expense expectations running at around 20 million dollars. Is that starting in the third quarter? I think previous guys was by the fourth quarter, but I hear you maybe move it up into the starting this quarter.

Yeah. So we had our expense reductions took place towards the end of the first quarter, I mean, 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 dollar mark as we go forward.

Thanks, I'll hop back into the queue.

Thank you. Our next question comes from Christopher Myronack from Jenny 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 what 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, you know, 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, you know, significant declines in interest rates for those swaps to kind of reverse, if you will, from their initial positive carry. And, you know, if that were to happen, then there would 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. And then I had a question for Dee about sort of the gain on sale in the SBA channel overall. Did those possibly get better as we look prospectively the next year?

You

know, the SBA, it's been all over the place in the first half of the year, anywhere from eight 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 the 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 about 10%.

Gotcha. Okay, great. That's helpful. Thank you for that. And then for Heath, or really, Derek, 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 and 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, you know, 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 have 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. And we've seen that this has lasted as the rates have kept going up. So, you know, we feel good about it. I think this past quarter, you know, 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, you know, 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, you know, 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 accounts. But certainly the heightened environment has gotten the customer base, you know, our average balances are lower or low. But even then, you know, we got a lot of customers that have decided to make the move of excess cash over to interest-varying, which makes sense in this environment.

Gotcha. OK, great. Thank you for all that background. And just the 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 is just sort of what has to happen for any sort of downgrades just, you know, within your risk rate system on those loans?

We really don't have a lot that's come in due. The other part is a large chunk of ours, as you'll see, and there's 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 that have 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. As a reminder, should you have a question, please press star followed by the one on your touchstone phone. As a reminder, if you have any questions, please press star one on your touchstone phone. There are no further questions at this time. Please proceed with closing remarks.

Well, thanks again to everybody for your support of Colony Bancorp. 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.