Good morning, ladies and gentlemen, and welcome to Colony Bank third quarter 2023 conference call. At this time, all lines are in listen-only mode. Following the presentation, we will conduct a question-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 today, October 26, 2023. I will now like to turn the conference over to Derek Shelnutt, Chief Financial Officer. Please go ahead.
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 for future performance, but involve known and unknown risk 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.
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 began 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 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 continued 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 non-interest 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 non-interest income sources, especially with those that are less sensitive to the rate and 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 non-interest expense efforts.
The non-interest expenses declined $500,000 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, you know, 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'll 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 is 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-offs were up, primarily due to a few SBA loans from our SBSL division, where the portion of the loan that's not 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 in agriculture as we see the activity there. And we would generally expect both of those segments, you know, 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, it actually increased 1 basis point. The repricing of deposits has slowed, but the environment remains competitive, and, you know, 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 5-10 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.
Thanks, Heath. I'll begin with our earnings for the quarter. Net income increased about $502,000 quarter- over- quarter. When we compare to the prior quarter, we saw net interest income increase $440,000, non-interest income increased $766,000, and non-interest expense declined by $551,000. Interest income increased during the quarter as we remained 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 and 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 borrowings. 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, helped us both from the initial positive carry on the swaps and, you know, to 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 we'll discuss here in a minute when I talk about deposits and funding. With non-interest income, the increase in non-interest 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 non-interest 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 non-interest income from Colony Wealth Advisors increased $26,000, and merchant services income increased $10,000 during the quarter. All other non-interest 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 non-interest income remaining flat or even slightly down in some areas. With non-interest expense, we've been focused on operational efficiency and managing expenses throughout the year. The decline in non-interest expenses quarter-over-quarter is a result of those efforts.
Our net NIE to assets was 1.96% in the fourth quarter of 2022, and we've since 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 non-interest expenses for the quarter were $20,881,000 and $20,661,000, excluding some final severance expenses from our reduction in force initiative. We still feel comfortable with our expected run rate, around $20 million a quarter, 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. Nonperforming 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 in overall growth there. As we previously mentioned, a lot of the growth came from, the consumer loans in the Marine and 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. Historically, you know, looking back, especially pre, pre-COVID, we see a small dip in the third quarter, as these, muni deposits and, 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. 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 relative to our current funding costs and the expectation of any increases in those cost of funds going forward. There are 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 lines. With investments, we haven't seen a lot of activity in the securities portfolio throughout the year. We've 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 or look at as part of, you know, just evaluating any type of restructure in the securities portfolio, really the market conditions, a reasonable earn, earn back under a couple of years, no loss then, you know, that's greater than a portion of our quarterly earnings as to not erode capital, and then, you know, understanding the best use of those proceeds. One last comment about taxes for the quarter. There was a little increase in our tax rate from the prior quarters. We've been close to 18%-19% ETR, 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%-22% on that as we see that, you know, increase slightly just related to that, that TEFRA disallowance. And now I will turn it over to Dee to discuss our banking and business lines.
Thanks, Derek. First, I want to touch on a few things on the banking side of the house. As Heath and Derek mentioned, we are seeing loan growth slow. 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, and 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 remained 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, 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 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. 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 weaknesses 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 startup 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. The profitability there is either gonna 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 startups. We expect to see continued progress to the performance on all of these business lines. 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 break even 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've 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 it is not an overall drag on performance. Our SBSL division, we're working on building and implementing a system for the smaller dollar 7(a) loans. Our hope is that that should be in place during the fourth quarter, and we'll be, we will 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. As we talked about earlier, from a charge-off standpoint in SBSL, it was from a few smaller loans that we had talked about last quarter. So I think there was 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.
Thanks, Dave. Appreciate those comments. That really wraps up our prepared remarks, and with that, we'll call on, Sergio to open the line up for questions.
Thank you. Ladies and gentlemen, we will now begin the question and answer session. Should you have a question, please press star one. If you want to withdraw your question, please press star two. Your questions will be pulled in the order they are received. If you are using a speakerphone, please lift the handset before pressing any keys. One moment, please, for your first question. Your first question comes from Feddie Strickland from Janney Montgomery Scott. Please go ahead.
Hey, good morning, gentlemen.
Morning.
Morning, Freddy.
Just wanted to start with the incremental cost of raising new deposits today. You know, what are, what are new deposits coming on at, and how much variation do you see among different parts of your footprint?
Yeah, that's a good question. I think that's changed over the course of the quarter. I think, you know, 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, you know, needing to be in the high fours to bring in new business to in the low fives to bring in new business on the deposit side. So we have seen that move up a little bit, you know, towards the end of the quarter, but that's sort of the area we are at to bring in new money.
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 catch up on deposits? Or do you think you're more or less near the peak on deposit costs?
No, I think we're gonna see that continue to rise. I mean, the unknown there, right, is what we may or may not see the Fed continuing to do. You know, assuming we level out into this higher for longer, you know, somewhere around now, I think that we could see rates stabilize, but if we get increases, you know, we're gonna see that continue to move up some. So it's pretty hard to predict, but, you know, the, I guess, as we look at the beta, you know, when we look towards the end of the quarter, we're up to the high 30s, you know, cycle to date.
And so I think we will see that creep up a little more, you know, if rates stabilize, you know, just the catch up of getting rates to where they need to be.
That makes sense. Switching gears, Heath, I know you talked about expense initiatives, some technology investments, new hires, and, you know, you had some good information on the deck, and it, it seems like there's some, you know, near term, expenses should stay flat or maybe come down a little bit. We'll just see. But can you talk about, you know, longer term over the course of 2024, what we should expect in terms of an expense, you know, growth rate for the year? Should we look at something, you know, low single digits, you know, mid single digits? Just trying to think about net-net, how much we see, expenses potentially rise over the course of the year.
Yeah, sure. So, you know, obviously, expense management is, you know, really on our radar, the biggest piece there being, you know, the headcount piece of that, and we've seen good progress there. You know, as we go into next year in our budgeting and our discussions, you know, we've talked a lot about, you know, 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, you know, if we have the opportunity to generate revenue. So, you know, we're really focused on that net non-interest expense to average assets, which Derek mentioned, that we drove down from, you know, I think it actually, at one point, peaked a little over 2 to under, you know, to, like, 1.42 on an operating basis. So, you know, there are some moving pieces there, you know, that we have to consider, right? Like, on the mortgage side, you know, we, you know, that could improve as we, as we, you know, continue to adjust, you know, there.
But we'd also look to add, you know, on the, you know, on any other revenue generating lines of business we can, if we can get an immediate pickup to net NIE to assets. And so, you know, with our non-interest side, non-interest or complementary lines of business, you know, we-- those are gonna add non-interest expense, obviously, but, but, but improve that net NIE to assets. So on the expense side, I think, you know, it will start creeping up a little bit at some point next year, but I think we can continue to improve that net NIE to assets a little bit. And then, at some point, you know, we're gonna get to a place where mortgage will level off in the environment, and you could see that improve.
You know, it'll increase total expenses, but it'll help us improve that net NII to assets. So, that's where we're really focused on, that net NIE to assets. I hope that helps you kind of understand how we're thinking about it.
No, that, that's very helpful. Just one last question from me. As you look to slow loan growth, do you think over the course of 2024, you could potentially look at reducing the level of brokered over time and replace that with core deposits, maybe giving you a little bit of tailwind in the back of the year on some deposit costs, assuming we have a Fed pause?
Yeah, we definitely, you know, want to, you know, get work on that mixture. And so, you know, that's something, as we look at, you know, between loan growth slowing and the cash flow off the loan portfolio and off the investment portfolio, you know, opportunities to, to knock out some higher cost funding. You know, anything we do on the high end, we, we try to keep short as we can so that we can, you know, that, that we have opportunities to pay that off. I guess the, the, the other, you know, thing to, you know, to think about that, as, as Derek mentioned, you know, we continue to look for opportunities to restructure.
Obviously, with incremental borrowing costs where they are, you know, any kind of restructure that we could look at doing, you know, a likely candidate for the proceeds of that would be borrowing costs.
Understood. Thanks for the color, guys.
All right. Thank you, Teddy.
Thank you. Your next question comes from David Bishop from the Hovde Group. Please go ahead.
Yeah, thank you. Good morning, gentlemen.
Morning, Dave.
Morning, Dave.
Hey, Heath, Dee, Derek, just curious, I saw the slide deck in terms of some of the future initiatives to drive profitability. I know, on the long-term objectives, and maybe, maybe it's financial at this standpoint, but, you know, getting the five complementary lines of business to that $1 million in net income, is that gonna be a function of, just, you know, for some of these, just a volume to take advantage of scale in some of these segments? Just curious how, you know, how, what, what's the biggest driver to get you to... Or what has to happen to get to this $1 million dollar level?
Sure. So, you know, when you look at what we're doing on the merchant side, on the insurance side, on the wealth side, you know, those three lines of business are those are more dependent on the referral network from the bank, and those lines of business are, you know, what I would call infant stage, you know, at at Colony. We've only really, within the last quarter or two, you know, had the ability from our CRM and data perspective to get information out in front of our bankers, and going into the next few quarters, the ability to take that data and actually do proactive marketing with it. And so I mentioned, like, our our data warehouse and our API connection.
So the ability to take our internal data and be able to use that to cross-sell and to market to our current customers, is really been more on a manual basis than an automated basis, so we haven't even really scratched the surface of opportunity there. So you've got those three lines that are very, you know, very early on in their ability to produce income and aren't at those levels. And then, you know, with SBA, our SBSL group and mortgage, those are groups that we're producing income above those levels. You know, obviously, everybody knows about the challenges on the mortgage side. That will level out at some point, and we will be able to get, you know, there.
And then on the SBSL, as Dee mentioned, you know, we did pull back a little bit this quarter in profitability, but a lot of that was, you know, related to those charge-offs coming from the SBSL group. And so, you know, that's a group, you know, that should easily be over those levels, you know, consistently. So that's kind of the areas that we're focused on, and there's a lot of upside opportunity, you know, for those areas especially, that are dependent on the bank referrals. And we're just, like I said, just beginning to scratch the surface on the opportunity there.
Got it. That's great color. And then, Heath, maybe just, you know, from a holistic standpoint, you know, you mentioned the... and Dee mentioned the pullback in lending, you know, from a conservatism to just advance, not credit. Just curious, as you look out, do you think this environment is a sort of a low single digit growth, mid-single digit growth environment, as you sort of put on your forecasting hat?
Yeah. I think, you know, continuing to see slowdown but growth, you know, for the remainder of the year. And again, you know, obviously, as you're forecasting, you got to think about a lot of things out of our control with the Fed and the economy. But if kind of things outlook stays similar to now, you know, I could see it being flat or even maybe slightly negative into the first part of next year, from a loan perspective. So, you know, that's kind of where we think it'll go.
Got it. Then just, I know, Dee, you mentioned a little bit of a delay in terms of the launch of the Alabama LPO. Just curious, maybe what's driving that lag, just given that, you know, it's typically, you know, thought of as a pretty robust market. Is it just the market condition, interest rates? Just curious, maybe an update what you're seeing in terms of loans and deposits in that market.
Yeah, the Birmingham, if you really look at the profitability there, is gonna be driven, you know, through acquisition of deposits and through loan growth. You can imagine, in today's environment, it's not market driven, but in this environment, the loan growth is slow. I'd say the team over there has done a good job in bringing on, you know, C&I customers, wanting relationships that go with that. So pieces there, and it's been slowing because of the loans side and the investors as well.
Dee, you were cutting out a little bit, but I'll just add to that comment, Dave. I think, you know, when we started those initiatives, you know, the expectations were to grow loans faster than we have. I would again repeat what I said earlier: we really haven't changed our credit metrics, but our desire, you know, from a pricing perspective and a willingness to, you know, concede on pricing, is not there in this environment. And so, it just, you know, between that and between the customer side, you know, not as much activity. So the real estate side is just pretty much gone. It just takes longer to develop deposit and C&I type relationships. Our team is really doing a great job over there.
We are very committed and happy about that from a long-term perspective. It's just the ramp up will take a little longer, and we've reduced some on the expense side from that to match the growth expectations as well.
Right. Do you have the dollar amount of loans outstanding at the quarter end?
We do. We put that in our earnings release. I believe it's about 40 something million, $45 million at the end of the quarter. And, you know, that, if you look at that, you know, it increased significantly as we first got going, you know, third quarter of last year, going from $7 million to $21 million, then to $41 million, and then since then, it's been slower, $41 million to $44 million to $45 million. So just a little bit slower to get through at this point.
Perfect. Appreciate the color.
Yep.
Thank you. Ladies and gentlemen, as a reminder, should you have a question, please press star one. There are no further questions at this time. You may proceed.
All right. Well, thank you again, everyone, for being on the call. Thank you for your support of Colony Bankcorp. We appreciate you being on the call and look forward to talking to you soon. That concludes our call. Thanks.
Ladies and gentlemen, that concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines. Thank you.