Ladies and gentlemen, thank you for standing by, and welcome to the Bank OZK Third Quarter 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. In a moment, we will have a question-and-answer session. Please be advised that today's conference is being recorded. It is now my pleasure to introduce, Tim Hicks.

Good morning. I am Tim Hicks, Chief Administrative Officer and Executive Director of Investor Relations for Bank OZK. Thank you for joining our call this morning and participating in our question-and-answer session. 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, and other public filings for more information on the various factors and risks that may cause actual results or outcomes to vary from those projected in or implied by such forward-looking statements. Joining me on the call to take your questions are George Gleason, Chairman and CEO; Greg McKinney, Chief Financial Officer; and Brannon Hamblen, President and COO of our Real Estate Specialties Group. To make the most efficient use of the time, we ask that you please limit your questions to one or two at a time and then reenter the queue for any follow-up questions if needed. We will now open the lines for your questions. Let me ask our operator, Andrew, to remind our listeners how to queue in for questions.

And our first question comes from the line of Ken Zerbe with Morgan Stanley.

Great. Good morning, everyone. You guys do such a great job of underwriting in the RESG portfolio. I was actually hoping you could talk instead about the credit trends in the non-RESG portfolio, right? Do you think that they're going to follow the same path of credit losses that most other banks are talking about, which is peaking in the middle of 2021, or should they perform differently?

Ken, what I would tell you is that our RESG portfolio is our best underwritten, best documented, best collateral, best sponsorship, best structured loans there. Because of their size and complexity, they get an extraordinary level of attention and care in all aspects of the process related to those loans. I would tell you that our community bank lending in its various forms and our indirect lending as well, we believe are underwritten to standards relative to the way most banks underwrite them that are favorable. While they're not quite as low leverage or quite as thoroughly documented and serviced as our RESG loans, we think they are much better than average. So, the secret to our 24 years now of having outperformed the industry on net charge-offs every year is a result that not just our RESG loans, but all of our portfolios are underwritten and serviced to a very conservative standard. We think these portfolios will perform well in the downturn. Our aggregate portfolio was really underwritten and designed to withstand the rigors and challenges of a very adverse economic environment. So, we feel like we are very well prepared for this environment. I don't know that we have a specific expectation of when net charge-offs will peak or exactly how much they will rise, because that is going to be very dependent upon government policy action, additional stimulus, COVID cases, and so forth. Clearly, our deferred loans that received a pandemic modification dropped from a high of 6.9% of our portfolio at June 30 to 2.8% at September 30.

Yeah. The 6.9% was actually our highest peak incurred in July. But that was the highest peak down to the 2.8% at the end of the quarter.

Loans are coming off both deferral and obviously the vast majority of those loans have just picked right back up and continued to pay and perform as we expected they would, and we would expect that the vast majority of the 2.8% remaining in deferral will continue to do so. So at this time, we're not seeing any significant emergence of charge-offs. I'm sure we'll have some loans that will break in this economic environment. But our low leverage gives us a lot of confidence that our losses will continue to be very modest when we do encounter assets that have a problem. So, I don't know if it's second quarter, or third quarter, or first quarter, I don't know exactly what the high point is going to be. But I think the more important overarching bottom line is that the portfolio has been designed and underwritten and booked with the idea that it would be extremely resilient and perform very well in a difficult environment. Through the first couple of quarters, three quarters of the pandemic situation, it has performed exactly as we thought it would.

All right. Great. That's very helpful. And then just the other question I had. George, I know you said that the RESG portfolio – sorry the RESG loan repayments are likely to increase in the fourth quarter and 2021 could remain elevated as well. Why don't you think that this pandemic has caused more of a change in the behavior of the capital markets or other competitors that are taking out these loans?

There's a lot of capital out there, Ken. The Federal Reserve's very aggressive action in March and April to ensure adequate liquidity in the financial system and to buy up tremendous quantities of investment-grade-rated securities on the short end has created a lot of liquidity in the system and created an environment where people are having to get yield. In many situations, they're having to go out and take on more risk to do that. That's the beauty of our business model. We've created a business model particularly in our RESG group, but elsewhere where we get, and have historically gotten, much better-than-average yields while taking lower-than-average risk than our competitors, which is why for the last two to three decades our net charge-off ratio has been always less than our competitors' and our margins have typically been much higher than our competitors'. As at last comparable data for Q2, I think we were 93 basis points wider than the industry's margin. Our business plan has been very thoughtfully and very carefully designed over the years to let us get better-than-average yields with lower-than-average risk. That current environment is really proving the quality and durability of our business model very well.

All right. Thank you.

Thank you. And our next question comes from the line of Timur Braziler with Wells Fargo.

Hi. Good morning. Thanks for the question.

Good morning.

Maybe just starting on the appraisal commentary, excellent color in the release around updated appraisals. Maybe looking specifically at the five hotel and two office appraisals that were done in the most recent quarter, which geographies are those in? Are those geographies coming back online maybe quicker than New York is? And, I guess, more broadly, can you just talk through the appraisal process? I think last quarter you mentioned that you work with a third-party to get values kind of 12 to 18 months out. How sensitive are those values? And is that a process that's not going to be ongoing on a quarterly basis essentially, as we get updated cash flow information. Thanks.

Brannon, do you want to take that?

Sure, sure. Thanks for the question. As we've said in the past, as it relates to our appraisal process, it continues as it has been. Even before COVID, we were re-underwriting and re-rating every loan in the RESG portfolio at least once annually. If we had material degradation in circumstances, something changed around leasing or delays, we would get an appraisal at that point. With the advent of COVID, there have been numerous negative impacts in markets and property types. The volume of new appraisals this year is up as a result of that, but it's still normal course. The most appraisals that have been conducted, our comments have reflected on, have been in our New York market by property type, probably most in multi-family. The results are going to be mixed, depending on any quarter, where it is and what it is, but the results are pretty similar. Our loan-to-value remains within a pretty tight range. Some are up, some are down, and some of the LTVs are affected by principal pay-downs that we collect in conjunction with loan extensions. Many of these appraisals are coming as a result of loan maturities and extensions.

And Timur, let me add a couple of comments to Brannon's excellent color on that. We're using mainstream appraisal firms that are leaders in the industry all over the country, with a particular focus on their expertise in specific markets or property types. Our lenders have no influence or interaction in the appraisal process. We've created our own separate structure within the company to make sure that we have professional appraiser expertise in-house that is engaging, reviewing, and making sure those appraisals meet our quality standards, as well as all regulatory standards, and we're using top-quality firms. Our loan-to-values are being much closer to in line with previously reported loan-to-values than what might naturally be expected.

Okay. Thank you. That's great color. And then my second question, maybe shifting gears to expenses. You talk about how the new stay-at-home environment is making you adjust your thinking on branch operations, staffing, technology, etc. As we look ahead, what does that do to the expense growth rate?

Greg, do you want to take a shot at that? Obviously, there are a lot of pluses and minuses. We're taking staff out in various places and adding. But Tim or Greg, do you want to talk about our expectations regarding non-interest expense in the aggregate?

Yeah, I can sort of do that. I think that our expense run rate in Q3 is a pretty good indication of where we think that looks like at least in the near-term. We've done a lot of work trying to make our operations more efficient, more effective, and to make sure we've got the right people in the right places doing the right jobs. Our new headquarters came online during the second quarter. We've talked about that. That's a full quarter in the run rate now. I really think that, as we look at our overhead and our thoughts around the next two or three quarters, I think Q3 is a very good starting point for that. I would expect at least based on what I know at this point for Q4 and in the first part of next year to look very similar to what you see in our results here in Q3.

Great. Thank you.

Thank you. And our next question comes from the line of Catherine Mealor with KBW.

Thanks. Good morning.

Good morning.

Good morning, Catherine.

We've talked before about how deferrals are less relevant for you all just given the dynamic of interest reserves. But can you quantify and talk about maybe the level of loan modification that you've seen over the past couple of quarters and ones that have been restructured since the pandemic, and maybe would have been considered a TDR if it weren't for the CARES Act? Thanks.

Catherine, we are very reluctant to ever do TDRs, and we are strongly resistant to that. We have very few loans that qualify as TDRs. If it's going to be a TDR, and the sponsorship borrower can't modify the loan without it being a TDR, we're pretty much inclined to blow that loan up, and move it out. The CARES Act created these extensions of 90 days or six months for deferral of payments that were not by definition TDRs. We were pretty resistant about doing those extensions. If we think a customer has not been affected by the pandemic, then they're not going to qualify for an extension under the CARES Act. If we thought they were impacted, but a 30 or 90 or 180-day extension was not going to be constructive, we just didn't grant the extension and proactively addressed it.

Great, that's really helpful. And do you have the balance of the loans within RESG that you mentioned you did a modification for?

Yes, it's—Catherine, George referred to figure 49. It's actually 10. One of them is expired, so there's nine that are on deferral now.

Sorry, I overstated it.

That's all right. 10 versus nine, that's not too far off. And then maybe one follow-up on just— the credit is so good for you all right now and I guess the main market that we're all worried about is New York. Any anecdotes you can give us on some of your larger projects in that market and what you're seeing there?

Yes. As the bubble charts on pages 28 and 30 show, we have five hotel properties in New York and four office properties in the New York MSA, and those are low leverage loans as reflected on those charts. We expect that our sponsorship is very capable on those properties and they're high-quality properties. New York is probably our most challenged market, it was hit early and hardest by COVID-19. We realize New York is more dependent upon mass transportation than a lot of other markets, but I think New York will recover. Our projects in New York have continued to have sales volume even through the pandemic, continuing to sign contracts.

Great. Helpful. Thank you. Great quarter.

Thank you.

Thank you. And our next question comes from the line of Michael Rose with Raymond James.

Hi, good morning, guys. Thanks for taking my questions. First, I wanted to get an update on the Tahoe property. It looks like the LTV moved below 100% this quarter. It seems like there's been some sales activity. Is there any optimism that that credit could be resolved or come off of non-accrual status?

Michael, that property was on the special mention list until I think January or December 31 last year. We took it from special mention to substandard accrual based on the fact that we had very few lot sales going into the New Year and were concerned. The increase in sales velocities and the improvements in pricing have resulted in the loan-to-value on that as of the end of this last quarter dropping below 100%. It continues to be substandard accrual on our books. If we continue to see the improving conditions and continued demand, we are optimistic about moving it from substandard accrual to special mention and then to a pass over time.

Got it. And just as my follow-up in the management comments, you talk about some of the restructuring in pricing, in terms that you've done in the RV and marine book. Can you give us a little bit more color there?

Our guys have my great respect. They originated a lot of volume last year, and it was good volume. But we just said this isn't as profitable as some of our other lines of business. We've concluded that we can be more focused and predictive of credit quality, and get volume and better spreads while taking equal or lower risk. So we took enough time to really test this and compare the performance of our portfolio. Now, we are ready to reengage. We're looking for better spreads, lower premiums, and maintaining equal or improving credit quality. We think we are going to be producing an even better quality going forward than we were.

I appreciate the color. Thanks for taking my questions.

Thank you.

Thank you. Our next question comes from the line of Stephen Scouten with Piper Sandler.

Hey. Good morning, everyone. George, you referenced your condo exposure in New York City. I'm wondering if you have any numbers around how much of that $3.6 billion in commitments, how much of that is in New York City?

I don't have that data now. But I would tell you that our New York condo exposure is very similar loan-to-value to our condo exposure in other markets.

Okay. Great. Great. And then, just the only other question is really just around loan growth trends. What's changed? And I know the target is to keep it between 10% to 15%. Is the expectation in the change that you do expect these trends to continue in the foreseeable future?

Yes, we hope to use the ample capital. We've got to grow our portfolio and capitalize that on those opportunities. But I will tell you that, yes, we expect payoffs and prepayments to be larger in Q4, and we do think 2021 will be a likely record payoff year. The RESG guys are keenly aware that the payoff treadmill is running full speed again, and they have got to pick up their game without degrading credit quality. We've historically been able to participate in a lot of restructuring and repositioning of assets that other lenders and other sponsors are getting out of. So, I think capitalizing on some of those opportunities is important to us achieving our growth goals. We feel pretty good about the top line that we have at RESG now that we're working on for Q4 and early 2021.

Perfect, perfect. Great. Helpful, George. Glad to see you guys proving out the strong credit quality once again.

Thank you.

Thank you. And our next question comes from the line of Brian Martin with Janney Montgomery.

Hey, good morning. I wanted to follow up on that last question just on the RESG pipeline. Given the pandemic and the conditions that originations have been down each quarter this year, is your expectation, given the refocus there that maybe we can get to an inflection point where you start to see that trend higher?

We're working hard to make that happen, Brian. $1.40 billion is not a terribly bad number, but we would definitely like for that trend to be upward instead of downward. The guys have demonstrated the ability to achieve those goals in the past, and they're working hard. So, I'm absolutely confident in Brannon and Mike Moran, and their leadership.

Got you. Okay. And then you talked about adding some positions recently. Can you give any color on where maybe staffing was beefed up a bit?

There are too numerous changes and adjustments in the company to mention, but from the fourth quarter of 2018 through the third quarter of 2019, I visited every office in the company. We came away with hundreds of recommendations for improvement, and we've been working on them. We've re-staffed and reorganized at our community bank. We've created a whole new synergy and alignment.

Got you. Okay. Thanks for the color. And just last one for me. Was there any change in special mention credits this quarter of note?

Tim, you want to take that?

Yes, Brian. The special mention trend was actually a positive trend quarter-over-quarter, so we had a decent decrease.

Okay. Perfect. Thanks a lot, guys.

Thanks, Brian.

Thank you. And I'm showing no further questions.

All right. Guys, thank you so much. We appreciate you all being on the call today. There are no further questions. So that concludes our call. We look forward to talking with you again in about 90 days. Have a great quarter.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.