Q3 2025 Bank OZK Earnings Call

Speaker #2: After the speaker's presentation, there will be a question-and-answer session. To ask a question during the session, you will need to press *11 on your telephone.

Speaker #2: You will then hear an automated message advising your hand is raised. To withdraw your question, please press *11 again. Please be advised that today's conference is being recorded.

Speaker #2: I would now like to hand the conference over to your speaker today, Jay Staley, Managing Director of Investor Relations and Corporate Development at Bank OZK.

Speaker #2: Please go ahead.

Speaker #3: Good morning. I'm Jay Staley, Managing Director of Investor Relations and Corporate Development for Bank OZK. Thank you for joining our call this morning and participating in our question-and-answer session.

Speaker #3: In today's Q&A session, we may make forward-looking statements about our expectations, estimates, and outlook for the future. Please refer to our earnings release, management comments, financial supplement, and other public filings for more information on the various factors, risks that may cause actual results, or outcomes to vary from those projected in or implied by such forward-looking statements.

Speaker #3: Joining me on the call to take your questions are George Gleason, Chairman and CEO; Brandon Hamblin, President; Tim Hicks, Chief Financial Officer; and Jake Munn, President, Corporate and Institutional Banking.

Speaker #3: We will now open up the lines for your questions. Let me now ask our operator, Gigi, to remind our listeners how to queue in for questions.

Speaker #2: As a reminder, to ask a question, please press *11 on your telephone and wait for your name to be announced. To withdraw your question, please press *11 again.

Speaker #2: Please stand by while we compile the Q&A roster. Our first question comes from the line of Steven Scowen from Piper Sandler.

Speaker #4: Yeah, good morning. Thank you. So, George, you and Brandon, your whole team, obviously know these real estate markets better than any of us. I'm wondering, you know, from the heightened fear peak of like 2023 to today, if you could give some commentary on how, you know, absorption is trending in some of these various classes, whether it's office, industrial, land, kind of how you view those in the landscape today.

Speaker #4: the attractiveness of each of those, how they're trending. and additionally, and maybe on these two new, loans that moved to substandard, how we can think about when the ACL would would tend to get recognized, because obviously the Chicago loan doesn't appear to have an ACL, and the Boston one appears to have a massively significant ACL already associated with it.

Speaker #4: So just kind of understanding some of the puts and takes as those loans migrate.

Speaker #3: Yeah, let me, let me, let me take that last part of your question, and then I'll turn it over to Brandon for some more general commentary on what we're seeing.

Speaker #3: You know, in regard to the, we did have three loans migrate: one from substandard to substandard non-accrual. That loan had a significant charge-off on it that recognized our exposure on that.

Speaker #3: We had a significant reserve part last quarter. But, that did manifest itself in a charge-off. And that's a good example, to answer your question, when do you, when does a reserve on a loan become a charge-off?

Speaker #3: And that is when it becomes evident that, you know, we're we're moving forward with a liquidation or other resolution of that, that does not, as an ongoing loan.

Speaker #3: the, second project you mentioned, the, Chicago project, we took, when we moved that, that moved from special mention to, substandard non-accrual. We took the charge-off on that, reducing that to, you know, what we consider a liquidation value on that asset.

Speaker #3: The third asset you mentioned moved from special mention to substandard, and we put a sizable reserve on that, representing, you know, what we think is a wide range of potential outcomes on that. Those sponsors are continuing to actively work a really good lease prospect and maybe others.

Speaker #3: I'm not aware of, but I know they've got one really good lease prospect that they're they're far along with. and hopefully they'll be the, winning proponent on that.

Speaker #3: They're also evaluating how to recapitalize that project and go forward. I think by the end of this next quarter or into Q1, we'll have more clarity on that.

Speaker #3: Now, with that said, I've read some of the analyst reports that have already been written on our release last night, and it seems that the universal characterization is that it was a mixed bag on asset quality.

Speaker #3: And I would certainly agree that that's an accurate, picture. We did have those three migrations, and in a couple of charge-offs on that. none of those were surprises.

Speaker #3: They were all either substandard or special mention assets. But the flip side of that is, on the positive side, we had our largest foreclosed asset, which constituted more than half of our foreclosed assets: the Lincoln Yards land in Chicago, sold during the quarter at the book value we had it on the books for.

Speaker #3: so, that was that was a big win. And the second and third largest Oreo assets that we had, at June 30, which are now, you know, our our first and second largest Oreo assets, are both under contract as of October 2nd.

Speaker #3: With expected closings this quarter, and those that will have neutral to positive gains on sale, break-even to gain on sale, on those if they close and assuming they do close.

Speaker #3: We never know they're going to close until they do. But if they do close, we'll have a positive outcome on that. So, I think we're doing a really good job of resolving credits that do come into the foreclosed asset category in a very effective way.

Speaker #3: And feel good about that. I think that's a positive. The other thing that I think's a positive, if you look at our combined special mention, substandard, and foreclosed assets, that aggregate number was actually down modestly.

Speaker #3: During the quarter, it reflected a pretty stable asset quality from that front. The third or fourth point, I guess, I would make is, you know, on page 29 of our management comments, we've talked, you know, for years now, since the beginning of the COVID-19 pandemic, about the importance of sponsor support.

Speaker #3: And we had an outstanding quarter in sponsor support. We had 41 loans that reached maturity and were extended and modified. We had almost $70 million of additional reserve deposits posted in connection with those modifications and extensions.

Speaker #3: We collected $13.5 million in fees. We had over $80 million in unscheduled paydowns on those loans and $14 million in unfunded balances that were curtailed.

Speaker #3: As a result of those, some of those numbers are among the highest over the 13 quarters that we've been tracking and reporting that data.

Speaker #3: So, while you did have three loans migrate, risk rating-wise, which you would always prefer to not see, but they were identified credits. We had, you know, just a number of really strong sponsor support examples in our modifications.

Speaker #3: in extensions. And then the final point I'd make before I turn it over to Brandon in that regard is, you know, you've seen a, an infusion of liquidity into the CRE space.

Speaker #3: As evidenced by the record level of RESG paydowns in the quarter just ended. We, you know, we've been communicating for some time that we expected a high level of elevated RESG paydowns for a number of quarters.

Speaker #3: That reached a new height in the quarter just ended. That should not have been a surprise to anybody because we've been talking about it for, you know, a number of quarters now.

Speaker #3: But it does reflect the fact that there is a growing degree of liquidity for refinance options and that sponsors are reaching the point that they're willing to grab onto some of those refinance options.

Speaker #3: So, all that is kind of my view on the credit quality front. I'll let Brandon address what he's seen at the ground level, project to project, kind of CRE trend.

Speaker #4: Yeah, thanks, George. Thanks, Steven, for the question. I think broadly, a lot of the things that George just described are evidence of continued improvement in real estate markets.

Speaker #4: You know, our largest concentration in real estate is on the residential side, multifamily, and then, you know, through condos in there as well.

Speaker #4: And that particular part of the world has been performing very well across the portfolio. But then, as you work down, you know, you mentioned office and industrial, and we were pleased in both cases with the continued absorption and leases that are being signed up in various projects across the country.

Speaker #4: You know, there are there are markets that are that are hotter, that are you know, they've they've filled up, they've used up all the the really strong Class A office space.

Speaker #4: And that trend of of flight to quality just continues. We see it, you know, everywhere we go. And as leases roll, you know, it takes it takes a little bit longer for an office contract to work its life than it does an apartment.

Speaker #4: And so it takes time to see the ultimate degree and magnitude of the migration from lower quality projects to higher quality projects. But we're encouraged at how we're seeing that take place in a number of markets across the country.

Speaker #4: I mentioned industrial. We continue to see good lease up there and, you know, I know that that you know we had a saw a question around industrial appraisals.

Speaker #4: We're you know, all our appraisals on these projects are reflecting current state of markets, whether it's strong leasing or lesser leasing. And we're really pleased that, as always, at our basis in these deals, that that may be not moving quite as quickly as as others that are that are really leasing up well.

Speaker #4: So, good good good activity there. And and you know, the office space is is strength is has been strong enough that that you're starting to get a bleed over in the life science sector.

Speaker #4: In those markets where there's just not enough really high-class office space for tenants to move to, our sponsors in the life sciences world, where demand has been slower, are seeing them being open and courting tenants that are more of a traditional office use in those projects.

Speaker #4: And of course, as we've noted several times over the past, our basis in those projects makes an office lease a very executable proposition. So, while life science has has has is not attained the the level of the magnitude, velocity of leasing that that office has, you are starting to see office be considered an impactful two projects that are otherwise labeled life science.

Speaker #4: So, you know, you've you got all the things George mentioned as evidence of of the recovery in the in the in the commercial real estate markets.

Speaker #4: You've got perhaps a reignition of the easing cycle that will take some pressure off, slowing some headwinds with respect to both sponsors and real estate projects, as well as tenants and operating businesses. All of this has an impact that needs to be considered.

Speaker #4: And and obviously the capital markets are giving a nod to to those market dynamics in in the origination of a lot of a lot of loans that many of which are are are are coming to take our our projects away.

Speaker #4: And as has been mentioned, our payoffs this quarter are a pretty significant indicator of that.

Speaker #3: Yeah, fantastic level of detail. Really appreciate that. And maybe flipping the script a little bit, reading through the management commentary, management comments, and I went back and read, gosh, a bunch of them last night, all the way back to like 2017.

Speaker #3: It feels like new guys are about as bullish as I remember reading, as it pertains to 2027 loan growth and kind of how you're positioned to be opportunistic there.

Speaker #3: And you know it seems like a lot of that is getting past the wall of of these older vintage repayments. And RESG, but just kind of you know if you could comment further on that, it sounds like you know mid-single-digit growth expected in '26, meaningfully more expected in '27.

Speaker #3: So I don't I don't know if you can frame that up at all, but but it feels like loan growth and fee income growth, you're both pretty bullish on as we get into '27 and just any any additional commentary there would be great.

Speaker #4: Yeah. Yes, Steven, I think you've correctly understood how we view the future here. Obviously, you know 2022 was RESG's record origination year. We originated $13.8 billion.

Speaker #4: We give that in that year. We give that cadence chart in our management comments document and have for years. That Tim, what page is that on?

Speaker #3: Page 13. Figure 13.

Speaker #4: Hey, page 13, figure 13, and the management comments document. That shows that cadence. And, you know, we have told people for years that most of these loans have a three- to four-year life cycle.

Speaker #4: So it’s no surprise to anyone that’s been following our stock that we would have an exceptionally high level of RESG payoffs in 2025, probably late 2025. You certainly saw that in the quarter just ended.

Speaker #4: And in 2026, as those loans kind of reach that three-four-year timeframe. So we we've known since we were celebrating the extraordinary level of originations in 2022, that gosh, we were going to be we were going to be having to pedal hard to keep up in '25 and '26.

Speaker #4: And that realization was, you know, a strong impetus behind our effort to really ramp up our CIB group and diversify and build its origination capabilities so that we could achieve a handoff of the growth baton from RESG as it was absorbing that payoff wave.

Speaker #4: To another business unit that could match the quality that we've traditionally had in RESG, that 12 or 13 basis point life of portfolios sort of net charge-off number, that high asset quality.

Speaker #4: And also originate in significant volume. So our timing there, I think, was very good. You know, if I were criticizing my leadership as CEO, I would have said, "Gosh, we should have started CIB a year sooner." And the timing would have been perfect.

Speaker #4: But you know we started it when we had the human resources lined up and felt like it was time to go on it.

Speaker #4: And and we're pretty close to pretty close to spot on there. So what I think happens is that RESG repayment wave, you know just continues through '26 as we grind through the natural payoff cycle from all those '22 originations.

Speaker #4: And of course, there'll be a few older and a few newer originations that will pay off next year. And some of the '22 will slide to '27.

Speaker #4: But next year is going to be the big payoff wave if the normal expected cadence holds true. And CIB is growing. We've really ramped up the staff there.

Speaker #4: So I think those guys are going to carry the growth ball for us next year. And of course, we would expect our high-quality indirect marine and RV business to continue to grow, you know, kind of at a similar rate of growth to what it has grown this year.

Speaker #4: We would expect our commercial banking business to grow. And with that big RESG payoff wave, we think that gets us to a mid-single-digit loan growth rate next year.

Speaker #4: But once that payoff wave is behind us and RESG is beginning to contribute positively to future growth, and we're not absorbing all those payoffs, we think we've got all of those growth engines really contributing in a meaningful way. That really is going to lead us to some nice, very diversified growth in the portfolio in '27 and years thereafter.

Speaker #4: And and at that point, you know I think you're 40% you know 30/30 or 38/32 whatever, you know it's a much more balanced, almost three parts of the portfolio that are more or less equal.

Speaker #4: With RESG, of course, being the legacy dominant part of that. CIB being almost equal, if not equal, to RESG. And the commercial banking indirect piece really filling in the final kind of third part of that equation.

Speaker #4: I think that diversification is good for asset quality. I think it's good for eliminating some of the concentration risk that's weighed on our valuation.

Speaker #4: And I think it's good for growth. So we're really excited. I think we've positioned ourselves well to be in a really good place at that point from a growth perspective.

Speaker #4: And you know I think we grind through with mid-single-digit growth next year and a lot of banks out there would be happy with mid-single-digit loan growth.

Speaker #4: So we're feeling good about it.

Speaker #3: Great. That's fantastic, George. And maybe just one accounting question to follow up on what you just said: as you migrate towards that maybe 40/40 percentage over time with CIB and RESG, if that reduces the unfunded book further—which I would think it would—that would just simply unlock more potential capital for share repurchases.

Speaker #3: Is that right on how that accounting would generally work at a high level?

Speaker #4: Yes. And and the CIB guys are are very cognizant of that. And you know their focused on opportunities that not only meet our high asset quality, and and returns, but also have high utilization rates.

Speaker #4: Because we're very sensitive from from our history with RESG where we got almost as many unfunded as funded that that capital burden of all those unfunded loans really impairs our ability to be as efficient with capital allocations as we would like to.

Speaker #4: And we've had those conversations. Of course, Jake and his team are a bunch of really smart guys; they didn't need to have that explained to them.

Speaker #4: So, they are actually working to weed out some of our older legacy business in those books that have a very low utilization rate and a preference for new business that's very high quality—new business that is going to have a higher utilization rate and less unfunded.

Speaker #4: So, we’re focused on that as part of the strategy.

Speaker #3: Yeah. And George, to piggyback off of that, you know, you can look in our management comments specifically in the CIB section. You'll notice quarter over quarter, we had a little bit of shrinkage in our fund finance group, for instance.

Speaker #3: That is exactly what George is explaining. We're actively, as we grow, rebalancing these legacy books to ensure that we're optimizing utilization and the deployment of capital, but also ensuring that we're getting the best return possible for our shareholders.

Speaker #3: And so you saw a little bit of a dip there in fund finance. That was primarily by design. As we've shed some legacy borrowers who, in some cases, weren't even utilizing their facilities.

Speaker #3: We weren't getting the fees that we wanted out of those opportunities. Opportunity came around to exit those relationships on good terms. And so we did that.

Speaker #3: And so you'll see that continued rebalancing, to George's point, of the CIB book actively as we grow to ensure that we're improving our utilization quarter over quarter over quarter.

Speaker #3: That's great coloring. I wasn't aware of that, so I appreciate the context. I appreciate all the time and the effort.

Speaker #4: Yeah.

Speaker #3: color.

Speaker #4: Thank you.

Speaker #2: Thank you. One moment for our next question. Our next question comes from the line of Manan Gosaliya from Morgan Stanley.

Speaker #5: Hey, good morning, all. Thanks for taking my questions.

Speaker #4: Good Good morning.

Speaker #5: Good morning. So appreciate all the comments and the credit for the RESG side. Can you talk a little bit about the CIB side, you know maybe what you're hearing, what you're seeing in the portfolio, especially you know given the recent headlines and the asset back lending corporate banking sponsor finance, fund finance portfolios?

Speaker #5: Can you just talk a little bit about what you're seeing there?

Speaker #4: Jake, do you want to take that?

Speaker #3: Sure. That sounds great. Good morning, Manan. It's great to hear from you. You know, quarter over quarter, we actually had record origination growth for CIB.

Speaker #3: We originated nearly two dozen new relationships upsized nearly a half dozen relationships which is very exciting to see. Now, what you'll see within the management comments on a net basis, due to both some of the strategic realignment that we mentioned earlier, as well as the capital markets being really active this quarter, we had a record number of bond issuance and high yield issuances which are a blessing and a curse that that took a little bit of a nick out of our outstandings growth quarter over quarter.

Speaker #3: But the upside is now that we have our loan syndications and corporate services group, we're able to reap the benefit of additional fee income from our capital markets program, which is exciting.

Speaker #3: But, quarter over quarter, I do want to point out that it was very successful for CIB overall. Our ABLG group really led the way, along with CBSF.

Speaker #3: And then our new natural resources group. To a lesser degree, we had great contributions from our fund finance and lender finance groups as well.

Speaker #3: And so we're excited about the continued diversification we're seeing there, the consistent growth we're seeing there, and candidly, the additional fee income that we're producing in partnership with CIB's LSCS with that growth.

Speaker #3: You touched on something that's really made the headlines lately, the NDFI space, the lender finance group. You know, the beauty of what we're building here is we're building a wholesale banking infrastructure based on that diversification play.

Speaker #3: And so, with the launch of these new business lines that we've brought into the fold, and with the launch of some business lines that we're looking into on the horizon here for the next couple of quarters, we feel like they will be very complementary.

Speaker #3: As a whole, our exposure to that lender finance space will continue to dilute as a percentage of the banks' overall portfolio. And so, you know, I did want to point that out as we kind of get into the nitty-gritty here on the NDFI side and then some of the headline risk that you all have heard of there.

Speaker #3: The bulk of our NDFIs here at Bank OZK are really found in that Lender Finance group led by Jim Lyons. They have a very experienced team. That is our formally former EFCS group, just to make it clear for everybody, as we've renamed them and really honed in a focus on what they've been doing.

Speaker #3: But an experienced group that’s locked in arms with our portfolio management operations team to ensure deep underwriting, compliance, oversight, and really a credit-focused and credit-first mindset, specifically in that space.

Speaker #3: We're a little bit different in that space than most, and most that you've seen in the market who have stubbed their toes there lately.

Speaker #3: You know we really focus on single lender opportunities and to a degree two bank club deals within that niche more than the broader syndications.

Speaker #3: We think that's important in that space because that allows us to have tighter control allows us to have a deeper look at the underlying portfolio companies within those the attachment points that the bank has at the loan level as well.

Speaker #3: And also ensures that we can put in place a structure that we find to be palatable and conservative in nature too. And so, you know, we take a little bit of a different approach there.

Speaker #3: We do a bottoms-up risking, which is very different from other institutions. We take the time to look at each portfolio company investment. We actually rate that against the bank's risk-rating methodology to ensure that it meets the standards of our institution.

Speaker #3: We also dive into their policy and their procedures to ensure that they're properly monitoring these loans. In addition to that, we also engage third parties for field examinations, appraisals— you name it— to ensure that what we're lending to is, A, actually there, but B, is valued at the valuation that plugs into our assumptions for our overall loans.

Speaker #3: And so you know, that's a space we've been in since 2019. That loan book has continued to grow, but grow at a much smaller pace than our other business lines.

Speaker #3: And while we remain focused and committed to that space, I I do want to point out over time it'll be continue to be a bit diluted just with the introduction of some of these other more diversified C&I business lines.

Speaker #3: George, is there anything you would like to add?

Speaker #4: Yeah, I'm you know, you were talking about the NDFI loans, Jake, from your CIB group. But a chunk of our NDIF loans that show up on our call report are actually RESG loans.

Speaker #4: And this goes back to our longstanding relationships with a lot of the debt funds that do commercial real estate lending. And you know we compete with those guys a lot of times. If they win a unit, we're trying to steal their bifurcated into a senior mezzanine, and we're the senior lender and they're the mezz.

Speaker #4: Sometimes they want to hold that whole loan on their books, but leverage it with a loan from us. And we do a loan-to-lenders or an NDFI loan to those guys.

Speaker #4: And we underwrite our loan to them exactly and service it and manage it exactly as if we were the senior lender on that and if we were making the senior loan.

Speaker #4: So, in our view, there is no difference in the way we rate or evaluate those loans or the risk profile of those loans versus us being senior and them being mezzanine.

Speaker #4: In the transaction, that's a big chunk of our NDFI loans. We feel really good about that. You know, it's business we've been doing for many years with an exemplary track record.

Speaker #4: And in CIB, you know we are looking at the portfolios of the lenders that we're leveraging. As Jake said, our attachment points are very low in those.

Speaker #4: It gives us a lot of comfort and insulates us from a lot of risk. I was appalled when I was listening to one of the news programs the other day, and one of the executives from one of the lenders that has been called in during one of these situations was on there.

Speaker #4: And he said, "Frankly, we just need to do better underwriting." And you know I you know, I thought, "My gosh, you're making loans to complex entities out there and you just now figured out you need to do better underwriting?" I mean, we are thoroughly vetting and and doing very diligent underwriting on these things.

Speaker #4: And Jake, really emphasize that talking about a lot of our deals, we're a single lender or small group lender, so that we're able to really influence that and dig in there and look at the underlying portfolios in great detail.

Speaker #4: And of course, we got locked boxes and third-party servicers and other protections there. That ensure that we're doing those things the right way. Yeah.

Speaker #4: And George, just to piggyback off that again, you know I think it's important to point out that you know the NDFI opportunities and you know when we're looking at our our lender finance book, for instance, it's going to be think of BDCs, business development corps, for instance.

Speaker #4: We look at how they're looking at their investments, right? Concentration risk, ensuring that the bulk of their loans are senior secured loans or improperly perfected.

Speaker #4: And then you know we also look at what industries are they focused in. We've mentioned on prior earnings calls that you know CIB recognizes there are certain industries out there that are currently a little bit higher risk or very competitive, but we're seeing people stretch on structures and it makes us candidly uncomfortable.

Speaker #4: And you know, we see that in the consumer space, the auto space. We see that in the degree in healthcare, venture capital, and tech.

Speaker #4: And so you know there's a lot of BDCs and other what we'd classify as NDFIs that are focused in those niches. And you know good on them if that's if that's their prerogative.

Speaker #4: But just like a direct loan that we would do here at at Bank OZK when we're lending to an NDFI, we look at the industries they're investing in to ensure that it is aligning with our overall credit philosophy as well.

Speaker #3: Yeah. And that conservatism

Speaker #4: And thorough underwriting is evident in our pull-through rates. Jake, what are we running now in terms of our pull-through rate?

Speaker #3: Great point, George. We're still sub 15%, y'all. So when we look at that quarter over quarter, we're still being very selective on the opportunities that we're pursuing.

Speaker #3: You know, 85% of the deals that come across our desk, we're passing on primarily from a credit structuring standpoint and from a yield standpoint.

Speaker #3: The market has gotten very competitive, and we've said that quarter over quarter. And you know we're choosing to pick the spaces, pick the markets that make sense to us.

Speaker #3: And we're sticking to our guns. On credit quality, we'd rather have high credit quality names here and let our products and services speak for themselves versus chasing just yield and as a result, doing a bunch of highly levered deals or deals in kind of adverse industries and asset classes.

Speaker #4: Yeah, we're -- you know, as we've said earlier, we're looking for CIB to become 30% to 40% of our loan book over the next several years.

Speaker #4: And obviously, even if we're three or four percent, we would be paying close attention to it. We're realizing that it's going to become an our loan book we expect to rival our RESG book as far as volume.

Speaker #4: We're certainly intent on doing this right.

Speaker #5: That's very thorough. I really appreciate all the color. I'll leave it there. Thank you.

Speaker #4: Thank you.

Speaker #2: Thank you. One moment for our next question. Our next question comes from the line of Matt Olney from Stevens.

Speaker #5: Hey, good morning. Thanks for taking the question. I wanted to switch gears a little bit and appreciate the commentary around the margin and the guidance for the NII in the fourth quarter.

Speaker #5: Very helpful. Not all that all makes sense. Just want to understand your expectations of when that margin could could stabilize. If we go back a year ago, that the Fed cut aggressively in the fourth quarter and the margin was down in the fourth quarter and then down a little bit more in in in one Q and then stabilized in two Q of this year.

Speaker #5: So called a a quarter or two lag after the Fed paused. We saw the NIM stabilize. So just looking for any any color on on when you expect the the margin to stabilize as it relates to the Fed cuts.

Speaker #4: Yeah. Happy to address that. You know, If Cindy, we're here today and and she's off and not with us today, but if she were here, she would tell you that our predominant interest-bearing deposit product is a seven-month CD special.

Speaker #4: We have other maturities, but probably 80% or more of our CD issuance is in that seven-month timeframe right now. So, you know, our variable rate loans typically tend to reprice around the time of a Fed cut.

Speaker #4: Those CDs are going to reprice seven months later, more or less. So that that's a a good example Matt of of why you know there's a two-quarter lag more or less.

Speaker #4: You know, you see spread getting compressed a little bit for a couple of quarters after a Fed cut until that deposit pricing catches up.

Speaker #4: And, you know, you certainly will see that this quarter. I would expect, with the September Fed cut and likely one or two more, this quarter.

Speaker #4: So, we're going to be chasing those loan yields for a couple of quarters with our deposit cost until the Fed stops, and a couple of quarters after that, we should catch up.

Speaker #4: Now, the other side of that equation, though, is important. We have included in our management comments on page 19, Figure 20, the floor rates in our variable rate loans.

Speaker #4: So it's September 30, '22 percent of those loans were at of our variable rate loans were at their floor. If the Fed cuts a quarter more, 36% will be at their floor and 50 basis points, 41%.

Speaker #4: So as as we get to that 36% and then then you know into the 40% numbers, those floor rates significantly slow down the repricing or or stop the repricing of some portion of our variable rate loans.

Speaker #4: And that, you know, gives us the ability to catch up that margin differential much more quickly. So, I would tell you, given where the floors are now, it's probably a couple of quarters of compressed margin following Fed cuts to catch up.

Speaker #4: But as we go through more Fed cuts, if we end up with three, four, or five Fed cuts, we're going to begin to derive some meaningful benefit and shorten that catch-up period because we'll have a lot of those loans that we'll no longer adjust downward.

Speaker #5: Okay. That all makes sense. I appreciate the color there. And just to also go back and clarify a comment from a few minutes ago around 2026 and 2027.

Speaker #5: I think we all appreciate that the residue paydowns are going to be elevated in '26 and will continue to expense build-out next year as well.

Speaker #5: It sounds like we should assume that the net income growth and the EPS growth year-over-year in '26 may not be significant, but as the loan growth accelerates in '27, it sounds like this is the year where we could see a lot more operating leverage and the EPS growth, and then income growth could be more material.

Speaker #5: Is that a fair interpretation of your commentary?

Speaker #4: Yes, I think that's an accurate interpretation. We believe that we can achieve record net interest income and record EPS next year. It's going to require a lot of work to do that.

Speaker #4: And probably the year-over-year gains will be relatively small, as they've been this year, while we've been building out a lot of this infrastructure for the future and beginning to absorb a lot of these payoffs.

Speaker #4: But we're putting up positive numbers. Year over year, we would expect to do that next year. Then, to really see the benefits of all that investment kick in significantly in 2027 and future years.

Speaker #5: Okay. Thanks, guys.

Speaker #4: All right. Thank you.

Speaker #2: Thank you. One moment for our next question. Our next question comes from the line of Catherine Miller from KBW.

Speaker #6: Thanks. What's the follow-up to the margin question was just on the on I totally appreciate the floor impact right now. That will limit kind of the beta's as we get further cuts.

Speaker #6: And then how do we layer on just the mix change with pricing at CIB being lower yields than the RESG book, and how that can impact loan yields over the next couple of years?

Speaker #4: That's a good question. And obviously, on our CIB book, we typically have a little lower spread than we do on our RESG book.

Speaker #4: We do get some fees, and you know more treasury management opportunities, other miscellaneous fees on that book. And then Jake mentioned that as our customers go to capital markets, whether it's for bond issuance or equity issuance, we have now got, through our CIB team, a unit that shares in those fees and lets us participate in that.

Speaker #4: So, net-net, I think you know CIB's revenue-generating capability is not far off RESG's on a pound-for-pound basis. Where we really, I think, will equalize or actually benefit from CIB is as CIB becomes a bigger part of our book, and particularly if they can achieve the higher utilization rates on their credit lines that we are going to strive to achieve there.

Speaker #4: We will not have as much unfunded loan commitments on that portfolio. The diversification and elimination of our CRE concentration will allow us to be a little more judicious in our allocations of capital.

Speaker #4: So I think on an ROE basis, CIB will help us actually improve our return on equity, even if on an ROA basis, there's a slight deterioration in ROA.

Speaker #4: Because I think it will allow us to be much more judicious in the use of our capital.

Speaker #3: And and Catherine, is it just to help there as a reminder, you know as as George mentioned, through LSCS, and the introduction and build out of that business line last year, and it's really ramping up now, we have capabilities to collect you know bond tips and other capital markets fees.

Speaker #3: We have the capabilities to collect and serve our clients from an interest rate hedging standpoint and FX standpoint. We have the opportunity to produce income from a permanent placement standpoint too.

Speaker #3: And so you know, we're starting to see a real nice uptick and build there of additional fee income from LSCS, which is serving the broader bank as a whole.

Speaker #3: And then as a reminder too, and and how we do these deals over 96.9% of our deals this last quarter or for our book, I should say as a whole, we're either single lender or two bank club or if they're syndications where the admin agent, we're leading deals now, or we're the JLA.

Speaker #3: And so because of that, not only can we positively impact the overall structuring of those deals, but it's allowing us to unlock substantially more fee income as we serve in more impactful roles for our clients.

Speaker #3: And both across a sales standpoint and then also just an upfront fee, the ranger fee, etc. Standpoint. So, to George's point there, we're really starting to see a nice uptick in fees driven by that business unit, and we feel very optimistic about the future.

Speaker #4: Yeah. And the one item that Jake and I have both neglected to mention that's really super important is our deposit opportunities. For non-interest deposits, non-interest-bearing deposits, or low-interest-bearing deposits, low-cost deposits through CIB is really an important part of the return on equity equation.

Speaker #4: On that book of business. And and obviously, we strive to get deposits with our RESG loans, but commercial real estate loans just don't have anywhere near the same level of deposit opportunities for low-cost deposits that you get with a a CIB type of book.

Speaker #4: So, that's a big part of the equation as well.

Speaker #6: Okay. That's great. And then my follow-up is that there was a lot of movement in credit. I agree with your conversation that it was kind of a mixed quarter on credit.

Speaker #6: But it was good to see the overall level of credits basically unchanged, right? Some came in because some went out, but the overall level was unchanged.

Speaker #6: So I guess the big question is, what’s kind of left to maybe come into special mention, you know, in your book?

Speaker #6: And maybe is there a way to give us some color around maybe some kind of migrations within the rest of your past credits?

Speaker #6: Like are you seeing kind of stabilization there? Or is there anything there that you know you you're keeping an eye on? And then secondly, how do we think about how lower rates could potentially impact the health of your RESG book and perhaps limit the new inflows into special mention just because lower rates kind of help the credit of some of those of some of those projects?

Speaker #6: Thanks.

Speaker #4: Yeah, that's a great question. Obviously, all that RESG book is variable rate loans. There are a lot of floors in there, but we're not at the floors unfortunately on a lot of those loans.

Speaker #4: So our sponsors will in large number benefit from additional Fed rate cuts that also a lower rate environment also creates additional opportunities for them to go to a permanent loan or go to a bridge lender that may be loaning them higher leverage money or or cheaper money.

Speaker #4: That will be attractive. So, Fed cuts will tend to magnify, to a small extent, the rate of RESG loan repayment. So, it's a good thing on the quality side and good for our customers.

Speaker #4: It's a bad thing on the repayment side. But all these loans are going to pay off, you know, sooner or later, one way or the other.

Speaker #4: So we're we're happy for our customers to get a good exit if market conditions allow that. Your your other question about what else is what else is out there and and what are we watching?

Speaker #4: Well, I would tell you we have guys who watch every loan in our portfolio every day. So we're looking at everything all the time.

Speaker #4: And that's part of the secret of the success we've had over, you know, our history as a company and certainly our 28 years since we went public, where we beat the industry's charge-off ratio every year.

Speaker #4: We're paying attention and servicing our loans in a in a very effective manner. As as for you know how do you how do you know when something is going to become going to migrate to those problems?

Speaker #4: Well, you know, deteriorations in value, deteriorations in market conditions, and failures, you know, to lease, all really are kind of summarized on page 29 of our management comments where we talk about sponsor support.

Speaker #4: And that really is the key. Are our sponsors going to continue to support their projects until they get them leased or sold?

Speaker #4: And our track record on that, and you know we've said this. We said when the COVID pandemic started that we expected most of our sponsors would continue to support their projects until conditions normalized.

Speaker #4: We've reemphasized every quarter since the Fed started raising interest rates 13 quarters ago that we expected most of our sponsors would continue to support their projects until conditions normalized.

Speaker #4: Now, there are obviously a handful of exceptions, and you know sponsor fatigue and energy and resources to support projects get exhausted over a prolonged period of time.

Speaker #4: So we've seen some examples of that, but they've been limited number of examples. And when we've seen those examples, that's when loans become special mention.

Speaker #4: That's when loans become substandard. That's when loans move into the Oreo book and then get liquidated out. So, you know, I would say the same thing I said at month one of the COVID-19 pandemic and after the first Fed increase: we expect the majority of our sponsors, the vast majority of our sponsors, will continue to support their projects until they get a successful conclusion.

Speaker #4: They'll do it because their high-quality sponsors have high-quality assets and they have a ton of money invested in them. And that keeps them engaged in the projects.

Speaker #4: We will have some along the way where they'll just become exhausted in their ability, energy, and resources to support a project. And we'll deal with those when we do.

Speaker #4: And you know, I think we're very well reserved for what we think is an plausible set of scenarios in that regard.

Speaker #6: And any changes you're seeing to trends in life science loans? I think that's the one asset class we're all watching and worried about.

Speaker #4: Brandon, do you want to talk about life science?

Speaker #7: Yeah, Catherine, good to talk to you. You know I alluded to it in my comments earlier. It's you know that that's been a an industry that's that's you know had a lot of a lot of product delivered and and less less demand for its space.

Speaker #7: And I would say there are still headwinds. There is still time to have some of those projects get where they want to go.

Speaker #7: But what we are seeing is a shift in, you know, the intention—the intended use of that space. You know, it's...

Speaker #1: Yeah, and we've said this quarter after quarter after quarter. It absolutely has the flexibility to serve, you know, more typical office users.

Speaker #1: And because of demand improvement that we're seeing in the office space, there is starting to be a lot more indication, and real lease interest.

Speaker #1: Around the life science space by the typical office user. So I think that's, you know, one of the green shoots that we're seeing. And that space, you don't always execute exactly the way you want to, but at the end of the day, getting a user in the space to pay rent is what it's all about.

Speaker #1: And again, as I said earlier, our basis in these life science deals is such that executing on a different use, on an office use in particular, is absolutely an executable transaction.

Speaker #1: So, and, and, you guys are aware, as we've said so many times, about the significant good news funding that we have in these loans. The cost of building out an office tenant space is typically a good deal lower than it is for a life science tenant.

Speaker #1: So, the dynamics that exist there, again, you, you, you'd love for them to all be full with life science tenants, but, we're encouraged at the office markets that are, that are pushing, prospective tenants to really high-quality, assets that we've financed the construction of.

Speaker #2: Great, thank you.

Speaker #1: Thank you, Kat.

Speaker #3: Thank you. One moment for our next question. Our next question comes from the line of Janet Lee from TD Cowan.

Speaker #4: Good Good morning.

Speaker #5: Good morning.

Speaker #4: On just given, I know you. I appreciate that we'll get more clarity in the fourth quarter and January, but on that, you know, the Boston office loan that moved to a substandard accrual, is that baseline expectation that they will win that one-third of the building for that potential tenant? And is that how your reserve tied to this loan is baked in?

Speaker #4: Like, I just given the size, would appreciate if you could give a little more color on what the likely path of this loan is in your currency.

Speaker #1: Yeah, we certainly don't want to get ahead of our sponsor here and their negotiations. You know, they are working hard on leasing; they're also evaluating how to recapitalize that project for a longer runway.

Speaker #1: Our reserve on it, as I said in my preliminary comments to the initial question, reflects a wide range of scenarios here. So, I think we're very well reserved on this, and we're going to let our sponsor continue to work this and endeavor to execute on it. We'll see how that plays out over the next couple of quarters.

Speaker #4: Got Got it. and just switching gears to loan origination, so if I look at the, the third quarter, it was, you know, one of the low, lowest levels, and in your management commentary, you talked about the expectations for higher origination volumes for 4Q and I would believe beyond, 4Q.

Speaker #4: Can you explain to us how the third quarter is sort of an outlier quarter and then it will likely look better in, in that fourth quarter and, and beyond, just given that you also commented on, on RESG commitments are likely to decline, but I guess that's more of the f more, more driven by the, the payoffs activities.

Speaker #4: Would appreciate any color.

Speaker #1: Yeah, so you're correct in surmising that our expectation for continued decline in RESG commitments is really driven by the payoffs. I think it is very likely that our very low volume of originations in the quarter just ended was an anomaly.

Speaker #1: You know, you can never say that for sure. We'll be glad to put up another quarter of results and prove that. Hopefully, we will.

Speaker #1: What I can tell you is that we've already originated, in the first two weeks or so of the current quarter, about half the origination volume, or a little more.

Speaker #1: That we originated in the whole quarter last quarter. So, those transactions, I think there are three of them that we've already closed this quarter, would have been transactions we actually expected to close last quarter, but for one reason or another, they got pushed into this quarter.

Speaker #1: So, we hope we'll return to a much more typical and normal level of originations in Q4 and future quarters. As I mentioned, and as we mentioned in the management comments document, there are not as many new CRE projects being originated, just reflective of all the various market conditions out there.

Speaker #1: There are a lot of lenders chasing those projects, so you've got a situation where you've got too many lenders chasing too few projects.

Speaker #1: That's leading to some structures and pricing and leverage points that we would not go to. That is having an impact on our origination volume.

Speaker #1: But even with that, I do think we will return, more likely than not, to a better, more typical origination volume in Q4 and future quarters.

Speaker #4: Thank you.

Speaker #1: Thank you.

Speaker #3: Thank you. One moment for our next question. Our next question comes from the line of Brian Martin from Janney.

Speaker #6: Hey, good morning, guys.

Speaker #1: Brian?

Speaker #5: Good Good morning.

Speaker #6: Hey, most of mine have been answered here, but George, just I've been kind of bouncing back and forth between calls, but just your further build-out of the, the CIB group, George, can you just talk about if there's, you know, a lot more stuff and a lot more teams or people or, you know, ve verticals that maybe you're, you're contemplating, you know, adding, you know, I guess in, in just kind of spell out kind of where you're thinking given the, the growth outlook in that unit and, and, and, just give a little bit of color on that and then just I know you've talked about in the past, the fee income opportunity.

Speaker #6: You know, given it's such a small piece of revenue today, just kind of, you know, over time, where do you think that fee income to revenue percentage can get to as you go forward?

Speaker #6: Thanks for taking the question.

Speaker #1: Sure. let me, let me tell you that, you know, we have a, a wonderful leadership team in our CIB group, and it's not just Jake, but it's the, the leadership team under him.

Speaker #1: And they are, they are, thank you, operator. They are doing a great job of recruiting just top-tier veteran talent to the team. They are being very careful about it, but they're also being very active out there.

Speaker #1: In the market. So, Jake, I'm going to come to you and let you unmute and talk about that, and give a little additional color.

Speaker #5: No, I appreciate that, Brian. You asked my favorite question of the morning, talking about the fun stuff here. So, I appreciate the question; it's a good one at that.

Speaker #5: I want to emphasize that you're looking at the third quarter. You know, if you look at the management comments, you can see that quarter over quarter, we're up $575 million.

Speaker #5: And outstandings, if we were looking on a commitment basis, that would be your outstandings plus your unfunded. We're up $1.19. That's our net number, and I wanted to point that out again from an origination standpoint.

Speaker #5: These teams are really starting to hit their stride across the board. Our natural resources group, led by George McKean and Monty and Arthur, that team is really taking off and, and, and putting together some nice opportunities for us.

Speaker #5: CBSF continues to grow. We have identified our leader out in Atlanta. I'm John, and he's joined us, and he's building up our presence in that part of the country for us and our footprint.

Speaker #5: We've identified our leader and brought on Mish within CBSF. Out in Nashville, he has great experience and comes from a very large institution. We're excited to have him here.

Speaker #5: And we'll continue to build the team there as well. And so, the CBSF and the diversification, the great yield that comes from that book, is really, again, still at its infancy, and we're going to see that continue to grow and build, and really be impactful leaders here for the institution.

Speaker #5: In addition to that, Mike Scheff's ABLG group is continuing to expand. We just hired a gentleman up in New York, and we will continue to focus on finding the right people for the right spots, the fifth EOZK credit culture, and the overall culture.

Speaker #5: We're going to find those people. We're going to source them. We're going to bring them in and give them all of the support they need to be successful.

Speaker #5: And we're seeing that in our ABLG group. Our lender finance group, previously mentioned and led by Jim Lyons, is doing a fantastic job.

Speaker #5: We're seeing some nice opportunities come that way. We're being highly selective in that space, as I previously mentioned, because we are seeing a lot of pressure on the pricing and structure.

Speaker #5: That we refuse to give on. Our fund finance group, with Parul and team, is really doing a nice job and is going through that legacy book of business, as mentioned, and optimizing it.

Speaker #5: So we're proud of her and, and, and what she's doing and, and our portfolio management and operations group, which is really the backbone in more than 50% of our CIB staff, continues to do really good job in the underwriting, the compliance, the oversight space, and partnering with our second line, our loan review, credit risk management partners, our enterprise analytic partners, as well as our third line to ensure that all the lending that we're doing is safe and sound and is what's best for both our institution and our shareholders and the communities we serve.

Speaker #5: If we look at the overall growth of what we did in the third quarter, we actually originated about $1.6 billion in net new opportunities and material upsizes, which would have equated to about $850 million in outstandings.

Speaker #5: And so again, some of that delta between the net and the growth there is optimization of the book, which we mentioned. But also, as mentioned previously, capital markets were very ripe, and I'm sure you all saw it as well, but we had a lot of clients, our, our public clients, access the markets, bond issuances, high-yield issuances, and as a result, we're reaping the benefits of the fee income now that we have a great capital markets, partnership and program.

Speaker #5: But that resulted in a little bit of a chip-off of our overall growth. For the third quarter, as we look into the fourth quarter, we're very cautiously optimistic.

Speaker #5: We feel good about what we're doing. We have teams in place, and they are executing at a high level. We originated over a dozen names.

Speaker #5: in third quarter, that will be booked here, really in October and then going into November too, so we anticipate fourth quarter being, being strong as well.

Speaker #5: And we continue to look at opportunities for additional business lines, as you asked, that make sense for what we do; that are natural, complementary, kind of bolt-ons.

Speaker #5: that have nice returns for us, but also have positive, kind of credit profiles that really fit the bill of OZK. So, we're just getting started on the CIB side.

Speaker #5: I think you're going to see continued growth and momentum there, and we're very excited about it.

Speaker #1: Yeah, and let me add, Jake, and Jake's operating this addition and expansion of his staff under a gating metric, but Brandon and I are monitoring, and that metric is really volume and revenue generation.

Speaker #1: And as his volume grows and revenue from his business line grows, he can add the next guy or the next three guys. And there's a gating metric on that.

Speaker #1: We are adding, you know, these are very high-level team members. They're very well-paid. They're veteran people, so you're paying for the experience and the knowledge and the relationships that they built over decades, and in most cases.

Speaker #1: And it's not inexpensive to build this team. In fact, it's expensive to build this team. However, we're being very disciplined about the way we do it, and we're getting revenue in place to generate positive leverage before we add the next person or the next group of people.

Speaker #1: We get positive leverage on that group. We get the next group. So Jake is growing it in a very responsible manner, and we're building it with high-class people in a very professional manner. That's why, you know, I think we talk about 2027 being these guys really hitting full stride in 2027.

Speaker #1: We will have added a lot of additional people to their world between now and 2027 that will generate a lot of additional growth opportunities across a very diverse book of business.

Speaker #1: You know, CIB, we're talking a lot about our desire to diversify our portfolio more. CIB is inherently internally diverse in what they're building, and that's another big plus out of that.

Speaker #5: Yeah, and, and George, to that point, you know, if we look at CIB as a whole, it represents over, over 40, 45 unique industries, and so there's a lot of diversification within that book, within the structures and the business lines that are under.

Speaker #5: And again, I just want to emphasize for everybody's, you know, everybody's sake, to George's point there that, you know, as we hire, we take a very different approach than what our competitor banks do.

Speaker #5: You see, a lot of other banks will enter a market, and they'll hire 10, 20 people, and they'll give them years and years to, you know, build up a book and repay the institution for that initial hiring slug. But here, we’re really doing it in a methodical way. To George's point, before we hire the next person, the existing team pays for them.

Speaker #5: And so, as a result, we ensure that as we grow, we're keeping a very close watch on expenses and a close watch on that efficiency ratio to ensure that we don't get over our skis.

Speaker #3: Thank you. At this time, I would like to turn the conference back over to George Gleason, Chairman and CEO, for closing remarks.

Speaker #1: Hey, thank you all for being on the call today. We greatly appreciate it and look forward to talking with you in about three months.

Speaker #1: Thank you. Have a great day. This concludes our call.