Bank OZK (OZK) Earnings Call Transcript

We have a pretty healthy ACL for that portfolio, reflecting the general challenges on that sector. We've got several of these life-sized assets that do have good leasing. And we're -- they're no issues at all with those. They're well leased. We got 1 of our really nice paydowns that we got in the quarter just ended was a big paydown on well-leased life science project that we extended the term on -- so that was a nice win. The life science loan that we took a charge-off on this quarter that was previously special mention that we took a short payoff on to exit. That was, I think, probably our least desirable, in my view, single asset in the portfolio. Now other folks might disagree with that. But we're focused on asset-by-asset basis, looking at these, and that's all that was probably a more challenging asset from a long-term value and future perspective than some of the others. So we got a chance to exit that at discounted payoff, we thought that was a nice improvement to the portfolio to move that out. There is a fair amount of leasing activity ongoing on several of the life science projects, a lot of it is not for life science, it's for technology, AI or office purposes, but there is some activity there. So Brannon, I'll let you share any additional thoughts you want to share about life science.

Well, you hit most of the bullet points that would have hit there, George, in talking about portfolio. I mean, look, we've shared, it's been a challenged market. It's a -- it's hurdles with respect to the macro picture with respect to specific funding pictures in the industry. But generally speaking, this year, we've seen a pickup in venture capital focus that way. And we've seen an increase in just tenant activity in certain markets and specifically around some of these projects that we have. George mentioned the AI influence. That continues to be the case. We continue to see tenants in the market that are operating from that perspective that are looking at these uses. But -- there are also very life science-focused tenants in the market as well. So we still have, as they say, some more to chop and working with the sponsors to continue to support these through lease-up. But I would say that generally, the first half of the year has had a more positive flavor to it just broadly in markets with had activity in space.

Okay. Great. Very helpful. And then my follow-up is just on the margin trajectory. Can you give us an update on just kind of how trends you're seeing in incremental deposit costs? I feel like -- and you've mentioned in your prepared remarks or your management comments that this is probably a bottom in deposit cost and move through the year, that will trickle up just with higher rates. But just any kind of incremental data on where your CDs kind of are coming on and -- and then any benefit that we'll get just from kind of some 4 to 5 from CIB, where it's just the incremental deposit costs coming on today?

Yes. We are probably 10 basis points higher than our low point on our CD specials across the board. We have increased that really in the last probably about 4 to 6 weeks ago. I don't remember the exact timing of that, but that is a reflection of the fact that we expect to need to grow more deposits in Q3 and Q4 based on moderately increased volume of outstanding loans. So we're ramping up a little bit for that. We said in the management comments, Catherine, that we thought the Q2 cost of interest-bearing deposits was probably an inflection point and we go higher from there. I don't think we're expecting to run off the rails going higher. I think it's just somewhat of a slight increase higher from where we were on COIVD in Q2. So modest increases in that cost as we go forward. And part of that is driven by the need to generate more deposit volume simply because we expect more loan growth in Q3 and Q4. We commented and managed some comments, we were really pleased with the good work that our funding team, deposit-generating teams did in Q2, getting that 5 basis point reduction in our cost of COIVD which combined with the work our investment team did on the investment portfolio, let us actually improve net interest margin 4 bps during the quarter. I don't think anybody probably are not many people expected that improvement. It was a nice result for the quarter, particularly given the high level of paydowns early in the quarter that beat our average earning assets down for the quarter. So that was a nice offset. Will benefit less from that ability in Q3 and Q4 as we grow loans more, we'll have to be a little more aggressive on deposit generation. And when we were getting a lot of loan payoffs early in the quarter, our deposit guys were able to adjust their deposit gathering strategy and squeeze a little bit of margin benefit out as a result of the higher level of loan payoffs. So there's a give and take there place we would rather have the volume. But if you don't get the volume, you like the way our team responded to that, and they were able to grind some margin improvement out in a lower volume environment.

the next question will come from Brian Martin with Brean.

The insight thus far. Maybe just 1 question for whomever, just on the progress you made this quarter and just recent quarters, George, on the shift to CIB and away from real estate, given the payoffs continue and the momentum continues at CIB -- the drop this quarter seems a little bit more given the payoffs were a little bit higher. But should it just be a more gradual decline also being equal, I know your comments about the payoffs being volatile. But kind of from this 48% level. Just give us some update as you look out over the next 4 to 8 quarters, kind of how that -- where that ends or just maybe the trajectory. If you can give any color on that or any help on that?

Yes. The RESG origination volume, as we've reported in management comments has been pretty muted. We're working hard to find volume. But a lot of these cities where we've originated a lot of volume in the past or raising taxes and adopting policies that are not specifically pro business and a really anti-business and that is affecting the need for new product in those markets. So that, plus the fact that there is a lot of capital out there chasing debt in the CRE space. It's very competitive on new deals, that's keeping that volume muted and probably is going to do so for some number of quarters farther. My crystal ball doesn't go too far out on that. But it's a challenging environment to originate volume, and of course, because of the high level of originations in '22 and to a lesser extent, '23, we're in the heart of a big payoff wave. RESG is going to continue to drop. And -- we don't talk about it a lot, but we're now, I think, at our second quarter end where we're under 300%. So we're below the regulatory concentration guidelines for total CRE and probably by the end of the year, we'll be under -- or early next year, we'll be under the 100% guideline for construction and development. So that portfolio is going to continue to shrink for the remainder of this year and into next year. We commented in the management comments that we expect CIB and RESG portfolios will be equal in size next year, and that at some point next year. That gives you a real indication because CIB is $7 billion plus now an RESG is $15 billion plus, and we're expecting those are going to equalize and cross at some point in 2027, which means we're going to continue to see strong growth in CIB and strong paydowns in RESG. I think what we don't talk about a lot that is important as is I think over the next 6 quarters through 2027, you're going to see more positive momentum out of our community banking group and continued positive momentum out of our indirect and RV group. That group was in the 12-something percent. It's now 13.7% of our portfolio in the indirect. Our community banking portfolio is pretty much language around its current balance more or less for a couple of years now. We have reorganized some of the reporting structures there, took a little more straight line and clean cut set of reporting structures we've implemented there. I think the team is really excited about that. I think we're going to get some positive growth out of that. If you look at the portfolio, is really being kind of 3 parts, the community banking indirect being 1 part, RESG being 1 for, CIB being 1 part. I think you get to more or less equal sized to a very diversified portfolio in 2027. I think being below the regulatory CRE concentrations, having that portfolio very diversified is really accretive to our long-term shareholder comfort and franchise value. That's part of this multiyear design and strategy we've been pursuing of getting more diversified. I do think you will see RESG being an important contributor to our growth and portfolio long term. I think you will see it grow again. But it may get into the 20% of portfolio range before it hits that inflection point where origination of fundings exceed payoffs and it turns back to a more positive contributor to growth. So I don't think we're going to see a lot of change in the paydown volume for a number of quarters.

Got you. That's super helpful, George. And maybe just 1 follow-up, just on the credit front, given your comments about special mention and kind of some more positive movement there than negative, it normally would be anticipated in and the fact that most of the nonperforming issues are concentrated with a handful of credits. Can you just give any big picture kind of resolution on the credit path. It feels like your bias or your outlook is a bit more positive, particularly with maybe not as much concern on the special mention. The other credits identified, the reserve coming down. I just kind of want to understand if we're hearing that right? And just if that's more kind of how we should think about it if we do see some path for resolution here in the next couple of quarters, that's what it sounds as though.

Brian, what I would say on that is the RESG portfolio is recycling in a constructive and healthy and normal way. We mentioned there, we've had $9.95 billion, almost $10 billion of that portfolio pay off over the last 4 quarters. If you think about that in the context of the entire -- and those are funding balance. If you think about that in the context of the entire commitments in the portfolio, I mean that's a massive recycling of those assets. It has been a very long and very tough CRE cycle for a lot of our customers. The quality of our sponsors and customers as shown up really well because we went through several years of that challenging environment with no problems to speak of, and we've had a handful of problems. We'll have a few more assets that will emerge as problems over the next year, 1.5 years as we work through this kind of final stages of that cycle. But the portfolio is recycling really quickly with $2 billion to $3 billion a quarter in payoffs and the vast majority of our sponsors, as we have said all the way through, the vast majority of our sponsors are continuing to support their transactions in a very positive way. You saw that in the quarter just ended, we had $91.5 million of unscheduled paydowns in the RESG portfolio, $19.5 million of additional reserve deposits posted in connection with extensions of loans. We had $37.5 million of unfunded balances curtailed in connection with the modification extension or loans and collected $5.4 million modification fees. So -- the vast majority of our sponsors continue to support their loans. There have been -- obviously, we've got 10, 12 assets that we're -- we've identified that are either in foreclosed assets or classified assets that we didn't get the support we needed. There will be a few more of those as we go forward. But -- we also have 1 of those OREO assets and 3 of the substandard loans that I feel pretty optimistic about our ability to work those out over the next few months. We're far along with the resolution liquidation plans on those assets. We're working through the problems. The problems have been fairly isolated in number. I think we're doing an excellent job working through them as they come up. Lastly, I would say we built a big reserve in our ACL to deal with potential loss exposure on that, and we feel very good about the adequacy of the ACL to deal with that exposure across the entire portfolio.

Perfect. That's all helpful for me. I'll step back. Maybe -- and parting, maybe Tim could just comment if you've got 1 easy comment, Tim, on just the out your outlook on the buyback, but that'd be it. But thank you very much, George, for the comments and everyone else.

Thanks, Brian, buyback, Tim.

Yes. Brian, certainly, I was pleased with the buyback activity over the last 4 quarters. I think we used about $175 million of the $200 million repurchase authorization. The average price there was below tangible book value. which was very accretive, not only to attainable book value but EPS. Moving forward, I don't -- we have the brand new $200 million authorization for the next 4 quarters, how much we'll use of that will really be dependent on our on our stock price over that time period. I would anticipate we would use some of that, but how much, again, just really is going to depend on our stock price.

The next question will come from Timur Braziler with UBS.

In regards to the net charge-off language, it looks like the commentary of it being roughly in line with 2025 was removed. Just wondering if the current cadence that we are on is the right way to think about charge-offs here going forward? And then maybe to use a baseball analogy, if you can provide what inning you think you're in, in terms of classifying kind of reappraisal of the current book? And then similarly on where we are with actually charging off and kind of dealing with those new appraisals?

Tomorrow, I'm going to resist the temptation to use the baseball analogy. I'm not a huge baseball fan. Even though our Arkansas Razorback baseball team is a great college team. But what I will point you to is the language that we've had for several quarters now in our management comments document, that is, we think we're in the right stages of a long cycle that has been a challenging cycle for our customers for a number of years. As that cycle has worn on the resilience of some of our customers to continue to withstand that cycle and support their assets is diminished and that's why you're seeing the handful of special mention and foreclosed assets and then classified assets that you're seeing. So as I said in response to Brian's question, the RESG portfolio is recycling quickly the $10 billion in round numbers of payoffs over the last 4 quarters is a strong indication that, that portfolio is recycling and recycling quickly to current generation assets that are underwritten in a different environment. We feel like we are adequately provisioned for that as I told, Brian, I think there'll be a few more bumps in the road, and we'll have a few more problem assets. But we're also resolving assets at a pretty diligent rate as well. So late stages, that probably continues this year and into next year. But I think we are we're feeling pretty good about where we are in the cycle. Now as for the net charge-off number we are a little above the industry's Q1 number through 6 months. We have a long history of outperforming the industry, multi-decade history of outperforming the industry. I think we've got a good shot of getting back under the industry's number for the year. We'll see how that plays out. It's a chunky mix of charge-offs, the vast majority of our charge-offs in the quarter just ended were on for credit. It tends to be a little chunky. -- in the way those are recognized. It's not like we have 100,000 loans that there's an averaging effect on. But we're cautiously optimistic about our ability to get back under the industry number for the year. We'll see how that plays out.

Okay. Great. And then as a follow-up, maybe 1 more on RAD in San Diego. Can you remind us, as IQHQ still making full cash payments? Or is that payment in kind? And then I'm just curious in terms of how you're thinking about risk migration with another extension coming up here in August. Maybe talk us through why pass rated from a risk kind of standpoint is still the right way to be here?

Yes. What I can tell you on payment and kind PIK interest, we don't pick interest on any loans. The interest on that credit is as all of our credits is being paid from reserves that were established for that purpose. You'll recall early last year and then previously in '24, there were 2 very large contributions to the reserve so that we were holding on those loans from the sponsorship group on that asset specifically, that have been paying operating cost and interest and other costs related to those projects. We do not pick interest on loans. That's not relevant to that project or any other project. What I could tell you is this is a pass-rated credit there, and that's because of the very constructive dialogue that we've had with the sponsor and the mezz lender both of whom, as Brannon alluded to, are working in what appears to be a very constructive and positive negotiation work out a multiyear extension of that asset. That really is a negotiation with us, but it's also a negotiation between those 2 parties. It will take a little while to negotiate that, but we're cautiously optimistic about the outcome of that and have every expectation that, that will be a successful outcome, and that will remain a pass-rated credit. Obviously, if our thoughts in that regard change will make appropriate adjustments to the classification of that asset.

The next question will come from Janet Lee with TD Security.

Good morning. So your expectation around CIB and RSG being roughly equal in size in 2027, which is great for diversification purposes. My understanding was that CIB loans are slightly lower yielding than RESG. What is the implication on NIM perhaps in 2027 at CIB were to become a larger size? Does it result in a structurally lower NIM? Or maybe it also brings in some lower cost depots over a longer term, but I just want to understand the structural impact of larger CIB on your net interest margin?

I think a lot of that, Janet, is already in our net interest margin. Our RESG originations over the last couple of years have had -- because of the competitive environment for those assets and the fact that a larger and larger part of our RESG loans are multifamily loans where the spreads on those loans look very much like the CIB loans. The remixing of the RESG portfolio to be predominantly multifamily and really industrial is a big part of it. Those spreads look like CIB related spreads. If you point back 3 or 4 or 5 years, we certainly were getting higher spreads on RESG loans then when we were doing more large complex mixed-use projects, more office, life science sort of projects than we are getting on that portfolio today. That differential has tended to somewhat diminish and the yields on those portfolios have tended to get closer and closer together. They're still there's still a delta, but it's a much smaller delta than it would have been in past years. The second thing you're correctly surmised that we get a lot more deposits with our CIB loans, and we get a lot more contribution to noninterest fee income from CIB. Jake's talked about that in his comments and talked about the partnership with treasury management and the focus on those various service parts of their business that generate fees, whether it's on interest hedges or commodity hedges or syndication of debt or equity transactions or just other kind of loan-related but noninterest of fees that they generate. We think CIB is going to be as profitable for us as RESG long-term and that the yield differential we expected is really no longer there. Jake mentioned the way he is managing that CIB book and the different types of loans we make there. There are sometimes that various categories of loans get very aggressive because you've got a few people really trying to put a lot of money into that space. Jake mentioned 1 category where we've seen yields compressed and we're finding we get better yields in other categories with the same or better risk profiles than those other categories. So he's done an excellent job he and his very capable, very better and team doing an excellent job of decelerating growth in areas where spreads are getting compressed by competition and accelerating where we can get real good value on a risk-adjusted basis. So super proud of the job they're doing on managing that.

Yes. And George, I'll just piggyback quickly off of that. If you really to emphasize what you were saying, yes, if you were to go back 2019, the fund finance book was created. 2021, you had the legacy ABL and lender finance group. Since then, we've launched our CBS F, our FCS, our NRG, EMM, EFG. All that being said is those new business lines are really relationship focused to George's point. You have the opportunity for this great cross-sell this additional noninterest fee income generating engine, whether it's the commodity hedging, interest rate hedging, capital markets fees, treasury management, you name it. a lot more single lender direct deals as a result of that relationship is. As CIB has kind of grown and evolved over the last couple of years as part of the enterprise, the average return, the average spread has improved greatly for the CIB names, but also the average kind of all-in yield has improved greatly. I think it's been quarter after quarter after quarter, if you were to look at for that most recent quarters, new loans originated. The average spread has actually increased over the historic book and quarter-over-quarter for this last quarter, it went up by over 25 bps on the average spread on these new loans that were originating in CIB just compared to the average across the legacy book. We really are focused on relationship banking where we can harvest deposits where we have the opportunity to cross-sell products and services that are beneficial to our clients but results in a great return for the bank and for our shareholders. We're doing that without giving up any sort of credit or loosening terms or anything of that nature, too. So we're taking our time. We're picking our plays. We're doing it in a conservative and strategic manner.

Got it. And not to be on the dead horse, but on average earning assets, I just want to make sure that I'm understanding this correctly. So -- should we expect average earning assets in the second half to be relatively stable to the second quarter given the RESG repayment? So while you're still targeting mid-single-digit loan growth for the year. Or should it still step up in the second half of '26?

Tim?

Yes. Jan, I still expect it to step up each quarter in Q3 and Q4 from where we are in Q2.

Thank you. I will now turn the call back over to George Gleason for closing remarks.

Thank you, guys, for being on the call today. We appreciate it. We look forward to talking to you again in about 92 days. Have a great day. Thank you.

This concludes today's conference call. Thank you for participating, and you may now disconnect.